Who'd stand to gain from HDFC-HDFC Bank merger?

Analysts say HDFC Bank should not bear the cost of merger

Ever since the Reserve Bank of India (RBI) relaxed reserve requirements and norms for infrastructure lending, the market has been abuzz with talk of a merger between HDFC Bank and HDFC. Analysts believe RBI is pushing a for change in the financial sector, by incentivising infrastructure loans. A section of the market has increased the target prices of both HDFC and HDFC Bank scrips by 10 per cent on the possibility of a merger.

Brokerages Ambit and Citi believe the change in regulation could drive a merger in the future. However, both are divided on the benefits and what shareholders should watch for.

By exempting banks from reserve requirements and priority-sector lending pressure while financing infra projects and affordable housing, RBI has paved the way for a possible merger. Citi Research does not expect a merger announcement soon, but believes both entities should react positively. It  has raised the target prices of both by 10 per cent. Apart from a strong brand synergy, a merger would improve the capital efficiency of the new entity.

Also, HDFC Bank has stayed away from long-term project financing due to the risks. However, with RBI doing away with the reserve requirements for infrastructure and housing bonds, lenders such as HDFC Bank would have greater comfort to enter this segment. Other analysts are questioning the current valuation of HDFC’s housing loan business and the costs associated with a possible merger. Ambit believes the cost of such a merger would offset any benefit, as the cost would have to be borne by one or both sets of shareholders. The brokerage believes ideally, HDFC should bear the cost of the merger but in reality, HDFC Bank’s shareholders could end up sharing the cost by paying more than what the HDFC's lending business fundamentally deserves. Hence, Ambit is recommending investors to sell both.

The cost of a merger would stem from the fact that HDFC’s lending business should comply with banking regulations and HDFC would need to maintain reserve requirements, which could lead to a cost of Rs 400 crore. Also, a priority-sector requirement could lead to a cost of Rs 290 crore. Moving to a base rate regime might lead to weakening of HDFC's competitive positioning in the home loan market. Ambit says HDFC Bank’s shareholders should oppose the merger, unless the valuation given to HDFC's lending business is at a 20-40 per cent discount to current valuations. HDFC shareholders should support at current valuations, as it is the best they could get.