Rationale for the deal:
- Changes in the regulatory environment
- Regulatory changes for NBFCs imply the deal makes more sense now
- In 2020, RBI introduced regulations pertaining to the conversion of large NBFCs with asset size greater than Rs 500bn to banks.
- Regulations pertaining to semi-urban and rural branches have addressed bottnecks in this regard.
- Allowance of only one entity of a group to operate in a given business line.
- Harmonisation of asset quality rules for NBFCs with banks.
- LCR guidelines for NBFCs.
- Requirement of core financial platform for NBFCs.
- Scale-based regulations for NBFCs could further harmonise rules for NBFCs with those for banks.
- Other incremental aspects pertaining to regulation also imply the deal makes more sense now
- CRR SLR requirement
- The combined CRR and SLR requirement of 22% for banks is less onerous now.
- Also, HDFC Limited has Rs 800bn worth non-convertible bonds which, due to affordable housing status, would not attract CRR CLR requirement.
- Also, due to a lower interest rate environment, the negative carry due to raising funds for CRR SLR requirement is lower today than it was before.
- PSL requirement
- A deep PSL certificates market makes it more straightforward for the combined entity to meet the increased PSL requirement due to bringing the HDFC Limited loan book on board.
- CRR SLR requirement
- Broad regulatory environment has improved for real estate lending by banks
- Both RERA and IBC has created an improved environment for real estate lending by banks.
- Regulatory changes for NBFCs imply the deal makes more sense now
- Access to low-cost funding franchise
- HDFC Limited’s business, sitting inside the combined entity, will now have access to HDFC Bank’s low-cost funding franchise.
- HDFC Limited’s expertise
- The combined entity will benefit from HDFC Limited’s expertise in conducting specific lending businesses, which it has been executing with low cost to income ratio.
- Cross-sell opportunities and other synergies
- About 70% of HDFC Limited customers do not bank with HDFC Bank, indicating significant opportunity.
- About 80% of HDFC Bank customers do not have mortgages, indicating low penetration.
- The friction that exists currently between sanction and disbursal will go away.
- There would also be opportunities to sell life insurance and non-life insurance products.
- There would be other synergies for the combined entity.
- HDFC Limited’s capital adequacy and RoE
- Any amount invested by HDFC Limited into HDFC Bank is reduced from Tier 1 capital, which has a negative impact on HDFC Limited RoE.
- Any future infusion of capital by HDFC Limited into HDFC Bank to maintain stake would have resulted in a drag on HDFC Limited RoE.
- Holding company discount
- The deal would do away with holding company discount applied on HDFC Limited’s investments.
- Larger balance sheet
- The combined entity would have a larger balance sheet and would be able to make larger ticket loans including in the infrastructure space.
Key contours of the deal
- Share swap ratio
- Shareholders of HDFC Limited would get 42 shares of HDFC Bank for every 25 shares of HDFC Limited held by them, as on record date.
- HDFC Limited’s current stake in HDFC Bank
- The current shareholding of HDFC Limited in HDFC Bank of ~21% would be fully extinguished.
- This is treasury stock that will be extinguished against the equity shares.
- FII headroom
- Since the shareholding of HDFC Limited is regarded as an FII investment, the extinguishing would lead to opening up of ~7-8% headroom for FII investors into HDFC Bank.
- EPS accretive
- The extinguishing of shares would also mean that the deal would be EPS accretive for the first year itself.
- Subsidiaries of HDFC Limited
- Post-completion of deal, all subsidiaries and associate companies of HDFC Limited would be held by the bank.
- HDFC Bank has requested to the regulator to be allowed to hold the stakes in the various subsidiaries, including the insurance entities.
- If the regulator so desires, the combined entity remains open to an NoFHC structure to hold the insurance subsidiaries.
- Shareholding in combined entity
- Post the deal, HDFC Limited’s shareholders would hold 41% stake in the combined entity.
- HDFC Holdings and HDFC Investments
- HDFC Holdings and HDFC Investments would merged into HDFC Limited.
- Human resources
- The jobs of HDFC Limited employees will remain protected.
- Deal closing
- The closing of the deal is expected in 18 months.
Operational aspects
- Till effective date
- The two entities will operated as is till the effective date, while paying heed to regulatory requirements post deal.
- Branches
- The HDFC Limited branches will be retained but, at some point in the future, they could be converted to full-service bank branches.
- CRR SLR requirement
- The bank has been carrying high quality liquid assets well in excess of regulatory requirement.
- This will incrementally aid the meeting of incremental CRR SLR requirement.
- Excess liquidity will start to build up further from here in order to build up CRR SLR.
- Operating expenses
- The bank has a large appetite to grow distribution and will start to grow it faster this year (FY23).
- This could lead to the deterioration of opex ratios for some time but the ratios would improve over the medium to long-term.
- PSL requirement
- There will be multiple avenues to meet PSL requirement including PSLC.
- The bank has also been ramping up MSME lending, which will help.
- Tech integration
- The tech integration will not be as onerous as it is with other transactions.
- The scalability of the home loan business will be examined for the existing architecture and a call will be taken regarding whether to continue with the same.
- Construction finance
- While the bank does not have expertise in construction finance, it plans to conduct this business as it will help the mortgage business.
- The bank is compliant with regulations in this regard.
Leadership aspects
- The CEO of the bank will continue to be the CEO of the combined entity.
- Keki Mistry will be 69 years by the time approvals come in and the age limit of 70 years will make it infeasible for him to be considered as CEO of the bank.
- Current HDFC Limited senior management will occupy senior positions within the combined entity.
Other key aspects
- HDB Financial
- Regulatory clarity is awaited in this regard.
- Insurance open architecture
- The combined entity intends to continue with open architecture.
- Capital adequacy
- CET1 ratio of the combined entity would improve as HDFC Limited has a capital adequacy ratio 22% after reducing the investments made by HDFC Limited in the bank.