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hdfc merger: The merger of the HDFC duo may affect lender profitability and cash flows

NEW DELHI: The rally in the HDFC Gemini on Monday reflected buoyant market sentiment and the thumbs-up investors gave to the proposed merger. Analysts said the merged financial giant will create scale and synergies, noting that the move has also restored some lost shine to the group’s shares.

However, the combined company’s profitability could suffer for some time, they warned. Since many funds also own very large amounts of HDFC and HDFC bank and therefore may require a reduction in their investments.

Abhay Agarwal, Piper Serica’s founder and fund manager, said the merger will be more beneficial for HDFC as it has a less profitable business and can increase its product penetration with HDFC Bank.

“However, the business-related synergies could have been advanced even without the merger. Management’s bet is clear that the company’s increased balance sheet size will allow it to increase its competitiveness and create shareholder value. We see some cost synergies from this merger. However, it is difficult to see how the merger alone will help the combined company increase its market share,” he said.

HDFC Bank has been plagued by the problems of its digital initiatives and many parts of its retail banking are under pressure from fintech companies, he said, adding that HDFC is facing increasing pressure from public sector banks for mortgage business.

“At the same time, it is commendable that management has decided to proactively pursue this merger in order to increase its competitiveness. However, it has work to do. While markets have reacted euphorically to this news, we believe HDFC Bank’s earnings could be downgraded in the short term and the responsibility lies with management to demonstrate the benefits of the merger through operational performance,” he said.

HDFC has about 50 percent of HDFC Bank’s loan book size, and nearly 80 percent of that is home loans, which are like ultra-low yield loans.

“Two things are happening here. First, HDFC now had a spread of about 1 percent in the home loan business, when I add the SLR and CRR charges that are now sitting on this book post-merger, the spreads get even lower. See HDFC has made a lot of profit from real estate sector lending, developer lending, corporate lending and restructured businesses. I don’t think all of this can happen so easily in a banking structure,” said Digant Haria, GreenEdge Wealth.

Haria said the merger could hurt profitability in two ways.

One of them is that the cost of credit or the effective cost of HDFC increases due to the SLR and CRR requirements.

“Second, your book yield is actually going down because you probably won’t be making the kind of real estate loans that you used to make as NBFC or HFC. Either way, the numbers will be pretty subdued for some time. Although HDFC’s overall NIMS was around 3.6 to 3.7 percent, HDFC Bank is above 4 percent. So in all cases it is profit dilution for HDFC Bank,” he said.

Haria believes it will take up to three years to simply integrate, taking all the bonds off the book and replacing them with CASA and term deposits.

“Now we’re talking about adding a very large book to HDFC Bank with a kind of low-yield book. HDFC Bank itself was struggling with its own IT systems and trying to digitize and stuff and now you have this whole merger. I think that this group probably won’t disappoint for a year or two, but might not report the usual 15 percent growth that we’ve come to expect from this group. So that’s my first assessment of this merger,” Haria said.

HDFC Bank will now become a holding company for all major businesses of HDFC group.

“Of course, when these subsidiaries do well, valuations go up. There are so many funds that hold 8-9 percent of HDFC Bank and 8-9 percent of HDFC in their portfolios. What are these people doing? I think that’s going to be another challenge from a cash flow perspective, since you can’t hold 16 percent to 17 percent of the same stock in your portfolio. So I think this will be interesting to watch from a capital flow perspective,” said Sandip Sabharwal,
askandipsabharwal.com called.

“I wouldn’t be surprised if we could see some downside as people will be concerned about the regulatory requirements that will be required for the merger to go ahead in terms of the impact on margins due to the SLR, CRR and etc. requirements and their coming into effect, bank resolutions,” Sabharwal said.

https://economictimes.indiatimes.com/markets/stocks/news/hdfc-duos-merger-may-hit-lenders-profitability-fund-flows/articleshow/90635633.cms hdfc merger: The merger of the HDFC duo may affect lender profitability and cash flows

Adam Bradshaw

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