HDFC Bank-HDFC Merger: There's No Time Like The Present

For years, the managements of HDFC Bank Ltd. and HDFC Ltd. were asked one question—when will the two entities merge? When the time is right, was often the response.

The time, it seems, is now right.

On Monday, the two announced their intent to merge into an entity with a balance sheet of nearly Rs 18 lakh crore. Once merged, HDFC Bank will offer a full suite of banking and financial sector products under one roof, strengthening its lead among private banks.

Incorporated in 1994, HDFC Bank was born to HDFC, which had come into being much earlier in 1977. When Indian banking opened up to the private sector, HDFC was an obvious candidate to promote a bank and it did. Over the years, HDFC Bank rode India's economic liberalisation with skill and caution, and became larger than the parent. And now, as HDFC Chairman Deepak Parekh put it: "the son has grown up and taken over the father's business."

Regulation + Regime Change = No Time Like The Present

The merger was in many ways inevitable. It was always a question of when and not if. What held the merger back over all these years was a combination of regulation and personality.

In the end both came together, allowing for the long-rumoured deal to be signed.

On the regulatory front, two aspects played a role.

For long, housing finance companies, which until recently were under the purview of the National Housing Bank, had easier prudential norms to comply with. Most notably, bad-loan recognition were less stringent. Then came the collapse of Dewan Housing Finance Corp. and mishaps in other mortgage lenders such as Reliance Housing Finance Ltd. This prompted the Reserve Bank of India to take greater control of HFCs.

What has followed since is a harmonisation of prudential rules that apply to banks, large NBFCs and HFCs. In short, the regulatory arbitrage has narrowed considerably.

A second regulatory issue was that a merged entity would have to make sizable provisions to meet the cash reserve ratio, statutory liquidity ratio requirement and priority sector lending norms which applied to banks. Given the substantial size of the HDFC book, this was always onerous. This remains the case, but the cost of capital is lower with interest rates at their lowest in decades. Besides, both entities are sitting on a fairly large stock of liquid assets.

But it was likely more than just regulatory change that prompted the timing of the merger. Personalities had a large part to play in it as well.

Since incorporation, HDFC Bank was led by Chief Executive Aditya Puri, who led the bank to become the success it now is. Urban legend has it that Puri was never in favour of the merger, since it would take up too much time and bandwidth of the bank. The bank always had more to focus on— staying on top.

HDFC was run by equally strong personalities. Deepak Parekh, the long-time chairman, and Keki Mistry, who over the years had become the face of the housing financier.

In a merged entity, who will call the shots was always a subject of water-cooler chatter.

Now it doesn't matter.

Puri has retired. Parekh, above 75, can't be on the board of a bank and Mistry is a few years away from turning 70. By the time the merger is concluded in 12-18 months, Mistry will have little time to hold an executive position at the bank, which, according to him, he doesn't want in any case.

With Parekh and Mistry getting on in age, the question of succession had also started to crop up. As Parekh put it: "After 45 years of housing finance and 9 million homes provided to Indians, we had to find a home for ourselves. We have found it within our own family and in our own bank."

Sashidhar Jagdishan, in his 50s and less than a year into the job of HDFC Bank's CEO, would be seen as well placed to take on the task to merge and lead the merged entity. A veteran of the bank, Jagdishan would be well aware of the complexities and sensitivities of the merger. There will be challenges along the way but Jagdishan, potentially, has a long runway to ensure that the combined entity remains best in class.

It Still Won't Be Easy

By no stretch of imagination will the task be easy.

Macquarie estimates that an additional Rs 70,000-80,000 crore will be needed to meet SLR and CRR needs. The two companies have sought time of two-three years to meet the requirements on the legacy book, Mistry said at the press briefing. However, the regulator, which did not permit similar relief at the time when IDFC Ltd. became a bank may not be easily convinced.

The requirement to add on priority sector loans will also be large, estimated by Macquarie at Rs 90,000 crore, although this can be met through subscription of priority sector lending certificates.

There is a large cross-sell opportunity, yes. As Mistry said, 70% of HDFC's customers don't bank with HDFC Bank. Also, with peer lenders like ICICI Bank Ltd. growing their mortgage book aggressively, HDFC Bank will eventually get the opportunity to do the same.

But margins will compress and growth rates will vary. The excel sheet formula of 20% growth at 4-4.5% margin, that HDFC Bank had come to be known for, will undergo a change.

Before that, there will be a plethora of regulatory approvals to get through. Branches to be merged. Staff to be reallocated. Insurance, asset management and NBFC subsidiaries to be fitted in to the new structure.

All this will take up considerable management bandwidth, even though Jagdishan said it would be seamless and a "lift and move" merger. This, at a time when HDFC Bank has barely managed to shed the overhang of a technology upgrade and governance problems that had emerged in the last couple of years.

Much of this heavy lifting will have to be done by Jagdishan. But, as he put it, "the elephant can dance".

Ira Dugal is Executive Editor at BloombergQuint.