Will the HDFC merger live up to its promise?

In a sense, the hesitation about the name was understandable. HDFC, which was then about 16 years into the business, had a sizeable book of ₹2,562 crore and a solid reputation. The top brass was uncertain about how the new bank would perform and wanted to protect the HDFC brand. But CEO-designate Aditya Puri made it clear that nothing other than the name HDFC Bank would work.

Eventually, chairman Deepak Parekh gave in. The rest is history. Today, the subsidiary has eclipsed the parent and is all set to absorb it. On 1 July, private lender HDFC Bank and its mortgage-financier parent HDFC will merge in one of the largest M&A deals of all time in India.

The numbers reveal just how big a deal it is. HDFC Ltd had assets under management of ₹7.2 trillion as on 31 March, up 11% from the previous year. Its gross bad loan ratio stood at 1.18%, down from 1.91% in the fourth quarter of last year. HDFC Bank has a total loan book of ₹16.1 trillion, 17% higher than the previous year. Its gross bad loans were at 1.1% of total loans, down from 1.2% in 2021-22. As for the bottom line, HDFC Ltd recorded a profit of ₹16,239 crore in 2022-23, while HDFC Bank reported a profit of ₹44,110 crore the same year.

“A merger between the two entities has always made sense. We have evaluated it time and again. In fact, back when we got the banking licence, the debate we had was whether to convert HDFC into a bank or to set up a separate entity," said Keki Mistry, chief executive and vice-chairman, HDFC Ltd.

With over four decades of experience at HDFC, Mistry saw the evolution of India’s largest mortgage lender up close. And he will now witness his organization being merged into the bank it spawned three decades ago. Mistry will still have a ringside view of the combined entity, most likely taking a board seat in the bank again after three years, in a non-executive role.

The merged entity, which will significantly widen its lead over private banking rival ICICI Bank on the asset front and come closer to state-owned behemoth State Bank of India, will be led by current HDFC Bank chief Sashidhar Jagdishan. Chairman Parekh will retire.

Interestingly, HDFC Ltd, has not seen any senior-level exits since the merger deal was announced last April, a statistic its management says points to the fact that everyone is happy with the amalgamation.

“People are comfortable with the merger, people are comfortable with the culture," said Mistry, seated in the fifth-floor conference room of HDFC House, a building just a few meters from Ramon House, the mortgage lender’s old headquarters, at Churchgate, Mumbai.

Cross-selling opportunity

The bank sees tremendous opportunities in cross-selling products to existing and new home loan customers of HDFC Ltd, all of whom will now be part of the bank’s book. Under an existing arrangement (pre-merger), HDFC Bank used to source loans for the parent, which would then conduct due diligence and disburse the loan. After retaining some of these loans on its books, the housing lender would transfer some to the bank. It was a mutually beneficial arrangement.

“For mortgages, the bank did not have product, credit and marketing teams specific to that product but acted as a sales agency. Just like an auto dealer sells a product, the bank sells mortgages produced by HDFC," said Srinivasan Vaidyanathan, HDFC Bank’s chief financial officer.

Currently, about a third of HDFC Ltd’s customers bank with HDFC Bank, a space the latter wants to aggressively fill by cross-selling products and services after the merger. The bank has 83 million customers, of which only about 2% have home loans from HDFC Ltd.

HDFC Bank plans to offer a bouquet of other products to home loan customers. For instance, someone taking a home loan would be able to get bundled offers from the bank. “As part of the merger and immediately thereafter, we are trying to bundle loans where we offer mortgages and along with that, a savings account, and a loan to procure white goods, among others," said Vaidyanathan.

Over the years, the bank has observed that customers with mortgages have a bank balance seven to eight times higher than other account holders. Having more such customers on its books would allow HDFC Bank to garner a sizeable chunk of low-cost savings account deposits. Term deposits, on the other hand, have a higher interest payout and can hurt lenders.

As on 31 March, the bank’s total retail loans stood at ₹6.35 trillion, up 19% from the same period last year. Personal loans, a category of unsecured credit, form the largest portion of the retail loan book and stood at ₹1.72 trillion in 2022-23.

The bundled offering will also include insurance products and credit cards to deepen their penetration. Given that the customer is being assessed for a large loan like housing, the bank believes that getting a credit card would not be difficult.

“Mortgages would be at the center of the plate. The bundled products will be light on documentation as the borrower is already providing a host of documents for the home loan," explained Vaidyanathan.

On the effective date of the merger, HDFC’s investments in subsidiaries such as the insurance businesses will belong to the bank. The Reserve Bank of India (RBI) recently permitted the group to increase its stake to over 50% in both HDFC Life Insurance Company and HDFC Ergo General Insurance Company before the merger.

While HDFC Life has six million customers, HDFC Ergo has 15 million. The bank believes that once merged, it will have a closer relationship with the insurance business—it can push penetration into its customer base.

The integration

About 20 integration teams of two-four people have been working behind the scenes to ensure things are ready on day 1. The bank is currently developing and testing various internal processes to allow the consolidated entity to function seamlessly once the integration switch is turned on. These encompass areas such as branches, technology and websites, among others. For instance, on day 1, there will be one consolidated website for customers to navigate various products.

Although the integration is being primarily driven by these internal teams, there is some amount of external involvement in the integration of human resources, one of the trickiest factors in any merger. The bank, however, did not reveal details about the exact nature of the external involvement. HDFC Ltd has 4,017 employees, while HDFC Bank has 173,000 employees.

About 500 of HDFC’s branches will be used as mortgage engagement centres for the bank and will house specialists who have been dealing in such loans in the past. Although these employees will gradually be retrained to sell other banking products, these branches will also be staffed by people from the banking side to assist them.

The borrowing challenge

Even as the bank eyes vertigo-inducing growth, despite the larger book, it needs to match those ambitions with adequate deposits. As far as liabilities go, analysts see HDFC Bank facing a challenge replacing HDFC Ltd’s ₹5.7 trillion borrowings. Of those borrowings, around ₹1.5 trillion are in deposits, while the rest is through wholesale sources such as bonds and loans from banks.

When these dues mature, the merged entity will have to replace them with fresh funds of its own. Although the bank can continue to issue bonds after the merger, it would need to replace the loans HDFC has from other banks since regulatory norms do not allow banks to borrow from each other. The bank is thus aggressively raising deposits to meet this requirement over time.

As part of its strategy to replace HDFC’s dues and prepare for the merger, the bank has also been on a journey to open 1,500 branches every year for the next three-four years and garner more deposits. It has set a target of attracting ₹1 trillion in customer deposits every quarter, an uphill task given the kind of competition for these funds. After failing to meet this ambitious target in the third quarter of the last fiscal year, HDFC Bank added ₹1.5 trillion in the January-March quarter.

“As HDFC’s liabilities mature, we will replace those, as much as possible, with deposits. At the same time, we are not shutting out alternative funding sources like bonds," said Vaidyanathan. He seemed unfazed by the enormity of this challenge, perhaps as a result of the bank surpassing its deposit target comfortably in the March quarter.

Suresh Ganapathy, managing director and head of financial services research at Macquarie Capital, expects “heavy participation" from HDFC Bank in the bond markets over the next 12 months as part of the merger exercise.

Issuance of bonds—especially long-term bonds that are used to fund affordable housing—has benefits in meeting regulatory requirements such as cash reserve ratio (CRR), statutory liquidity ratio (SLR) and priority sector lending (PSL). Under the RBI’s regulations, banks need not account for these bonds in meeting buffer requirements and priority sector targets.

On 15 April, the bank’s board approved raising of up to ₹50,000 crore perpetual debt instruments, tier II bonds and long-term bonds for financing of infrastructure and affordable housing over 12 months through private placement.

HDFC Ltd has been able to iron out some regulatory issues that could have affected its performance after the merger. On 20 April, the RBI allowed the bank to achieve compliance on some of these in a staggered manner. For instance, the bank has three years to meet the priority sector lending norms that mandate lenders to make 40% of the total loans to weaker sections of the society. Since the merger would add over ₹7 trillion of loans to the merged entity, the priority sector requirement would surge overnight.

A powerful voice

Interestingly, the group has had the ear of regulators and governments in the past, which sometimes lead to tweaks in laws and regulations. Although HDFC was among the first to get an in-principle banking licence in 1994, the final licence came a year later. In the interim, it was able to convince the government to amend the Banking Regulation Act to increase shareholder voting rights to 10% from 1% earlier. The RBI ‘listened’ because HDFC created India’s mortgage industry—for the first time, aspiring middle-class Indians could own an apartment in a city like Mumbai.

The bank also got its way in another matter. Back then, the RBI wanted new banks to be headquartered in different Indian cities (to avoid concentration in metropolitan cities and overbanked areas). Mumbai already had public sector banks. ICICI Bank, therefore, had to be headquartered out of Vadodara. Nevertheless, HDFC convinced the RBI to make an exception, saying that it had to be headquartered in Mumbai because of its ambitions to use technology and be close to corporate clients.

In retrospect, being close to corporate clients worked—over time, it grew into a systemically important bank. And while Deepak Parekh may have been reluctant at first to let his new bank use the HDFC name, today, as he gets ready to retire, he will be pleased that Aditya Puri convinced him otherwise. The child is now ready to absorb the parent, making India’s biggest private bank even bigger.