HDFC Ltd to merge into HDFC Bank and what it means?

In one of the most significant developments in the financial sector in a long time, HDFC Ltd announced its merger into HDFC Bank. It would be a reverse merger of sorts since HDFC Ltd is the holding company that holds a 21% stake in HDFC Bank. Post the merger, HDFC Ltd will cease to exist and shareholders of HDFC Ltd would become shareholders of HDFC Bank Ltd. As much as the merger sounds like a win-win situation for both the parties, there is likely to be many a slip between the cup and the lip. That possibly explains why the price of both the stocks corrected after the initial euphoria.

What you must know about the HDFC Bank — HDFC Ltd merger

Here are some basic contours on which the merger between HDFC Ltd and HDFC Bank is based.

a) The deal will be a complete stock swap deal. As per the exchange ratio approved by the boards of HDFC Bank and HDFC Ltd, shareholders of HDFC Ltd on the record date will get 42 shares of HDFC Bank for every 25 shares of HDFC Ltd held by them. Consequently, post-merger, HDFC Ltd shareholders will own 41% in HDFC Bank. The deal is subject to shareholder approval.

b) After the merger, HDFC Ltd will cease to exist as a separate listed entity and would be subsumed into HDFC Bank via stock swap in the ratio mentioned above. After the deal, there will be no promoter group for HDFC Bank and it will become a 100% public shareholder company. HDFC stake in HDFC Bank would be fully extinguished.

c) The subsidiaries and associates of HDFC will shift to HDFC Bank and these will include the life insurance, the general insurance, the mutual funds and the securities business of HDFC Ltd. There could be issues over a systemically important bank holding two large insurance companies, but we will come back to this point later.

d) All the branches and employees of HDFC Ltd will be absorbed into HDFC Bank, although rationalization at a later date cannot be ruled out. Since the portfolio of HDFC Ltd is predominantly of secured mortgage loans, this merger will help reduce the share of unsecured loans in the books of HDFC Bank.

e) In terms of immediate gains, HDFC Ltd has been, for long, plagued by the holding company discount. Now that will go away and enable better value creation for the group. HDFC Bank customers will be offered mortgages as a core product in a seamless manner. HDFC Bank will also own the customer life cycle in a more comprehensive way.

What triggered this merger at this juncture?

The idea of HDFC merging with HDFC Bank is nothing new. Deepak Parekh had suggested this back in 2015, but the idea had been put off since the regulatory environment for such a deal was not conducive then. A lot has change and now the merger has been triggered by a combination of 3 factors.

The idea of the merger was always there. It is just that the timing was ripe now.

Are there downside risks to the merger?

Like in any merger, there is likely to be a clash of capital, methodology and cultures. The good thing is that both are part of the same group, so the cultural gaps should be lesser. However, there are some other distinct risks to the deal.

There is no gainsaying the fact that consolidation is the road ahead in the financial sector. However, for a behemoth like HDFC group, this exercise will not be that simple. How the integration is handled over the next 18 months will be the litmus test.