An underwriter who has been supplying homes for Indians for 45 years has moved in with its 28-year-old banker offspring. HDFC Bank Ltd. and Housing Development Finance Corp. are both well-suited to joining forces. Taking into account increasing pressure on lenders to tie interest rates to benchmarks they have little control over, such as the central bank's repo rate, mortgages are going to become more competitive. Moreover, regulators have been wary of the so-called "too big to fail" monoline financiers, as they lack access to cheap and assured funds from banks since India's mini-Lehman moment in 2018.
In addition to being the world's second-largest transaction through the end of this year, the announcement that HDFC Bank will make an all-stock offer for 100% of parent HDFC caught people's attention due to the sheer size of the deal: The $60 billion deal is the largest in the world so far this year. It is possible that the bulked-up bank could surpass the $200 billion mark in market capitalization, approaching the fourth-largest China Construction Bank Corp.
The balance sheet will top 25 trillion rupees ($340 billion) if no assets are shed during consolidation. That's still a lot for a private-sector bank of relatively recent vintage, given that it has only half the assets of the government-controlled State Bank of India. As India's economy remade itself during the 1990s, HDFC Bank was established. To compare the size of an expanded firm internationally, divide the rupee value of its assets by 22 - the purchasing power parity dollar value. The nation with a $1 trillion bank has a $10 trillion GDP, or $2 trillion in PPP-adjusted GDP, ahead of the $23 trillion economies of the U.S. despite Wells Fargo & Co.'s $2 trillion balance sheet.
According to Sashidhar Jagdishan, HDFC Bank's CEO, the acquisition will not reduce flexibility. The adage goes, “Elephants can dance too." Yet the bank is experiencing a problem with sloth. A ban on digital launches and new credit cards was imposed by the Reserve Bank of India in late 2020 as a result of frequent technology outages. HDFC, the mortgage financier, has seen interest margins fall by 1.5 percentage points and have been shrinking for ten years due to low deposit costs. It nevertheless earns a slightly lower return on assets than its more efficient parent, which earns over 2%. In her capacity as CEO of the expanded organization, Jagdishan must cut costs while upgrading tech. A second challenge is to make the bank more relevant to Gen Z, a generation that expects banking to be as intuitive as food delivery apps.
Does the efficiency of the parents rub off?
Despite earning a lower margin than HDFC Bank, HDFC's older institution sweats its loan assets more efficiently than the offshoot. However, HDFC Bank is not a digital leader. The asset quality it offers, however, has earned it a reputation. Small-ticket home loans are generally considered safe credits for middle-class salaried borrowers, but HDFC Chairman Deepak Parekh, who is stepping down after the merger, is also known for taking lumpy project loans from builders.
The wholesale loans, while juicing up returns on assets, can also be vulnerable to credit shocks, such as the one triggered by the collapse of IL&FS Group in September 2018. In the aftermath of Dewan Housing Finance Corp.'s collapse, RBI appointed the lender's administrator to manage its in-court bankruptcy process. Reliance Capital Ltd., the finance company of former Indian tycoon Anil Ambani, was later seized by the central bank.
It would be beneficial for central banks to have access to central bank liquidity for systemically important lenders. Investors seem to want the same thing. HDFC's historically greater valuation advantage over HDFC Bank has vanished almost completely since the IL&FS crisis.
A Shock That Hasn't Abated
With the collapse of nonbank financier IL&FS Group, the valuation advantage enjoyed by Indian mortgage lender HDFC vanished. Group Group. HDFC's customers make up over half of India's homebuyers. As the ease of comparing and switching rates among banks increases, that dominance will only shrink. The parent company's mortgage as well as wholesale lending can find a stable home with HDFC Bank's low-cost current and savings accounts. Additionally, cross-selling banking products to home-loan seekers will enable Jagdishan to gain a competitive advantage over competitors such as ICICI Bank Ltd.
In the past, any foreign investor coming to India would buy HDFC and HDFC Bank as their first stock purchases. They were known for their good corporate governance and sleek execution. HDFC Bank enjoys greater trust and prestige with investors than any other deposit-taking institution in the world. Those days are behind us. Things are changing in Indian banking. Smartphone-based payments have been revolutionized by a six-year-old public utility called Unified Payments Interface. HDFC Bank and Axis Bank are ready to start their dance, but they have to be careful not only of other banks but also of their fintech competitors who are trying to set the tune both for lenders and borrowers.