Why should you buy HDFC Ltd shares?

Is the elephant dance the popular question going around the HDFC – HDFC Bank merger. Elephants have the characteristic of being protective, with one foot always on the ground. They are alert and despite their size, they run fast. After the merger, the combined entity will presumably be able to take on these elephant qualities, if not be known for dancing. At Rs 18 lakh crore of loan portfolio, HDFC Bank can remain a must-have in the portfolio. But before the merger, here are four critical boxes to check.

Shareholder strategy

HDFC Ltd and HDFC Bank shares enjoy huge popularity among all categories including retail investors. After the merger, the weighting of HDFC Bank shares in Nifty is expected to drop from 8.43% to 14%. So first check on a combined basis what is the weight of HDFC Bank stock in your portfolio. If the weight is too high, you run the risk of putting all the eggs in one basket. If not, you might be inclined to increase exposure after the merger announcement. In this case, investors might consider buying shares of HDFC Ltd, as it offers better upside potential compared to shares of the bank on a consolidated basis (see table).

What if you already own HDFC Bank shares? Then it might be a good idea to use the fusion advantage. Exit your position in HDFC Bank and buy shares of HDFC Ltd. If you own both shares but there is room to increase the holdings, buy shares of HDFC Ltd. As for the shares of the bank, you can continue to hold them. But if you are inclined to take a tactical call, selling shares of HDFC Bank and increasing the position in HDFC Ltd is an option. Please note that this is an illustrative recommendation. Consider tax liability and incidental costs when making your decision.

In addition, both stocks are widely held by domestic and foreign institutional investors who are bound by the 10% cap on the weighting of individual stocks in their portfolio. Therefore, before the merger, fund companies could reduce their holdings, which could keep stocks under pressure. This rebalancing has started to happen and is part of why the two stocks pared most of the April 4th one-day gains during the week.

Also note that HDFC Limited has always offered a higher dividend than the bank. HDFC Bank’s average dividend yield since FY2016 is around 1%. It is more than four percent for HDFC Limited during this period, because until the financial year 2019, it paid a dividend twice a year. Prepare for a reset of dividend payments.

who earns more

At first glance, the merger appears to be a win-win.

HDFC Limited is getting wider access to banking products which would help build customer loyalty. For HDFC Bank, the share of housing loans will increase from 11% to 33% of its total loan portfolio. With that, a major criticism of its retail portfolio biased towards unsecured lending will be addressed. But there are equal measures of pain.

A much older housing finance business is becoming part of the bank and HDFC Limited’s operational autonomy may be reduced or eliminated to conform to the bank’s style of operation. HDFC Limited’s interest rate is higher than the industry floor rates of 6.45-6.5%. Even if the rate cycle reverses by the time the merger closes, HDFC may not have a free hand in loan pricing if it were to remain competitive in the market. Similarly, the stickiness of HDFC Limited’s Rs 1,50,131 crore deposits (in FY21) will be tested when it is integrated with the bank which would offer much lower rates on its deposits.

For HDFC Bank, which holds a record of maintaining its net interest margin (NIM) at 4% or more since 2014, the direct implication on profitability is inevitable. Home loans carry NIM by 3.6 percent and as a result asset rebalancing will weigh on HDFC Bank’s profitability.

Therefore, there is gain and pain for both in merging. On the one hand, HDFC Limited will give up its crown of jewels built over the years, while HDFC Bank will give up its profitability, which has been its USP.

Regulatory entanglements

If HDFC Bank’s loan portfolio increases to ₹18 lakh crore from ₹12.7 lakh crore (as in Q3 FY22), Priority Sector Loan (PSL) requirements will also increase. In the first years following the merger, the bank could tap into PSL bonds to consolidate this portfolio. This could impact the bank’s cost of holding funds by 2% per year. There are also statutory reserves – cash reserve ratio and statutory liquidity reserve ratios to be maintained, the burden of which can be ₹70,000-90,000 crore. All in all, a compression of HDFC Bank’s NIM by 100 to 125 basis points seems likely.

Then there is the tricky question regarding RBI’s comfort in allowing the bank to operate non-bank subsidiaries. The regulator’s position on this aspect has been very subjective. While ICICI Bank is to reduce its stakes in its insurance branches to 30%, Axis Bank did not get the green light to hold a 30% stake in Max Life Insurance. He was only allowed to own 10 percent. RBI’s comfort with HDFC Bank holding 50% or more of the shares in the insurance (life and general) and NBFC businesses after the merger is unclear. If the stakes were to be separated as a condition of the merger, it would put pressure on the shares of HDFC Life and HDFC AMC. But if HDFC Bank were to reduce its stake after the merger, it could be a blessing in disguise.

In fiscal years 2017 to 2019, while ICICI Bank and SBI did not raise capital despite the need arising due to pressures on asset quality, IPOs/selling of stakes in subsidiaries have helped. Similarly, subsidiaries may be beneficial rather than a burden to HDFC Bank, although the holding company’s equity discount may increase from the current level of 5%.

What to expect

In the Big Story of Portfolio edition dated March 20, we told you how HDFC Group companies, including banks and housing finance branches, are poised for a slower pace of growth. One of the contributing factors was that the size of books became larger than before. With the merger expected to close by FY24, the merged bank could have an asset size of ₹20 lakh crore (assuming CAGR growth of 6-8 cents in FY23 -24), which places it second after SBI in terms of balance sheet. Its loan portfolio is said to represent around 8.5% of India’s estimated GDP. The banking sector plays a role in the economy of the country. Therefore, a global economic downturn will not spare HDFC Bank.

Additionally, HDFC Bank along with SBI and ICICI Bank are classified as “too big to fail” banks. With this tag, comes greater regulatory oversight. Until now, HDFC’s home loans, education loans and investments held under HDFC Limited were not subject to close scrutiny. This will change.

But the good part is problems in a segment – ​​for example, agricultural, auto or SME loans may not have an overly impact on the overall portfolio due to the diversity of the loan portfolio. Expect loan growth and asset quality to be at a steady pace. After the merger, investors should treat HDFC Bank shares as safe havens. Expect steady returns, mimicking the Nifty or Sensex. After all, it’s a rate show to see the dancing elephants!

Published on

April 09, 2022