IGI Logo

Regulatory drag to hurt near-term RoEs; deal structure hinges on RBI approval

The key takeaways and our views post meeting with HDFC Bank to understand their plan to reduce regulatory cost drag from the proposed merger:

* Merger to meet regulatory ask, remain competitive; regulatory approval on deal structure could be a hurdle: HDFCL management has been vocal that the regulator has clearly indicated that large NBFCs/HFCs need to either operate with bank-like rules or convert into a bank, while housing business at a scale is best done now under a bank given their cost advantage (see Exhibit 11) and potential cross-selling benefits. That said, HDFCL shareholders’ may be apprehensive about selling housing/other businesses at valuations inclusive of holdco discount. For HDFCB, the merger of the housing portfolio could be RoE dilutive in the near term due to regulatory costs, but brings scale, security and higher portfolio tenure with better long-term RoEs, factoring in crossselling/leverage benefits. We believe the RBI may have reservations in approving the proposed merger deal structure with non-lending businesses (mainly insurance with current stakes >30%) under the bank, as it will challenge its longstanding stance to ring-fence banks and avoid regulatory overlap. Allowing NBFCs HDB Fin/HDFC Credila as subsidiaries under a bank could also be difficult given the RBI’s insistence to undertake lending business primarily under the bank.

* CRR, SLR drag manageable, but PSL build-up and eventual liability replacement could be challenging: We believe the merged entity will be largely complied on CRR in FY24, while additional requirement in FY25E will be minimal at Rs217bn (assuming 6% CRR maintenance). On the SLR front, the additional requirement for FY24/25E on expanded B/S (adjusted for higher SLR on HDFCB’s B/S) will be ~Rs1.7trn, which looks manageable, and, in fact, could lead to a positive impact given rising G-sec yields. However, the additional PSL requirement of ~Rs2.1trn in FY25 (on expanded ANBC) remains a key regulatory drag. Overall, factoring in the regulatory requirements (CRR+SLR+PSL) and assuming 20% of high-cost HDFCL borrowing are replaced, our workings suggest that the bank will have to mobilize deposits to the tune of Rs5.5trn over FY24-25E, which need to be met through a combination of growing vintage of branches and accelerated growth via some rate tinkering. However, the deposit ask can be reduced by slowing down HDFCL growth, increasing affordable housing/PSL compliant loan growth, phased grandfathering of HDFCL’s bank borrowings, and even raising relatively cheap overseas bonds. Based on our assumptions, the RoE for the merged entity works out to 15.9%/16.5% in FY24/25E vs. standalone bank RoE of ~17.1%/17.4% and would potentially converge by FY26E.

* HDFCB exuberates confidence of healthy credit growth trajectory even after merger: HDFCB has allayed concerns on growth on the large B/S post-merger, as it believes that the bank + HDFCL - on a combined basis - have grown at a healthy pace (~18-20%) in the past (pre-Covid) and could see continued momentum with better opportunities to grow the housing portfolio as then most branches will be able to offer housing loans based on the bank’s template. The bank would also not shy away from continuing developer loans, if it fits its risk-return profile. The bank believes that 18-20% credit growth after merger in a BAU scenario looks sustainable, subject to macro support. It claims that globally larger banks have also grown at a healthy pace, and thus size should not be a constraint for growth, particularly in India amid gross credit under-penetration.

* We reduce TP but maintain Buy as valuations remain comfortable; top-picks are ICICI, SBI: Based on the Gordon growth model for the merged entity and factoring in a slightly higher CoE, we work out fair value at 2.7x FY24E ABV for the merged bank (10% discount to FV basis merger overhang), or implied 3.0x ABV of standalone bank (pre-merger) vs. earlier 3.2x ABV of standalone bank. Add to that the subsidiaries’ valuation of Rs172/share for the merged bank (Rs78 for standalone bank pre-merger), we arrive at a TP of Rs1800 (Rs1,950 earlier). The stock has seen a sharp correction due to sub-par core profitability performance, which in turn was driven by lower margins/fees and merger overhang, thereby trading at near-trough valuations (trading at 2.1x FY24 standalone ABV/1.9x merged ABV). Given the reasonable upside to our TP, we retain Buy on HDFC Bank. That said, ICICI Bank has been consistently delivering healthy operating performance and could be an early entrant after HDFCB into the 17% RoE club among large banks, hopefully without any disruption, and thus remains our top pick in the banking space. Among PSBs, SBI could also be an entrant into the 17% RoE club by FY25E, without factoring in any capital raise, and it remains our second top pick after ICICI.

To Read Complete Report & Disclaimer Click Here

For More  Emkay Global Financial Services Ltd Disclaimer http://www.emkayglobal.com/Uploads/disclaimer.pdf & SEBI Registration number is INH000000354

Above views are of the author and not of the website kindly read disclaimer