Will HDFC Bank-HDFC, Axis-Citi, Bandhan-IDFC deals trigger banking consolidation?

In 1969, when the then prime minister Indira Gandhi nationalised all the country’s private sector banks, no one would have imagined a day when an Indian lender would be valued among the top 10 in the world. 

But that is exactly what would happen, in all likelihood, when the HDFC twins—Housing Development Finance Corp (HDFC) Ltd and HDFC Bank Ltd—complete their $60 billion merger. The merger would eventually create a bank with a market capitalisation of $200 billion, rivalling China Construction Bank Corp, the fourth-largest lender in the world by valuation. 

Although at Rs 25 trillion ($340 billion), the combined asset size of the merged HDFC Bank will be half that of the government owned State Bank of India (SBI), this is still a mammoth achievement for a bank that began life less than three decades back. 

HDFC, one of India’s first dedicated home loan lenders, was founded 45 years ago. It remains the country’s preeminent underwriter of housing loans, whose market opened up in the wake of the economic liberalisation of 1991 that made it possible for millions of middle-class families to afford quality housing.

Around 28 years back, its offspring, HDFC Bank, came into existence just as the Indian economy began taking off and the country broke out of the shackles of three decades of the so-called ‘Hindu rate of growth’ where the country’s gross domestic product grew by just around 3.5% every year while the per capita income went up by a mere 1.3%. 

On paper, the merger—essentially an all-stock deal that will see the bank acquiring its parent—makes sense. As part of the deal, shareholders of HDFC Ltd will receive 42 shares of the bank for 25 shares held. Existing shareholders of HDFC Ltd will own 41% of HDFC Bank, which will be 100% owned by pubic shareholders.

Following the deal, home mortgages, across the board, could become more competitive as lenders come under pressure to peg interest rates to benchmarks not in their control, such as the central bank’s repo rate. Moreover, as a Bloomberg news report notes, since India’s 2018 NBFC crisis, regulators have frowned upon too-big-to-fail non-bank financiers lacking access to cheap and assured liquidity.

In fact, what the merger would effectively do is to make it cheaper for the country’s biggest mortgage lender—HDFC—to access the cheap money that the country’s biggest private-sector bank raises from its depositors. 

Moreover, the merger also makes sense for the HDFC group as the current interest rate cycle should make it easier for HDFC to adhere to the central bank’s liquidity norms, while the bank can more easily write bigger loan cheques. HDFC Bank has more than 6.8 crore customers, while more than half of India’s homebuyers borrow from its parent. 

On top of that, the streamlining of the rules for reporting and delinquency provisions for banks and non-banking finance companies has brought the costs of such a merger down.    

Further, the merger comes after the country’s bad loan mess has been substantially cleaned up thanks to a new bankruptcy and insolvency mechanism that has released a substantial portion of the capital that was stuck with debt-laden companies. 

And this is why, analysts feel the Indian banking system could go into a phase of consolidation. But, as a recent Forbes India report points out, the consolidation will primarily be need-driven and neither widespread nor consistent.

In fact, the HDFC deal is not the only recent development in India’s banking sector that has led to people wondering whether the country’s lenders are in for a phase of consolidation. 

Check out: HDFC Bank Q4: Net profit climbs 23% and 10 other key takeaways

Axis Bank-Citi

Recently, another major private lender, Axis Bank acquired the Indian retail operations of Citibank, which has left the country, in a $1.6 billion deal. As per the deal, Axis Bank will pay Rs 12,300 crore in cash, which values the deal at 19 times 2020 adjusted profit after tax of Rs 840 crore for Citi’s consumer finance business. Axis Bank will pay another Rs 1,500 crore as integration cost spread over two years from the date of closing of transaction.

At this valuation, analysts at brokerage firm CLSA feel that the deal, which covers loans, credit cards, wealth management and retail banking, will be 8-9% book dilutive, but 150 basis points return on equity (RoE) accretive. CLSA feels that for Axis Bank, Citibank India’s retail business will be an attractive proposition and that customer retention will be key to its success. It does, however, feel that the deal has been inked at a fair valuation and that there could be an upside to Axis’ share price with a target of Rs 1,080 per share, which is a significant mark up on its current price of Rs 792. 

Edelweiss said the deal will not only add to Axis Bank’s retail lending profit, but will also give it access to a valuable deposit franchise with better-than-expected CASA of 81%—salient since Axis has been lagging large banks on CASA. The valuation, it said, is attractive at 0.3 times market cap to CASA—a steal compared with over 1 time for other banks. Besides, there is a clawback clause if attrition in the portfolio is higher than the threshold, it said.

“In addition to the deal being positive, we expect Q4FY22 earnings to serve as a re-rating trigger. And we expect 7% quarter on quarter loan growth and lower cost/asset ratio for the quarter. Valuation is undemanding at 1.6x P/BV FY24E,” Edelweiss said while suggesting a target of Rs 1,000 on the stock.

Factoring in the bank's estimated RoE of 21.7% and the net worth of Rs 390 crore, the implied price-to-book value (P/BV) at 4.1 times is not too high for a readily available profitable retail business with Return on Assets (RoA) of 1.6%, Emkay said.

“That said, Axis will have to deliver on business retention/upscaling and drive cost/revenue synergies after the acquisition, leading to better RoAs and, thus, justifying high valuations paid for the acquisition,” Emkay said while suggesting a target of Rs 1,020 on the stock.

Other brokerages, though, have set lower targets for the Axis stock. JPMorgan expects EPS dilution of about 4-7% in FY24 but said the longer-term benefits of the deal are positive. CET1 (common equity tier 1) post the transaction will fall to 13%, it said while suggesting a target of Rs 770 on the stock. 

Macquarie said Axis Bank trades at 1.8 times FY23 price-to-book value and that it is neutral on the stock with a target of Rs 790.

Bandhan-IDFC

There is also the Bandhan-IDFC deal as part of which a consortium of Bandhan Bank’s parent Bandhan Financial Holdings Ltd (BFHL), private equity firm ChrysCapital and Singapore’s sovereign fund GIC will acquire IDFC Asset Management Co. Ltd for Rs 4,500 crore. This is the biggest buyout yet in India’s Rs 38 trillion asset management industry. 

IDFC AMC, the ninth-largest mutual fund in the country, had assets under management (AUM) of Rs 1.15 trillion as of 31 March. Accordingly, the deal valued IDFC AMC at 3.9% of its latest AUM.

Though not a banking merger yet, the transaction aids IDFC’s plan to exit non-core businesses and reverse-merge with IDFC Bank Ltd. It also helps Bandhan Financial make an entry into India’s fast-growing mutual fund industry.  

“This transaction is a significant milestone in our plan of unlocking value, and the consideration demonstrates the strong position of IDFC AMC in the Indian mutual fund space. We have achieved signing within six months of the board’s decision to divest, which further demonstrates IDFC board’s commitment to consummate the merger of IDFC Ltd and IDFC Financial Holding Co. with IDFC First Bank,” Anil Singhvi, chairman of IDFC said. 

Fintech threat

While a phase of consolidation may be on the cards, the Indian banking industry itself may have to evolve its business model. It faces an existential threat from payment systems like the government-promoted Unified Payments Interface (UPI), payment wallets and other fintechs that have made online money transfer seamless. 

Data shows that UPI transactions 2021-22 crossed the $1 trillion mark. As on March 29, the value of UPI transactions for the year added up to Rs 83.45 trillion, with the number of transactions at 45.6 billion.

The usage of UPI as a payment channel has grown exponentially over the last few years, and is set to increase further as payments for feature phone users gets enabled. In a recent report, analysts at HDFC Securities said that mobile payments continue to gain incremental market share at a furious pace, constituting 52% of retail digital merchant payments during the first 11 months of FY22.

The increasing share of UPI at merchant payments has begun to eat into banks’ fee incomes, as it becomes a viable alternative to credit and debit cards. 

HDFC Bank’s fee on payments products fell on a year-on-year (y-o-y) basis in the quarter ended December. Axis Bank’s retail card fee income as a share of card spends fell to 1.9% in the third quarter of FY22 from 2.5% in Q1FY18, a report in The Financial Express said.

Merchant establishments, especially small storefronts across the country, have taken to UPI QR-based payments in a big way since they do not have to shell out a merchant discount rate (MDR) to their bank or non-bank service providers, also known as acquirers. The shift to QR-based payments has been accelerated by consumers’ tendency to use their mobile phones for making payments instead of handling cash during the pandemic. 

According to the FE report, industry estimates suggest that half of all merchant transactions in 2021 happened through mobile phones. At Rs 1.63 trillion, the value of merchant UPI transactions in February 2022 stood well above the value of debit and credit card transactions at point of sale (POS) terminals, which was Rs 1.43 trillion.

“The shift in merchant payments towards low-yielding form factors such as UPI, coupled with rising competitive intensity across payment modes, is driving the overall payments fee yields lower across the ecosystem,” the HDFC Securities report cited earlier said. 

And then there’s cryptocurrency. While the Reserve Bank of India and the Indian government have dealt a body blow to cryptocurrencies by not letting them become legal tender and by imposing a capital gains tax on all profits, besides a 1% tax deduction at source on each transaction at an exchange, the rest of the world is adapting to new technologies like decentralised finance. India too will have to give in, sooner or later, albeit with safeguards. Moreover, the RBI itself plans to launch its own digital currency, which too will eat into banks’ revenues. 

So, while Indian lenders become bigger, they should be mindful of the fact that unless they evolve their tech game quickly, massive disruption may just be around the corner.

Also read: Indian mutual funds add record 3.2 crore folios in FY22