The clarification provided by the RBI on the PSL (priority sector lending) compliance period of three years is a positive development for HDFC Bank as it provides the bank with sufficient time to meet the targets. There will be no relaxation on cash reserve ratio (CRR), statutory liquidity ratio (SLR), and liquidity coverage ratio (LCR) as per the RBI’s regulations. Additionally, borrowers will have to shift to new benchmarks within six months.
The clarification on LAS (loan against securities) and income recognition policies is minor, and it is unlikely to have a significant impact on the bank. As the phase of the merger comes to an end, the focus will now shift to deposit mobilisation. Overall, considering the positive development on PSL compliance and HDFC Bank’s strong position in deposit mobilisation, we maintain a BUY rating on the stock with an unchanged fair value.
PSL relaxation is helpful but we shift focus to deposit mobilisation
While the initial response to this merger has generally been positive from investors, we must highlight the following issues: (i) PSL relaxation is harder to quantify, as the timing of these calls and the prevailing value of these choices are not easy to forecast. It is a positive development as it gives more headroom to comply. There are several variables to forecast such as the extent of shortfall, choice of instrument (loan buyout, organically grown, PSLC certificates, de-grow non-PSL loans or allow the shortfall and invest in RIDF bonds. (ii) The key issue that we have been highlighting has been deposits. We currently are in a period where the loan growth for the sector has been ahead of deposit growth. Banks have used their excess deposits, resulting in increased competition in the market. If the underlying trend normalises or reverses, it would make this merger easier to consummate. (iii) Benchmarking of interest rates on loans would result in volatility of NIM from hereon. (iv) HDFC Bank has yielded better risk-adjusted returns for investors in the previous two decades.
However, the post-merger balance sheet (assets as well as liabilities) is broadly similar to peers, making it harder to demonstrate differentiated underwriting unless we have under-estimated the weakness in underwriting for the system as a whole. This, in our view, would be essential to demonstrate a premium valuation over peers. (v) The structure of the merger is positive for the subsidiaries of HDFC Ltd as it removes any overhang. We maintain a BUY rating with a FV of `1,925. At our FV, we value the bank at 2.7X book and 17X 2025e EPS for RoEs at 16% levels and 15% CAGR respectively.