HDFC twin stocks slide over outflow fears post merger

HDFC Ltd will merge into HDFC Bank, and the merged entity will be called HDFC Bank. Merger is imminent in July. MSCI has recently changed the calculation for direct investment limit for banks, called ‘foreign room’, prompting fears of an outflow and Friday’s massive selloff.

The MSCI index is closely monitored by foreign investors interested in Indian equities.The intensity of selloff was significant enough to prompt the 12-constituent Bank Nifty to drop 2.34% to 42,661.20, its largest fall in seven months. Concurrently, the Nifty fell by 1.02% to 18,069, its steepest fall in four months.

HDFC Bank Ltd, which had hit a record high of ₹1734.45 on Thursday, plummeted 5.9% to ₹1625.65 on Friday, the most in 37 months. HDFC Ltd shed 5.6% to close at ₹2,702.3, the sharpest fall in 38 months. Investors in the so-called HDFC twins saw their wealth eroded by a whopping ₹86,342 crore.

Contrary to the earlier estimation of over $2 billion in inflows following the merger, current estimates predict $150-200 million outflows.

“After a sharp rise in the last few days, Nifty is now consolidating around 18,000-18,200 zones,” Siddhartha Khemka, head, retail research, Motilal Oswal Financial Services Ltd, said. “While the overall market structure is positive expect the Nifty to consolidate in the near term on the back of subdued global cues and profit booking in the index heavyweights. Next week, the market will also take cues from inflation, state election outcomes and ongoing earning season.”

The expected outflows from the merged HDFC Bank is the result of a modification by the global index provider MSCI in its weighting calculation. The adjustment takes into account available foreign room—proportionate shares that foreign investors can still purchase up to the allowable limit—when determining the HDFC stock’s weighting on the index.

The estimated foreign portfolio investment holding for the merged HDFC Bank is approximately 61%, compared to the permissible foreign ownership limit of 74% for any bank, indicating that the current foreign room available is 17.56% (13/74%).

Foreign room exceeding 15% typically results in inflow, while one below 15% leads to outflow.

However, the MSCI expects foreign room to contract due to the increasing demand from FPIs.

Due to this it has revised the so-called foreign adjustment factor down to 0.5% from 1%. This is normally done when the foreign room is expected to be low.

MSCI’s tweaking of the methodology to determine the weight resulted in investors who accumulated the stock ahead of the merger , to offload their shares on fears of outflows instead of the expected $2.5-3 billion inflows which would have resulted in them making tidy gains post the merger.

While HDFC is currently part of MSCI India Index , the eponymous bank is not . Once the entities merge the behemoth will become part of the MSCI India index.

“Currently HDFC’s weight is 6.74% in MSCI India Index and as per our preliminary calculations the merged entity would have slightly lower weight of about 6.5%,” said Abhilash Pagaria , head of alternative and quant research at Nuvama Wealth. “We had estimated the foreign room for the merged entity to be around 18% which is above 15% and above the MSCI threshold to maintain stock with full factor.

“However, as per the current methodology, the weighting of the merged entity would be again reduced in the next quarterly index reviews if the foreign room would have come below 15%.”

Pagaria expects the stocks to face heightened volatility in the short term .

MSCI conducts periodic reviews of the eligible universe of stocks comprising its indexes.

“Bank Nifty bears took over the control and the index fell by more than 2% breaking the support of the 43,000-42,800 zone,” said Kunal Shah, Senior Technical & Derivatives Analyst at LKP Securities. “If the index sustains below 43000, it could witness a further correction toward the 42,500-42,300 zone where the next demand area is visible. The upside resistance of 43,000 if taken out decisively will lead to further short covering toward 43,300 levels.”