HDFC Bank Is Still Paying for a Merger It Closed Three Years Ago

The most useful sentence on HDFC Bank's earnings call for the quarter ended June 2026 came from its chief financial officer, and it was about what will not happen. The roughly 11% coupon on the bank's inherited borrowings, he said, "doesn't change in the short term."

That admission explains an otherwise unremarkable set of results. Standalone profit after tax for the quarter rose 5% year on year to ₹190.6 billion. Net interest income rose 6.7% to ₹335.3 billion. Deposits and advances both grew at low double digits. Volumes are fine. Pricing is not.

Net interest margin on total assets came in at 3.26% for the quarter, down 9 basis points from the quarter ended June 2025 and 24 basis points below the 3.5% the bank reported through most of the financial year 2024-25. Those two numbers describe two different problems. The 9 basis points is the rate cycle, shared by every lender: when the RBI cuts rates, loans reprice almost immediately while deposits reprice only as they mature, so income falls before costs do. The 24 basis points is the merger: the wholesale borrowings, mostly non-convertible debentures, that arrived with HDFC Ltd in July 2023. Those legacy bonds carry coupons of around 11%, more than double the bank's blended cost of funds of under 5%.

The arithmetic of that gap is the entire investment case. On earning assets of roughly ₹41.15 trillion, each basis point of margin is worth about ₹1 billion of net interest income per quarter. The full 24 basis points therefore costs the bank about ₹25 billion of net interest income every quarter, close to ₹99 billion a year, or roughly ₹75 billion of annual post-tax profit. That forgone profit is about twice the bank's entire profit growth over the past year. The bank is not underperforming. It is carrying a weight.

The weight is coming off, but slowly. Borrowings have declined from 21% of liabilities in September 2023 to 13% by June 2025, and to just over 11% by March 2026. Current and savings accounts, the deposits that cost the bank little or nothing, have stabilised at 34% of the total, below the 38 to 40% management targets. Getting there, in management's own word, is a journey.

The peer comparison sharpens the point. ICICI Bank, which never had to digest a lender's wholesale debt, has held its margin broadly steady through the same rate cycle. In the quarter ended June 2026, its net interest income grew nearly twice as fast as HDFC Bank's and its profit three times as fast. The difference is not strategy or execution. It is the debt ICICI never bought.

Which brings the question to price. At ₹761.5, HDFC Bank trades at about two times its consolidated book value of ₹378 per share. A standard valuation check asks what return on equity would justify that multiple, assuming investors want 10.5% a year and the bank grows 7% over the long run. The answer is just over 14%, almost exactly what the bank currently earns. The stock is priced for stasis: no further margin damage, no recovery either. The bull case near ₹863 requires return on equity of 15%, about 100 basis points of expansion, and there is only one place that can come from: the borrowing cost the CFO just told investors not to expect to move soon.

Timing is what makes the next two quarters interesting. Management has acknowledged roughly ₹1.5 trillion of long-term debt maturing across the group in 2026; it also noted that redeeming it early would trigger fair-value hits, which is why the bank is waiting for the bonds to run off on schedule rather than buying its way out. July 2026 marks month 36 from the merger. If the maturity wall is real, the quarter ending September 2026 should be the first where interest costs fall visibly as the old bonds are repaid. There is an early hint: in the quarter ended June 2026, interest expended fell 0.4% year on year even as interest earned rose.

So the number to watch is neither the margin, which will keep moving with the rate cycle, nor the profit line, which volumes can carry for a while yet. It is the cost of funds. The quarter that line falls decisively is the quarter the merger stops defining HDFC Bank's results and margins can start recovering. Until then, profits will keep carrying the cost of the old borrowings. At two times book, investors are paying today's full price for a recovery that is still a forecast.

 (This column reflects the author's personal views and is based on publicly available information. It is intended for general commentary and analytical purposes only and should not be construed as investment advice.)