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K. Subramanian

While framing the Articles of Agreement connected with the share issue to CDC, the UTI Bank seems to have tripped up. The Agreement stipulated that the UTI should continue to hold 26 per cent equity in the bank. While the UTI was subject to these obligations, there were no counter obligations on the other holders, especially CDC.

ON December 4, 2003 there were reports about HSBC acquiring 20 per cent of shares in UTI Bank and how it took the bank management by surprise. It appeared that the Chairman and Managing Director, Mr P. J. Nayak, was himself informed of the sale only after the agreement between CDC Partners and HSBC was signed. This was coupled with an offer to the public to buy 20 per cent of the bank shares at Rs 90 per share.

It is somewhat difficult to give credence to the statements of the representatives of HSBC or to the clarifications given by the bank management. Surprisingly, both maintain that it is not a take-over but only a financial investment. Why UTI Bank?

It is on record that the bank was looking for a `strategic partner' since 2001. Its investment banker, Salomon Smith Barney, was said to have received `expressions of interest' from AIG, ING Barings Private Equity, DBS Singapore and Chrysalis for a stake. The offer, reportedly, was for a 20 per cent share of equity. No decision could, however, be taken on these bids for a long time.

Part of the delay was probably due to the investment guidelines, which restrict foreign equity in banks to 49 per cent. By March 2003, the Government had announced, through its 2003-04 Budget, that non-resident equity in private banks could be raised to 74 per cent. A Bill was to be introduced in Parliament to give effect to this. (It has been done in the current session.) It is this expectation of higher equity that sent many suitors to UTI Bank.

A greater part of the delay was perhaps due to the difficulties faced by UTI and UTI Bank in devising a long-term strategy to govern the growth of the bank. It was well-known that UTI had to divest its equity in the bank and transfer the proceeds to strengthen itself after it was rocked by the US-64 imbroglio. But UTI Bank, which had grown and become stronger since its establishment in 1994, began to have ambitions of its own.

As repeatedly asserted by its CMD, the bank wanted to grow organically. Indeed, the bank's progress in recent years was impressive. Among the newly-established private banks, it had turned into a hi-tech data-oriented bank. It had built up a large infrastructure with 147 branches and extension centres covering 65 cities and towns and supported by a network of 524 ATMs as on June 2002. As at end-March 2003, its reserves were over Rs 688 crore and equity Rs 230 crore. (It was raised to Rs 300 crore later.) Its deposits rose to Rs 17,000 crore and the return on equity was 25.07 per cent. No wonder the bank management had its own ambitions of growth and expansion.

The management decided to opt for private placement as it felt that the prevalent stock market conditions were not conducive to public issues. It put through two major schemes of private placement: One in September 2001 and the other in March 2003. While doing this, especially in the CDC allotment, the bank seems to have played its cards badly.

On September 21, 2001, the bank's board resolved to allot 46.35 million shares in favour of two funds — South Asia Regional Fund and CDC Financial Services registered in Mauritius — at a uniform price of Rs 34 per share. These funds were the offshoots of the erstwhile Commonwealth Development Fund managed by the British Government for international development and aid. CDC's investment was Rs 157.59 crore. It changed the equity pattern of the bank substantially. UTI's holding came down from 60.65 per cent to 44.88 per cent. The share holding of financial institutions such as LIC, GIC, and so on, also fell proportionately. South Asia Regional Fund came to hold 9.99 per cent and CDC Financial Service (Mauritius) 16.02 per cent.

In March 2003, the bank put through another private placement valued around Rs 164 crore to LIC, Citicorp Bahrain, and Chryscapital Mauritius and Karur Vysya Bank. The share value was fixed at Rs 42.75 (inclusive of a premium of Rs 32.75 per share). As a result, UTI's equity was reduced to 33.6 per cent from 40.3 per cent. GIC and others came to hold 7.6 per cent against 9.2 per cent. CDC's holding was reduced to 20.1 per cent. While framing the Articles of Agreement connected with share issue to CDC, the bank seems to have tripped up.

The Articles of Agreement stipulated, among other things, that UTI should continue to hold 26 per cent equity in the bank. In the event of its divesting its equity in excess of this level, it should not offload more than 5 per cent at a time and without consulting others. Moreover, it was enjoined to put through a sale without unduly upsetting its value in the share in the market. The only exception under which it might divest its holding below 26 per cent was confined to any statutory direction, which the government might give. While UTI was subject to these obligations, there were no counter obligations on the other holders, especially CDC.

There were, however, many suitors to the bank. Under the articles, UTI or others could not have put through any sale/divestiture to anyone without taking CDC along. The delay on the bank management's part in deciding the bids of other parties could have been due to CDC's reluctance to let in any other bank, Indian or foreign.

When the new policy on foreign equity in banks was announced in the Budget, many foreign banks were on the prowl seeking acquisition. The major contenders in India were Citibank, HSBC and Standard Chartered Grindlays. This was on the demand side.

On the supply side, the attractive candidates were SBI, ICICI HDFC and UTI groups. Nationalised banks were not suitable, as foreign equity was limited to 49 per cent. Other private banks were too small and unattractive for acquisition. ICICI and HDFC have diversified equity structures and prove intractable and costly for corporate raiders.

Clearly, UTI Bank had become vulnerable. At one level, its promoter — UTI — was under compulsion to exit. At another, its equity pattern had led to CDC becoming the de facto controlling holder. The Articles of Agreement prevented UTI from isolating CDC even it had an independent strategy. In short, CDC held all the aces and UTI had to play even without a trump.

HSBC, on all accounts, has been well advised by its legal experts. CDC's holdings are registered in Mauritius and the sale is to HSBC Holdings, which is also registered there. Any transfer or sale of shares from one non-resident to another does not require approval under the Foreign Exchange Management Act (FEMA). The Foreign Exchange Regulation Act of 1973 (FERA) had a specific section — Section 19(5) — to regulate transfers from one non-resident to another. This was repealed when FEMA replaced it. The net result is that CDC or HSBC does not need any approval under FEMA. If approval from the RBI was necessary under the banking laws or guidelines, it could be well within the new guidelines on the anvil. However, there is, as yet, no clarity on these regulatory issues. In his recent address to the Bank Economists' Conference, the RBI Governor, Mr Y. V. Reddy, expressed discomfort over the opacity of the current regulations governing takeover of banks.

Yet another fallout is that the sale of shares from CDC to HSBC is totally free from capital gains tax in terms of the Indo-Mauritius Double Taxation Avoidance Agreement. CDC acquired these shares for Rs 158 crore and at Rs 34 per share in 2001. They are being sold for about Rs 417 crore at Rs 90 per share. Ordinarily, capital gains tax on this transaction would be Rs 52 crore. The Government will lose this if the deal finally happens .

HSBC seems to have done its homework well. It may be difficult to prevent it under extant laws and regulations. Its offer to the public to buy the shares at the same price is more a legal formality to appease the SEBI.

In any case, the floating stocks do not exceed 16 per cent on date. The current quotation far exceeds the offer price of Rs 90 and HSBC may not mop up more shares. All the same, it might not stop HSBC in its tracks from taking over the UTI Bank. What has happened is indeed a palace coup. The praetorian guards were either asleep or disarmed.

(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)

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