Event update: Kotak Mahindra Bank (Outperformer) - Preference issue to reduce promoter stake. Will RBI object?

Kotak Bank has issued preference shares to domestic investors of Rs5bn. This has resulted in dilution of promoter stake to 19.7% from 30%. The reduced promoter stake now meets RBI’s promoter stake requirement which Kotak was expected to achieve by Dec-31, 2018.

Key details of the issue 1) The preference shares are non – redeemable, perpetual, non-convertible and non-cumulative. 2) Domestic investors and corporates have invested 3) The face value is Rs5 and the dividend rate is 8.1%. 4) This issue will be treated as additional Tier 1 5) The preference shareholders will not have voting rights 6) The issue will not be dilutive to existing shareholders because it is non-convertible.

Management feedback: 1)RBI has a set of issues which require pre -approval. Issue of Preference shares is not one of them. So KMB does not have pre approval from RBI.  2) They have not discussed this specific stake sale strategy (of preference shares) with RBI before the issue 3) They intimated RBI after the issue.  Since Kotak has not pre discussed this with RBI, RBI’s feedback on the issue is important. Kotak says their license is based on paid up total capital not equity capital alone so for them preference shares can be counted as capital and promoter stake calculation can include preference shares in the denominator.

Will RBI object? – it’s a tough call: One concern is whether RBI will object to using paid up capital rather than equity capital for calculating promoter stake. Old banking licenses are based on paid up capital while new banking licenses are based on equity capital not paid up capital. RBI’s possibly changed the paid up capital to equity capital in the new guidelines to plug the loop hole in the old norms. However in the past, RBI has allowed banks to continue with their old licensing terms even if the new ones are stricter. A case in point is the non-lending businesses of banks. The banks with older licenses have been allowed to carry out non-lending businesses as subs of the bank while the newer ones have to go through the NOFHC structure. So there are instances of RBI allowing both new and old license norms to co-exist. While it is clear from the new guidelines that RBI wants to base stake calculations on equity not total capital, RBI may still honour the old licensing norms for Kotak like it has done in the past for other issues. While old banks may be allowed to use total capital based on their licenses, we believe it is unlikely for RBI to change the definition of capital (from equity to total) for new licenses.