Sebi raises concern over $1.5 bn HDB Financial Services IPO

Sebi’s initiative to extend algo trading to retail investors marks a transformative moment in India’s financial markets. (File Photo: Reuters)
Sebi’s initiative to extend algo trading to retail investors marks a transformative moment in India’s financial markets. (File Photo: Reuters)

Summary

HDB filed its draft IPO papers in November. Parent HDFC Bank will sell its shares worth 10,000 crore in an offer for sale

Mumbai: The stock market regulator is examining a potential violation of the Companies Act by HDB Financial Services 17 years ago as the non-bank lender prepares for a $1.5 billion initial public offering (IPO), three people aware of the matter said.

The Securities and Exchange Board of India (Sebi) found that the lender in 2008 issued shares to more than 50 employees of its parent HDFC Bank through a private placement, one of the three people said. The regulator now plans to refer the matter to the Union ministry of corporate affairs (MCA), since this may constitute a violation of the Companies Act, the person said on the condition of anonymity.

Under the Companies Act, issuing shares to more than 50 people is considered a public issue, requiring compulsory Sebi clearance. A preferential issue such as the one made by HDB is a private placement, and such an issue cannot be made to more than 50 investors without Sebi approval. The threshold of 50 was added to the Companies Act in 2000.

Also read | HDB IPO: Two concerns that could hurt the HDFC Bank subsidiary’s valuation

“If Sebi discovers a breach in the extant laws any time after Sebi’s inception, the issuer company may either be asked to pay a penalty or be debarred altogether from the market for a certain period. In this case, the company may have to pay a penalty to get its IPO application cleared," the person added.

Queries emailed to HDB, HDFC Bank, MCA and Sebi remained unanswered.

HDB filed its draft IPO papers in November. Parent HDFC Bank will sell its shares worth 10,000 crore in an offer for sale to comply with RBI norms on compulsory listing of so-called upper layer NBFCs. Alongside, HDB Financial will issue fresh shares to raise 2,500 crore. HDFC Bank owns 94.36% of the shadow bank.

According to the draft red herring prospectus (DRHP) HDB had made a preferential allotment of 12 million shares to 410 employees of HDFC Bank on 12 January, 2008. Some of these employees include Aditya Puri, the then chief executive officer of HDFC Bank, and other senior officials.

Also read | For HDFC AMC, falling equities could deal a double whammy to profitability

However, a second person said given the company’s parentage, the matter may not stall the IPO, and may be settled.

"HDB is yet to hear from Sebi. We understand that Sebi will take action once it gets the feedback from MCA on the matter," the second person added. “It’s a matter of legal interpretation whether the issuance by HDB can be considered as Esop issuance or a public issuance. If it had been interpreted as an Esop issuance, then the company would not have required Sebi approval," he added.

"Instances of preferential allotments to employees or related parties are not uncommon in the corporate world, and each case is evaluated based on its specific facts and circumstances," said Sumit Agrawal, a partner at Regstreet Law Advisors. "At the time of an IPO, substantial compliance is reviewed, including any issuance or transfer of shares since the company’s incorporation."

HDB IPO filing

HDB Financial may need to amend its IPO filings to specifically mention the deemed public issue or adjust the offering structure, said Agrawal, a former Sebi official who has worked on such cases in the past. "Additionally, upon receipt of a show cause notice, HDB Financial Services may apply for a settlement, and Sebi, as a pre-condition to settling securities law violations, may direct the company to approach the NCLT or the regional director to compound violations under Section 67(3) of the Companies Act, 1956. This has been Sebi’s approach in past cases, such as with IPO documents of Utkarsh Small Finance Bank and RBL Bank Ltd, unless Sebi takes a different approach in the case of HDB. This situation could result in delays or require additional disclosures," he added.

The lender should engage with Sebi, submit necessary disclosures on the allotment, and work towards resolving any concerns in full compliance with current regulations, Agrawal added.

"The capital structure built up by the company (HDB Financial) was in accordance with the prevalent Companies Act applicable at that point of time," said a fourth person aware of the matter.

Last month, Moneycontrol reported that HDB had restarted talks with Mitsubishi UFJ Financial Group (MUFG) after a brief pause for a 20% stake in the company. The board of HDB Financial Services had initially rejected the proposal made by MUFG last year after the top management was divided over selling stake to the Japanese financial conglomerate before an IPO.

Also read | Why HDFC Bank turned down MUFJ's overtures on HDB Financial

HDFC Bank also will have to bring down its stake in HDB Financial Services to below 20% in future to comply with RBI’s draft norms on regulating banks’ group businesses. The central bank's draft rules released last year aim to remove any overlap in businesses carried out by a bank and its subsidiaries. HDB Financial Services, a non-banking financial company, and HDFC Bank offer similar products but to different sets of borrowers. HDB primarily lends to first-time borrowers and underserved customers.

HDB financials

The company reported a 20% sequential decline in net profit to 472.3 crore at the end of December 2024, primarily due to higher credit costs.

Also read | Three reasons HDFC Bank may turn around sooner than you think

According to Macquarie Research, the non-bank lender has seen an increase in credit costs due to stress in unsecured, commercial vehicle and construction equipment loan portfolios. Credit costs increased 70bps sequentially to 2.5% on account of increase in gross non-performing ratio to 2.25% at the end of the third quarter from 2.1% at the end of the second quarter.

Credit cost reflects the actual financial impact of credit risk by accounting for provisions, write-offs, collection expenses, loan restructuring costs, and interest income loss.

 

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