US-64: A survivor’s guide
A lifeline just about keeps investors afloat
Another bail-out
Though it is a pale shadow of its former self, UTI continues to shake and stir the markets with frightening frequency. Is there no end to this story?
On 30 August, the BSE Sensex witnessed a gain of 67.07 points and closed at 3181.23. On the next trading day of 2 September, the Sensex rose even higher and touched the 3187.26 – level last seen only in mid-July.
The rise was on rumours of a rescue package to bail out UTI and prevent it from distress sales in the market. In the past few months, UTI had turned into an aggressive seller to meet redemption pressure on US-64, its maiden open-end scheme, and on MIP-97 II and MIP-97 III, its assured return schemes redeemed in June and August. From its recent high of 3690.27 on 7 March, the Sensex had shed 740.18 points and touched its recent low of 2950.09 on 8 August in the absence of FII inflows and selling by UTI.
Though the Centre announced a Rs 500-crore budgetary support to UTI in July 2002 to enable it to meet the shortfall between the repurchase price and NAV of US-64, UTI had to approach the government for a Rs 5000-crore fund support to bail out US-64 in view of the increased gap of Rs 5.14 per unit.
While the shortfall in US-64 was roughly Rs 6000 crore (against an NAV of Rs 6.06 on 30 August, the repurchase price of US-64 for September 2002 is Rs 11.2 per unit), it was estimated to be Rs 8561 crore on 20 other assured return (12%-14%) schemes. At least 8-10 assured return schemes of UTI are coming up for redemption in the next couple of months. MIP-97 IV will be redeemed in October, MIP-97 V in December, MIP-98 in March 2003 and IISFUS-97 II in January 2003.
The government had, thus, to put together another bail-out package of Rs 14561 crore for UTI in August 2002. It also offered certain tax concessions such as tax-free dividents and exemption from capital gain tax to enthuse unit-holders to stay beyond May 2003.
The bail-out will only bridge the gap between the NAV and the repurchase price that has been promised to US-64 investors who were in the books of UTI as on 30 June 2001 (Rs 12 for holdings under 5,000 units and Rs 10 for holdings in excess of 5,000 units on 31 May 2003). As for investors who had entered US-64 at NAV-based prices, their units will be redeemed only at NAV-based repurchase prices.
Besides redemption, the heavy sales by UTI were also to keep with its promise of gradually reducing equity holdings in US-64. When the scheme was made NAV-driven in January this year, UTI had announced it would maintain a maximum of 55% in equities. Its exposure to equity has marginally reduced from 63.55% (Rs 8,048 crore) in June to 62.4% in Rs 7,133 crore in July.
Apart from significantly reducing its holding in Essar Steel, Reliance Petroleum, Tisco, Mysore Cements, and many others, UTI fully divested stocks such as Essar Oil, German Remedies, Merck and Reckitt Benckiser India. It has sold off huge chunks pivotals like IPCL, Tata Steel, Tata Power, BPCL, MTNL, L&T, State Bank, Nestle and HDFC.
In fact, UTI managed to sell some of its holdings at a premium to their market prices. For instance, on 23 August, UTI sold a large chunk of Nestle shares at Rs 570 per share as against a market price of Rs 565, and sold Indo Gulf Corporation at Rs 53 per share on 27 August, when its market price was ruling at Rs 52.15.
The market is, thus, expecting UTI to undertake many such block deals in stocks it holds at a premium. For instance, many of these stocks, like Nestle, HDFC and L&T had risen in the last three weeks in anticipation of such block deals. From Rs 618 on 24 July 2002 ITC surged 13.8% to Rs 703.30 on 29 August 2002. L&T soared 19% to Rs 187.25 on 29 August 2002 from Rs 157.25 on 1 August 2002.
Meanwhile, as part of restructuring, the UTI Act is to be repealed and UTI will be split into two companies – UTI-I and UTI-II. UTI-I, comprising US-64 and all assured return schemes and an asset base in excess of Rs 25000 crore, will remain under public control. On the other hand, with all NAV-based schemes and an asset base in excess of Rs 17000 crore, UTI-II will be privatised eventually. While the government will continue managing UTI-I through an administrator and a team of advisors, UTI-II will be professionally managed.
The government is also toying with the idea of creating a company or trust to manage UTI-I, while proceeds from the sale of UTI-II will be utilised to meet the shortfall in UTI-I. It is also contemplating splitting US-64 into two. While UTI I will have the administered price segment, UTI II will have the NAV-based segment of US-64. Since US-64 became NAV-driven from 1 January this year, its total sales amounted to Rs 100 crore as on date. This corpus of approximately Rs 100 crore will be snipped from the total US-64 corpus. So while US-64 in UTI I will have a corpus worth Rs 12000 crore, US-64 in UTI II will have roughly around Rs 100 crore.
The government will issue securities to be utilised for new subscriptions to UTI-II. These funds can be used to buy out the risky assets of UTI-I and invest in fixed-income securities, consistent with its commitment of assured returns. There is also a plan to offer tax-free dividends and exemption from capital gains tax for US-64 investors who wish to continue beyond May 2003. The government also plans to extend the guaranteed repurchase price beyond May 2003 at Rs 12 per unit.
Says Srinivas Rao, vice president, Rooshnil Securities, "The package is a temporary relief. The only good thing is that distress selling will get replaced by rational selling." Jamshed Desai, head of research, Taib Securities, also agrees that there is a feel-good factor in the package, but the market still fears the overhang of UTI selling.
Reflecting these concerns, the rally in the Sensex, on the hopes of a bail-out package, soon fizzled out. On 2 September, the first day of trading after the announcement of the package, the Sensex, after surging as much as 46 points to a high of 3227.62 during the session, settled with a modest gain of 6.03 points at 3187.26 largely on account of profit booking at the higher levels.
The concerns are justified as this is not the government’s first attempt at saving UTI from going in the dumps. In September 1998, when US-64’s reserves had turned negative to over Rs 1000 crore, UTI reported redemptions worth 3% of its total corpus. Later, in October 1998, when it declared its intention to reduce equity holdings, the market crashed 224 points. The government had to infuse Rs 3300 crore by way of securities to restore investor confidence in US-64.
UTI stunned its investors when it froze the sales and repurchases of US-64 from July 2001. This resulted in a panic situation with a fall of 114 points in the BSE Sensex. Despite the NAV hovering at Rs 7-8, UTI kept accepting investments by way of fresh sales till May 2001, and this is what led to a crisis situation in 2001. The anomaly crept in primarily due to the pricing mechanism of US-64, which never declared its portfolio or NAV.
The finance minister yet again worked out a rescue package, which offered a step-up structure of repurchase till May 2003. Starting with Rs 10 in August 2001, the repurchase price rises by 10 paise every month and will end at Rs 12 per unit in May 2003. By formulating this package, the government gave US-64 the status of an assured return scheme, which is not only frowned upon by Sebi, but is also risky, given the low interest rate regime. Its second bail-out in July 2001 cost Rs 300 crore.
Last year’s package did give UTI time and opportunity to benefit from a possible appreciation of stock prices when the Sensex rose to touch the 3700-level in February this year. But the party was spoiled by the Ketan Parekh scam in March and fears of an Indo-Pak war in May. The Sensex again went into a tailspin and touched 2950 on 8 August – a level last witnessed in September 2001, soon after US planes bombarded Afghanistan, following terrorist attacks on the US on 11 September.
Incidentally, two assured return schemes of UTI were redeemed during this time. While MIP 97 II, with net assets of Rs 1380.11 crore matured in June, MIP 97 III, with Rs 732.65 crore net assets, was redeemed in August
It withdrew heavily from its Development Reserve Fund (DRF) thereby shrinking it further. UTI’s Development Reserve Fund is supposed to meet any shortfall between the returns promised and the earnings of particular schemes.
Apart from the cash crunch, UTI is also saddled with non-performing assets (NPA) of over Rs 4000 crore as on 31 July 2002. More than Rs 2000 crore of NPAs are from its assured return schemes. Consequently, the market share of UTI has gone down from 51.10% in March 2002 to 44.71% in July, with gross redemptions during April-July standing at Rs 1704 (not inclusive of Rs 5297 crore due to maturity of its schemes) as against fresh sales of Rs 961 crore during this period.
Till date, the Centre has pumped in roughly Rs 4100 crore into UTI – Rs 3300 crore was infused in 1998, Rs 300 crore was provided in 2001 and Rs 500 crore was given as additional demand for grants in the current fiscal. Add the current Rs 14561- crore bail-out, and the UTI episode will burn government coffers of Rs 18661 crore. But who bears the brunt?
Avers Jayesh Patel, head of research, LKP Securities, "It is the tax-payer on whom the burden will fall." Says an equity dealer, "It could have been worthwhile to disband the scheme as any bail-out will have a run on tax-payers." Finance secretary S Narayan, however, refutes the belief that the UTI bail-out will stretch out Central finances and adversely impact the targeted 5.1% fiscal deficit for 2002-03.
After the 1998 fiasco, the Deepak Parekh Committee had recommended a speedy transition of all assured return schemes with a portfolio of risky assets to NAV-based schemes. In August 2001, the Malegam Committee, headed by Y H Malegam, recommended a three-tier structure for UTI, comprising a sponsor, trustee company and an asset management company, a must for all mutual funds under Sebi guidelines. But most of them recommendtions have been put in cold storage. Assuming US-64 was made NAV-driven in early 2000 when the markets were at 6,000 levels and the US-64 portfolio was reshuffled, then its assets would not have eroded so heavily.
The package of Rs 6000 crore for US-64 and Rs 8561 crore for other assured return schemes is based on the shortfall at the current prices.
Any further fall in the Sensex will only make the existing shortfall in these schemes shoot up. In that case, UTI will have no option but to tap the market again and sell its holdings to raise funds and meet redemptions.
Though Umesh Kamath, fund manager at Canbank Investment, is optimistic that such a situation will not arise, others are not so hopeful. Warns Desai, "The package is only a short-term cure. The long-term problem still persists."
In October 2002, the Cabinet issued an ordinance for restructuring UTI, including repealing the UTI Act and bifurcating it into UTI-I and UTI-II. UTI employees protested against the government's decision to privatise UTI by staging dharnas outside UTI offices. The employees demand that the government should give a written assurance that there will not be any retrenchment following the recast.
UTI was finally bifurcated into UTI-I and UTI-II in December 2002, with UTI-I comprising US-64 and other assured return schemes, while UTI-II getting all the NAV-based schemes. In February 2003, UTI-II was converted into UTI Mutual Fund, with assets worth Rs 15,179 crore under management.
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