Mumbai, June 1: An increasing number of Indian corporates are accessing bank finance at rates cheaper than commercial banks' prime lending rates (PLR) by placing preference shares with profit-making public sector banks. Through this route, they are able to raise money at incredibly low rates of 12-13 per cent.

In effect, the cost of funds for blue-chip corporates has dipped about one to two percentage points (100 to 200 basis points) below the public sector banks' prime lending rates, which is now pegged at 14 per cent.

Profit-making commercial banks, led by the State Bank of India, have been lapping up the preference shares of blue-chip companies and even mid-cap ones offering 12 per cent to 13 per cent dividends over the past few weeks.Confirming the development, a senior State Bank of India executive said the bank has struck a number of deals this month buying "quasi-equity" from corporate clients.

"Even at 12 per cent or 13 per cent dividend, the yield is attractive since we do not have to pay any tax on the dividend income," the executive said. Madras-based Spic is one of the mid-corporates which has recently placed preference shares with State Bank.

Two other Mumbai-based public sector banks -- Bank of Baroda and Bank of India—are also reportedly subscribing to preference shares in a big way at rates much below their prime lending rates. The PLR of all the three banks is pegged at 14 per cent.

"We prefer to raise funds through the preference share route as it does not restrict the borrowing limit of the company," said the finance director of a Mumbai-based corporate house.

Moreover, preference capital does not dilute equity since preference shareholders (in this case, banks) have no right to the company's reserves. Thus, the company's earnings per share are not adversely affected.Commercial banks are lapping up preference shares despite low yields because they do not have to pay income tax on dividends.

"Even if we lend funds at 15 per cent—one percentage point above the PLR—the yield is less attractive than accepting preference shares at 12.5 or 13 per cent as the interest income is subjected to 35 per cent corporate tax while dividend income is free," said a senior banker.

According to him, a large number of corporates plan to source short-term (18 months) money through the preference shares route.

The trend has become visible in the last few weeks following the passage of the Finance Act 1997. Section 10 (33) of the amended Income Tax Act has granted complete exemption from tax to all dividend income.

The exemption applies to equity as well as preference shares issued by corporates.

In an attempt to cut the cost of funds, corporates have also started directly placing debentures with banks.

Recently, ACC directly placed Rs 100 crore worth of debentures at a fine rate with four banks.

"Non-convertible debentures (NCDs) are gradually replacing term loans for three to five years.

" One advantage of NCDs over term loans is the end-use of funds is not stipulated and, unlike term loans, corporates are not required to create assets out of NCDs," bankers argued.

However, corporates have not yet started slashing their working capital limits and replacing them with non-convertible debentures, bankers pointed out. y

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.