The DFCC Bank has indicated the possibility of returning to shareholders funds attributable to them if the bank is required in the future to divest all or part of its holdings in the Commercial Bank of Ceylon (CBC) which may result in a surplus of regulatory capital.

Such return of funds will be to the extent that these resources are not required for the projected medium term business expansion plans of the DFCC Bank, shareholders have been told.

Currently, the DFCC holds 29.77% of the voting shares of the Commercial Bank following an investment of slightly over Rs.1 billion in 1997 to acquire this stake with the approvals required under the Banking Act.

DFCC subsequently subscribed to a rights issue of the Commercial Bank by investing a further Rs.541.9 million to maintain its stake without dilution.

The DFCC board has told shareholders that the pending rights issue of the Commercial Bank will require DFCC to invest approximately Rs.1.6 billion to take up its rights in full. It is intended to do so, raising cash through a pricey rights issue sweetened by a bonus, despite on-going litigation and regulatory moves that may not permit DFCC to own as big a slice of the Commercial Bank as it does at present.

"The board is of the view that it is in the best interests of the bank and its shareholders to retain the current level of shareholding in the Commercial Bank for the time being by subscribing in full to the proposed rights issue of CBC,’’ DFCC directors said in a detailed circular to its shareholders.

"The board has taken note of the fact that any future divestment of all or part of the holding in CBC may result in a surplus of regulatory capital and in such an event the board will consider returning to shareholders funds attributable to them to the extent such funds are not required for the projected medium term business expansion plans of the bank."

Based on the volume weighted average price of the Commercial Bank share on March 15 at Rs.222, DFCC’s investment in the Commercial Bank was worth nearly Rs.8.6 billion on that day.

"The envisaged investment will carry the risks and rewards associated with the banking and financial services, industry," the DFCC directors said.

In addition to in subscribing for its full entitlement in the Commercial Bank, DFCC also plans to invest some of the cash raised in the rights issue to maintain its capital adequacy ratio at a level above 12% "as otherwise it may have an adverse impact on the (DFCC’s) credit trading and subsequently the cost of funds of the bank."

Some employees of the Commercial Bank have filed legal action against the DFCC and some other defendants in October 2005 in the District Court of Colombo seeking among other things an order directing the DFCC and other named defendant shareholders to reduce their aggregate shareholding in the Commercial Bank to a maximum of 10% by selling the excess holding.

Although the District Court has refused the interim relief sought, on November 2, 2005, the Court of Appeal issued an enjoining order restricting the aggregate voting rights in the Commercial Bank of the DFCC and other defendant shareholders to 10%.

DFCC has filed objection to this restriction and the Appeal Court has reserved its order.

The DFCC circular said that it held 28.99% of the Commercial Bank’s voting shares and the other defendant shareholders named in the Court action who were subject to an enjoining order held 12.51% as at December 31, 2006.

"The bank’s holding is consequent to an acquisition made in 1997 with the necessary special approval required under the Banking Act. There has been a slight reduction in the percentage holding by the bank over time due to the dilution arising from shares issued under Commercial Bank’s employee share option plan," the circular said.

On July 24 last year, the District Court made an order dismissing the action on the basis of preliminary objections raised by the defendants but this judgment is under appeal in the Appeal Court. Meanwhile the enjoining order continues to be binding on the DFCC and other defendants.

"A shareholder of Commercial Bank has also initiated an action seeking a writ against the Monetary Board on the same issue. The bank is also a defendant in this action and has filed objections. This matter is pending in the Court of Appeal," the circular said.

In the meantime, the Monetary Board of the Central Bank made a direction on January 19 this year stipulating that previously approved shareholdings exceeding 15% in licensed commercial banks must be reduced to 15% within a period not exceeding five years to be determined by the Central Bank.

If such reduction is not effected by the stipulated date, the voting rights relating to such shareholding will thereafter will be limited to 10%.

The Central Bank has not yet made a determination under this direction made earlier this year in respect of the DFCC’s shareholding in the Commercial Bank.

Meanwhile, the Commercial Bank had recently announced that it was in discussion with the NDB with a view to a merger of the two banks. Such a merger will require regulatory approval as well as the approval of shareholders of both banks.

If such a merger is accomplished, DFCC noted that this would mean an automatic reduction of its shareholding in the merged entity.

The forthcoming DFCC rights issue will not be underwritten. In the event of an under-subscription, the issue will be concluded with the amounts subscribed and the DFCC’s capital adequacy ratio will be strengthened to the extent of the subscription collected, the directors said.