Raw deal? Weak books complicate teachers’ bid to buy Merali bank

If all things remain constant, it could take Mwalimu Sacco 36 years to recover a Sh1.6 billion investment in Equatorial Commercial Bank (ECB), based on the bank’s current financial statements.

This is three times longer than the 12 years investors in Kenya’s booming banking sector are taking to recover their investment.

These calculations are based on a financial metric known as the price to earnings ratio, which for ECB, currently stands at 36, while the average ratio for other commercial banks stands at 12.

The price to earnings ratio shows how much investors are willing to pay for each shilling of earnings.

Shareholder funds

Further, for every Sh100 of shareholders money ECB holds, it returned Sh3 in net income last year. This is seven times lower than the Sh21 for every Sh100 of shareholders’ funds in top Kenyan banks.

ECB enjoyed a return on equity — a measure of how efficiently a bank is using its shareholder funds — of 3 per cent compared to an average return on equity of 21 per cent for some of the commercial banks listed at the Nairobi Securities Exchange (NSE).

Perhaps these are some of the cold, hard figures that have seen financial services regulators and the Government beat a hasty retreat and call off an acquisition that had received their blessing earlier.

The question that closer scrutiny of the numbers begs is what teachers — who occupy the highest number of workers in the public sector workforce, and who own Mwalimu Sacco — are expecting from the deal, should it go through.

In what would have been one of the most brazen acquisitions in the Kenya’s financial sector, Mwalimu Sacco — the largest savings and co-operative society by assets — had bid and received approval to acquire a 51 per cent controlling shareholding in ECB, a bank associated with business magnate Naushad Merali. The Sacco’s shareholding would later increase by 24 per cent.

Under the terms of the deal, Sh600 million of the Sh1.6 billion purchase price would be invested in the bank and Sh1 billion would go towards buying shares, according to an earlier statement from Mwalimu Sacco CEO Robert Shibutse.

Francis Mwangi, a banking sector analyst, told Business Beat that the price tag on the bank could be higher than the industry price, at least going by profitability ratios.

In its latest annual financial statements, ECB reported Sh55.7 million in profits for 2013, overturning a Sh481.9 million net loss in 2012.

But Mr Mwangi said the valuation of the bank cannot solely rely on the price to earnings ratio. The business strategy, the quality of assets owned by the bank and even its management would typically determine how much the business is worth.

“It would be critical for Mwalimu to understand why the bank reported losses in the first place, and how its plans would ensure sustained profitability moving forward,” he said.

He noted, however, that ECB’s client profile should be a “big point of concern to any buyer”.

“I would want to know who banks with ECB to determine the exposure,” he said.

The basic rule in banking is to source money cheaply from customers and institutions, and then lend it at a higher rate, while ensuring borrowers do not default.

Over the years, ECB appears to have got these basics wrong. This can be seen from the fact that the bank’s interest expense — which is money paid out on customer deposits — has been growing at a faster rate than interest income.

Take, for example, in 2012, when the bank’s interest expense more than doubled — growing at 125 per cent — to Sh1.5 billion from Sh684 million in 2011.

On the other hand, the interest income increased by only 75 per cent to Sh1.8 billion the same year, compared with Sh1.07 billion in 2011.

And there is more about the acquisition that is intriguing.

In August last year, Mwalimu Sacco unveiled its new CEO, Mr Shibutse, a career banker.

Shibutse had for a one-year period — May 2012 to April 2013 — served as ECB’s acting managing director. He was replaced by Sammy Itemere, another career banker.

Shibutse continued to act as a director at the bank until his move to head Mwalimu Sacco last year.

Instructively, Shibutse is listed as a director at Fidelity Shield Insurance, in which ECB has a 23.86 per cent stake. ECB has another 20 per cent stake in Equatorial Investment Bank.

Therefore, for Mwalimu Sacco, the deal becomes about much more than just acquiring a commercial bank licence.

In one fell swoop, the teachers’ Sacco would become a financial supermarket, offering highly sought-after insurance services, and an avenue for its members to buy and sell shares through its investment bank.

If you add the mortgages and plot-buying opportunities Mwalimu Sacco already offers its members, this acquisition would have caused the Sacco to become a big influencer in Kenya’s financial services.

Financial muscle

In the early days of the deal, financial services regulators, Central Bank of Kenya (CBK), the Competition Authority of Kenya (CAK) and Sacco Societies Regulatory Authority (Sasra) had given the transaction their go ahead.

The deal was expected to see Mwalimu Sacco boost its estimated 60,000 members’ financial muscle, while giving the institution an edge over other top co-operative societies in the country, such as Harambee, Stima, Kenya Police and Ukulima Saccos.

But two days after the news was made public, the Government froze the transaction, with Commissioner of Co-operatives Patrick Musyimi invoking sections 58 and 73 of the Co-operative Societies Act to veto the regulators’ decision.

The Government and Sasra disowned the deal, saying no due diligence had been done to determine the value of the bank and subsequently the price that a buyer would pay for a stake.

A statement from Mwalimu Sacco, however, stated that the deal had gone through rigorous financial and legal due diligence by Ernst and Young, and Mose and Mose Advocates. The regulators had raised no objections, it added.

Further, Mwalimu Sacco’s Shibutse said the transaction had been approved during the society’s special delegates meeting in September last year.

But a letter from the Co-operatives Alliance of Kenya, the umbrella body for co-operative societies in the country, sent to Industrialisation Cabinet Secretary Adan Mohamed, said Mwalimu Sacco members had not given their consent to the purchase of ECB.

The alliance accused Mwalimu Sacco and ECB of “flouting due process at every stage of the transaction, despite the massive value of members’ investment involved”.

“No specific Annual Delegates Meeting (ADM) approvals have been granted to authorise the investment,” said the alliance.

“Instead, very limited disclosure promising unsubstantiated returns to members was presented for delegates to approve in a broadly worded resolution.”

The alliance further states that the decision to purchase ECB was unclear in terms of investment, how much money was involved, potential risks, returns and a financing model for the investment.

“The delegates of Mwalimu Sacco have given no specific approval for the Sacco to purchase shares in Equatorial Commercial Bank.”

Unanswered questions

Daniel Marube, the head of the alliance, added that the deal had more unanswered questions than earlier thought.

“Teachers would have spent at least Sh7 billion to turn around ECB,” he said.

This amount would be used to buy out Merali’s 75 per cent stake and shore up the bank’s core capital to required levels, he said.

“Teachers were never going to get value in this deal,” claimed Mr Marube, saying his lobby speaks for the individual saver within Saccos.

The alliance’s fears are compounded by concerns that most of the accounts at ECB could be affiliated with businesses owned by Merali, further complicating the bank’s risk profile owing to a perceived narrow client base

In his analysis, and that of unnamed financial professionals that he quotes, ECB’s accumulated losses and non-performing loan portfolio had more than wiped out the lender’s capital base, and as such, there was “nothing to be bought”.

Another Sh3 billion would be required to turn around the bank’s fortunes, he added.

“I am always asked why the Sacco did not just apply for a banking licence from the Central Bank,” Marube said, adding that it is now emerging that the contested deal “hugely favoured the bank”.

CBK requires a minimum capital of Sh1 billion for a banking institution, an amount Marube says would be “coins” for a Sacco whose total assets are estimated at Sh24 billion.

Controversial approval

While Sasra Chief Executive Carilus Ademba had approved the buyout, his board of directors has distanced itself from the decision, which might now leave him exposed.

Board Chairman John Nthuku told Business Beat he knew nothing about the deal, adding, “I also heard it from you.”

It is now unclear whether Mr Ademba, who still stands by the approval, signed off without consulting the board, much less the Industrialisation Ministry under which the co-operative movement falls.

Ademba said Sasra had given the deal between the two institutions the green light because it was within the confines of the country’s financial regulations.

“Mwalimu Sacco had raised the minimum share capital of Sh1 billion required by the Central Bank and even surpassed it by Sh2 billion,” he said.

“At the same time, Mwalimu Sacco is not transitioning into a bank, but has only invested in one, which will be its subsidiary to help Mwalimu Sacco in its investment activities.”

In the dark

Industrialisation Principal Secretary Wilson Songa has demanded an explanation about how Sasra approved the buyout, saying his ministry was kept in the dark the whole time.

“We will put Sasra to task to explain to us what is happening and how they arrived at the decision,” said Dr Songa.

But below the surface of the back and forth between regulators, ministry officials and Sacco officials lies a bigger struggle whose resolution could set a precedent and transform the balance between commercial banks and Saccos in the country.

Kenya’s giant Saccos — Mwalimu, Unaitas, Stima and Wakenya Pamoja — have in the past indicated a strong desire to take the next step and grow into the country’s commercial banking sector.

With deposits and loan books running into the hundreds of billions of shillings combined, Saccos are feeling caged and there has been an argument made for the transformation of these institutions into fully fledged banks.

The challenge, however, and one that is currently at the centre of the ECB-Mwalimu Sacco controversy, is where members’ interests come in, given that the commercial bank business is complex and risky.

Additional reporting by Wanjala Were

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