dfcu acquired Crane Bank for peanuts? Only if your head is buried in the sand

Two weeks ago, dfcu released its half-year after tax profit and it was all good. Dfcu announced a surge in after-tax profit of Shs114bn – the highest for any bank in Uganda in the first half of 2017. Dfcu over the same period in 2016 had only made Shs23bn. In the entire 2016, it made Shs46.3bn. The surge in after-tax profit is in the most part due to the fact that it is now a much larger bank after the acquisition of Crane Bank in January 2017.

The Crane Bank acquisition was significant – they would not have risked their money on it if they thought it was not going make money. The addition of some of the Crane Bank assets increased the loan book from Shs759bn to Shs1.2trillion as at end of June 2017. About Shs450bn of the total loans were acquired from Crane Bank. Loans to customers are assets for a bank because that is where the money is made. Other assets are things like furniture, branches and the core banking system among others.

The other significant acquisition from Crane Bank were the customer deposits. These are classified as liabilities because the money belongs to depositors. Dfcu’s customer deposits increased from Shs982bn to Shs1.8trillion. About Shs600bn of the new deposits came from Crane Bank.

The figures indicate that the acquisition of some Crane Bank assets and liabilities was indeed a good purchase. In terms of loans and advances, it meant dfcu could earn more interest income by the much larger loan book. More-so, dfcu also had access to deposits, however, the Crane Bank deposits also came with a large interest expense – in order to attract deposits, Crane Bank had perhaps the highest interest return on fixed deposits in the entire sector.

The higher income levels brought about increased profitability. Thus the after-tax profit rose to Shs114bn. For shareholders, the acquisition of Crane Bank was only but worrying at the start because they felt it was too toxic to take on. The performance provides some level of confidence.

A breakdown of that profitability indicates that about Shs60bn is from  fair valuation. In other words, this is a “paper profit” or what accountants call “unrealised gains.” This is a process hard to explain in English. dfcu hired an independent audit firm to carryout fair valuation process.

So, the core operational banking business contributed about Shs54bn to the after tax profit of the bank. Reasonable enough for a bank that made Shs23bn in the first half of 2016.

The reasons for the failings of Crane Bank are currently a subject of court case so we shall try to avoid that discussion. Bank failures are normal. They have happened before and will continue to happen.

There are some claims, rather unfounded that dfcu got Crane Bank for peanuts and that explains the profits. Pedestrian claims, like they say. For mergers and acquisitions, it is rather pedestrian to look at the loan book in isolation of deposits.

“BOU and DFCU also claimed that a lot of the assets of Crane Bank were bad loans, worth Shs 550 billion. They claimed that DFCU inherited Shs 800 billion worth of good loans from Crane Bank. Even a child of six years would see the stupidity of such a position – or the fraud involved in such a deal. If I am wrong to let BOU publish the sale agreement,” Andrew Mwenda claims in a rant.

Don’t mind the language.

In any transaction, as far as know, you don’t look at the assets in isolation of the liabilities. Also, transactions like this one are complex. Not just like buying tomatoes.

My understanding, from the several articles I have written, Crane Bank had more liabilities than assets. They had a negative net asset book of about Shs300bn. That is why it had liquidity challenges. It was struggling to meet needs of depositors. It was borrowing money from the interbank market (other commercial banks) at a premium, that the bankers at some point stopped to meet liquidity needs.

That is how Crane Bank ended up running to BoU – as a lender of last resort. Other banks had stopped lending and were charging as high as 20% because Crane Bank had become risky to lend to. BoU rejected.

 “Under the sale agreement, DFCU is required to pay back this money to BOU over a period of three years without interest. Yet Sudhir had asked for a loan of only Shs 165 billion from BOU (as lender of last resort) at an interest rate of 5% to recapitalize the bank. So BOU would earn Shs 8.25 billion per year. Instead, BOU refused to play its legal role as lender of last resort to the fourth largest bank in the country which posed a systemic risk to the industry. BOU instead said it could only lend Sudhir at an exorbitant interest of 20%. Unbelievable! But even then it didn’t lend him, suggesting that it deliberately wanted Crane to fail.” Mwenda writes.

Oh well, there was a problem with Crane Bank. BoU was going to lend money to Crane Bank to recapitalize the bank – to meet the short term needs of depositors. That was Crane Bank’s big problem. On one hand, cash was being burnt to meet depositor needs, whereas there was another large chunk of loans had gone bad. About 45% of the Crane Bank loan book had gone by end of November 2016. So, on one hand, the bank needs cash to meet depositor needs but also people are defaulting on their loans. Without resolving the NPLs, any capital injection would go out the same way to cover for depositors.

Mwenda’s suggestion is that BoU colluded with dfcu to “steal” Crane Bank from Sudhir. If you start failing to meet depositor demands by reducing withdrawal limits, then you re putting them at risk. Instead of waiting for the wound to expand, you treat the wound to ease the pain until it is fully cured.

For BoU to keep Crane Bank afloat and meet depositor needs, about Shs450bn was injected in the bank. In one week alone, about Shs250bn was placed in the bank in form of liquidity. BoU needed assurance that this money will be paid back by the new investors in the bank.

That was a requirement prior to any sale agreement. Dfcu on acquiring some of the assets and liabilities of Crane Bank also raised $50m (Shs180bn) from Arise BV – in less than a month -, now its largest shareholder. So, there was an acquisition fee, the Shs450bn (dfcu will pay this back in phases) and also capital injection of Shs180bn. Notably, dfcu had to set aside cash to ensure depositors had access to money, even those that wanted out.

And still, dfcu got Crane Bank for peanuts? Only if your head is buried in the sand.

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