A bank sold for just Rs1,000. Does it make any sense?

“She walked up to my seat and handed me a tissue paper that had a phone number scribbled on it. This was unusual: a female flight attendant giving her cell number to a random male passenger – it’s mostly the other way around, you know. She asked me to call her after the flight and explain how I was able to buy a whole bank for just Rs1,000, even though her personal account in the same bank had a deposit of Rs20,000,” BankIslami Pakistan Ltd (BIPL) CEO Hasan Bilgrami said at a recent public event in Karachi.

This little anecdote captures the bewilderment of ordinary Pakistanis at a transaction that transferred the ownership of KASB Bank to BIPL three years ago for just Rs1,000.

The ‘fantastic deal’ has not just stopped at perplexing so many people – an overwhelming number of experts and ordinary folk alike find the opaqueness of the whole deal unsettling.

The issue received renewed media attention early this month when a report by the auditor general of Pakistan (AGP) called the amalgamation ‘irregular’, noting that it caused a loss of Rs3.4 billion on concessional loans extended to BIPL by the State Bank of Pakistan (SBP). The National Accountability Bureau (NAB) also smells a rat and has expressed it without reservation in one of its reports.

The relentless scrutiny has not stopped at that. Post its meeting on April 25, the head of the National Assembly’s Public Accounts Committee and the leader of the opposition in the National Assembly, Khursheed Shah, was miffed at the unseemly merger to the point to make that rarest of requests to the Supreme Court: To take suo motu notice of the SBP’s transgression, “terming it the biggest scandal in the central bank’s history that had also tainted its image.”

With the issue already under investigation by the bureau, Shah also called on the NAB chairman to turn it into an exemplary case.

Sold for a song?

A bank is supposed to be well-capitalised, i.e. it should have the capacity to absorb losses on its assets and continue to remain solvent. As events transpired, the SBP put KASB Bank under a moratorium in the middle of November 2014 for its lack of capitalisation.

In May 2015, KASB Bank with 105 branches and total assets of almost Rs67 billion was sold to BIPL at a token price of Rs1,000.

KASB Bank wasn’t capitalised up to the regulatory requirements. Hence, it posed a risk to the banking system, according to the SBP. Any failure on its part to honour its financial obligations could possibly lead to system-wide repercussions.

The central bank froze the accounts of the bank, meaning big depositors and sponsors were not allowed to take out any funds. The SBP directly engaged KASB’s audit firm (Ernst & Young) that reviewed the bank’s financial statements and concluded that the enterprise had a negative net worth.

Next, the SBP invited interested buyers to conduct due diligence of their own. Four banks – BankIslami, JS Bank, Sindh Bank, and Askari Bank – showed their interest and BIPL eventually acquired it at a token price of Rs1,000.

But what about the deposit of Rs20,000 that the flight attendant had in KASB Bank? Wouldn’t Bilgrami have a surplus of at least Rs19,000 on day one?

In fact, the last published balance sheet of KASB Bank showed it held deposits of almost Rs62 billion on September 30, 2014.

How could a bank with deposits of billions of rupees be handed over to a buyer for just Rs1,000?  

The question has apparently befuddled everyone, ranging from a rank non-cognoscenti like a flight attendant to the hawk-eyed AGP and from probing media pundits to the NAB’s cynical sleuths.

“… (The SBP) management amalgamated KASB Bank, having assets and deposits of Rs57 billion with BankIslami on May 7, 2015 without considering market value of assets of KASB Bank or its shares price at the stock exchange…”, the AGP report for 2017-18 stated.

The language used in the AGP report is unclear on whether Rs57 billion was the value of KASB Bank’s assets or deposits. For a bank, deposits are liabilities, not assets.

Simply put, deposits are funds that a bank owes to its clients. Just like an unpaid electricity bill, deposits represent an amount payable for the bank.

In a distressed sale, which was the case in KASB Bank, carrying a deposit base without an equivalent amount of assets (loans to borrowers) is a bad thing. It’s bad because the buyer has to undertake that it’ll pay depositors their money whenever they come knocking at its door.

“So the price consideration of Rs1,000 that you hear is wrong. The net price is Rs1,000 plus an undertaking to take Rs53 billion of deposits,” said Bilgrami. He was obviously exaggerating by not taking the assets of KASB Bank into consideration.   

A loss-making enterprise

The Chakwal Group was the original owner of KASB Bank, which was then licensed as Platinum Commercial Bank. It sold the bank to Nauman Builders in 1998. The KASB Group acquired the bank in 2002 and renamed it.

The new owners then decided to keep their myriad businesses on the balance sheet of KASB Bank, which became a holding company of sorts for the KASB Group.

So when BIPL took it over, KASB Bank was operating as a commercial bank and acting as a significant shareholder of an oil exploration company, an asset management company, securities brokerage firm and investment bank, a modaraba management company, a foreign investment company, a foreign venture capital company and even a real estate company.

According to Bilgrami  KASB Bank was the only bank in the region that had a negative capital adequacy ratio (CAR) as per a later balance sheet that KASB Bank prepared itself in November 2014. The ratio stood at minus 4.6 percent. That means that its liabilities outstripped its assets.

With a loss of Rs49.5 million in the third quarter of 2014, the bank’s accumulated losses amounted to Rs12.5 billion on Sept 30. Its non-performing loans (NPLs) as a percentage of total loans were the highest in the industry at the time.

In its last printed financial accounts, the bank acknowledged “the existence of material uncertainties” regarding its “sustainability”.

In the notes to the unconsolidated financial statements for the third quarter of 2014, KASB Bank stated: “Currently, the bank is in violation of the applicable regulatory capital requirements, which exposes the bank to regulatory actions under the banking laws… The bank may, therefore, be unable to continue realising its assets and discharging its liabilities in the normal course of business,” it said.

In a thinly veiled statement, the defunct bank also implied that it wasn’t receiving support from the SBP to implement a restructuring plan. “While the bank has regularly updated the SBP on its plans and proposals regarding the recapitalisation and restructuring of the bank, it needs an explicit support of the SBP in accepting and moving forward with its recapitalisation and restructuring plan.”

In short, the bank was in poor shape. It was bleeding money quarter in, quarter out. Its restructuring plans were not being approved. The SBP was getting anxious, and the bank seemed to know something bad was going to happen.

Liquidity to deploy

BIPL was a small Shariah-compliant lender at the time and also struggled to meet the regulatory requirements regarding CAR. Its earnings amounted to only Rs134.3 million in the third quarter of 2014.

As opposed to the share capital of Rs19.5 billion on the balance sheet of KASB Bank, BIPL’s share capital was just Rs5.2 billion on Sept 30, 2014. However, BIPL didn’t have huge accumulated losses on its balance sheet like KASB Bank.

This resulted in net assets of BIPL amounting to Rs6.8 billion against just Rs1.3 billion on the books of KASB Bank.

In order to raise its capital, BIPL had just concluded a rights share issue of Rs400 million and was in the process of holding another issue to meet the SBP’s requirement regarding capitalisation.

“The reason we went [for the acquisition] was that we had a rights issue. There was a dearth of assets in the Islamic banking industry. So we thought if we acquired a bank we could deploy our capital,” Bilgrami said.

As on Sept 30, 2014, BIPL’s book value per share was Rs12.90 against Rs0.60 per share of KASB Bank. The book value per share is a key indicator that analysts use to assess the real value of shareholders’ equity in an entity.

Even the miniscule book value per share of KASB Bank at the time was due to heavy deferred tax assets, according to Bilgrami.  Deferred tax assets are created when a company pays taxes in advance. These are returned to the company in subsequent years in the shape of tax relief.

KASB Bank’s deferred tax assets amounted to almost Rs4.8 billion on Sept 30, 2014.

The decision to acquire a conventional bank with a troubled balance sheet wasn’t difficult for BIPL. It had the prior experience of buying out Citibank’s entire mortgage portfolio and then converting it into the Islamic mode. “We were fairly confident that we could convert the (KASB) portfolio, we could also extract some value out of it.”

Due diligence

The SBP engaged PricewaterhouseCoopers, a chartered accountancy firm, in December 2014 to conduct KASB Bank’s financial due diligence and valuation, supposedly a comprehensive appraisal of a bank’s books to determine its net worth.

The exercise concluded that the bank was tanking: its net worth was negative.

This means the bank’s liabilities were actually higher than its assets. According to one senior central banker who was directly involved with this transaction, the valuation exercise unearthed too many “unacknowledged losses” in the form of bad loans that eventually ate into the bank’s equity and turned it negative.

The SBP didn’t make the valuation report public. It didn’t even share it with the sponsors of the defunct bank. The former SBP official refused to state the negative value that the audit firm arrived at after conducting the valuation exercise.

“The Banking Companies Ordinance 1962 doesn’t require the central bank to share the valuation report with stakeholders,” he said.

Afterwards, Sindh Bank, Askari Bank, JS Bank and BIPL expressed interest in acquiring KASB Bank and conducted their own due diligence exercises, using different audit firms.

“Then all the leading (audit) firms of Pakistan, including KPMG, Ernst & Young and Deloitte, evaluated the bank and all arrived at a negative net worth… so the negative net worth is very well-established,” claimed Bilgrami.

BIPL decided to go ahead with the transaction. Using Section 47 of the Banking Companies Ordinance 1962, which gave the central bank the power to apply to the federal government for the suspension of business by a banking company and prepare a scheme for its reconstruction or amalgamation, the SBP let BIPL assume all assets and liabilities of KASB Bank in May 2015.

“The SBP uses the power of a high court. So it’s a quasi-judicial power that is used and can be challenged only in a high court. This is a powerful section. Everywhere in the world, central banks have got this power. Especially after the crisis of 2008, all central banks armed themselves with more powers. The idea is that financial markets should be working smoothly and there should be no destruction in the financial markets,” said Bilgrami.

One of the reasons other potential buyers looked at KASB Bank with suspicion, according to Bilgrami, was the presence of ‘Iranian deposits’ of $200 million.

“It was the big elephant in the room,” he said. Having funds of a sanctioned entity can spell disaster for a bank. Seemingly small acts of noncompliance with global financial regulations can attract severe penalties. Case in point: the recent penalty of $225 million on Habib Bank Ltd (HBL) for regulatory noncompliance and the subsequent closure of its New York operations.

Unlike other interested buyers, BIPL decided to actually evaluate the implications of having an entity that “had a sanctioned account”. It engaged lawyers in Pakistan and abroad and corresponded with the US Treasury. “We found out that probably the least concerning thing was Iranian deposits as long as we comply with sanctions’ conditions… it’s been three years and we have never been bothered about it. The lesson learned is do not go by the popular perception. The reality may be completely different,” he said.

This comment raises questions about the quality of the due diligence exercise conducted by the rest of the potential acquirers. Were they allowed to contact the sponsors of the defunct bank to seek an explanation about the “Iranian deposits”? In a typical case of due diligence, potential acquirers get such information from the current management. Why did the other three banks stay in the dark about the non-toxic nature of these deposits? Did SBP try its best to sell KASB at the best possible price?

The run, largest ever in Pakistan

Even a hint about a bank going under can ruin its credibility for years to come. What depositors heard in November 2014 wasn’t a little murmur. It indeed was a blast. Every depositor was worried. Everyone wanted out once the moratorium was imposed.

Imagine you had a savings account at KASB Bank and you had a medical emergency in the months following the imposition of the moratorium. It was your money and yet you could not withdraw it from the bank. Imagine you had to remit funds overseas for your daughter’s tuition, but your bank had shut shop indefinitely.

As soon as the moratorium was lifted, and KASB Bank branches reopened under the BIPL banner, there was a run on the bank – the largest in our banking history.

People queued up outside branches and withdrew their deposits in droves. BIPL’s umbrella didn’t inspire much by way of confidence. After all, it too was not a big bank with a balance sheet carrying assets of trillions of rupees! It really was a small bank itself, with limited brand recognition.

“We had collected data and found out that the worst run in the banking industry was 30 percent (of deposits). So we budgeted that 30 percent would be withdrawn, which was around Rs16 billion,” Bilgrami said.

He clearly underestimated the desperation of depositors to take out their money at the first opportunity. “Withdrawals amounted to Rs27 billion. Everyone was paid the money they demanded,” Bilgrami said, adding that no depositor returned empty-handed once the bank reopened.

BIPL sought support from the SBP to ease the growing pressure on deposits. It demanded that the SBP extended a credit facility of Rs8 billion at no cost to BIPL for 10 years at least so that the negative net worth of the bank could be plugged. The central bank partially agreed to this demand, giving Rs5 billion instead.

BIPL also requested that whatever amount was withdrawn should then be made available to it by the central bank (in the form of a loan) so that there is no pressure on deposits.

The SBP accepted the demand, but capped the amount at Rs15 billion. “For both Rs5 billion and Rs15 billion (loans from the SBP), we provided our assets as collateral. Had BIPL not stepped forward and offered its assets to be put in as collateral, Rs20 billion was not available with KASB Bank to meet withdrawals,” Bilgrami said.

BIPL received the first loan of Rs5 billion at an interest rate of 0.01 percent while the second loan of Rs15 billion had a subsidised annual cost of 4.7 percent. According to BIPL’s own estimates, this translated into a benefit of almost Rs3 billion for BIPL.

An empire crumbles

Walk a mile in the shoes of the KASB Bank sponsors, and you’ll know what it means to build a business empire over decades and lose it all in just one night.

Almost 84 percent shares of KASB Bank were owned by KASB Corporation before the moratorium kicked in. The corporation owned, besides KASB Bank, seven other subsidiaries – KASB Funds, KASB Invest, KASB Capital, KASB Securities, KASB Modaraba, My Solutions Corporation and Structured Venture.

But with BIPL acquiring the entire KASB Bank consisting of 1.9 billion shares for just Rs1,000, the value of KASB Corporation’s stake in the bank came down to zero.

Furthermore, KASB Bank owned 77.1 percent shares in KASB Securities, one of the prominent brokerages of the time. As a result of the forced amalgamation of KASB Bank with BIPL, KASB Securities automatically became a subsidiary of BIPL when the Islamic lender took over the distressed bank.

Sponsors of erstwhile KASB Bank have stayed mum since May 2015. They have generally refrained from giving press interviews, despite hundreds of TV shows having discussed the KASB saga between then and now.

Speaking to Profit on the condition of anonymity, a source close to the group sponsors said the battle for shareholders’ right to KASB Bank is still not over.

“Around 15 shareholders have gone to the Sindh High Court (SHC). As a citizen, I have a fundamental right to my property. No quasi-judicial authority (SBP) can usurp this right,” he said.

In the third week of April, the SHC ordered the SBP to reconsider the valuation of the defunct KASB Bank, saying it did not adequately fulfil its statutory duty to protect the interests of all stakeholders.

Flawed valuation

The past sponsors of the bank maintain a strong difference of opinion with the SBP and BIPL on literally every aspect of the KASB Bank saga.

For example, they don’t accept the SBP-mandated valuation of the bank by PricewaterhouseCoopers on both legal and technical grounds. He said the valuation has not been shared with the past sponsors of the bank even after three years of the forced amalgamation. “The board of directors was never shown the valuation.”

As for technical flaws, he said the valuation by PwC assessed the net worth of the bank based on the book value of assets purchased many years ago.

In other words, the valuation exercise by the audit company did not take into account the price appreciation in assets, such as real estate and shares in other listed and unlisted companies. Had the valuation been conducted on the basis of mark-to-market, a system of assessing the value of assets by the most recent market price, the net worth of the bank would’ve been tens of billions of rupees, he said.

For example, KASB Bank invested Rs620 million 12 years ago in Good Milk, a product by an unlisted dairy company that has grown substantially since then. Using the valuation that Engro Foods received recently on the Pakistan Stock Exchange (PSX) as a benchmark, it can safely be assumed that the share price of the unlisted company should now be around Rs100, he said.

This means that the current price of the bank’s investment of 12 years ago should hover around Rs6.2 billion. Good Milk is just one such example. “Investments at cost” in the ordinary shares of unlisted companies amounted to more than Rs1.1 billion on Sept 30, 2014.

“Even a qaroon ka khazana would amount to nothing if you calculated its net worth at prices recorded on books,” he said.

In its latest order, the SHC ordered the central bank to share the external auditors’ report on KASB Bank’s valuation with shareholders.

As for the valuation done by Ernst & Young, he said the SBP brought it in to close the accounts. The firm served as the bank’s auditor and the SBP needed its certificate to go ahead with the forced amalgamation. “We still have Ernst & Young’s valuation report of Rs13 billion that it made in 2014,” he claimed.

Instead, the audit by Ernst & Young that it carried out in early 2015 on behalf of SBP held that KASB Bank’s book value was a negative Rs5.8 billion.  

No regard for stock price

Usually, the starting point to arrive at the net worth of a listed company is the stock exchange. Multiplying the share price on a given day by the total number of shares outstanding gives investors a basic idea about the approximate worth of the company.

But the market price was completely ignored in this case. The bank was sold for Rs1,000 although retail investors were trading the share at around Rs3 a piece. With 1.95 billion outstanding shares, the net worth of the bank – in the eyes of stock market investors at least – should’ve been around Rs5.85 billion.

But the logic of valuing the bank based on the stock price is rejected by Bilgrami. “One must take note that on the basis of the market price-to-book value (P/B) ratio, KASB Bank was more expensive than MCB Bank, which was the most capitalised bank in Pakistan,” Bilgrami said.

 

A P/B ratio that is higher than other players in the same industry reflects that the stock is overvalued. Simply put, Bilgrami, as well as the regulator, believed investors trading the stock on the PSX were clueless about the actual financial condition of the bank.

According to the former senior official of the SBP, the central bank believed that the shareholders of the bank had already lost their investments when the bank’s equity became negative as per the valuation conducted by PwC. The regulator also believed that its primary responsibility was to protect the interests of the bank’s depositors, not shareholders, he said.

NPLs, provisions and reversals

The source in the KASB Group insists that having a negative CAR constituted a weak basis for its forceful sale to another bank. “Why did they let us operate for so long then?” he said, noting that not a single depositor ever had to return without their cash.

There was no concern about the bank lacking liquidity, which includes cash and cash-like assets. In line with the regulatory requirement, the bank’s ratio of liquid assets and liabilities was 51 percent at the end of the third quarter of 2014.

“A bank collapses only when it lacks capacity to pay depositors. Our CAR was negative for a single reason: our provisioning against NPLs. But their recovery was already well under way,” he said.

Banks are supposed to set aside funds, called provisions, against potential loan losses. But provisioning is only an accounting adjustment. It incorporates changing projections for expected loan losses. So while provisioning puts a dent in a bank’s profitability, any reversals in subsequent quarters also help it grow back.

KASB Bank was heavily capitalised back in 2008. But NPLs rose in later years. This resulted in the bank recording substantial provisions for those loans in 2011, 2012 and 2013, thus hurting its bottom line.

He said, with growing recovery of loans underway, the bank’s CAR was set to improve in a short span of time. “In 2014, we posted a net profit of Rs1.4 billion. But the SBP didn’t let us hold the annual general meeting for shareholders’ approval. A profit of Rs1.1 billion came from recovery (of NPLs) only. It was the momentum of our recovery that BIPL has already got Rs5 billion in cash that the valuation had shown to be zero,” he said, adding that NPL recovery was expected to increase next year and get even bigger in the year after.

Chinese investors

Bilgrami believes the emphasis should be on capitalisation rather than liquidity. Internationally, banks are put under moratoriums for three distinct reasons: lacking liquidity to pay depositors, corporate governance issues, and solvency i.e. the entity losing its capital. “Globally, more banks have been put under a moratorium due to a loss of capitalisation than the loss of liquidity,” he said.

But even if the bank’s lack of capitalisation was a pressing issue needing immediate resolution, the KASB source said, Chinese investors were willing to inject capital into the bank.

The Cybernaut Group of China had shown interest in investing $100 million in KASB Bank. But the then SBP governor reportedly refused to meet Dr Tom Zhang, senior partner of Cybernaut.

Cybernaut agreed to invest $20 million initially which, going by the number of shares on offer, came close to the market price of KASB Bank shares at the time. But the SBP did not allow Cybernaut to open an escrow account, which is a temporary pass-through account held by a third party during the process of a transaction between two parties. This stopped the Chinese investor from remitting $20 million.

“Chinese investors offering money would have solved the CAR issue. The embassy of China wrote letters. They lie when they claim that the embassy refused to support Chinese investors. That correspondence is part of the court petition,” the source said.

As for the bank’s statement released on the PSX denying the presence of any Chinese investors, he said the SBP forced the CEO to issue it as the bank was under the moratorium.

However, Bilgrami asserts that the Chinese equity investors could not even produce their business cards although they claimed to have $100 million. “The Chinese embassy refused to extend any help to those investors,” he insisted.

Special credit facility

An inquiry report prepared by the National Accountability Bureau (NAB) concluded that the credit line of a total of Rs20 billion that the SBP extended to BIPL at low-interest rates showed that the acquirer was “not capable of managing the losses of KASB. So there was no point in merging (KASB Bank) with BIPL as other remedies were also available in the SBP Act and Banking Companies Ordinance,” it said, adding, that similar financial assistance could be given to KASB Bank by appointing an administrator and changing its board structure.

The ex-official of the SBP believes the original sponsors of the defunct bank had ceased to fulfil the central bank’s fit-and-proper criteria — a set of requirements to ensure that untrustworthy people stay away from the decision-making process at commercial banks. “The central bank didn’t consider any scheme under which the original sponsors could retain control over the bank post-moratorium,” he said.   

In response to the charge of availing cheap financing from the SBP to survive the bank run, Bilgrami said it was perfectly in line with the precedents set by different central banks all over the world.

“In the United States, the Federal Reserve spent $247 billion to provide liquidity to the banking industry… In Canada, authorities pumped in $114 billion,” he said.

But referring to the liquidity crisis of 2008, the KASB source said about a dozen and a half banks took a credit facility from the SBP at the rate of 18 percent. “This is Pakistan, not America. How could BIPL receive credit at 0.01 per cent?”

The fact that BIPL faced a bank run as soon as it opened the rechristened branches of KASB Bank proves that BIPL lacked public trust, he added. “Would there still be a run had a strong entity like HBL acquired KASB Bank?”

The KASB source also asserted that, contrary to Bilgrami’s claim, the run was actually of Rs23 billion, and not Rs27 billion. BIPL in its annual accounts for 2015 puts the number at Rs 24.9 billion.

He said KASB Bank would’ve absorbed the shock had the regulator let the sponsors be and allowed foreign investment from China in time. Cash and available-for-sale securities, like treasury bills and PIBs, alone amounted to over Rs30 billion, sufficient to survive the run, at the end of September 2014.

The last published quarterly accounts of KASB Bank showed it had cash and balances with treasury banks amounting to Rs4.8 billion. Separately, its investments listed under the available-for-sale securities were worth Rs25.5 billion.

This means it had liquidity of more than Rs30.4 billion on September 30, 2014.   

According to him, BIPL sold only those treasury bills and PIBs that were lying with KASB Bank to meet deposit withdrawals. “They didn’t spend a single rupee out of their own pockets.”

The NAB report also accuses the SBP of sabotaging the possible sale of KASB Bank to Samba Bank and MCB Bank right before the imposition of the moratorium. KASB Bank’s deferred tax asset of at least Rs4.8 billion could have provided substantial tax savings to a large profitable bank, like MCB Bank. Yet the central bank ‘favoured’ BIPL, the NAB report concluded.

It called the appointment of PwC an ‘illegal act’ by the SBP. It also highlighted instances of insider trading and “backdoor takeover” of BIPL.

The SBP maintains that it committed no wrongdoing and acted only in the interest of the depositors.

Shareholders of erstwhile KASB Bank have still not lost hope. The SHC order entails that the SBP should revisit the process to determine the bank’s valuation as per statutory requirements. The central bank will have to compensate the shareholders in case the fresh valuation is higher than the previous one.

If the fresh valuation is also unfavourable to them, the shareholders plan to knock at the door of the Supreme Court of Pakistan.

“No one has the right to arbitrarily determine the value of my property,” the KASB source said.

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Editor’s Note: The state of the State Bank

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