At The Market with Tetrad – Sector banks on consolidation for survival

By Brian K Mugabe

The almost inevitable shake-up in the banking world, induced by the rapid rise in interest rates to as high as 1 000% near the end of 2003 and the downward impact this had on the stock exch

ange, which saw the industrial index almost halving from an opening position in December of 714 250 points to a low of 396 316, before eventually closing the month at 401 543, is probably still in its infancy.

This negative correlation between equities and the money market saw individuals and institutions who had leveraged heavily on hugely negative real interest rates to invest on the stock market, (as well as in properties and foreign exchange), proved to be their downfall, as a hitherto profitable strategy became a loss-making one.

Financial services which because of the skewed but profitable fundamentals in place saw many new entrants joining the party. These new players, in a bid to head hunt staff from more established players, offered very healthy remuneration packages, packages that they were able to sustain from stock market, foreign currency and “real asset” trading profits, all of which provided escalating streams of income, that is, until interest rates shot up.

The economic concept that assumes rational investors prefer lower risk for the same return, or higher return for the same risk, came into play. The question being, of course, why risk your capital on stock/property/parallel rate movements, when you can simply place your money on the money market and earn compounded returns well in excess of 1 000%?

Thus a sell off of the abovementioned asset types began and their prices fell. Suddenly there wasn’t enough money to pay salaries, maintain vehicle fleets and, in the worst case scenario, repay some depositors.

Those who were holding those assets found that to sell them would mean taking a big loss and so attempted to hold them leaving them short of cash, and along with the introduction of more stringent central bank liquidity support criteria, a liquidity crunch ensued.

The closure of ENG, Century Discount House and the liquidity crisis at Trust amplified the sector’s negative situation. A run on deposits at the less well-known and relatively newer institutions began as there was a “flight to quality”, putting these institutions under even more pressure. Closures of many quasifinancial institutions have since followed, while behind-the-scenes, mergers and consolidations between some of those remaining are said to be on the cards as players look to survive going forward. The massive jump in minimum capital requirements for financial institutions has also contributed to this.

A cautionary published by First Bank on Friday last week advised shareholders that the directors of the company were contemplating a transaction and were simultaneously involved in negotiations that could have a material impact on the company’s share price, has been reported in the press to involve a merger of the bank with National Discount House and listed reinsurer Sare which also published a similarly worded cautionary statement.

No doubt this transaction, if confirmed, will be the first of many, especially given that for some the only alternative available would be closure.

Those that feel that merging is unnecessary will probably still require rationalisation of some sort, a process that has already begun at some banks who are offering retrenchment packages, as cost to income ratios come under fire given the reduced earnings potential of the sector. Also publishing cautionaries over the past week were Trust and First Mutual, who along with Century had been suspended from the stock exchange pending statements explaining to shareholders what their financial position was, particularly in light of their direct and indirect exposures to ENG.

Trust’s cautionary commented on the group’s liquidity constraints and highlighted the steps that were being taken to address this such as an asset disposal programme and management restructuring, steps that had the full backing of the central bank as confirmed by the statement published by the latter. In terms of financial performance, the group still expects to report a profit for the year ended December 31 after fully providing for the potential costs of the liquidity problem, the costs of liquidity support provided by the Reserve Bank of Zimbabwe, the unrecovered $2,2 billion arising from the publicised fraud, adequate provisions for bad and doubtful debts and a potential write down of $10 billion on its investment in First Mutual. Under these conditions, EPS for the year is expected to be $41, with fully diluted EPS of $39,25 having been made in the first half of the year.

The cautionary by strategic partner First Mutual enunciated the potential impact of the group’s direct exposure to ENG. This exposure unsecured and reportedly unauthorized at the time of placing, amounts to $39,8 billion, representing capital of $29,6 billion with the balance being interest.

Efforts to recover these funds through the liquidation of ENG are in progress, but assuming no recoveries, the impact of the exposure on First Mutual’s financials will be a write off of $33,2 billion for the year to December 2003, and a further $6,6 billion in the half year to June 2004.

Taking into account the group’s 25% shareholding in Trust, a potential write off of $31,4 billion to December and an unchanged $6,6 billion to June 2004 is foreseen. This translates into write-offs per share of $7,48 and $1,57, respectively.

The two counters have since had their suspensions lifted but it will probably be a long time before either regains its lustre on the bourse, a condition that holds true for the sector as a whole.