THE reporting season for financial concerns is in full swing.
The Brett Chulu Column
Two salient features stand out with respect to the corporate results of financial institutions released so far.
Listed financial concerns are trading below their book values. There are corporate governance gaps. The cases of FBC Holdings (FBCH) and CBZ Holdings (CBZH) are instructive and representative in these two regards.
Discounted book values
FBCH traded at about 50% of its market value; its net asset value (NAV) was and is still well below its market capitalisation. When it comes to CBZH, its NAV at US$283 million is inordinately way above its market capitalisation of US$69 million.
For the entirety of 2016, CBZH’s market capitalisation oscillated between US$69 million and US$82 million, a book value discount of between 71% and 76%.
These discounts do not square with the financial performance of these two entities. FBCH posted a 21% increase in after-tax profit for 2016 to US$21, 9 million. CBZH posted an after-tax profit of US$23, 8 million. Although this CBZH profit level represents a 32% fall in after-tax profit from 2015, it does not justify a massive discount of CBZH’s book value. When a company trades below its book value, it signals several adverse possibilities.
It may indicate that intrinsic investors strongly believe that profits reported are overstated. It is a possibility that investors perceive banks in general to be under-provisioning for loan defaults in this liquidity-constrained and credit-default-prone economy. It is possible that investors do not share the faith in the quality of Treasury Bills that the chief executives of banks enthusiastically peddle in public. It may well reflect the view by intrinsic investors that the earnings growth prospects of the entire financial sector are not attractive in the foreseeable future. It could also reflect that investors are not confident with the quality of leadership directing the financial institutions. It could be that foreign intrinsic investors place a high-risk premium on the country and thus shy away from taking equity stakes in the Zimbabwean financial sector.
Intrinsic investors (as opposed to mechanical and short-term traders) typically hold their investments in a company for years. They typically trade in high volumes. For this reason, their trades cause significant movement in share prices. Intrinsic investors do a thorough study of a company and its wider context before investing. This can translate to months of patient fine-combed dissection of a company.
The absence of foreign intrinsic investors on the Zimbabwe Stock Exchange (ZSE) seems to be the most plausible explanation for financials trading at a discount to booked equity. The evidence for this is the disclosure made by our Reserve Bank of Zimbabwe governor and Finance minister that foreign investors prefer to invest in debt than equity, attracted by assured interest payments. CBZH is rated A-minus by global rating agencies. That is a good credit rating. Although FBCH’s credit rating has dropped from A-minus, it has for a long time been in the A-band.
It’s clear then that intrinsic investors are more worried by the perceived high country risk than financial sector attractiveness fluidities.
Corporate governance gaps
FBCH and CBZH are wanting with respect to best practice in terms of the composition of audit and remuneration board committees.
First, the best practice in constituting a board audit committee is that all members of the audit committee should be independent non-executive directors. FBCH in this regard is closer to this benchmark except for one flaw. One of the FBCH audit committee members has been a board member for over 10 years. It is now accepted that any person holding board membership for more than 9 years should be annually subjected to an independence test.
Unfortunately, FBCH have not explained if this audit committee member is deemed independent in light of exceeding the nine-year benchmark. Even for the two other members of the FBCH audit committee, nothing was said about their deemed independence. We cannot assume that since they are both non-executive directors, they are automatically independent.
The onus is on the CBZH to state so with reasons why they deem each audit committee member independent. As a result of this important omission, it is difficult to say the FBCH audit committee is composed of independent non-executive directors.
CBZH, on the composition of the audit committee, is nowhere near best practice compliant. For starters, the chief executive is a member of the audit committees of CBZH and CBZ Bank. Best practice is that a chief executive should not be a member of the audit committee.
Besides the chief executive, one other executive director is recorded as a member of the CBZH audit committee. CBZ Bank has two executive directors who are members of the audit committee. The impediment to adopting best practice in terms of the composition of the audit committee is that the audit committees double as finance committees, which perhaps necessitates the inclusion of executive directors. It would be in the best interest of CBZH to separate these, either by having a stand-alone finance committee or completely excluding executive directors from the finance and audit committees.
Second, the composition of remuneration committees deviates from best practice. Best practice is that the entirety of the remuneration committee should be non-executive directors. The majority of the remuneration committee members should be deemed independent. The chairperson of the board can be a member of the remuneration committee but cannot be its chair.
FBCH is defective in its composition of the remuneration committee. The chairperson of the board is also the chair of the remuneration committee. This is further complicated by the fact that the chairperson has been a board member since 1997 when FBC was formed, that is 19 years ago. This is twice the nine-year independence benchmark. The chairperson in 2015 was reported as indirectly holding 410 339 shares. It is incumbent upon FBCH to pronounce on the independence of its chairperson; they cannot leave us to second-guess the chairperson’s independence. Two other non-executive directors who serve on the remuneration committee have served as FBCH board members for more than nine years. FBCH’s pronouncement on their independence is unavoidable. The chief executive of FBCH is also a member of the remuneration committee. This is not in line with best practice.
CBZH is no better. The chief executive sits on the remuneration committee. This is not expected. We are not told who the chairperson of the remuneration committee is. With such incomplete information, one is left with inadequate information to fully appraise the composition of the remuneration committee. The naming of the remuneration committee at CBZH is confusing.
In the same report, it is named the human resources and corporate governance committee and also referred by the appellation human resources and remuneration committee. Which is which? Then what’s with naming a board member non-independent in the annual report and the website naming the same board member independent? Can a board member be simultaneously independent and non-independent? It is an oxymoron. It is incumbent upon CBZH to correct any information slip-ups unintentionally availed for public consumption.
Chulu is a management consultant and classic grounded theory researcher. He has published research in an international peer reviewed academic journal.