Last week I started reflecting about the key issues that were driving the current turmoil in the banking sector, and concluded that both the regulator’s banking supervision unit as well as the guilty bank boards were culpable. Today, I want to take a closer look at the financials of one of those banks, Chase Bank, as much was written last week regarding the disputed audited financials that gave rise to the run it experienced that led to its closure.
I began by pulling up what they published on their website as the audited financials for the year 2014. I then looked at what was published in black and white, tucked into the back end, classified section of the Standard Newspaper on Wednesday, April 6th 2016. I will refer to these as the gospel truth accounts. This was a good six days after a full set of color financials had been printed in the Nation newspaper on March 31st 2016, which was the last date that a regulated financial institution in Kenya could publish their full year audited accounts. A few items clearly stood out as having been restated in the 2014 audited accounts. What do I mean? The 2014 audited accounts that were published in 2015 did not have a qualified opinion (I will refer to these as the chameleon accounts). However, when the gospel truth 2015 accounts were published on April 6th 2016, a few items in the 2014 numbers had been restated, which begs the question: what caused the chameleonic changes? Let’s begin at the top. In the published 2014 chameleon accounts, customer loans had been booked at Kes 53.8 billion. In the gospel truth accounts, customer loans for the same 2014 financial year were now reflected as Kes 64.4 billion, a difference of Kes 10.6 billion. Evidently in the 2015 audit, the auditors decided to treat certain assets differently, and found Kes 10.6 billion worth of new loans in the 2014 financial year, which had previously not been picked up in the 2014 audit that had been passed. But a balance sheet doesn’t just change dramatically; the movements on one line have to balance with movements on another. So I dug a little deeper and found the offending items. In the 2014 chameleon accounts, “other assets” were booked at Kes 11.9 billion. This is where the Islamic financing assets were said to have been parked. In a sudden change of heart (likely caused by missing documentation to convince the auditors that the other assets were indeed booked appropriately as Islamic financing products) the 2014 numbers restated “other assets” as Kes 3.4 billion, suddenly yielding up Kes 8.5 billion as the corresponding surprise entry in loans into the gospel truth accounts.
But that means that I needed to find Kes 2.1 billion in order to balance the figure of Kes 10.6 billion in new loans that appeared in gospel truth accounts. The only other significant movement that I found was that 2014 chameleon accounts showed that cash held at the Central Bank was Kes 7, 105, 986 by December 31st 2014. The gospel truth accounts reflected a different position of Kes 4, 953,180 by the same December 31st 2014, a difference of Kes 2.1 billion. Now that is a remarkably curious finding to which I have no answer. How does the same auditor convert funds that are reflected as held at the Central Bank in one year into customer loans the following year?
I bundled on some roller skates and slid into the profit and loss statement, as this was becoming an interesting ride. The 2014 chameleon accounts reflect a total staff cost figure of Kes 1.9 billion while gospel truth accounts restate this amount to Kes 1.7 billion a difference of Kes 200 million. The auditor, come the 2015 review, clearly did not accept some staff costs. What did the auditor discover that was different? I guessed that the answer was sitting in the other operating expenses line as it had moved by a similar Kes 200 million, from Kes 2.3 billion in chameleon accounts to Kes 2.5 billion in gospel truth accounts. Someone had tried to park Kes 200 million worth of expenses as staff costs, and while the auditor bought that story in 2014, he clearly wisened up in the 2015 audit process and restated the 2014 numbers accordingly.
That was just a cursory view on the 2014 numbers, as much attention has been paid to the 2015 full year numbers without looking at the significant restatements of key areas of the 2014 results. This restatement was a key contributor then to the growth of two numbers: the gross non-performing loan (NPL) numbers in 2015 as well as insider loans to directors, shareholders and associates. Gross NPLs moved from Kes 3.1 billion in 2014 to Kes 11.3 billion in 2015, an increase of Kes 8.2 billion and a figure quite close to the movement in the other assets line stated above. Insider loans grew from Kes 1.3 billion to Kes 10.5 billion in 2015, an increase of Kes 9.2 billion. This would mean that includes Kes 8.2 billion of “other assets” plus an extra Kes 1 billion that has emerged as new loans. Insiders had a few busy years clearly! The challenge for the receiver or for any new investor were the bank to be sold, will be to realise the securities held against these insider loans, assuming of course, first that the insiders do not have the capacity to repay these surprise loan entries and secondly that the true realizable value of the securities is reflected. If the insiders do have the capacity to repay, then that’s another story. Public focus has largely been on the insider loans, but the rubber will meet the road when proper due diligence is undertaken on the existing loan book, a large part of which sits as un-amortizing over drafts. Therein lies the true challenge in establishing capacity to repay.