Monday, May 07, 2012

The cancellation of the TFC deal leaves more questions unanswered

Newspapers on quoting the Presidential Secretariat reported on Saturday that the purchase of shares in The Finance Company by the National Savings Bank had been canceled.

The controversy started when the state-owned National Savings Bank(NSB) bought a 13.2% stake in The Finance Company(TFC) on the 27th of April. The NSB paid a price of Rs.49.74 per share well above the current market price, which raised many eyebrows. On the day of the deal The  TFC shares traded in the range of Rs.30-Rs.32.50. A few  days after the deal was completed the market returned to Rs.30, raising still further suspicions that something was amiss.

The deal was stoutly defended by the Chairman of  TFC, Preethi Jayawardena who said that the value of the share of TFC previously did not reflect the company’s performance or potential.

The valuation of shares can be complex and is sometimes subjective, but the market obviously does not agree with Mr Jayawardena because it returned to the previous levels within a few days. Usually when there is a sudden increase in the price of share, especially when a large block is traded, investors and analysts will take another look at the company, to see if there is some hidden undiscovered value. If they believe there is some undiscovered value, there will new interest in the share which should support the share price  at the higher level. The fact that this did not happen suggests that the rest of the market does not see any reason to re-rate the share.

The Finance Company posted some very unimpressive numbers for the quarter to December 2011. The Chairman of the TFC correctly points out that the TFC reported a profit of Rs.15m for the nine months to December 2011. It is however worth noting that the TFC reported a profit of Rs.33m for the six months to June 2011, meaning that the company lost Rs.17m in the most recent quarter.  In other words, after a more hopeful start to the year, company performance deteriorated in the most recent quarter.

A cursory glance at the reported numbers reveals that the company has a negative gross interest margin. The interest margin is the markup that a financial institution will keep over its cost of borrowings. It is the equivalent to the margin that a trader keeps when selling goods. A negative interest margin indicates that the TFC is paying out more interest to its depositors than it earns from its what it loans to customers, which means the company is losing money even before any administrative or running expenses are charged, a situation that even the most hardened banker would regard as dire.

Where then have the improvement in TFC's results come from? From a sharp increase in 'other operating income', of which we know nothing since the results carry no further details. The cashflow statement reveals that the profits for the year appear have benefited from a Rs.200m reversal of provisions for loan losses and doubtful receivables, analysts would want to know if there has been a real improvement in the quality of the portfolio.

The sellers of the two blocks included a director of the TFC. According to disclosures made to the CSE, these shares were purchased at Rs.48 per share on the 21st of September 2011.

If the deal itself looks questionable the manner in which it was cancelled raises yet more questions.

Was the trade reversed on the CSE? Not yet. Usually when an erroneous trade is made it is reversed on the day itself or at latest on the next market day. In this instance the NSB did not make the payment due on the shares on Friday, itself a breach of the CSE trading rules. It offered no explanation nor, as far as anyone is aware, did it make a request for the trade to be cancelled.

On Saturday there was a decree from the President ordering that the trade be canceled but there   was complete silence from the industry watchdogs.  The Central Bank and the SEC have remained silent leaving it to the President to take action. What of the internal Governance of the NSB, is there no investment committee that vets large investments?  Given the fact the similar deals have involved the ETF, EPF and Sri Lanka Insurance should there be a public investments board that vets all public sector investments?

Despite all of these unanswered questions on due process, one thing is clear – the value of transparency. Because the deal took place on an open market and because of the disclosure requirements of the CSE, it was possible for interested parties to examine and detect suspicious transactions. Perhaps the regulators should simply push for greater transparency, a good dose of sunshine in some dark corners will keep many a nasty germ in check.

Update : Further reading - the TFC deal and the CJ.


Anonymous said...

It is very embarrassing all round as the value of TFC in the end depends on insider knowledge of the portfolio of land it actually holds, cost vs market value.

In my opinion due to the economic crisis the value of land will drop in the short term thereby further worsening the position of TFC, and its shares are likely to drop further and they may even require some capital injection, if they are unable in the short term to dispose of some of their land bank.

So what for the shares to drop to about Rs20 shortly (definitely before the end of the year) before taking a long term view from that point.

Just out of curiosity isnt the NSB chairman the husband of the Chief Justice.

What a mallung of lack of Governance as a court case to resolve the dispute will not get justice either!!!

Jack Point said...

Thank you anon, think there are many connected parties in this transaction.