LBC Development Bank: Where Did the Money Go?

Editor's Note:  This blog was inspired by the spectacular failure of Banco Filipino Savings and Mortgage Bank for the second time in its 38 years of existence.  This blog post and other blog posts like it attempt to describe why the bank failed.  But it also attempts to assess what other Philippine Banks have the potential to fail in the not too distant future. To see blog posts on other distressed banks, click on the Banco Filipino Graphic at the top of the blog or click on the blog archive on the right hand column, or simply go to bancofilipinofailure.blogspot.com.


Six months ago, LBC Development Bank (LBC Bank), like Banco Filipino,  blew up in a most spectacular fashion, surprising 321,516 depositors and affecting PHP 6.09 billion in deposits.  According to the Bangko Sentral ng Pilipinas (BSP) statements made soon after the closure, LBC Bank had been making huge cash advances to its sister company, remittance firm LBC Express so that the latter could facilitate the faster delivery of remittances to clients.  Some of the advances went unpaid, increasing the bank's financial burden.

BSP Deputy Nestor Espenilla Jr.  said that LBC Bank had been placed under the BSP's "Prompt Corrective Action (PCA) Program more than a year prior to the bank's closure.  Under the PCA Program, the bank was tightly monitored and given directives to stop giving out cash advances to LBC Express.  Due to non-compliance with its directives, the BSP issued cease-and-desist orders to LBC Bank but the bank still did not comply with the cease-and-desist order.  BSP Director Chuchi Fonacier, who had direct supervision over LBC Bank, said that the bank had lent over PHP 3 billion to LBC Affiliates prior to its closure on September 12, 2011.

On September 15, 2011, LBC Express denied the veracity of the statements of the BSP, saying that they were erroneous and untrue, and had a negative impact on their business.  (See "LBC Express says BSP charges are untrue").  LBC Express emphasized that "LBC Express is an entity separate from LBC Development Bank and is neither a bank nor a nonbank financial intermediary."

Where did the Money Go?

The closure of LBC Bank has caused PDIC some PHP 3.73 billion in deposit insurance.  But other than that, media reports on the case of LBC Bank have been sparse.  A congressional inquiry into the bank's closure scheduled for November 30, 2011 was abruptly postponed, sparing LBC Bank's Chairman, Juan Carlos Araneta, from answering questions regarding the evaporation of the bank's funds.  See Cocktales.ph: LBC Owner stopped from giving testimony November 30, 2011.  To date, none of the bank's officers and directors have been charged.

So the question remains unanswered:  Where Did the Money Go?

History of LBC in Five Charts

This blog has highlighted LBC Bank several times, beginning with "LBC Bank Development Bank bites the dust, Are there other LBCs out there waiting to implode?", then with "Borderline Thrift Banks Still Borderline", and lastly, "Worst Philippine Thrift Banks get Worse - June 30, 2011".  Those posts show that LBC Bank had a consistently high proportion of distressed or non-earning assets relative to its total asset base, and more importantly, relative to its capital base and/or capital cushion.  In fact, LBC Bank was consistently in the top five distressed Thrift Banks from December 31, 2010 to June 30, 2011, its last Published Statement of Condition from www.bsp.gov.ph.  In fact, if you go way back to 2005, the bank was already in poor condition at that time.  Its ratio of Distressed Assets to its Capital was always above the borderline level of 100%.

As can be seen from the above chart, LBC Bank's Distressed ratio hit a peak of 391.79% in 4th Qtr. 2005 before dropping to a low of 124.52% in 2nd Qtr. 2007.  But since then, the ratio never looked back and reached a peak of 781.95% prior to the bank's closure in 3rd Qtr. 2011.

Unlike Banco Filipino, LBC Bank funds were not tied up in overvalued real estate, they were tied up in non-earning assets outside of classified loans, outside of "investment properties" or acquired real estate, they were tied up in "Other Assets", the bulk of which, according to the BSP, were advances to LBC Affiliates.

In fact, from the 1st Qtr. 2005 to the 4th Qtr.  2007, Other Assets was roughly equal to LBC Bank's loan portfolio in terms of absolute size.  But Other Assets began to surpass the bank's loan portfolio by a significant margin, beginning in the 2nd Qtr. 2008.  In the first half of 2011, Other Assets climbed very sharply, reaching a peak of PHP 4.76 billion in the 2nd Qtr. 2011.

LBC Bank's Other Assets were not funded by the bank's capital base.  They were funded by deposits.  As can be seen from the chart below, the bank's capital base remained flat, but the bank's deposits grew consistently higher every year.

Other Assets was such a big component of the bank's Total Assets that, in later years, it comprised the bulk of the bank's assets.  In comparison to Other Assets, loans were almost an afterthought.  The bulk of the bank's business was not really in making loans but, if BSP is to be believed, in funding the affiliates of LBC Bank.  If this is the case, how could the bank possibly make money?

Given the high level of distress, the rapid climb in Other Assets, perhaps the bank should have been placed in the PCA Program much earlier - possibly as early as 4th Qtr. 2008, when Other Assets was more than three times the total loan portfolio.

In the case of LBC Bank, traditional indicators of a bank's health, such as NPL levels, DOSRI levels, and DOSRI Past Due ratios are almost meaningless.

For more than two years, 1st Qtr. 2005 to 1st Qtr. 2007, NPLs as a proportion of the Total Loan Portfolio were in the low single digits.  Then they climbed to the mid-teens from 2nd Qtr. 2007 to the 4th Qtr. 2009, which was high but not unduly alarming.  Then they climbed again to reach the low thirties in the 3rd Qtr. 2010 and stayed there.

DOSRI as a proportion of the Total Loan Portfolio, mostly remained below ten percent.  When the bank closed in 3rd Qtr. 2011, the DOSRI ratio was a meaningless 2.16% of loans.  Throughout the entire period in question, past due DOSRI Loans was reported as zero: the bank had no past due DOSRI Loans to speak of.

The low level of DOSRI loans and past due DOSRI loans are definitely misleading.  The purported diversion of funds to LBC Bank's affiliates was, according to BSP Deputy Governor Juan de Zuniga Jr., an out-and-out violation of the DOSRI law, which is the granting of unsecured loans to directors,officers, stockholders, and related interests.

History of Fraud with ATR Kim Eng

The history of the LBC Group of Companies is a checkered one and is literally littered with examples of fraud.  The most famous one of all is the LBC Group's run-in with ATR Kim-Eng (ATR), a large investment house that is publicly listed on the Philippine Stock Exchange as MAYBANK ATR KIMENG FINANCIAL CORPORATION (Ticker: MAKE).

In 1999, childhood friends Ramon Arnaiz (the "A" in "ATR") and Carlos R. Araneta (Araneta), the Chairman of the LBC Group, decided to enter into a 50:50 joint venture called  Professional Holdings Corporation (Professional Holdings) to acquire a controlling interest (80%) in The Professional Group, Inc. (TPG), a corporation that sold pre-need insurance policies.  The residual 20% stake in TPG was owned by Francisco J. "Topax" Colayco (Colayco), the company founder and president.

To accomplish this, ATR advanced PHP 157 million (USD $ 3.922 million) for Araneta's share in the Professional Holdings.  Araneta, in turn pledged, in an Undertaking Agreement, to contribute the LBC Operating Companies along with his newly acquired interest in TPG, to a new holding company and issue ATR a 10% stake in that entity.  The LBC Operating Companies were valued at USD $36 million.  To protect ATR's investment in the LBC Operating Companies, the Undertaking Agreement granted ATR:

1. the right to a seat on the board
2. a five-year put option, which required Araneta to buy out ATR's interest at the higher of the issue price of ATR's shares plus a premium between 22% and 25% per annum or the adjusted book value of ATR's shares.

The new holding company, called LBC Global Corporation (later changed to PMHI Holdings Corporation) was incorporated as U.S. based company in the state of Delaware in January 2000.  ATR was presented with 3,000 shares of stock in the company, while Araneta retained the remaining 27,000 shares.  Appointed to the board of LBC Global were Araneta, Liza Berenguer (Araneta's niece and the CFO of the LBC Group) and Hugo Bonilla, the head of LBC's U.S. operations. According to the Undertaking Agreement, ATR had the right to a seat on the board of the holding company.

In December 2000, ATR negotiated, with the knowledge and consent of Araneta, to sell its 10% stake to Philtread Tire & Rubber Company.   ATR reinvested the sale proceeds as well as an additional USD $ 1.2 million in capital back into Philtread to create an Internet service and fulfillment business.  ATR intended to use the the LBC companies as part of the fulfillment side of the business model for Philtread.  The transaction was closed in November 2001.

On January 22, 2001, Araneta signed a Deed of Adherence Letter attesting to the transfer of the LBC Operating Companies to LBC Global.

On July 26, 2001, Araneta sent a Confirmation Letter clarifying the Deed of Adherence and provided a balance sheet indicating that certain assets were owned by LBC Global as of March 31, 2001.  Listed as the assets of LBC Global were the following companies:

1. LBC Domestic Franchise Co. and its subsidiaries
2. LBC Express, Inc. and its subsidiaries
3. LBC Mabuhay Development Philippine Corporation and its subsidiaries
4. LBC Holdings USA and its subsidiaries
5. LBC International Inc and its subsidiaries
6. LBC Development Bank
7. Foreign Exchange Business arising from remittance transactions

In November 2002, ATR sold its 50% interest in the JV company, Professional Holdings back to Colayco, giving Colayco a majority 60% stake in TPG and rendering Araneta a minority investor in TPG with only a 40% stake.  Araneta was given a right of first refusal by ATR but Araneta declined to add to his stake.

According to court documents, the sale made Araneta furious and Araneta declined to entertain any request by ATR for information on LBC Global throughout the entire calendar year of 2003.  Although letters were exchanged between ATR's and Araneta's lawyers in the Philippines, the matter remained unresolved.

On July 18, 2003, ATR's attorneys sent a formal books and records demand letter to Araneta.  Through the letter, ATR exercised its right as a stockholder of a Delaware Corporation to request financial statements of LBC Global as well as the documents showing LBC Global's ownership of the LBC Operating Companies and Araneta's interest in Professional Holdings.

On October 27, 2003, ATR filed an action under 8 Del. c. 220 demanding to see the books and records.  Soon after, the Delaware Chancery Court ordered Araneta to comply.

On January 14, 2004, Aranete produced a "Compliance" 29 that purported to include all available documents but totaled only nine pages and failed to include many essential corporate papers.  The financial statements included in the papers submitted by Araneta indicated that Araneta stripped LBC Global of the LBC Operating Companies, leaving only Araneta's stake in Professional Holdings.

U.S. Litigation

On June 3, 2004, ATR filed a lawsuit against Araneta and LBC Global along with directors Berenguer and Bonilla.  The complaint alleged that the removal of the LBC Operating Companies, valued at USD $36 million, from LBC Global between March and December 2003 caused ATR grave harm.  Araneta had effectively made a $36 million liquidation payment to his family without following the required process and without distributing to ATR its pro rata portion.

On December 21, 2006, the Delaware Chancery Court ruled in favor of ATR.  It found Araneta, LBC Global, Berenguer and Bonilla liable for waste and breach of fiduciary duty over the disappearance of substantial assets of LBC Global.  Araneta et al were ordered to jointly and severally pay ATR USD $24.49 million, representing damages award and pre-judgement interest plus post-judgement interest and collection costs.  Araneta was deemed responsible to pay the entire judgement.  Should Berenguer and Bonilla pay any or all of the judgement, Araneta should be required to make them whole.

The Delaware judgment was subsequently registered in the Alameda County Superior Court in California for enforcement, and this has resulted in the recovery of cash from Bonilla in the amount of $530,000, or roughly P25 million.  In April 2007, Bonilla filed for bankruptcy after the fraudulent transfer of the multi-million dollar Araneta home in the tony San Francisco suburb of Hillsborough for only $100 to Araneta's 27 year old daughter, Monica Araneta.

Philippine Litigation

During 2003, Araneta sued ATR in the Philippines, seeking to annul the Undertaking Agreement and JV Agreements on the grounds that ATR fraudulently concealed the implications, risks, and consequences involved in the acquisition of TPG.  The Regional Trial Court (RTC) dismissed Araneta's complaint on January 24, 2006.  On May 24, 2006, the RTC reaffirmed the validity of the Undertaking Agreement.  RTC found Araneta liable for the aggregate subscription or issue price of LBC Global and a premium of 25% per annum.

Settlement Agreement

On May 8, 2009, ATR finalized its settlement agreement with Araneta and LBC.  It received a total PHP 617.4 million (USD $12.8 million), represented by USD $2.5 million in cash, USD $ 5.0 million in promissory notes backed up by fully secured and unconditional standby letters of credit, 226,072 shares of stock (valued at USD $ 5.3 million and representing a 49% stake) in MNB Holdings Corp, the bank holding company of Mission National Bank in San Francisco, California.

On January 31, 2010, ATR sold a 40% stake in MNB Holdings to the Lucky Group of Companies for USD $5.675 million in cash.  The Lucky Group, which is owned by Filipino American entrepreneur Rene Medina, is comprised of six companies, including Lucky Money, a money remittance firm.   Lucky Group already owned 23% of MNB Holdings and the purchase of MNB resulted in a majority 63% position in the company.  ATR retained the remaining 9% stake it received as part of the settlement agreement with the LBC Group.

Other Fraud Charges


In 2007, TPG sued LBC Development Corporation for failing to remit PHP 68.15 million the LBC Group had collected from TPG's plan holders, causing TPG's plan holders to default from their pre-need plans.  Under a deal in place since 1999, LBC's overseas branches would act as collection agents for OFW clients, especially US-based Filipinos, who wanted to pay for their pre-need accounts.  The said collections for TPG were used to pay for another loan due to LBC Bank and were applied to pay for the legal fees of LBC.  LBC Director Eliza Berenguer ordered the unauthorized and illicit offsetting of the payment collections with that of another loan that was falling due.  According to TPG President Yolanda D. Miranda, Marilou Olan, LBC Express President, admitted to Miranda that LBC Express could not afford to pay the outstanding amount it owed TPG due to cash flow constraints.  Miranda alleged that LBC had been remiss in remitting collections to TPG as early as 2002.

Initially, the Mandaluyong Prosecutor dismissed the complaint against the LBC Bank, prompting the officials of TPG to elevate the case to the Department of Justice. On June 23, 2008, the Professional Planholders Association appealed to Justice Secretary Raul Gonzalez that the TPG petition be acted upon with fairness for the sake of some 50,000 planholders.  After evaluating the pieces of evidence submitted by the TPG, on May 28, 2009, Justice Secretary Raul Gonzalez signed the resolution finding cause to file estafa cases against the LBC officials including Juan Carlos Araneta, Carlos Araneta, Javier Montecon, Joseph Jeffrey Rodriguez, Marilen Aben, Theresa Raneses, Eliza Berenguer and Marilou Olan.

On March 2, 2010, the Mandaluyong Court issued warrant of arrest against the LBC officials. Except for Berenguer, Rodriguez, and Raneses, all of the accused have posted bail of PHP 40,000.00 each.


Are the LBC Fraud Cases and LBC Bank's "Other Assets" Linked?

The LBC Group's history of fraud shows LBC/Araneta's penchant for defrauding investors such as ATR and even its own customers - the 50,000 planholders affected by LBC's failure to remit customer money to TPG.  It is not clear why the LBC Group needed to engage in this behavior.  After all, the remittance business, by all accounts, is booming.

OFW Remittances
By Region of Origin
In USD $K
2003 to 2011
Country	2003	2004	2005	2006	2007	2008	2009	2010	2011	CAGR
Americas	4,370,705	5,023,803	6,605,231	7,198,212	8,244,344	9,213,372	9,307,781	9,987,628	10,656,862	11.79%
Europe	1,040,562	1,286,130	1,433,933	2,061,067	2,351,704	2,658,726	3,061,625	3,180,474	3,348,118	15.73%
Middle East	1,166,376	1,232,069	1,417,491	1,909,208	2,172,417	2,502,639	2,665,031	2,964,341	3,215,819	13.52%
Asia	894,310	918,329	1,172,373	1,496,120	1,543,173	1,883,996	2,078,241	2,363,001	2,568,567	14.10%
Oceania	44,470	42,600	54,573	85,610	121,417	149,423	212,983	236,358	297,378	26.81%
Africa	11,371	3,439	4,517	10,272	16,027	17,746	22,282	31,187	30,248	13.01%
World Total	7,527,794	8,506,370	10,688,118	12,760,489	14,449,082	16,425,902	17,347,943	18,762,989	20,116,992	13.07%
Source: www.bsp.gov.ph

Particularly in the USA, where LBC has a strong presence, remains the largest market for OFW Remittances:

Has its history of fraud affected LBC's businesses?  Probably not, given that the remittance business has continued to grow even during the global economic downturn of 2008 and 2009.

LBC Express European Expansion

The LBC group continues to expand.  In 2008, LBC Express Philippines undertook a PHP 150 million re-fleeting and expansion program.

In 2009, LBC Express aggressively expanded in Europe, opening branches in Spain and Italy and eyeing a branch in London for 2010, as well as branches in Austria, Switzerland, and Germany from 2011 onwards. It is not clear how much this expansion will cost or whether it is wise to expand so aggressively at a time that Europe's economic growth is slowing or even declining.

What is clear is that an aggressive expansion in Europe may require even more working capital if LBC Express were to provide the same level of service it provided in the USA.  Since 1999, LBC Express has partnered with its sister company LBC Bank to provide its US customers with LBC Express "ATM Bilis Padala" service wherein OFWs can send their money to their family beneficiaries in as little as 15 seconds.  Under this scenario, LBC Bank advances the money to the OFW Family beneficiaries through its ATM network and collects the actual remittance from LBC Express or its US affiliates.  This process can take as long as a week and can, given the huge volumes, require a huge amount of working capital, happily provided by LBC Bank.  Could the aggressive European expansion sucked up a lot of funds from LBC Bank?  This is highly possible.

Other Assets vs. Fraud Cases

Could the negative judgements against LBC have precipitated a diversion of LBC Bank's funds to other LBC Companies?  Or could the anticipation of negative judgements caused LBC Bank to advance even more money to its affiliates?  Given the chart below, this is not clear although it remains a distinct possibility.

Conclusion:

Whatever the case, depositor's money as well as the public's money remains unaccounted for.  If the money of LBC Bank was illegally advanced to other parts of the LBC Group, regulators should step up their game and charge who ever needs to be charged.  They should also seek to recover the money from the LBC Group and if not possible, take over their businesses.  LBC's operations in the US would be a good place to start:

LBC Group Revenues
US Companies
2010
Company	USD $ M
LBC Holdings USA	23
LBC Mabuhay USA	9
Total	32
Source: Hoovers