Export and Industry Bank: Getting Back to Zero

It's been almost a year since the collapse of Export and Industry Bank (EIB). After repeated attempts to bid out the rehabilitation of the bank have failed, the regulators have now ordered its liquidation.

Why did EIB fail?

Since its collapse, several reports have come out explaining the bank's demise.  Various reasons for the bank's collapse have been given, including:

1. Alienating Uninsured Depositors of the defunct Urban Bank with a 40% haircut, which EIB acquired in 2001, converting 30% of uninsured deposits into illiquid stock in EIB, and dribbling out the remaining 30% in several cash repayments over the course of a year. According to "Double bank deposit loss", the depositors were forced to personally retrieve these cash repayments at designated payment centers instead of crediting the payments to their existing bank accounts.  As a result, these depositors were forced to "spend time, money, and effort to receive their deposit crumbs." As a result, these depositors quickly withdrew their money instead of continuing to form part of EIB's deposit base.
2. No Cash Dividends.  According to the article "Double bank deposit loss", EIB failed to declare any cash dividends which would have attracted investors to its thinly traded stock.
3. A pending legal dispute with Filipino Chinese Businessman Willian Gatchalian which threw a monkey wrench into the bank's merger negotiations with Banco De Oro Unibank (See: "EIB execs say they did everything to save bank" and "Company denies causing Export Bank closure")

According to recent news reports, the pending legal dispute with Mr. Gatchalian has continued to play a role in the failure of the Philippine Deposit Insurance Corporation's (PDIC) efforts to rehabilitate the bank through an auction to interested investors (See: "Rebidding on rehabilitation of EIB a failure, says PDIC").  Continued failure to rehabilitate the bank via a purchase of assets and an assumption of liabilities could now result in the bank's liquidation.

Elephant in the Room

All these purported causes of the bank's failure  ignore the reality of the so-called "elephant in the room": that EIB has essentially been bankrupt since 2005.  When it collapsed last year, EIB's capital base wasn't just zero.  It was negative. And it didn't just turn negative in 2012, it had been negative since 2005 when it lost almost Php 1.7 billion and booked a negative capital base of - Php 985 million at the end of 2005.

Export and Industry Bank	2006	2005
Financial Highlights
Income Statement
Gross Interest Income	894,624.00	618,332.00
Net Interest Income/(Expense)	-667,273.00	-1,102,558.00
Other Income	3,007,683.00	379,662.00
Net Income/(Loss)	130,178.00	-1,683,789.00
Balance Sheet
Total Resources	34,173,227.00	23,792,007.00
Loan Portfolio	8,678,310.00	4,068,523.00
Investment & Trading Portfolio	9,294,431.00	2,022,641.00
Deposits	15,249,827.00	10,757,513.00
Capital Funds	5,283,506.00	-984,898.00

Source: EIB 2006 Annual Report, page 28

These losses were compounded even further in 2006 when it sold Php 13.3 billion of Non-Performing Assets (NPAs) in the first half of 2006 to Special Purpose Vehicle companies (SPVs), realizing a discount (read losses) of Php 7 billion which it booked as "Other Resources" on its balance sheet. 

Export and Industry Bank
Losses Realized on NPA Sales to SPVs
	2006
Account	(In Php Billions)
Gross Value of NPAs Sold	13
Less: Allowance for Impairment	3
Book Value of NPAs Sold	10
Less: Consideration Received	4
Discount or Losses Realized on Sale	7

Source: EIB 2006 Annual Report

Through the miracle of financial re-engineering as well as assistance from both the PDIC and the BSP/MB, the bank was still  able to reflect a Capital Funds base of Php 5.284 billion at the end of 2006.  How?  EIB was extended "regulatory relief" by the Bangko Sentral ng Pilipinas (BSP) as per Monetary Board (MB) Resolution 694 dated 26 May 2005, which allowed the bank to not book the losses immediately but amortize them over a 15 year period.

In other words, the BSP allowed EIB to pretend that the losses it incurred did not exist and that the bank really had no capital to back up its assets.   This "pretense" was not just true of EIB but of a whole slew of other banks (See previous posts: "BSP's Ampaw Accounting System" and "Can Philippine Universal and Commercial Banks Charge their Unbooked Losses Against Retained Earnings? - September 30, 2012").

Nevertheless, the losses were realized and had entirely depleted EIB's true capital base to something less than zero.  Had those losses been actually booked against earnings and its capital base, EIB's capital funds base would reflect reality: a negative Php 1.54 billion.

Export and Industry Bank
Actual Capital Funds
	2006
Account	(In Php Billions)
Capital Funds	5.28
Less: Unbooked Losses	6.83
Actual Capital Funds	-1.54

Source: EIB 2006 Annual Report

BSP's "regulatory relief" was designed in the hope that EIB and other banks like it can "earn" their way out of their losses when the economic cycle improved. But perhaps EIB was just too far gone to do just that: earn its way out of insolvency.  After all, EIB's actual asset base in 2006 was significantly less than reported - almost 20% less.  In 2006, it had an actual asset base of only Php 27.68 billion versus its reported asset base of Php 34.50 billion.

Export and Industry Bank
Actual Asset Base
	2006
Account	(In Php Billions)
Total Assets	34.50
Less: Unbooked Losses	6.83
Actual Total Assets	27.68

Return on Assets

Given the average Return on Assets of 0.80% that Universal and Commercial Banks posted from March 1999 to December 2006, it would take 28 years, assuming only internal asset growth, for EIB's actual asset base as of 2006 to reach the Php 34.5 billion in assets it reported in 2006.  It would take EIB's actual capital base just as long to reach its the Php 5.3 billion it reported in 2006.

If EIB projected its Return on Assets to be much higher, at 1.30% - the high end of the range of ROAs posted by Universal and Commercial Banks from March 1999 to December 2006,   its actual asset base, assuming internal asset growth would reach parity with its reported 2006 asset base 11 years sooner.  It would only take 17 years.  Ditto for its actual capital base.  In fact, it would take at least seven years (until 2013) for its actual capital base to get back to zero.

Obviously, relying on internal asset growth (i.e. no additional deposits), would be too slow.  To boost returns, EIB would have to seek additional external assets, meaning more deposits. EIB's deposit base did grow from Php 15.9 billion in 2006 to around Php 17.82 billion as of June 2011.

EIB's reported asset base did grow for a few more months, peaking at Php 44.04 billion in September 2007.

But EIB's reported capital base never grew.  It peaked in 2006.  In other words, it's actual capital base stayed negative until the very end.

Why? Because it continued to post horrendous losses, underperforming U/KBs by a wide margin.  And the losses accelerated in the last several years of EIB's life.

Not If But When

There may have been the possibility that EIB would have earned its way back into solvency.  But the probability of it doing so was very low, even nil.  As any ordinary businessman can attest, a business with zero to negative capital is more likely to fail than succeed.  So the question was not if EIB would fail, but when. Bankers are trained to deal in probabilities and not possibilities.  Perhaps Central Bankers and their ilk should do the same.