RCBC's Zombie Past Due DOSRI Loans

DOSRI loans, short for loans to Directors, Officers, Stockholders, and Related Interests (DOSRI) has been the bane of the Philippine Banking System for some time now.  DOSRI abuses and violations have led to the downfall of banks such as Banco Filipino and LBC Development Bank.

Under current BSP regulations, the amount of loans to each DOSRI, 70% of which must be secured, should not exceed the amount of each DOSRI's deposit and book value of investment in the bank.  In the aggregate, loans to DOSRI, generally, should not exceed the total capital funds or 15% of the total loan portfolio of the bank and/or any of its lending and nonbanking financial subsidiaries, whichever is lower.

As of December 31, 2013, the Yuchengco family, through the Pan Malayan Management & Investment Corporation (PMMIC), owned 45.20% of RCBC.  Given that RCBC's Capital Funds amounted to Php 45.975 billion as of December 31, 2013, the book value of the Yuchengco family's investment in RCBC amounts to Php 20.781 billion as of December 31, 2013.  Together with their related party deposits of Php 4.478 billion, the theoretical upper bound for RCBC's DOSRI loans amounts to Php 25.259 billion as of December 31, 2013.

Another upper bound is the ratio of DOSRI loans to the Total Loan Portfolio.  Given that RCBC's Total Loan Portfolio stood at Php 188.945 billion, another theoretical upper bound for RCBC's DOSRI loans is Php 28.342 billion or 15% of the Total Loan Portfolio.

DOSRI regulations stipulate that the actual DOSRI loans should be the lower of each DOSRI's deposit and book value of investment in the bank or 15% of the Total Loan Portfolio.  So as of December 31, 2013, the theoretical upper bound of RCBC's DOSRI loans amounts to Php 25.259 billion.

Needless to say, RCBC's DOSRI loans amounted to Php 6.416 billion as of December 31, 2013.  This amounts to just 3.39% of RCBC's Total Loan Portfolio of Php 188.945 billion as of December 31, 2013 and 13.93% of its Capital Funds base of Php 45.975 billion for the same period. In other words, RCBC's DOSRI Loans have room to grow.

Around 8.21% of RCBC's DOSRI loans or Php 526.027 million of its DOSRI loans are past due.  Moreover, RCBC's past due DOSRI loans have been past due for some time now - since at least December 31, 2009. Prior to that (or at least since March 2005), RCBC's DOSRI Loan record was spotless: it had no past due DOSRI Loans at all.

What is curious about RCBC's DOSRI Past due is that it has remained roughly the same for the past four years, roughly Php 525 million.  It has never varied by much, fluctuating by only a few million at most each year. The constant nature of this DOSRI Past due gives credence to the idea that the past due DOSRI Loans relate to a transaction or a specific set of transactions.

RCBC describes a few of its major related party transactions in its 2013 Annual Report:

• RCBC and certain subsidiaries occupy several floors of RCBC Plaza as leaseholders of RCBC Realty Corporation (RCBC Realty). Related rental expense are included as part of Occupancy and Equipment-related account in the Statements of Profit or Loss. RCBC’s lease contract with RCBC Realty is until December 31, 2015. (Note 30.05, Notes to Financial Statements)

• In October 1, 2009, RCBC entered into a joint development agreement with RCBC Savings Bank (RSB), Malayan Insurance Company, Inc. (MICO), Grepalife Financial, Inc. (Grepalife), Bankard Inc. (Bankard) and Hexagonland, Inc. (Hexagonland), with the conformity of Goldpath Properties Development Corporation (Goldpath), the parent company of Hexagonland, to form a consortium for the pooling of their resources and establishment of an unincorporated joint venture (the “UJV”) for the construction and development of a high rise, mixed use commercial/office building, now operated by the Parent Bank as RSB Corporate Center.

In 2011, RCBC acquired the rights and interest of Grepalife in the UJV. Also in 2011, RSB was able to acquire the rights and interest of Hexagonland after the latter’s liquidation and partial return of capital to Goldpath. RSB, accordingly, contributed the land amounting to P383 million to the Project. (Notes 13 and 30.02, Notes to Financial Statements)

On October 2, 2012, the remaining co-venturers executed a memorandum of understanding agreeing in principle to cancel or revoke the UJV, subject to the approval of BSP. As of December 31, 2012, total cash contribution of RCBC, RSB and Bankard to the UJV amounted to P1.6 billion which is recorded as Construction in Progress.

On March 13, 2013, through MB Resolution No. 405 dated March 7, 2013, BSP approved RCBC’s acquisition of the land contributed to the RSB Corporate Center as well as the rights and interests of its co-venturers (Note 30.02, Notes to Financial Statements). As a result, RCBC paid its co-venturers a total consideration of P1.2 billion which is inclusive of compensation at the rate of 5.00% per annum computed from the date of the co-venturers’ payment of their respective cash contributions until the date of the actual return or payment by RCBC. In addition, by virtue of a deed of absolute sale executed between the Parent Company and RSB on April 5, 2013, the latter transferred its ownership and title to the land where the RSB Corporate Center is situated to RCBC for a selling price of P529 million. (Note 13, Notes to Financial Statements).

• On August 31, 2011, the Bank’s BOD approved the acquisition of selected assets and assumption of selected liabilities of JPL Rural Bank, through Rizal Microbank, subject to the approval of Philippine Deposit Insurance Corporation (PDIC) and BSP with the following conditions: (a) RCBC JPL shall surrender its rural bank license to BSP within 30 days from BSP approval; and (b) RCBC JPL shall likewise cease to accept deposits and change its business name so as to delete the word “bank” therein. Consequently, in 2011, the Bank infused P500 million worth of capital to Rizal Microbank to support the acquisition of assets and assumption of liabilities of RCBC JPL. The application for the acquisition of selected assets and assumption of selected liabilities was approved by PDIC and BSP on January 31, 2012 and March 2, 2012, respectively. In 2012, JPL Rural Bank changed its name to RCBC JPL. (Note 12, Notes to Financial Statements)

• On January 30, 2012, the BOD approved the acquisition of a total of 448,528,296 common stocks or around 97.79% of the outstanding capital stock in First Malayan Leasing and Finance Corporation (FMLFC) from PMMIC, House of Investments, Inc. (HI) and other investors. The sale and purchase of FMLFC stocks were made in accordance with the three share purchase agreements signed by the contracting parties on February 7, 2012 and were conditioned on among others, the receipt of approval of the transaction from the BSP, which was received by RCBC on March 12, 2012. After the acquisition, FMLFC was renamed as RCBC LFC. (Note 12, Notes to Financial Statements)

• On 31 July 2013, the RCBC Board approved the sale of the Bank’s 25% shareholdings in RCBC Realty and 49% shareholdings in RCBC Land, Inc. (RCBC Land) representing the Bank’s 34.8% economic interest in RCBC Realty to PMMIC, HI, and RCBC Land. The transaction was valued at Php 4.547 billion. The purpose of the transaction was to comply with Basel III guidelines. (See Note 12, Notes to Financial Statements)

• On 18 October 2013, the RCBC Board approved the sale of the Bank and RCBC Capital’s 89% total stake in Bankard to Philippine Business Bank Trust and Investment Center, on behalf of various clients. Bankard’s total assets, total liabilities and net assets amounted to P1.075 billion, P14 million and P1.061 billion respectively, as at the date of disposal. As a consideration for the sale of the investment, the Group received cash amounting to P225 million and a right over an escrow account amounting to P870 million established by the buyer investor in settlement of this transaction.

Gain on sale recognized related to this transaction amounting to P44 million is included as part of Gain on sale of equity investments under Miscellaneous Income in the 2013 statement of profit or loss. Moreover, the disposal of Bankard resulted in the reversal and transfer of P233 million other reserves recognized in years prior to 2011 directly to surplus. (Note 12, Notes to Financial Statements)

On 04 December 2013, RCBC Bankard was incorporated as a subsidiary of RCBC Capitalto perform card processing services for the Bank.

• The Bank’s and certain subsidiaries’ retirement funds covered under their defined post-employment benefit plan for qualified employees are administered by the Bank’s and RSB’s Trust Department in accordance with their respective trust agreements. The retirement funds have transactions directly and indirectly with the Group which consist of investment in commonshares of the Bank and investment in other securities and debt instruments wherein dividend income and trading gains are earned by the retirement funds. The retirement fund neither provides any guarantee or surety for any obligation of the Group nor its investments in its own shares of stock covered by any restriction and liens. (Note 30.03, Notes to Financial Statements)

• The Bank entered into a Memorandum of Agreement with HI, a member of the YGC, for the procurement of outsourcing services. Under the agreement, HI is the Bank’s sole representative in negotiating the terms of the contracts with selected suppliers or service providers for the procurement of certain outsourcing services, primarily IT related services. The agreement stipulated that HI would not charge fees for its service except for its share in the savings generated from suppliers and service providers. Moreover, HI is obligated to ensure that the contracts they initiate do not prejudice the Bank in any way and that the Bank does not pay more than the cost of buying the items without aggregation.

• The law firm of Angara Abello Concepcion Regala & Cruz (ACCRA) Law Office is among the firms engaged by the Bank to render legal services. Atty. Teodoro Dy-Liaco Regala, Director, is a Senior Partner of ACCRA Law Office. During the year, the Company paid ACCRA legal fees that the Company believes to be reasonable for the services provided.

These transactions give no clue as to why RCBC's Past Due DOSRI Loans have remained relatively constant for the past four years.

The bank stipulates that under its Policy on Related Party Transactions, the bank conducts its related party transactions on an "arm's length basis" with any such transaction "being on no terms no more or less favorable to the bank than terms available to nay unconnected third party under the same or similar circumstances".

"Under the Bank’s Policy on Related Party Transactions, related parties, including directors, are required to notify the Audit Committee of any potential related party transaction as soon as they become aware of it. If a transaction is determined to be a Related Party Transaction, such transaction, including all of the relevant details regarding such transaction, shall be submitted for analysis and evaluation to the Audit Committee to determine whether or not the Related Party Transaction is on terms no more or less favorable to the Bank than terms available to any unconnected third party under the same or similar circumstances. The transaction shall thereafter be presented to the Board for approval. Any member of the Board who has an interest in the transaction under discussion shall not participate in discussions and shall abstain from voting on the approval of the Related Party Transaction. Pursuant to BSP Circular No. 749 as amended and the Bank’s Corporate Governance Manual, the Bank’s stockholders confirmed by majority vote, in the last annual stockholders’ meeting, the bank’s significant transactions with its DOSRI and other related parties."

This policy, however, governs the initiation of the Related Party Transaction.  It does not seem to govern how the DOSRI Loan is treated once it has been approved by the Audit Committee and after the loan has been extended out by the bank to the related party.  According to the bank's Annual Reports for 2013 and 2012, despite the size and amount of the past due DOSRI loans remaining relatively constant and non-accruing for the past four years, the bank has not recognized any impairment of these loans for the years 2013, 2012, and 2011.

In effect, these past due DOSRI loans are zombie past due DOSRI Loans, neither living or nor dead.  Maybe it's high time that the bank rethink how these loans are treated and make the necessary adjustments to reflect their true recoverability. Are these past due DOSRI Loans worth less than their stated book value? Perhaps, or perhaps not. Only RCBC and/or its regulators will know for sure.

But the fear that the carrying values of these past due DOSRI Loans are higher than what they should be are not unfounded.  After all, RCBC was one of the major banks that maintained the accounting fiction that unbooked losses on assets it had already sold in a true sale should comprise almost 30% of its capital base for years on end. (See previous blog post, "BSP's Ampaw Accounting System.")

Maybe RCBC should provide more color as to the nature of its DOSRI transactions, such as, but not limited to the following:

1. Names of DOSRI Borrowers
2. Amount of Loan
3. Date of Loan
4. Loan Tenor and Maturity Date
5. Price of Loan (Interest Rates)
6. Purpose of Loan
7. Nature of the Collateral provided
8. Collateral Valuation and Appraisal
9. Loan Status such as Current, Past Due, Restructured

This will subject the bank to some market discipline.  Disclosure of loans that are made at less than arms length (they are subsidized by shareholders) basis might lead to a loss of shareholder value.  Similarly, disclosure of poorly performing DOSRI loans may also lead to a loss of shareholder value.  In this way, the market will decide whether these loans were granted and maintained on an above board basis.

See the previous blog post, "Sunlight is the Best Disinfectant to Purge the Rot in the Philippine Banking System".