Ian Nar­ine

I have re­ceived hun­dreds of e-mails pro­vid­ing feed­back on my writ­ings re­lat­ed to CL Fi­nan­cial (CLF). Most have been com­pli­men­ta­ry but one ques­tion that stood out was why did I not speak out ear­li­er? The re­al­i­ty is that with­in the con­fines of what was avail­able I did try to warn. Re­call my ar­ti­cle on Ju­ly 31, 2008: "Guard­ing against fi­nan­cial col­lapse."

You could not have asked for a more pre­scient head­line than that and while Cli­co was not specif­i­cal­ly men­tioned there were enough hints. At the end of the day I have to bal­ance pro­vid­ing in­for­ma­tion to the pub­lic with be­ing a fac­tor in a run on an op­er­at­ing fi­nan­cial in­sti­tu­tion. What was in mid 2008 an opin­ion is to­day a re­al­i­ty.

To­day. there is the op­por­tu­ni­ty to pro­vide in­sight to the pub­lic, show things that were missed and raise ques­tions on per­ti­nent is­sues. The re­al ben­e­fit is to use this fi­as­co as a case study to en­sure that the mis­takes made, es­pe­cial­ly by in­vestors are un­der­stood and not re­peat­ed any­time soon.

High In­ter­est

A key take­away from last week was the prof­it per­for­mance of the CLF Group ex­clud­ing the con­tri­bu­tion from Trinidad Methanol and Re­pub­lic Bank (RBL). Cli­co a 100 per cent sub­sidiary ac­tu­al­ly con­tributed more prof­it to the Par­ent (CLF) than the Par­ent earned in to­tal from Cli­co and the rest of its ma­jor sub­sidiaries com­bined. This sug­gests loss­es by oth­er group com­pa­nies, some of the same com­pa­nies that were pre­sum­ably the ben­e­fi­cia­ries of EF­PA funds. Re­mem­ber the ra­tio­nale be­hind the EF­PA was pol­i­cy­hold­er funds were in­vest­ed with­in CLF which jus­ti­fied the abil­i­ty to pay a rate that no one else in the mar­ket was able to pay.

Recog­nise that, at the end of the day, in­sur­ance is not a high mar­gin busi­ness; so while, last week, I high­light­ed the small mar­gins earned by Cli­co that by it­self is not the warn­ing flag.

The prof­itabil­i­ty and cash flow of CLF and Cli­co in the con­text of the EF­PA with its above mar­ket in­ter­est rate is the is­sue. A com­pa­ny with min­i­mal prof­itabil­i­ty hav­ing pre­vi­ous­ly made promis­es of high re­turns to in­vestors runs the risk of a short­fall and if it per­sists can lead to the type of sce­nario that is be­ing wit­nessed to­day.

Ap­pre­ci­ate that the statu­to­ry re­serve at the Cen­tral Bank that every­one seems so hap­py to ref­er­ence in an at­tempt to pass the blame on­to the reg­u­la­tor on­ly dealt with the prin­ci­pal sum. The in­ter­est had to be earned with­in the CL Fi­nan­cial Group.

If the abil­i­ty to pay the "guar­an­teed" in­ter­est was un­der chal­lenge be­cause falling prof­itabil­i­ty, but there was a con­trac­tu­al oblig­a­tion un­der the EF­PA to do so where was the mon­ey com­ing from to pay the ex­ist­ing in­ter­est oblig­a­tions to pol­i­cy­hold­ers? The in­ter­est pay­ment was ac­tu­al cash that had to be paid out. Was it com­ing from more bor­row­ings or new EF­PA pol­i­cy­hold­er funds? Ei­ther way its means more debt on the CLF bal­ance sheet. What would hap­pen if this were to con­tin­ue on for six or 12 months?

Note, too, that re­ports are sent to the reg­u­la­tor on a pe­ri­od­ic ba­sis and this re­port­ing is af­ter the fact for the sim­ple rea­son that the li­a­bil­i­ty (the EF­PA sale) has to be es­tab­lished and ac­count­ed for be­fore it can be re­port­ed and funds placed in­to the Statu­to­ry Fund. That is plain com­mon sense. If a prob­lem is not­ed by the reg­u­la­tor and the com­pa­ny is giv­en time to ad­dress the is­sue but then col­laps­es be­fore the deficit can be ad­dressed then the reg­u­la­tor is no more to blame than every EF­PA in­vestor whose in­di­vid­ual re­spon­si­bil­i­ty is to re­view the ac­counts of both Cli­co and CL Fi­nan­cial but did not take the time to un­der­stand the com­pa­ny that they were in­vest­ed in. Fur­ther, if the reg­u­la­tor were to have called a halt to Cli­co in 2007 and took away the punch bowl of high in­ter­est rates, imag­ine the up­roar and the ac­cu­sa­tions that would have flown. Even to­day there are peo­ple who refuse to ac­cept CL Fi­nan­cial is bank­rupt.

Pledged As­sets

Last week I at­tempt­ed to quan­ti­fy the as­sets of CLF that may be avail­able to be sold to meet pol­i­cy­hold­er li­a­bil­i­ties. By my rough es­ti­mate the out­right saleable as­sets as per the 2007 bal­ance sheet amounts to $21 bil­lion in fi­nan­cial as­sets, $4.6 bil­lion in in­vest­ment prop­er­ties and, if the land held for de­vel­op­ment is reval­ued to re­flect a mar­ket val­ue, then as­sume an­oth­er $1 to 2 bil­lion. To the to­tal we should add the val­ue of the Re­pub­lic Bank (RBL) shares (deduct the as­sets of RBL and add the val­ue of the shares) and Methanol Hold­ings. As­sum­ing a val­ue of $14 bil­lion in to­tal for the shares of these two en­ti­ties you are deal­ing with a sce­nario of rough­ly $40 bil­lion in re­al saleable as­sets as at 2007. Turn to page 66 of the CLF an­nu­al re­port and note that out of the $21 bil­lion in fi­nan­cial as­sets $6.8 bil­lion are pledged to third par­ties.

Then on page 94 un­der a note As­sets Pledged recog­nise that at the end of 2007 $32.128 bil­lion of as­sets were pledged for over­drafts, short-term and long-term loans. It is clear that some prop­er­ty, plant and equip­ment as­sets are in­clud­ed in the pledged as­sets. Based on the note this $32 bil­lion is in ad­di­tion to a $6.3 bil­lion in as­sets pledged un­der re­pur­chase agree­ments (prob­a­bly in­clud­ed in the $6.8 quot­ed above). Al­ready we are close to $40 bil­lion in as­sets pledged and we are yet to dis­cuss claims by pol­i­cy­hold­ers. To ap­pre­ci­ate the cur­rent sit­u­a­tion one al­so has to fac­tor in the re­cent in­for­ma­tion that in 2009 the State had to pro­vide a guar­an­tee of $1.8 bil­lion to First Cit­i­zens as part of the deal to take over CMMB. Yet, just a few months ear­li­er in Oc­to­ber 2008, CLF paid ap­prox­i­mate­ly $260 mil­lion to make CMMB a 100 per cent sub­sidiary. It is safe to say that this $260 mil­lion rep­re­sents a loss to CLF.

From the Las­celles de Mer­ca­do deal in 2008 you will note that it cost CLF $4.2 bil­lion to ac­quire and $2.8 bil­lion was fund­ed through ex­ter­nal debt fi­nanc­ing. Was the dif­fer­ence of $1.4 bil­lion fund­ed from Cli­co (EF­PA funds)? Two weeks ago the ed­i­tor of the Busi­ness Guardian quot­ed the val­ue of Las­celles at $3.8 bil­lion. So CLF is cur­rent­ly $400 mil­lion short on this in­vest­ment and has to pay fi­nanc­ing costs as­so­ci­at­ed with at least $2.8 bil­lion of bor­row­ings at be­tween 9.5 and 10.5 per cent.

Are you be­gin­ning to re­alise that there ap­pears to be a dis­tinct short­fall in as­sets avail­able to pol­i­cy­hold­ers, not just in a fire sale but in any kind of sale, to­day or in­to the fu­ture sim­ply be­cause many as­sets were pur­chased at peak val­u­a­tions? Ap­pre­ci­ate as well that debt hold­ers will prob­a­bly en­sure they have the best qual­i­ty as­sets of the group as col­lat­er­al.

Note 43 on page 94 of CLF's ac­counts al­so in­di­cates that $28 bil­lion in as­sets are pledged to the reg­u­la­to­ry bod­ies how­ev­er on­ly the as­sets for the group's in­sur­ance op­er­a­tions are rel­e­vant.

From in­for­ma­tion dis­closed by the Cen­tral Bank we know that $10.6 bil­lion was placed in the Statu­to­ry Fund (SF) at the end of 2007 against T&T in­sur­ance pol­i­cy­hold­er li­a­bil­i­ties of $11.2 bil­lion rep­re­sent­ing a short­fall of $617 mil­lion. Ac­cord­ing to the Cen­tral Bank the unau­dit­ed ac­counts for 2008 showed a SF bal­ance of $11.6 bil­lion against pol­i­cy­hold­er li­a­bil­i­ties of $16.7 bil­lion, a deficit of $5.1 bil­lion. As I said ear­li­er this in­for­ma­tion would have been re­port­ed to the Cen­tral Bank af­ter the fact and re­al­ly it is the re­spon­si­bil­i­ty of Cli­co, es­pe­cial­ly as these were the rep­re­sen­ta­tions be­ing made to their clients, to pledge the as­sets as re­quired.

Based on the num­bers pro­vid­ed above one can ar­gue that at least for 2008, pos­si­bly longer, Cli­co may have mis­rep­re­sent­ed the pledg­ing of as­sets to their clients based on the fact that the deficit in the Fund in 2008 as per the Cen­tral Bank is rough­ly equiv­a­lent to the in­crease in in­sur­ance li­a­bil­i­ties dur­ing the year (EF­PA sales?). Whether you opt for a fire sale or to hold on to as­sets in the hope of price ap­pre­ci­a­tion it should be­come in­creas­ing­ly clear that, with mount­ing li­a­bil­i­ties, it is im­prob­a­ble for per­sons to get back all that was in­vest­ed.

In the cir­cum­stances, the State has cho­sen to rank the tra­di­tion­al in­sur­ance pol­i­cy­hold­ers ahead of the EF­PA and guar­an­tee those 225,000 per­sons with life in­sur­ance poli­cies and tra­di­tion­al an­nu­ities ahead of around 15,000 EF­PA in­vestors.

If the choice were yours what would you have done?

ian.nar­ine@gmail.com