Saving the Banks – understanding the GAT inherent risk structure

Government’s decision to assist solvent and well-governed local banks in meeting the new GH¢400million (US$83million) minimum capital requirement (through the newly set-up Ghana Amalgamated Trust (GAT) holdings) has been lauded by industry experts as positive. The proposed transaction structure will require the newly-set-up GAT to issue marketable corporate bonds to local pension fund managers and use the proceeds to inject equity capital into five (5) local banks. So far, a total amount of GH¢2billion (US$412million) has been committed by local pension funds toward this special purpose vehicle.

The current proposed GAT structure, though ingenious, exposes pension fund managers to several risk factors incommensurate to the expected yield. To begin with, let’s look at the transaction structure:

GAT Structure

The GoG intends to raise GH¢2 billion (US$412m) from local pension fund managers through a public bond issue to invest in five (5) local banks – namely UMB Bank, NIB Bank, ADB Bank, Prudential & Omni/BSIC Banks. The bond is expected to be a zero-coupon bond that will be issued at a discount to face value of 25% for a tenor of five (5) years. This translates to a 6.9% yield (YTM) – which is almost 300 basis points below the current inflation level. The proceeds from this transaction will be invested as equity in these companies to shore-up the capital to GH¢400million.

Cash Flow/Liquidity Risk

The first noticeable risk inherent in the GAT structure is the capital mismatch; raising debt to invest in private companies as equity presents enormous liquidity and cash flow risk for the fund’s investors at maturity. For GAT to meet the required payment to pension fund managers, it would need to exit its investments in these companies at a valuation of not less than 1.5 times of Book Value or IRR of 10% in 2024 to strategic or financial investors. However, given the low profitability (ROE) and growth outlook for these banks, exiting at such attractive valuations would be very difficult.

Statistically, it’s impossible for any of the banks, except UMB, to generate enough retained earnings to buy back its shares completely from the GAT at the targetted IRR yield of 6.9% in 2024 – provided it continues to grow its equity at the current 17% threshold.

Default Risk

The solvency of the GAT beneficiaries is a key determinant of the default risk for the GAT bond. Extending capital to mismanaged banks with poor corporate governance structures only increases the probability of default. This makes inclusion of the two government banks a bit problematic. For example, NIB which is a wholly government-owned bank has not been able to produce an audited financial statement since 2016. However, NIB alone will require approximately 45% (almost GH¢909million) of the GAT proceeds to make it compliant with the new regulatory minimum capital. Including NIB as a GAT beneficiary overexposes pension funds to uncompensated default risk.

Risk of economic loss

The proposed structure for GAT only affords pension fund managers a return of 6.9%, which is almost 960 bps below the current 5-year GoG bond, trading at 16.50%. GAT should provide a premium above this rate before it offers value for pension fund investors. Notwithstanding, given the low ROE of the beneficiary banks, increasing the yield to an appropriate yield of 19.5% (16.50+ spread of 3%) would eliminate the possibility of any of the banks buying back its shares.

The writer is with Cal Brokers Ltd., as Head Investment Banking & Research.