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.
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.
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?