By Joseph S. Kitamirike
In recent months a lot has been said about the acquisition of Crane Bank Limited (CBL) by DFCU Bank.
Less was said about the closure of National Bank of Commerce and Global Trust Bank, and the subsequent acquisition of their assets and liabilities by other banks.
These acquisition transactions sometimes have led to complaints, lawsuits and adoption of ill will towards the Regulator, who may stand accused of making gifts to the acquirer of the assets.
The Regulator’s motivation in seeking an acquirer is to ensure the depositors and borrowers are not inconvenienced by the closure of a bank and protect the integrity of the banking sector.
The most direct benefit in an acquisition is when the acquiring bank grows instantly by adding another balance sheet to its own.
Accountants refer to these direct benefits as the tangible assets and liabilities. This benefit is usually the easier to compute and determine.
There are also less direct benefits such as access to new markets, geographies, market segments and / or the customers that may come with an acquisition.
Further, other less observable benefits come from taking on the competencies of the acquired business – including skilled and experienced personnel; business processes; brands and licenses.
Accountants refer to these benefits as intangible assets. Many acquisitions display elements of both tangible net benefits and intangible net benefits.
Following the recent publication of the DFCU 2017 half year financial results unveiling the post-integration balance sheet, a lot has been said and speculation shall continue to abound about their excellent performance.
According to the publication, DFCU posted a profit after tax (PAT) of Shs 114bn and also has a 67 percent growth in the balance sheet from Shs 1.8tn to Shs 3.0tn, majorly contributed by the acquisition of the CBL assets.
However, this performance ought to put in context due to the impact of Fair Valuation as per requirements of the Accounting Standards, which dictate the accounting of acquisitions and mergers.
In this particular instance, the PAT includes the expected future net benefits out of this acquisition comprising of both the tangible and intangibles.
A thorough analysis of the financial results of DFCU based on credible sources familiar with the accounts indicate that atleast 50 percent of the PAT is contributed by unrealized expected benefits arising from the fair valuation carried out by an independent competent audit firm and apparently confirmed by their Auditors who reviewed the accounts prior to the publication.
This is a one-off unrealized benefit (not yet cash) booked in the accounts and has to be either realised in cash or written off over 5 years.
The concept of fair value is introduced because assets and liabilities are required to be measured at market value when they are first brought into an entity’s books.
In its simplest terms, fair value is the amount payable to acquire an asset (or get rid of a liability) in a transaction between an informed willing buyer and an informed willing seller.
It is a measure of market value and the terms are often used interchangeably.
Fair value introduces significant complexity and judgment to accounting for business acquisitions.
The determination of fair values for tangible assets is common and has been widely practiced for a long period. Whilst some tangible assets might be unique or specialized and hence more difficult to value, there are plenty of real estate and plant & machinery valuers, as well as the required data, in this and other markets to cope with the most demanding tangible assets.
What you need to know about the Crane Bank sale
Intangible assets are more difficult to measure as there are very few market transactions.
Also, intangible assets are rarely comparable as they differ from business to business, market to market, etc.
A key intangible asset is called goodwill and it is recognized as the difference between the price paid to acquire a business and the fair value of its tangible and separately identifiable intangible net assets.
Where the difference is positive, goodwill is recognized on the balance sheet. Once on the balance sheet, it is tested annually for impairment. Where the difference is negative, the acquirer must immediately recognize it in the income statement.
The valuation process for the tangible and intangible assets attempts to take account of the risks inherent in holding such assets.
Determining the risk of holding them can be a highly complex and judgmental process requiring costly specialist advice.
In many instances, complexity compels acquirers to focus on tangible assets, preferring not to take assets that might dilute their own brand, weaken internal policies and strategy whilst lowering economic performance.
It is easy to misjudge the actions of the Regulator in selling CBL, which had both good and bad assets.
However, it is important to note that at the time Central Bank took over the management of CBL, it was technically insolvent and the available good assets were not sufficient to cover the deposits of its customers, hence the need for a rescue by the Central Bank. Going by the numbers published by DFCU,
Crane Bank at the time of takeover had over Shs 600bn in customer deposits and a deficit in net assets of over Shs 200bn.
If the Central Bank had not expeditiously resolved this case by selling the assets to DFCU or any other suitable party and proceed with a liquidation, the tax payers could have potentially have had to pay Shs 600bn to the depositors, or these depositors could have lost their deposits and could have accessed a maximum of Shs 3m each as provided for in the Deposit Protection Fund.
Either outcome would have been disastrous to the economy as it could erode public confidence in the entire banking sector and also lead to collapse of some businesses whose funds would be lost.
I am also informed that the Central Bank sought potential bidders through a bidding process to which several parties responded and the choice of DFCU could therefore not have been by accident.
DFCU was required to increase its capital by Shs 180bn so as to qualify as a bidder. The consideration paid by DFCU is a matter that must have been negotiated and agreed with the Regulator based on their assessment of the benefits and risks associated with this transaction given all public disclosures that have graced our media in the recent past.
DFCU has successfully integrated the CBL assets and liabilities in their operations to enable all ex-CBL depositors to resume normal banking services which is a big plus in this transaction.
With hindsight, Central Bank appears to have exercised its mandate well to resolve a potentially explosive position to the benefit of the depositors and the economy at large.
Joseph S. Kitamirike,
The author is the CEO and founder of ALTX East Africa Ltd.
NB: These are entirely of the author