Markets in shock as EADB posts $8.9m loss on bad political loans

Heads could roll at the top management of the East African Development Bank as it emerges that East Africa’s largest regional bank and foremost development finance institution has just made a massive anticipated loss of $8.9 million.

The new results, which were quietly released last week four months behind schedule, have jolted the capital markets in the region — revealing for the first time that EADB has, away from the limelight, been suffocating under the weight of huge “political loans” that have seen its non-performing loan portfolio hit an unprecedented level.

The EastAfrican has learnt that most of EADB’s bad loans have been extended to companies owned by people with connections to powerful individuals within the National Resistance Movement.

On the list of bad loans are a number of serial loan defaulters — including a Kampala-based fish exporting company currently under receivership by a leading multinational bank in Kampala.

A Nairobi-based mining company belonging to an individual with links to politically powerful individuals in Kenya is also on the list of bad debtors.

The oldest institution of the East African Community, owned equally by Uganda Kenya and Tanzania, this year’s results reflect the bank’s worst performance in 30 years.

The loss has confounded the markets because it has come after a sustained upward trend in profitability in the past three years, and despite the bank having posted an operating income of $19.3 million last year.

Also puzzling is how a bank that had managed to progressively reduce its huge losses to $4.2 million in 2003, returning to profitability with profits of $200,000 in 2004, $1.4 million in 2005 and finally $4.6 million in 2006, suddenly found itself in the red with a loss of $8.9 million.

In 2002, the bank posted a loss of $10 million, prompting a major shake-up and restructuring process leading to the exit of five top executives and decision-makers in key departments, including operations, business development, human resource and research.

Insiders at the bank’s headquarters in Kampala are predicting another shake up in the top management of the bank.

Already, a key officer and Zambia national, operations director Passwell Shapi, has left the bank. In a conversation with The EastAfrican last week, Mr Shapi said he had left the bank of his own volition, declining to discuss the causes of the bank’s dwindling fortunes.

But insiders at the bank have seen the departure in the context of the pressures that the board of directors are exerting on the bank over the pile up in non-performing loans.

Efforts to discuss the issue with chief executive, Godfrey Tumusiime, proved futile. Neither were other directors — Ugandan Finance Ministry Permanent Secretary Chris Kassami and James Mulwana, who is the Ugandan private sector representative on the Board — willing to discuss the bank’s dwindling fortunes.

According to the financial report, EADB made a loss due to bad debts amounting to $21 million written off in the course of the year.

This is how the report put it: “The bank recorded a loss of $8.9 million compared with net profit of $4.6 million in 2006. The decline was occasioned by a charge on non-performing loans of $20.9 million.”

The distribution of these bad debts between the countries where EADB operates is not disclosed in the accounts.

Has EADB been under-providing for bad debts and misrepresenting facts in order to mask its financial blemishes? If not, what explains the sudden rise in the level of provisioning? Banks are masters of employing accounting gimmicks to mask their financial difficulties.

A closer look at the bank’s financial statement raises questions about the quality of the accounting information in its previous accounts.

For instance, in 2006 EADB declared $4.6 million profits after making a provision of $1.5 million for non-performing loans.

Yet in a period of just one year, the figure had jumped to $21 million. Has there been any material happening that has affected EADB borrowers within the year? Or has the bank employed new accounting standards with stricter bad-loans provisioning assumptions? The answer to both questions is no.

Investigations by The EastAfrican have traced the origins of the matter to a meeting of the board that took place in early May. Board sources said it was at that meeting, where it emerged that the bank had posted very bad results, that fresh audits on the bank’s loan book were ordered.

Consequently, the board directed that the books of the bank be scrutinised by a team of auditors drawn from the Offices of the Controller and Auditor Generals of Kenya, Uganda and Tanzania.

It is understood that it was after this scrutiny by the auditors that the true extent of the non-performing loan problem in the bank became clearer.

According to sources, two top managers were asked to prepare to leave the bank on completion of their contracts. The third top executive was asked to leave the bank immediately.

The source further revealed that last year’s loss would have been greater than $8.9 million were it not for extraordinary items on the income side — the money the bank earned from the sale of its stakes in Mumias Sugar in Kenya and Nile Bank in Uganda, which was acquired by Barclays Bank in a transaction in which EADB netted in excess of $3 million in extraordinary income.

Why did the accounts take so long to publish? Sources said part of the problem came about because the bank had just migrated to a new IT regime, so that the audit took eight months instead of the usual six months.

The upshot was that instead of the audits starting in December as usual, external auditors did not move in until February. It all culminated in that crucial board meeting in May.

According to the accounts, EADB approved investments worth $84.6 million, down from $108.6 million in 2006, with $69.9 million going into to short, medium and long-term lending — $13 million into asset leasing and less than $1 million into equity investments.

The report reveals that loans to the construction sector accounted for 28 per cent, transport, storage and communication 22 per cent, electricity, water, gas and oil 19 per cent, and manufacturing 13 per cent of the total.

Even with its mounting non-performing loan problem, it is clear that the EADB will continue to play a critical role in the region.

The long-term lending sector in East Africa is almost dead. The vibrant development financial institutions that drove the region’s import-substitution industrialisation strategy of the 1970s and 80s have all disappeared, leaving the field to mushrooming commercial banks.

The problem, however, is that commercial banks tend to concentrate on extending overdrafts and other short- term facilities.

Banks in East Africa tend to prefer lending to existing business. Worse, capital markets are underdeveloped. The stock exchanges in the region are to a large extent markets for trading shares in existing companies.

In Kenya, building societies that used to extend long-term mortgages have been forced by restricting banking regulations to turn into commercial banks.

Thus, long-term money is non-existent in East Africa. The market for long-term money for financing expansion and growth has been left to the EADB.

Yet East Africa remains a difficult zone for development financing, mainly due to poor loan repayment rates.

Then there is the fact that the multinational commercial banks who first came to East Africa did not train people in the area of risk management.

It is noteworthy that until last year, EADB did not have experienced risk professionals in its cadre. It was only in the course of the year that a risk manager was recruited.