Bank Mutiara : Trowing good money after bad Alexander Ugut  ;  A Former Principal Risk Management Specialist at the Asian Development Bank in the Philippines

JAKARTA POST,  08 Januari 2014

                                                                                                                       

Answers are needed to several questions regarding the move by the Deposit Insurance Corporation (LPS) to inject an additional Rp 1.25 trillion (US$102.1 million) into ailing Bank Mutiara.  Mutiara, formerly Bank Century, became a familiar name after it controversially received Rp 6.7 trillion in bailout funds a little more than five years ago. As a result, total capital injected into Mutiara to date amounts to Rp 8 trillion. The reason cited for the injection was to raise the bank’s capital adequacy ratio to 14 percent from 5.13 percent as of the end of September 2013.  The first question is about the rationale behind the decision for the second capital injection. Was it really the best way forward if the government wants to sell its entire stake in Mutiara? Has Mutiara undertaken significant reform and improvement in its management to deserve a second capital injection? Or will it prove to be a case of throwing good money after bad after the first capital injection?  Bailing out an ailing bank could pose a serious moral hazard. Banks can become imprudent or even reckless and take excessive risks with depositors’ money.  It also represents an additional burden for government finances, especially if done during a severe and prolonged downturn. Some argue that past experiences have shown that bailing out even a “too big to fail” bank could prolong and worsen a recession.  A bailout is often seen as a waste, especially if the problem is solvency and not merely liquidity because it could result in a “zombie” bank. This line of thought sees bank failures as a natural necessity of what they call “creative destruction” to give birth to a sound and thriving banking system.  Notwithstanding the argument between the different schools of thought about the necessity of a bailout, more judicious deliberations are needed in any decision to bail out a bank.  In one of its official statements, the LPS attributed defaults by six borrowers with a collective exposure of Rp 600 billion as the main reason behind the decision to inject more funds. This alone should have immediately raised eyebrows because the average exposure to a single borrower amounted to about 10 percent of Mutiara’s capital as of the end of 2012.  This situation could have existed for quite some time given that these defaulted loans were a legacy of the old management.  How could Mutiara allow exposure to only six of its borrowers account for 50 percent of its capital? Did Mutiara disclose the loan portfolio concentration and limit violation in its past financial reports?  By looking at its asset and liability maturity gap as of September 2013, it can be seen that Mutiara could have experienced a funding gap of more than Rp 7 trillion before the end of 2013.  Was the second capital injection aimed to avert a serious liquidity crisis that was simply caused by potential depositors’ refusal to roll over their loans?  Whereas the decision to divest is sensible, asking for a price that is as much as the amount of injected capital would not be realistic because it implies a huge premium over Mutiara’s fair value.  This is the main reason that to date no serious offer has been made for the bank. This stance has changed, since there is now a willingness to accept the highest offer based on the market price.  Now that the second injection is water under the bridge, a clear exit strategy is urgently needed. It should be clear by now that the first bailout should be considered a “sunken” cost. Given the likely continued deterioration of Mutiara’s loan portfolio, the immediate sale of Mutiara’s shares would be the most desired outcome.  It should be made clear that no one should be held accountable if the actual sale price of Mutiara is significantly lower than the amount of injected capital as long as the price reflects fair market value and bidding is transparent.  This leads us to the second question: At what price can the LPS expect to sell Mutiara? A serious bidder may use the following argument to determine the fair value of Mutiara. Given the Rp 569 billion book value of equity prior to the second injection, and applying a conservative price to book value ratio (PBV) of 1.5, the price of Mutiara’s existing shares should be valued at Rp 850 billion to Rp 900 billion.  An optimistic bidder may apply a PBV of 2.0, but I would not expect a rational buyer to use a PBV higher than 2.0. The new capital of Rp 1.25 trillion should be valued at a PBV of 1.0 only. This would give a fair value estimate of Rp 2.1 trillion to Rp 2.5 trillion.  A PBV of higher than 1.0 applied to the newly injected capital would be irrational as it would imply that the LPS can treat Mutiara as a money machine. This line of thinking is necessary to avoid future cases of throwing good money after bad in bailing out “zombie” banks.  In other words, the mere act of injecting new capital into an ailing bank does not add anything to shareholder value.  The sale of Mutiara’s common shares could have taken place even without the second capital injection, assuming there were more transparency and a willingness to accept a fair market value.  Above fair value estimates assume that there won’t be any unexpected surprises found during due diligence.  Finally, the last question would be: “Who would be the eligible buyer”? A second mid-tier local bank that has the required infrastructure and management capability should be preferred.  The selection of a successful bidder should not in any way result in the creation of a gargantuan bank in order to promote a more competitive banking industry without contributing additional systemic risk. ●