ETI Finance and Swarnamahal Finance, a jewellery retail chain Swarnamahal, a film production and distribution firm EAP Films and Theatres with a network of cinemas, a successful broadcast media company EAP Broadcasting Company Limited with two television channels (Swarnavahini and ETV) and three radio stations and several prime commercial properties in Colombo and other major cities.
The gold price slump in 2013/14 saw the two finance companies sustain huge losses which resulted in the entire group reporting a negative net worth of Rs5 billion. This was on top of several shortcomings in regulatory compliance, management and governance; typical challenges faced by family-owned businesses. EAP Edirisinghe built his empire with a pawning license in the 1930s with the establishment of Edirisinge Trust Investments Limited (ETI) and soon expanded into deposit taking. ETI profits were used to diversify and acquire new businesses and prime commercial property. After his demise thirty years ago, the businesses and assets of ETI went to his four children, which became a problematic situation after the Central Bank tightened the screws on the financial sector after the Ceylinco Group’s Rs26 billion Golden Key Credit Card Company collapse in 2008. Tittawella became chairman of EAP Holdings six months ago. He only agreed to restructure the group because the family was willing to make the hard choices. He failed to achieve one of his goals of taking the People’s Bank public; as a result some of the reforms had been rolled-back. Tittawella is determined to see the EAP Group restructure through to public listings of its companies. He spoke to Echelon about the restructure of the EAP Group and his experience of resurrecting People’s Bank.
You left People’s Bank in 2001 after successfully turning it around from a negative Rs20 billion net worth to a positive Rs10 billion net worth in just three years. A decade and half later you are in the middle of restructuring another financial institution.
Yes, a private sector restructure this time. It is a different ball game.
You were appointed chairman of EAP Holdings Limited to restructure the group. What’s the scope of the problems facing the EAP Group, particularly the two finance companies of the group ETI (Edirisinghe Trust Investments) Finance and Swarnamahal Finance Company PLC?
It is important to know the history of the group so we understand the context. The group was started more than 60 years ago by EAP Edirisinghe.His business was pawning and his is one of the oldest licenses in the country. He was a highly successful, astute, careful man who came from nowhere. ETI started with that business in 1945 and there were no rules and regulations back then. Central Bank rules came only after Ceylinco Group’s Golden Key collapsed. Edirisinghe gave cash for gold. He first put in his own money to the business but soon began taking money from people and paid them interest monthly. To-date, the company has a perfect track record and never defaulted on a deposit. We have over 40,000 customers who are extremely loyal to us. Not one of them has ever lost anything entrusted with ETI.
When he made profits he bought other businesses. He invested in the film industry. EAP Films and Theatres is the largest film producer and distributor in the country. We own several cinemas and make healthy profits each year and account for 60% of the cinema revenue of this country. Then he bought Swarnamahal Jewellers, which was an older company at the time. It is 75 years now and it made sense to him because he started out as a pawnbroker and instead of selling the unredeemed gold he started making jewellery and doubled profits. It is the largest jewellery retailer in the country with over 60% of the regulated market. Then he bought a load of properties, all commercial free hold properties, in and around Colombo, Kandy and Kurunegala, the next best security. He also invested in cinemas which were the best properties in the middle of a city or town. All these acquisitions were made with ETI funds, there were no bank loans.
[pullquote]In 2013/14 the group was hammered by falling gold prices, and the two finance companies in the EAP Group, ETI and Swarnamhala Finance, had to make a provision of Rs5 billion, as 90% of their business was around gold pawning[/pullquote]
There is an interesting story, although I cannot verify it. Edirisinghe passed away 30 years ago leaving behind a wife and four young children. The story goes that there was a long queue outside ETI the next day. People wanted their deposits back because the man they had trusted was no more. But Edirisinghe had left a letter with his bankers Standard Chartered Bank. In it he left instructions as to what should be done should anything happen to him; his lawyers were authorised to open the ETI vault and pay off the depositors. The bankers and lawyers opened the vault and discovered that he had maintained a cash reserve equivalent to the deposits he had collected. This was long before Central Bank reserve rules came into place. So all the depositors got their monies back and many of them deposited them right back with ETI. Trust was firmly established. Edirisinghe ran a very tight ship.
Then the family took over and the only new business to be added to the group was in electronic media; EAP Broadcasting, which owns Swarnavahini, is a very successful business. He left his assets to his four children and wife, and so although ETI monies were used to acquire various business and assets like land, these assets were divided and held in the names of different members of the family. Also, Swarnamahal Jewellers was accepting public monies by issuing debentures which were not officially sanctioned by regulators. Various companies in the group were engaged in lending and borrowing as well. After the collapse of Golden Key, the Central Bank kept tightening the rules and issuing new regulations, it soon became apparent that ETI was non-compliant with the new regulations.
Each business under the EAP Group was managed by a different member of the family. When they realized they were not compliant with the regulatory regime, four or five years ago, they hired S. Kariyawasam, a former central banker and upright man, to look in to the EAP Group. He found that the group had enough assets to meet all obligations, but the two finance companies were non-compliant with the regulations and this was a big problem. He and shareholders approached the Central Bank where they had a discussion with the regulator. Firewalls were not in place with too many entities in the group borrowing from each other, assets were in various names, accounts were not properly done and audits were delayed, the same story any family business has.
All lending and deposit liabilities must come through the finance company ETI, so this was done. But there were no corresponding assets, so the properties and shares were brought into ETI. Except for their personal houses, the shareholders voluntarily brought their shares and properties and everything else to ETI. In the 2011/12 financial year, these assets were valued by Ernst and Young and the balance sheet had a Rs4 billion net asset value. All this was done with the concurrence of the Central Bank. However, there was an assets to liabilities mismatch and this was huge. The assets were long term and not liquid but were shares of other companies and properties. So the first stage was to stabilize the balance sheet. Even if ETI were to close down we could have paid off all the depositors and had Rs4 billion leftover. Yes, there was a liquidity mismatch but profitability was not an issue until then. The big issue was being compliant with regulations. Then came the big blow.
In 2013/4 the group was hammered by falling gold prices and the two finance companies in the EAP Group, ETI and Swarnamhala Finance, had to make a provision of Rs5 billion since 90% of their business was around gold pawning. ETIs provision alone was Rs4 billion. When these provisions were made, ETI ended up with a negative net asset value. The latest figures show an Rs3.8 billion negative book value. I joined the EAP Group as chairman six months ago, and I told the family that, qualified or not, they should state the accounts. You have to know where you are. Luckily, the other businesses in the EAP Group were making a lot of money, enough to keep the group in business; last year we made about a billion rupees.So there is no cash issue still, but a non-compliance issue. I brought in a new team and the directors are strictly non-executives. We found that accounts were in arrears for three years. By the end of July we hope to have the accounts up to date, except for ETI which will be brought up to date by end December 2015, and thereafter prepared regularly for annually and for each quarter.
We are now in the process of monetizing the assets of ETI. EAP Broadcasting is worth Rs4 billion in the books and we will pull it out of the group and form it into a separate holding company. I am going to raise equity and venture capital. Discussions are at the advance stages with three major funds. We hope to raise Rs10 billion and buyout the assets held with ETI and replace them with cash in the ETI balance sheet. The Rs3 billion debenture issue is only part of this plan.
[pullquote]We hope to raise Rs10 billion and buyout the assets held with ETI and replace them with cash in the ETI balance sheet. The Rs3 billion debenture issue is only part of this plan[/pullquote]
We will eventually merge ETI and Swarnamahal Finance because there is no need to have two finance companies. We are also talking to two international financial institutions interested in entering Sri Lanka and remodel the finance companies with Rs6 billion in fresh capital.
The first infusion will take place between September and March. By then we will have Rs10 billion fresh infusion into ETI and the EBC debenture issue will buyout the land which will happen in a transparent manner with approval from the Central Bank. Next year ETI will be back to normal. In 2015/16 the loss will be less, but in 2016/17 the company will have a positive book value and be regulationcompliant. Swarnamahal Finance will go for a capital issue as well. Last year it had a 1.2 billion net asset value which we brought down to Rs200 million without any cash infusion at all. Then these two finance companies will be profitable once again and then we would have to bring them together.
The EAP Group was always very profitable, but saw a negative book value after the two finance companies dragged down profits after provisions were made after gold prices crashed. Profitability was not the issue; it was an issue of non-compliance. The finance company ETI started out as a holding company. The non-finance assets must be monetized and fresh capital must come in. Around 600 people were let-off, professional management was brought in and family members were made strictly non-executive directors. Now the time is right to infuse capital and the companies in the group will be made public during the next two years.
Will the family still be in control?
No, but they will have a stake and non-executive roles to play. A 100% stake in the group is worth on paper, but a 40% stake in a listed company will be worth much more and the family realizes this. What’s more, EAP Edirisinghe’s grandchildren are not interested in the businesses.
In fairness to Edirisinghe’s four children, they were initially forced by non-compliance to give up the group. But instead of fighting it they decided to take the hard route. I only came here because they were willing to cooperate. Not many people are willing to do this. They took a haircut and their lifestyles have significantly changed. A major share of their personal assets was brought in to ETI without batting an eye-lid. They were forced into this situation, and the Golden Key issue also jolted them. But they made the hard choices themselves.
What kind of impact did the losses of ETI and Swarnamahal Finance have on the group?
Without ETI, the group can be valued at Rs15 billion. Mismanagement was also there but 85% of the group’s problems were due to the slump in gold prices. Our task was to restructure the business, then capitalise, followed by making them public to make the reforms stick. I would say we have a 70% chance of succeeding. We did all we could. Now the rest depends on the market and the economy and outcome of the elections. If I was in the same stage at People’s Bank I would say 100% was done. But here, I have no safety net like government funds and backing.
The Central Bank is very facilitating. They are hard and strict but they are professional. They have learnt a lot from the Golden Key fiasco. It is a much improved Central Bank since when I was restructuring the People’s Bank.
[pullquote]In fairness to Edirisinghe’s four children, they were initially forced by noncompliance to give up the group. But instead of fighting it they decided to take the hard route[/pullquote]
In how bad a shape was People’s Bank?
People’s bank was technically bankrupt and this is not something I am saying. The then Minister of Finance, late President DB Wijetunga told parliament that state banks were bankrupt and this caused a huge stir at the time. He was not far away from the truth. If you apply the normal rules that would apply to any bank, People’s Bank was indeed bankrupt. However, because it was a state bank with the implicit guarantee of the state, it was allowed to continue. It soon became a major issue because multinational lending agencies like the World Bank and International Monetary Fund were pointing out that this was a disaster waiting to happen but the management and style of doing things were moving happily along regardless.
Now in the case of People’s Bank it was a very acute problem because the numbers indicated in the bank’s annual reports were not accurate. They did not state non-performing loans (NPLs) as NPLs and made no provisions for them. So in 1999, when the new board took over we were given a very specific mandate by then president Chandrika Bandaranaike Kumaratunga to look at the bank’s books and tell her what could be done. There was myself as Chairman, Dewa Rodrigo, Lalith de Mel, and others, all top professionals from the private sector and some ex-officio members from the public sector. So the first thing we did was to hire the services of a professional set of accountants to do an audit and restate the balance sheet: the first thing in restructuring is that you must know where you are. You must know exactly where you are without the frills, otherwise you would not know where you are going. We found that the bank had a negative net worth of Rs20 billion.
How did you turn the bank around? What exactly did you have to do?
The first thing we did was to make sure the business continued. It had a huge data base with four to five million accounts and a well-known brand name and massive deposit base. We found that a mere 10 or 15 people accounted for 90% of the NPLs which they had received through political influence. These were massive loans granted even without security. Cases had been filed to recover some of these loans but they were taking too long. So we took three decisions to help us get the bank on track.
Firstly, we gave our legal team carte blanch approval to prosecute these defaulters to the full extent of the law. But in reality we knew it would not help us because the legal process takes a long time and we needed to come up with something fast, and besides, some of them may not have had the means to pay back.
The next thing we did was to request the Treasury to issue the bank a letter that it would support the bank despite the negative net worth of Rs20 billion. That was taken for one purpose; it had no effect on depositors but did have a huge effect on corresponding banks around the world and helped avoid panic. These banks have various compliance processes and they could have withdrawn facilities to People’s Bank when they saw a negative book value of Rs20 billion in the balance sheet. So this letter went with the balance sheet and it provided some cover for two years; the Treasury had decided it would only issue the guarantee for two years.
The third thing was we looked at a practical business plan. I am a firm believer that when you do restructuring, you don’t take the undertakers approach. This is not what we are about. You can do restructuring in two ways: Kill the patient and disembowel him and sell. This will never work and has never worked in any part of the world and depositors are only left with another disaster.
This is why in my opinion, the Golden Key restructuring is a disaster. I don’t disagree for a moment that the culprits must be brought to book within the full extent of the law, but the first duty is towards the depositors. First you must ring-fence the company so that there is no panic. Then you have to realize assets. In Golden Key there was a forced mad sale of assets amidst various allegations that assets were under-priced and sold unfairly and now the result is that depositors have lost their money and incurred huge legal costs and are worse off than before. So this is where I feel that when markets fail-and it fails in the best of countries – the US has had several, there is a role for government. In my humble opinion, intervention was required here in the Golden Key case; special legislation would have been warranted to ring-fence Golden Key and protect its assets from the jackals. This would have given some comfort to depositors and ensured they did not panic. The government reacted a little too late. In the case of People’s Bank 15 years ago, its failure would have caused a financial tsunami. But the bank was too big to fail. So once we instituted legal proceedings, and there were many interferences to stop this, and ringfenced the bank, we began the real job of restructuring People’s Bank. We can only rebuild a business if we put a proper business plan in place. When businesses fall into a hole, the first step is to realise the mistakes, correct them and climb out of the hole. There is no magic wand. No one is going to come and give you money to come out of it. In fact, even if you have money you should not use it, otherwise you ignore the real problems that landed the business in a mess in the first place. In the case of People’s Bank, it had a major systemic problem; there was political interference, the staff was not independent, there was lack of accountability and initiative. So we took a sick man and ring-fenced him with life support so that he didn’t die the next day and then we moved on to curing him.
Unless the curing process concentrates on the real problems it will be a patch-up job, so the last thing you do is give money. People’s Bank did not get any money for restructuring. You give money and the same old habits will continue. Had money been given to capitalise the bank, everyone would have gone to sleep and five years down the line the problem comes up again double the magnitude.
We told the staff, that the problems were largely internal and that we needed a radical change in the way the bank operated. We froze all salary increments for two years and for the first time in history we had the support of the powerful bank employees’ union which had also shared with us their concerns mainly over political interference. We cut spending and wastage but this did not stop us from spending to grow the business.
The People’s Bank head office was an absolute white elephant. There was a joke at that time, and it was true, that if you close down all the branches of Bank of Ceylon and kept only its head office open, the bank would have made huge profits. On the other hand, if you closed down the People’s Bank head office and left its branches open, People’s Bank would have been highly profitable. Drastic changes to the bank had to start from there.
We brought in a complete set of management; including an expat CEO from HSBC, Derrick Kelly, an Englishman who had worked for the bank in the Middle East for a long time. He was very highly recommended. I told the unions that there was no one in Sri Lanka who can do this. If we got a Sri Lankan he would have gotten a hundred calls from people looking for favours and his task would have been impossible and it would have been a disaster. So we decided the CEO must be an outsider. Earlier I had asked the board to write down the main attributes of a CEO. One member had written just three letters; SOB. True, we needed someone tough to run the bank and resist political interferences. Kelly was tough and the right man for the job. We also hired 15 top young Sri Lankan bankers from the private sector at market rates and they did a wonderful job. There was a whole culture change. The bank was fully revolutionised. Another thing people in the state-sector fail to understand is that the chairman has a non-executive role to play. Many become chairmen with nothing else to do and then get too involved and try to play the CEO’s role. Soon the decline starts. I came to office just one hour a day. I never got involved in operational matters. I hired the right people and gave them the freedom to run the bank. The board only got involved on performance and policy matters. So, for example, I used to get calls from ministers about certain loans. I would tell them there was nothing I could do and that they should get in touch with the CEO. The CEO could not speak Sinhala so the politicians would call me back and I would say there was nothing I could do. Luckily I reported directly to the president so there was no further interference. We did not give loans to anyone during that period which did not meet the bank’s requirements.
Then next stage was building capital so that the bank can continue to grow its business. We were not going to get free money from the Treasury nor could we attract current accounts because the bank did not have a large corporate clientele; Bank of Ceylon was the preferred corporate bank at the time. Fixed deposits were too costly as well. So the best option we had was to promote savings accounts, low cost funding for the bank. People’s Bank had a big strength in terms of its outreach so we made use of this and everyone in the bank campaigned hard and in three months we had mobilized Rs200 million in savings accounts. This was the power of the People’s Bank brand. Once we built up our capital we began to lend.
It was tough going but in six months People’s Bank began to turnaround. When I left two years later in 2001, the bank’s Rs20 billion negative net worth had been wiped out and a year later it reported a positive net worth of Rs10 billion.
The only thing I could not do was list the bank on the stock exchange which would have improved the governance structure further. Had I stayed on I would have taken the bank public and it would have been one of the biggest banks in the country. Because this did not happen, some of the reforms, not all, have been rolled back. But the bank is much healthier now.
What are the lessons to be learnt from this?
In restructuring you need to bring in new blood, be absolutely oriented in good governance and lead from the front and improve trading so that the business can grow. You cannot restructure a business by giving it hand-outs because nothing would really change. This is the problem with state banks. They know the government will bail them out because they are too big to fail. I told the Central Bank to stop supervising us. I told them that they had been regulating us for forty years and we were still in a right-royal mess. If they didn’t regulate the bank it would not have been any worse, and this was clear to see. The Central Bank was not happy with my comments.
The bank also had several Central Bank retirees functioning as consultants and other rules. The first thing we did was send them all away. We found that jobs roles had been created just to absorb them.
We made a presentation to the president on how we planned to restructure People’s Bank. She wanted to know the odds of succeeding. We told her 50-50. However unpalatable it may have been, we had to be clear about where we were. She then addressed the entire staff of the bank and asked them to choose: People’s Bank had a Rs20 billion- hole. The education budget that year was Rs4billion. President Kumaratunga told them, “Do I double the budget for education for our students or keep 11,000 people in employment with a strong possibility that the bank could return to a negative Rs20 billion problem again”. Her message was clear; if the restructuring did not work, the bank would be closed down. We had two years to turn things around and we succeeded.