International -- Finance: Banking
Meltdown in Prague (int'l edition)
A near-collapse at IPB gives a stark lesson in how not to privatize a bank
The balaclava men got the O.K. just before noon on Friday, June 16. Outfitted in black battle gear and armed with machine guns and tear gas, the masked raiders stormed the Prague headquarters of Investicni a Postovni Banka (IPB), the Czech Republic's third-largest bank. In minutes, they had secured the building and rounded up top management.
What was going on? As with most other matters concerning the beleaguered IPB, the answer depends on whom you ask. The men were members of an elite police antiterrorism squad sent by the government to put IPB under central bank administration. A run on deposits had sucked IPB dry, and Prague estimated the bank's collapse could cut the nation's gross domestic product by 4% this year. Efforts to negotiate a rescue with Nomura Europe PLC, IPB's largest shareholder, with a 46% stake, had failed the night before. So the central bank swooped."NO JOKE." By Monday, the government had fired most of IPB's executives and agreed to sell the bank--for a price still to be set--to its crosstown rival, Ceskoslovenska Obchodni Banka (CSOB), a unit of Belgium's KBC Group. Prague guaranteed IPB's deposits and agreed to cover all its losses. "It was necessary to show the strong commitment of the government," says First Deputy Finance Minister Jan Mladek, the regime's point man for the crisis. "This was no joke."
No kidding. IPB's near-collapse has sparked a growing scandal that has renewed doubts about the stability of the Czech banking system, spooked foreign investors, and may yet topple the minority Social Democratic government. The affair could cost Czech taxpayers as much as $5.3 billion, or $530 for every man, woman, and child. "Just as things look like they are getting better in the Czech Republic, they get worse again," says Andrew Cowley, head of emerging-markets investment strategy at Dresdner Kleinwort Benson in London.
The Czech parliament set up a committee on July 3 to investigate the circumstances of the bank's downfall. A central question is the status of more than $5 billion worth of IPB assets, mostly shares in other companies. Investigators suspect some may be lost in a dense web of offshore holding companies set up by IPB's management. It will take months for auditors to complete their work, but already the finger pointing has begun. The opposition Civic Democratic Party (ODS), led by former Prime Minister Vaclav Klaus, has criticized the government for taking over IPB. The Social Democrats say Klaus bungled the bank's privatization in the first place. And just about everyone blames Nomura for not doing more to stem IPB's losses.
At the center of the furor is Randall Dillard, managing director of Nomura International PLC and deputy chairman of IPB's supervisory board. A 44-year-old Miami native, Dillard pulled off the 1998 deal in which Nomura bought the government's 36% stake in IPB for $80 million and made a commitment to boost the bank's capital by $160 million--which it did. The price was half what Prague had sought. Dillard says that Nomura, which already owned 10% of IPB, made clear that its aim was to restructure IPB and then sell it. "The sole purpose was to make a profit," he says.JUST GONE. Ex-Finance Minister Ivan Pilip, who negotiated the deal with Dillard, says the government had to sell to Nomura because no other major bank was interested in a minority stake. "We wanted to show that we were serious about privatization," he says. As for the missing assets, Dillard says he doesn't know where they might be. "When we were there, they were there," he says.
Investigators have found a few holdings, including a 40% stake in IPB Pojistovna insurance group, the country's third-largest. But most are still unaccounted for, including shares in industrial operations such as oil company Setuza, maltmaker Tchecomalt, and private television station Prima TV.
IPB began transferring most of its stock portfolio to various holding and offshore companies in 1999 in order to comply with new central bank regulations that prohibit banks from owning a controlling stake in nonfinancial companies. IPB doesn't deny making these transactions. Nor are they illegal. Auditors Ernst & Young initially approved the bank's plan in 1999 but later said IPB did not give them all the necessary information. The structure is so complicated, however, that investigators say it is nearly impossible to determine the legal owners.
In one instance, IPB set up its own holding company in Prague, IPB Holding. But instead of directly transferring assets to it, IPB used intermediaries. According to the Czech Finance Ministry, the bank somehow lost track of a considerable number of the shares in the process. In addition, the bank entered a series of option agreements, granting the holding companies the right to keep their stakes or transfer them back to IPB. Says Deputy Finance Minister Mladek: "It's rather difficult to find all of the connections. There are daughter companies and granddaughter companies." IPB executives declined to comment for this story.DEFAULTING. It's not only the missing assets that are raising questions. Even as concerned depositors began withdrawing money in February, the bank continued to make risky bets. In February, for example, it granted a 30-day loan of $56 million to a unit of holding company Sekyra Group. Sekyra, which had annual sales of $25 million, used the money to buy a 56% stake in the Czech Republic's leading contractor, Inzenyrske a Prumyslove Stavby, beating out Sweden's Skanska Europe, one of the Continent's largest construction groups. Then, Sekyra defaulted on the loan, and IPB reopened negotiations with Skanska. A few hours before the transaction was to be signed, IPB was taken over and sold to CSOB, which completed the sale to Skanska for $65 million. Says Skanska President Anders Karlsson: "We were beaten by a completely unknown entity. That was kind of strange." Dillard cites the Sekyra case as evidence of Nomura's positive influence: He says that IPB was smart not to grant Sekyra the longer-term loan it originally sought.
Critics contend that Sekyra is an example of Nomura's inability, or unwillingness, to exercise any real control over IPB. Possibly. But Nomura, and Dillard in particular, also inspired a fair amount of envy in Prague: He always seemed to get the best of a deal. "Dillard's motto was: `Take no prisoners,"' says one Prague associate. "And he didn't." Case in point, say critics, was the sale of IPB's beer holdings, including the brewer of the world-renowned Pilsner Urquell. They contend that the breweries were all that Nomura really wanted from IPB. Nomura bought them for about $250 million, pooled the stake with its own Czech beer assets, and then sold the entire package to South African Breweries PLC for $619 million in 1999. Says Dillard: "We worked hard for that money."
Meanwhile, IPB was beginning to buckle under the weight of bad loans, estimated by the bank's auditors earlier this year at about $1.1 billion. Dillard says that 96% of those loans predate Nomura's involvement in IPB. Fair enough. In the early days of Czech privatization, the government encouraged banks to lend generously to get Czech industry back on its feet. IPB's strategy was to get these dubious loans off its balance sheet by placing them in specially created vehicles and trying to sell them. But there were few takers. "IPB has been fairly aggressive in trying to expand in a barely stable environment," says Otto Dichtl, of Moody's Investors Service in London. "And you can make a case here that it didn't work so well."
Early this year, depositors started to hear about IPB's troubles. By June, they had withdrawn more than $1.5 billion, almost a quarter of all the bank's deposits. Nomura decided to try to sell. Dillard presented the government with three options: Under one, Nomura would transfer its 46% stake plus an additional 5% in exchange for the right to later sell 46% of IPB shares. In return, the government would recapitalize the bank, and Nomura would find a strategic investor. The second option was simple--Nomura would sell back its stake for $80 million. Under the third, Nomura would raise IPB's capital--it was zero then--to $530 million if the government agreed to issue guarantees and stabilize the bank. Prague would also get two seats on the 12-member supervisory board. Nomura would then sell to an investor who would actively manage the bank.HUGE RISKS. Nomura already had two such investors in mind: German insurance giant Allianz and Italy's UniCredito bank. By the evening of Thursday, June 15, Dillard thought he had a deal with Mladek on Option Three. But the government believed that it still wouldn't have effective control of IPB, because a two-thirds majority was required to pass a measure through the supervisory board. "These proposals contained substantial risks for the state," Finance Minister Pavel Mertlik told parliament on July 3. That's why, when IPB General Manager Jan Klacek sent the central bank a letter on June 15 warning that IPB might have to use up statutory reserves to pay depositors, the government sent in police.
Dillard says the takeover was about the worst decision the government could have made. "We were pretty surprised," he admits. Nomura was trying to minimize Prague's costs of shoring up IPB by passing them on to the new investor, he contends. Now, the Czech taxpayer will shoulder most of the burden. "Machine guns and taxpayers' money were used to expropriate IPB and make CSOB the dominant Czech bank," says Dillard. "When the smoke clears and the mirrors no longer dazzle, we will see a familiar tale of corruption, cronyism, and politics."
In fact, CSOB does appear to be the only beneficiary of the IPB fiasco. It gets IPB's 3.5 million accounts as well as its formidable retail network of 180 branches, plus 3,400 outlets in post offices. It will also inherit what's left of IPB's $9.5 billion in assets--which will make it the biggest bank in Central Europe. And because the government will cover all losses, CSOB carries virtually no risk.
But CSOB's sweetheart deal has left many in Prague uneasy. Critics wonder why the government didn't seek other bids for IPB. Some believe that CSOB's politically connected executives simply proved the most effective lobbyists. Officials say evaluating other offers would have taken too long. Says Mladek: "Time was a very scarce commodity."
The man in charge of integrating the two banks, CSOB board member Jan Lamser, argues that CSOB is in a more risky position than critics allow. "We took over a bank whose deposits were flying out in a completely uncontrolled manner," he says. "Also, it appears that the size of IPB's quality assets will be limited. CSOB is allocating very substantial resources to stabilizing those assets, to the benefit of the state."NOT A DIME. The investigators' report will help set IPB's price. But CSOB is apparently ready to pay as much as $444 million; Nomura would get $204 million of that for its 46% stake. Dillard, however, says he doesn't think Nomura will ever get a dime because Prague has overextended itself by offering such strong guarantees to CSOB. Nomura could sue the government for its stake, which Dillard estimates is worth $1.2 billion. On the other hand, government officials have said they may press criminal charges against IPB executives.
Meanwhile, it's not just the sale price that's preventing the government from closing the CSOB deal. Prague still doesn't know how much it will cost to clean up IPB. If it's more than $1.3 billion, the government might violate a law requiring it to seek parliamentary approval for guarantees above 8% of the federal budget. If the scandal grows and Klaus sees an opportunity to return his party to power, he could pull the plug on a so-called opposition agreement that keeps the Social Democrats in office.
Whatever the outcome, IPB has already become a parable of how not to privatize a bank. For those who approve of the government's decision to resell IPB, this is a turning point for Czech banking. "When historians write about the Czech Republic at the turn of the 21st century, they will differentiate between the period before IPB and the period after," says former Finance Minister Pilip. Maybe. But first the Czechs will have to figure out what happened.By Matthew Karnitschnig, with Hana Lesenarova in Prague