KASB TAKEOVER BY BANK ISLAMI

MIRZA ANAS BAIG-12433 KAZIM REZA MANKANI-12819 MOBEEN HASHMI-12384

Contents About KASB ...... 2 Performance ...... 2 Asset Quality ...... 2 Steps Taken to Improve the Capital ...... 3 Merger with International Housing Finance Limited ...... 3 Merger with KASB Capital Limited and Network Leasing Company Limited ...... 3 Capital Investment by Asia International Financial Limited ...... 4 Issue of Rights Shares ...... 4 Future Plan ...... 4 Capital Injection Proposal of Cybernaut Investment Group ...... 4 State Bank Regulatory Action ...... 4 Interested in KASB Bank Limited: ...... 5 Bank Islami Capital Adequacy History...... 5 Due Diligence by Banks ...... 6 Amalgamation ...... 6 Moratorium Lifted ...... 6 References ...... 6

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About KASB

KASB Bank Limited was a public limited company which had been incorporated in 1994 (KASB Bank Limited, 2012). It was listed on all the stock exchanges in Pakistan and was licensed to undertake the business of commercial, consumer and investment banking. The bank was a holding company with many associates as part of a group of companies known as the KASB Group. It was reporting losses due to poor profitability, as a result of which its regulatory capital was eroded and fell below the statutory minimum requirement. In order to meet the State Bank requirements of capital, the management and board of directors decided on a series of mergers with other group companies. Performance KASB Bank was among the small-sized banks and, along with its peers, was having difficulty in meeting the enhanced capital requirements of the SBP. As Basel III3 was being implemented, the pressure on asset quality and a narrowing of spreads made the operating environment for banks having a weak financial risk profile more challenging. Over the years, the bank had made poor credit decisions in building its loans and advances portfolio and, as a result, its non-performing loans (NPL) were very high. The bank’s performance from 2009 to 2013 was seriously affected by the NPLs and other strategic investments that were also non- earning. The banking sector continued to operate in one of the most challenging times during 2009 due to tight liquidity conditions, distressed corporate performance and an overall weak macroeconomic situation. During 2010–2011, the bank’s investments did not generate enough earnings and the net interest margin became negative. This fact, and the amount of loan loss provisions and impairments in 2009 of PKR3,328 million and PKR1,509 million in 2010, caused the bank to report huge losses of PKR4.3 billion in 2009 and PKR2.7 billion in 2010. There were also further provisions required for subsequent years. The bank also posted losses in dealings in foreign exchange due to a weak currency. The administrative expenses increased to a high of PKR3.1 billion in 2012 and the bank’s loss for the year was PKR806 million. By the end of 2013, the accumulated loss was a massive amount of PKR12,500 million. Asset Quality

On a quarterly basis, the bank reviewed the entire loan portfolio and made provisions for any NPL. This followed the prudential requirements stipulated by the SBP. The bank management’s focus had been mainly on the recoveries of its stuck-up advances (NPLs; see Exhibits 2 and 3). The overall advances portfolio registered no significant movement, but the NPLs were very high— these increased from 21 per cent of advances in 2009 to a high of 36 per cent of the advances during 2012. This was due to an increase in the interbank rate called KIBOR ( Interbank Offer Rate) which caused many customers to default. These advances not only took up a lot of management time but also required different expertise to restructure them. The bank took measures to strengthen the security structure and initiated prompt restructuring and rescheduling to limit the deterioration of the loan portfolio. The prudential regulations prescribed age-based criteria for the classification of NPLs and advances as held by the bank. The SBP Quarterly Report for the October to December 2014 quarter (SBP, 2014b) stated that the asset quality of banks, in general, continued to improve from July 2013 to December 2014 as the NPLs to loans ratio decreased by 70 basis points to 12.3 per cent. The report also noted that the operating performance of the banking industry showed a marked improvement as the profit before tax increased by 52 per cent during 2014.

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However, the performance of KASB Bank was very different in 2013. While the new NPLs identified were low at PKR649 million compared to PKR2.9 billion that were recovered in cash or regularized, their total as a percentage of the entire portfolio remained high at 35 per cent. Management had set up a Special Assets Management Group (SMAG) to adopt an aggressive follow-up of NPLs. The bank had developed measures to put likely NPLs on a watch list to address and reduce the accounts being classified. The bank had a dedicated recovery team that dealt with NPLs on a regular basis. Experience showed that a substantial number of companies and customers who had been classified and were not current on advances repayment were still operating their businesses; the bank staff was in contact with such cases to restructure their facilities wherever possible.

Steps Taken to Improve the Capital Merger with International Housing Finance Limited The bank sponsor, Mr. Nasir Ali Shah Bukhari, was a major shareholder in a public company called IHFL (KASB Bank Limited, 2007). This company provided mortgage financing in the housing and non- residential sector. The bank needed regulatory capital, and during a meeting on 27 October 2006, the bank’s board of directors decided to merge with IHFL. The SBP granted ‘in principle’ approval on 30 October 2007 to the merger. It also granted a period up to 31 March 2007 for the bank to meet the minimum capital of PKR3 billion needed by 31 December 2006. The scheme of amalgamation of IHFL with the bank was a stock swap (exchange of one equity-based asset for another) that resulted in additional capital of PKR585 million which raised the bank’s paid in capital to PKR3,106.9 million on 31 December 2007. The merger was considered a strategic decision as it was expected to jump-start the business of mortgage finance, a product that the bank management had already approved. The merger added a robust amount of PKR522 million in advances to the existing bank portfolio. After the year ended, 31 December 2007, a rights issue amounting to PKR907.9 million increased the paid in capital to PKR4,014.8 million on 31 December 2008.

Merger with KASB Capital Limited and Network Leasing Company Limited During 2008, there was a significant restructuring of the KASB Group which involved separating the group’s non-banking financial businesses from the bank. This resulted in the formation of a non-banking financial conglomerate called KASB Capital. The bank invested in 68 million shares of KASB Capital which was 27.5 per cent shareholding of the new entity. As a result of the global financial crisis in 2008, the economic scenario for the banks changed drastically, and the board of directors and management were required to act quickly. The board decided to amalgamate with the two group companies, that is, KCL and NLCL, and the scheme of amalgamation was approved by the SBP. KCL and NLCL were both non-banking finance companies and provided investment and lease finance services, respectively. The bank held 27.5 per cent shares of KCL, and KCL held 78.84 per cent of the shares in NLCL. By 31 December 2008, the bank had also acquired the remaining 72.5 per cent of KCL shares to merge it with the bank. Because of this amalgamation, the bank became the holder of 78.84 per cent of NLCL. It then acquired the remaining 21.16 per cent of shares to merge NLCL into the bank.

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After the issue of shares worth PKR3,618 million upon the amalgamation of KCL and NLCL into the bank, the paid-in capital was increased to PKR7,632 million. The bank then recognized a share premium of PKR1,989 million in the bank’s books. The bank’s board of directors later decided on 28 August 2009 to issue bonus shares of 26 ordinary shares for every 100 shares by utilizing the share premium of PKR1,989 million. Capital Investment by Asia International Financial Limited By 31 December 2010, due to accumulated losses, the regulatory capital of the bank amounted to a negative of PKR1,078 million, while its CAR stood at negative 2.2 per cent and did not meet the SBP requirements. In view of the continuing deficiency in regulatory capital, the bank’s sponsors entered into an agreement with a foreign investor whereby equity investment was to be made into the bank. In 2010, the KASB Group sponsor, Nasir Ali Shah Bokhari, introduced a restructuring proposal whereby a Chinese company M/s Asia International Financial Limited (AIFL) would be given 50 per cent shareholding against injection of funds in the group holding company KASB Finance Private Limited. The funds were to be used for capital injection into the bank and to purchase certain group companies. Later in 2014, the SBP was informed that the AIFL ownership structure had changed without SBP approval, which violated the SBP regulations; hence, the scheme was rejected.

Issue of Rights Shares A rights issue of one billion shares with each share at a discounted price of PKR3 per share was planned by the board, as this would increase the capital by PKR3 billion. Additionally, the bank holding company had planned to augment the capital by issuing subordinated debt up to PKR1,500 million. In 2011, the bank offered the one billion rights shares at PKR3 per share. In accordance with the underwriting agreement, the unsubscribed rights were claimed by KASB Finance Private Limited. The subscription of the rights shares increased the paid-up capital from PKR9,509 to PKR12,509 million as of 31 December 2011.

Future Plan Capital Injection Proposal of Cybernaut Investment Group In 2015 Nasir Ali Shah Bokhari informed SBP that they have identified Cybernaut Investment group as a possible investor. SBP requested complete information from CIG and asked CIG to establish its fitness and propriety in order to conduct due diligence. The letter sent by Nasir Ali Shah Bokhari stated that CIG was willing to inject USD 100 mil whereas a letter from CIG stated an amount of USD 50 million. Due to this the request of due diligence was declined by SBP.

State Bank Regulatory Action In November 2014 a temporary prohibition of 6 months was placed by the SBP on KASB Bank to protect the interests of depositors and stakeholders. The bank was not allowed to make any payments and continued to receive money from its debtors. Discussions were then held for a possible merger or takeover of the bank and JS bank, , , and Bank Islami showed interest while the other major banks did not approach the SBP for merger or takeover.

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Banks Interested in KASB Bank Limited: Askari Bank Askari Bank was formed in 1991 and had a network of 31 branches with 53 Islamic banking branches. It had an equity of PKR23.7 billion on 31 December 2014, an MCR of PKR26.7 billion and CAR of 13.3 percent. JS Bank JS Bank Limited (JSBL) was formed on 15 March 2006 and in 2014, it had 238 branches across 122 cities. The paid-up capital (free of losses) of the bank as of 31 December 2014 stood at PKR10.119 billion. The Bank’s CAR as of 31 December 2014 was 16.73 per cent of its RWA. Sindh Bank The Sindh Bank had 225 branches in 111 cities, and these included 5 dedicated Islamic banking branches. The bank had reported a profit of PKR1.07 billion in 2014 up from PKR665.9 million in 2013. The paid-in capital (free from losses) was PKR10 billion in compliance with the MCR, and the CAR was 22.57 per cent. Bank Islami Bank Islami was incorporated in Pakistan under the Companies Ordinance, 1984, as a public limited company on 18 October 2004 to engage in the business of an Islamic . Bank Islami had 213 branches at the end of 2014 with total equity of PKR6.2 billion. Its profit after tax for 2014 was PKR313.6 million, up by 69.3 per cent from the preceding year’s earnings.

Bank Islami Capital Adequacy History In 2009 the SBP increased the MCR to 10 billion. Bank Islami’s capital at that time was below 6 billion so in order to meet the requirement the BODs decided to issue right shares in 2011 which were then delayed to 2014. Extensions were granted to Bank Islami to meet the MCR requirement and so in 2013 the BOD’s approved a plan which was submitted to SBP. Permissions were granted by SECP and SBP to Bank Islami to issue 47.9 million shares to increase the paid in capital to 5.68 billion/ In order to meet the next MCR limit of PKR10 billion, the board held a meeting on 29 October 2014 and decided to raise the paid-in capital by a further PKR4.3 billion through a second rights issue. To enable this increase, the bank obtained permissions from the SBP and the SECP. Approval from the SECP was required to grant relaxation from the requirement of Rule 5(i) of the Companies (Issue of Capital Rules) Rules, 1996, which related to the second issue of shares within a year by a company. These approvals were granted by the SBP and SECP vide letters dated 5 November 2014 and 2 December 2014, respectively. After receiving the two approvals, the board of directors in their meeting on 30 December 2014 approved the issuance of 432,040,000 rights shares to all the shareholders in the ratio of 75.0236 shares for every 100 shares held. This rights issue was fully underwritten, and it would enable the bank to meet the MCR requirement of PKR10 billion by the second quarter of the calendar year 2015. The board of Bank Islami in its meeting on 10 January 2015 approved issuing Tier II capital up to PKR3.5 billion in tranches of PKR500 million.

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Due Diligence by Banks After conducting due diligence, a negative equity gap of around 10-12 billion and a shortfall of 10 billion in capital requirement was spotted. After which the other 3 banks backed out leaving only bank Islami to acquire KASB. Amalgamation To protect the lifelong savings of depositors of around PKR57 billion and to protect the jobs of 1,200 employees, as well as to ensure the stability of the financial system, amalgamation of KASB Bank with and into Bank Islami Pakistan Limited was considered the most appropriate option. Bank Islami was going to take over KASB Bank in line with an amalgamation scheme prepared by the SBP. The SBP’s confidential scheme would result in the acquisition of KASB Bank, the country’s smallest lender, by Bank Islami at a ‘token nominal value’, according to the statements released by the two banks. Following international practices, the SBP set a notional value of PKR1,000 for the amalgamation. This was surprising for many bankers who believed that Askari and Sindh were in a better position to acquire KASB bank. In 2014 Bank Islami was trying to meet the requirements and was issuing right shares but it failed to meet the deadline despite repeated warnings and at the end only KASB and Bank Islami were unable to meet the requirements as other banks raised their paid up capital in time.

Moratorium Lifted

On 7th May 2015 SBP informed the depositors about the merger of the banks and the ban of KASB being lifted. The depositors of the bank had become depositors of Bank Islami Pakistan Limited and were free to operate their accounts maintained at the respective branches of the former KASB Bank Limited. After the merger, the SBP granted PKR20 billion to Bank Islami, consisting of a concessionary loan of PKR5 billion at a low rate of 0.01 per cent and PKR15 billion for temporary liquidity. As there was no competitive bidding for this facility, the market considered that this grant raised transparency issues. Bank Islami, on the first day of its operations after taking over KASB Bank, paid billions of rupees to the depositors. The biggest payment was made to Bahria Town which amounted to PKR2.5 billion.

References

Ahmed, M. B. (2018). KASB Bank Limited: Capital Shortage. Asian Journal of Management Cases, 15(1), 1–22. https://doi.org/10.1177/0972820117744685

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