26 September 2017
When African Bank Investments Limited was put under curatorship by the South African Reserve Bank in 2014, very few shareholders appeared to have seen it coming. It’s a cautionary tale that reminds us why it is important to properly scrutinise the state of a company's corporate governance.
By Dr Stephanie Giamporcaro
For a large part of the first decade of this century, African Bank Investments Limited (ABIL), was one of the hottest stocks on the JSE. The company's share price rose from around R5.25 per share in 2003 to more than R22.50 per share in 2008.
It also offered investors a very appealing cash dividend. At its highest, ABIL traded on a dividend yield of over 9.0%.
Under the leadership of its charismatic CEO, Leon Kirkinis, ABIL was re-imagining what micro-lending could do in South Africa, and seemed to prove that this was not only a viable business model, but a very profitable one. Between 2003 and 2008, ABIL more than doubled its annual profits; from R660 million to R1.56 billion.
We know now, however, that the market's excitement about African Bank back then, was badly misplaced. In August 2014, ABIL's shares were suspended on the JSE and the underlying business was put under curatorship by the South African Reserve Bank (SARB).
The scary thing is how few shareholders had seen this coming. Less than a year earlier ABIL had raised R5.5 billion in a rights issue that was widely supported, even though it was already apparent that the company had severely underestimated its bad debts. Within months, these had sunk the business, and shareholders would have been left with nothing had the SARB not stepped in.
This case stands out as one of South Africa's most high profile corporate failures, but it is of far more than just historical interest. It offers us an opportunity to learn from our mistakes in order to ensure that history does not repeat itself.
The indomitable CEO
The Myburgh Report that analysed the reasons for ABIL’s collapse, made some very uncomfortable findings. Financially speaking, what had led to the bank's collapse was not making made sufficient provision for bad debts and engaging in unsustainable lending. But behind that was a CEO who believed too much in his own abilities, and a board that failed to exercise the necessary care and skill in overseeing what he was doing.
What is so interesting about this is that Kirkinis was held in high esteem by many people in the market. He displayed many of the characteristics shareholders would want in a CEO – he was a large shareholder in the business, he was extremely knowledgeable about the industry, he was very 'hands on' in its operations and he was widely liked and respected amongst his staff.
Thus, when looking at ABIL from the perspective of an asset manager who has made a substantial investment into the business, there were reasons to view it as a long-term investment prospect. It could have been argued that although management had made some mistakes, they could be corrected and the bank would emerge stronger. This was a story that Kirkinis himself told - very convincingly.
He also had a track record, since he had brought ABIL through the unsecured lending crisis in 1999 that had led to the collapse of Saambou Bank. This success was a big part of the reason that many shareholders believed in the ABIL story. Even when African Bank made what in hindsight was an obviously ill-advised purchase of Ellerines in 2008, people trusted what Kirkinis was doing.
Almost everyone who interacted with him over the years was impressed by his passion, and not just his belief in the business, but in a greater purpose. He was adamant that unsecured lending was a tool for lifting people out of poverty, giving them access to money that could start businesses, build homes and educate children. Proof of the strength of his message is that former deputy chief justice, Dikgang Moseneke, served as ABILs chairman for a number of years.
And yet, the board and the investors failed to address the predatory nature of the lending practices that African Bank adopted to get its business going. Neither investors, nor the board, questioned how these lending practices would in the end jeopardise the lives of African Bank clients. Corporate governance is also about asking the difficult questions at the right moment in a responsible way.
Corporate governance failure
The Myburgh Report found that Kirkinis had an overwhelming influence over the board and the operations of the bank. Essentially, no one questioned him. The starkest example is that he had unilaterally made the decision to buy Ellerines for R9.1 billion, without proper due diligence or full board approval.
In hindsight, many asset managers were also far too eager to believe what Kirkinis was telling them. And they continued to believe him until it was too late.
In addition, certain members of the board did not have the appropriate competence or knowledge of banking. The board was also extremely small for a banking board, with too many executive directors, which left no real room for challenging independent voices.
This is really the crux of the African Bank lesson – that no analysis of African Bank was truly complete without a thorough analysis of its corporate governance. And this is where many asset managers slipped up.
When things were going well for the bank, poor governance could easily be overlooked. What did it matter if Kirkinis acted unilaterally and his board couldn't control him, or even advise him properly, if he was making the right decisions?
Unfortunately, that is often a view shareholders take, not considering a possible future where things start going wrong. Nobody is infallible. Sooner or later even the best CEO in the world makes a bad decision, and if it’s a very big one, it can have very big consequences.
If we are not to fall into the trap of being incapable of learning from experience, then here is the lesson: while short term profitability might tell us something about how a company is being run, it doesn't tell us everything. As shareholders, we need to be confident that the board is really looking after our best interests, and for that we must truly scrutinise the state of a company's corporate governance.
Encouragingly, over the last few months, we have seen more local asset managers publicly showing that they understand this. They have spoken out against questionable practices at Net1 UEPS, and more recently Naspers. They are no longer content to not have a say in how companies are run. The fact that more and more South African asset managers are embracing the Principles of Responsible investment, as demonstrated by the latest African Investing for Impact Barometer, is also positive.
At the same time, the current shockwaves in the auditing profession following the Gupta Leaks revelations and more recently, KPMG’s spectacular withdrawal of its infamous SARS report, are highlighting the role, or the lack thereof, that auditors have to play in rolling out healthy corporate governance structures.
If the lessons from ABIL and others have truly been learnt, this is a trend that is only going to grow stronger. Shareholders can no longer think that corporate governance doesn't matter. And what makes a truly good investment, is a company that understands that too.
Dr Stephanie Giamporcaro is an Associate Professor at the UCT Graduate School of Business. This article is based on a case study written with MBA student Matthew Marrian as part of the Case Writing Centre, an initiative within the UCT GSB to generate more locally relevant teaching materials for business students. The case study was recently recognised as one of the top 10 in the 2017 CEEMAN (The Central and East European Management Development Association) Case Writing Competition.