Banking on change at NCB by John Jackson, Contributor

Source: Financial Gleaner, October 27, 2000

THE Financial Sector Adjustment Company (FINSAC) involvement in the NCB Group came about primarily because of ill-advised and downright irresponsible policies pursued by a Government hopelessly out of touch with reality who substituted political one upmanship for economic reality.

This manner of handling the country's economic affairs not only had far reaching effect on NCB but the entire financial sector and more.

The Group is a listed company that has shareholders who bought shares prior to and after the financial fall-out that resulted in FINSAC injecting capital therein.

The ones who acquired shares afterwards bought on the basis that the present ownership structure would obtain for some time. Accordingly those people who feel that shareholders should be thankful for FINSAC's intervention and therefore bow to their wishes ought to think again.

Any one who is interested in the development of the local stock market cannot possibly support the proposed restructuring of the NCB as currently set out. It would appear that some who are prepared to give support are of the view that if or when the bank is sold the buyer will have to offer the same price to the other shareholders and they will end up with a windfall.

The end result is the possibility of the bank being delisted thus reducing the investment options for Jamaican investors. If one were to look back at past Government sales it would be readily realised that the strong possibility is for the price to be depressed at any rate.

Pre-tax profit

NCB Group should make $1.4 billion in net profit after minority interest or $1.61 per share before dilution for this year. For 2001 the pre-tax profit should amount to $3.5 billion and net of $1.6 billion or $1.82 per share.

With the new capital structure, earnings per share will be reduced to $1.08 for 2000 and $1.23 for 2001. The dilution is 49 per cent for 2000 and 47 per cent for 2001.

This assumes that no preference share dividends will be paid. If such dividends were to be paid it would reduce earnings by 35 cents per share. By my reckoning, on a worse case basis, earnings for next year would be $1.50 per share on the existing share structure still well above $1.23 on the fully diluted basis.

What is the effect of the above? The market is currently selling most stocks at seven times last year's earnings. On this basis, the price of NCB Group's share would be $11 some time next year and roughly $9 assuming the preference dividend was payable in 2001. The chart below shows a comparison of earnings and potential value under both scenarios.

In 2001 the computation shows that earnings per share after allowing for preference dividends would be on par with EPS under the restructuring scheme. However thereafter the non-FINSAC shares would be at a disadvantage as earnings would be diluted as profit rises.

EARNINGS ADJUSTED FOR PREFERENCE DIVIDENDS

No provision is made for preference dividend in 2000 as profits would be inadequate to meet it as well as the need to set aside reserves required by various agreements and laws. By 2001 profits should be adequate to meet such payments.

Prudence suggests that it may not be until 2002 that such payments would be payable, by then profits are projected to rise further thus reducing the dilution impact of the preference dividends on earnings per share. The effect is that private shareholders would be worse off.

Based on the above figures the conversion of the $5.3 billion of preference shares are worth about 500 million ordinary shares which would be fair exchange for all shareholders and not only FINSAC as is the present arrangement.

Long term

The original capital injection plan could not have been supported by prudent advice. More importantly the advice that FINSAC got was not taken. Instead the injection created a loss on the Group's books when they had to write down the value of the investment in the bank and take a $763 million loss.

Prudence dictates that most of the capital injection should have been through the Group to be passed on to the bank. On this basis the Group would be able to benefit from a clear tax advantage enjoyed by the preference shares therefore reducing the cost of any dividend payment that would be made and boosting earnings per share.

The restructuring should result in the preference shares being an integral part of the share capital structure of the listed company thus allowing it to benefit from the tax break provided by law.

The reality is that smaller investors would benefit far more if the preference shares are retained. On the other hand they have much to lose by approving the restructuring.

Interest rates are falling against a background where inflation is going to be above our main trading partners' for awhile. Two things are going to occur.

Corporate profits will rise sharply and price earnings ratio of stocks is going to climb to levels not seen since the early 1970s.

PE's of 20 for most stocks will be common place in a few years. With this scenario the value that shareholders will give up if they approve the scheme will be enormous and well over any amount indicated above.

While I would not at this stage recommend the scheme, shareholders need to satisfy themselves as to the alternative plans that Government may be planning to gain the 76 per cent ownership and whether they may be better off with such a plan.

Editor's note: Shareholders should examine the detailed plans for the Scheme of Arrangement. Appendix F gives an annualised estimate of what effect the plan would have. NCB's court document states: "For example, a 100 per cent increase in Bank's annual post-tax profits in the period 30 September, 2002, will result in a: 14 per cent increase in EPS for Existing Group before reorganisation but 55 per cent for New Banking Group after reorganisation".

* John Jackson is an accountant and financial analyst.

Return to Course Materials.

Return to Articles.