Archive for June 21st, 2008

Chavez Guisonomics 101, part III: How to buy a bank without using your money

June 21, 2008

Growing your market share as a bank is not easy, you have to work hard,
do it for many years and convince depositors that they should prefer
you over your competitors.

On the way you also face many hurdles, economic swings can affect your
performance and if you stumble once, depositors and clients will never
forget it. While history says that “good” bankers are the ones that
grow their business organically, slowly and carefully, “nouveau”
bankers tend to want to grow faster by acquiring other institutions
and/or straying away from the core business of banking.

Venezuela is no different, for decades we have seen acquisitions and
takeovers as the way to grow banks and the last few years have seen
quite a few of those transactions. In many cases, these transactions
were made at prices which make no sense if you are a true banker.
Problem is, you may be stingy if you are buying something with your own
money, but if it is someone else’s money, you may not care if you are
paying too much.

In this third installment I explain how if you own a bank in Venezuela
today, it is possible to buy another one without putting up any money.
In fact, at the end of the day the transaction is such that the money
you used to buy the other bank simply “disappears” under the magical
world of structured notes.

Suppose you are a Venezuelan banker and you know one of your
competitors wants to sell. Unfortunately, you own a bank, but don’t
have enough money to acquire the other institution.

But wait! You have your depositors money…

For the sake of argument let’s say the bank is being sold for half a
billion dollars and your own bank has capital roughly the same as that,
but it has deposits that are eight times as much (US$ 4 billion). The
official rate of exchange is, of course, Bs. 2.15 per US$ and the swap
or parallel exchange market is at Bs. 4 per US$.

Well, you go to the parallel market and buy half a billion dollars using Bs. 2 billion of your depositors money.

But wait, there are regulations that say you can not have more than 30%
of your capital in foreign currency, thus, you turn around and give the
money to a European bank or Wall Street firm and ask them to issue a
“note”, guaranteed by them, but issued and denominated in Bolivars (2
billion) and having as its underlying asset the dollars you gave them.

This “note” is simply a contract between your bank and the other
financial institution and it is likely to have some conditions, such as
a rate of return, conditions under which get US$ or Bs. and even
clauses about borrowing against the guarantees.

From the point of view of your bank, you have done nothing but take
your depositors money Bs. 2 billion, “invest” it at the other
institution with a certain return, which is typically low. In your
balance sheet the money appears simply as an investment at XYZ Inc. in
Bolivars.

Now you ask XYZ to lend 80% of the guarantee at a market rate to a
company which is part of your financial group, as was pre-agreed in the
“note”.

This company in turn, goes and buys the bank that is on sale using your depositors money.

Voila!

You have acquired a bank with your depositors money, the money is no
longer there, but you have doubled the size of your holdings!

Hopefully, five years down the line, the parallel exchange rate will be
four times higher, you can bring bank the 20% of the original amount
that is left and tell the bank that hold the note to keep the other 80%
as you have no plans to pay back the loan. Or maybe the bank you bought
will make enough money to pay the loan back or a combination of both.

The point is that at the end you own that bank, for free! You put none
of your own money on the line and for quite a while you really don’t
even have the money you claim to have in your balance sheet and you are
circumventing Bank Laws by having more foreign currency than it is
allowed.

How many times has this been done in the last few years? At least four, as far as I can tell, but maybe more.

And I started this series because a fifth case was ready to be announced and may even still be announced, except that…

The Government decided to stop it for reasons that are not quite clear to me.

This time, the operation was going to be more sophisticated. Remember
that the Government issued a resolution ordering banks to get rid of
these notes? Well, one bank decided to do the following:

Rather than “get rid” of US$ 2.4 billion in notes that are worth about
US$ 1.2 billion, it offered to buy one of Venezuela’s largest banks by
handing over the notes to the owners of that bank.

In one swipe, this bank gets rid of these “bad” notes and acquires a healthy, large bank, one of the largest in the country.

Creative, no? Almost like magic…

Except that the Government decided to stop it this time around…

Next: Chavez Guisonomics 101, part IV: Why did the Government stop the latest bank takeover?

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