David Shirreff
Sunday June 18 seemed a normal Prague afternoon. Tourists streamed through the castle, down the hill, across Charles Bridge into the Old Town Square. At Stvanice tennis club, Jack Stack, American chairman of local bank Ceska Sporitelna was playing doubles with a journalist, a lawyer and an investment banker. Thomas Münkel, chief of Allianz insurance’s local subsidiary, was in the garden with his family, expecting a busy day on Monday. Randall Dillard, Nomura’s chief regional investment banker, downed a few jars of Pilsner Urquell, whose famous brewery he’d successfully sold to the South Africans last year.
But there was one thing probably foremost in these men’s minds, in fact in the minds of the entire Czech Financial community.
On Friday, special police with sub-machine guns had burst into the country’s third biggest bank, Investicni a Postovni banka (IPB) and installed a forced administrator.
The administrator assumed all the powers of both bank boards and its shareholders. That put an end to Five days of panic during which citizens had besieged its branches and withdrawn deposits totalling Kr17 billion ($430 million). Interbank lines were cut. The bank was dumping its equity portfolio to raise cash. IPB appealed to the Czech National Bank on Thursday night for Kr10 billion of liquidity, fearing that without a capital injection it wouldn’t open for business on Monday.
The forced administrator came in. The Czech National Bank, backed by the government, gave its guarantee, pumping in a few billion Czech crowns to stabilize IPB. The weekend brought a breathing space.
Dillard, a Miami-born 44-year-old, big build, boyish face, who worked for Merrill Lynch before joining Nomura in 1989, thought he still had a chance of selling the bank to a consortium of Allianz and UniCredito of Italy – Nomura had bought 46% of IPB in 1998 and was seeking an exit. Allianz had agreed with Nomura on exclusive negotiating rights and together with UniCredito was ready to Find a solution for IPB. On Monday they expected to see the details of a tender oVer from the government following the forced administration of the bank.
But at breakfast on Monday, Czech radio broke the news that the bank had already been sold at 6am that day – to IPB’s cross-town rival Ceskoslovenska Obchodni Banka (CSOB) for one euro.
The potential buyers were Flabbergasted. Why no competitive tender? Why no negotiation? Why not even a phone call?
The government’s main opposition party, the right-wing ODS, was also quick to cry foul.
Its leader, former prime minister Vaclav Klaus, called the action “daylight robbery of a bank.” Although the ODS had an “opposition agreement” with the coalition government to cover major national decisions, Klaus had not been warned about the forced administration or the sale. This made the takeover decision look rather political. CSOB chairman Pavel Kavanek was known to be close to Prague’s Financial top brass: Finance minister Pavel Mertlik, his deputy Jan Mladek and CNB governor Josef Tosovsky. Wasn’t this just a little bit cosy?
Now the other side of the story. There was a run on the bank. After months of wrangling between the bank and its auditors, Ernst&Young, about the depth of the loss – was it Kr20 billion, Kr50 billion or more? – the bank’s customers were distinctly nervous. This was the third biggest bank in the country but in terms of its links with Czech industry, municipalities, utilities, the post office – perhaps 30% of the Czech economy – it was the biggest. That surely fulfilled the definition of too big to fail. But there was no early sign that the central bank would intervene. In February, a similar run had been halted by the bank after a couple of days.
IPB had two sets of suitors: Allianz/UniCredito which had been talking since December and CSOB which had been talking seriously since March. Allianz was close to an agreement that it would buy IPB’s insurance arm, IPB Pojistovna, and inject some capital into the bank. UniCredito was to buy IPB and was looking for a commitment from the state to help solve the asset problem at the bank.
Allianz and UniCredito had already teamed up in this way to take over Poland’s Bank Pekao and Bulgaria’s Bulbank.
The other suitor, CSOB, the Czech Republic’s most successful bank, had been bought by Belgian group KBC the previous summer. KBC’s initial plan was to grow a retail business from CSOB, which is primarily a wholesale bank. But six months into the purchase it was clear this would take years. Meanwhile, IPB, despite its balance-sheet problems, continued to grab market share as the most aggressive and classiest retail operation in the country.
The CSOB-IPB Fit was obvious and had been proposed two years earlier by Nomura’s perspicacious Dillard. IPB was perhaps a bigger involvement than KBC might have wanted but CSOB itself was a capital-rich bank with around Kr19 billion to spend. Kavanek had been with CSOB, originally the international department of the former State Bank, since 1972. He had run the bank since 1993. Although the state stepped in twice to relieve it of bad assets, CSOB was reckoned to have the cleanest balance sheet of the big Czech banks and the best credit department. KBC’s light touch as owner showed great confidence in Kavanek.
Through March, April and May the battle lines were drawn. Nomura was keen to replace itself with a strategic partner which would recapitalize the bank. It was reluctant to pump in more capital without a subsidy from the state for the bad loans which it argued were endemic to the Czech banking system.
Company workouts were impossible because of poor regulation and the absence of an effective bankruptcy law.
But the Czech National Bank had little sympathy with IPB. It had been investigating the bank since January, suspicious of the structures IPB had used to try to shift non-performing loans and distressed equity off its balance sheet. Nor did it agree with IPB auditor Ernst&Young, which was Fighting for its reputation, having signed off on the 1998 accounts – items of which were rejected by a subsequent CNB audit – and was trying to make sense of the accounts for 1999.
Creatures of the state
IPB had never been a transparent bank. It had grown out of the small securities department of the State Bank. It thrived in the early days of the Czech Republic’s voucher privatization, taking advantage of the loose barriers between Czech banks and the privatization funds they were expected to manage, to build strategic stakes in selected industries and sell them at a premium.
Regulation was so loose that some managers of privatized Firms borrowed money they knew they would never repay and stripped the companies of assets that were transferable, passing kickbacks to their creditors.
Libor Prochazka, graduate of the Prague School of Economics and former State Bank employee, was adept as IPB’s vice-chairman at expanding the bank’s balance sheet and its equity portfolio without paying much attention to credit risk. Most of the big credit decisions were apparently evaluated subjectively, according to Prochazka’s own cerebral criteria. These entities were once creatures of the state and ultimately the state would pay: that was the prevailing culture in most Czech banks at the time. As the capital standards recommended by the Basel committee on banking supervision began to be applied there was a temptation to shift assets into vehicles that were off the balance sheet.
IPB set up scores, even hundreds of subsidiaries, which may, or may not, have assisted in this process. Consolidated supervision of banks wasn’t started by the Czech National Bank until this year. Some banks, including IPB, have been using IAS (international accounting standards) in parallel with Czech accounting standards for some years but consolidation under IAS is notoriously easy to get around, say accountants.
The weakness of securities regulation also made it tempting and easy for banks to plunder the investment funds in their care. The lesson that this was other people’s money and not the banks’ was learned only slowly. In 1996 one western fund manager instituted a court action against IPB’s fund management arm PIAS for “asset sales not in the best interests of the fund” and successfully settled out of court. It was nearly put into forced administration in 1996 but officials at the time feared that would have brought the bank down too. A ministry of Finance decision in 1997 to Fine PIAS Kr10 million was overturned on appeal. Many articles have appeared in the Czech press naming companies and funds linked with doubtful transactions. Hana Lesenarova of the Prague Business Journal turned the IPB witch-hunt into a weekly sport.
IPB’s top duo, chief executive Jiri Tesar and Prochazka were not, like Caesar’s wife, above suspicion. They were taken into custody in April 1996 on embezzlement charges but released after a month.
There were persistent rumours that Czech banks, including IPB, were a source of funding for both major political parties, via loans to ailing companies which would onlend to the party of their choice. But while this is talked about openly in Prague as folklore that “everyone knows,” nailing down the facts is extremely difficult.
Armies of big-name auditors crawled over IPB’s balance sheet and put their unqualified signature to it year after year – until this year. Cooper’s&Lybrand quit as auditor in February 1997 but won’t say why. Nevertheless, PricewaterhouseCoopers, McKinsey and the central bank itself last year gave their approval to a restructuring of the banking group which would have put its hundreds of affiliates under a single holding company.
That suggests either that the group was heading towards regularizing its structural problems or that even its new structure defied professional scrutiny.
Ernst&Young stepped into Coopers&Lybrand’s shoes as auditor in 1997, confident that it had quality control over its local franchise.
Yet audited provisions for Kr19.6 billion of impaired assets for year-end 1998 turned into what the Czech National Bank perceived as a black hole of around Kr40 billion by the autumn of 1999 just in the assets they had examined. Of course, auditors and central bankers can have a different view of the same assets, particularly the value of collateral and the degree of provisioning necessary.
Over the last two years the central bank has become tougher on collateral and capital adequacy rules for banks. In 1998 it ruled that real-estate could not be counted as collateral for loans that had not performed for one year unless the bank’s lien on the property had been clearly exercised by then.
That triggered a spate of attempts by banks – not just IPB – to get affected assets off the balance sheet.
The central bank initially approved a defeasance structure which in November 1998 put around Kr11 billion of IPB’s distressed assets into a special-purpose vehicle and sold them to an unrelated Czech company, NIPB, which paid for them in full by June 28 1999, according to IPB’s 1998 annual report. IPB hoped thereby to avoid heavy provisioning requirements.
Komercni banka bought a guarantee from CSFB for around Kr25 billion of impaired loans, allowing it to stagger provisions over the next 10 years. But the CNB said there was no effective risk transfer, so Komercni unwound the deal, presumably paying CSFB a second fee for its trouble.
The aim of the central bank is not just to improve the safety of the Czech banking system. The greater goal is the Czech Republic’s candidacy for EU membership. “Everything here must be seen in the context of admission to the EU,” says Ceska Sporitelna’s chairman Jack Stack. EU candidacy has meant that the present Finance minister and central bank governor are Finally addressing the need to clean up the Czech Republic’s terrible reputation for corruption and kleptocracy – the kind of capitalism, also rife in Russia, that abuses the rights of minority shareholders and others not canny or powerful enough to get their own way.
The great Czech reformer Vaclav Klaus, former Finance minister and prime minister, now out of power and out of favour, believed in handing economic power to the people in the early 1990s. Unfortunately the people had neither the nous, nor the legal structures, nor the capital, to benefit much from the free-for-all of voucher privatization. Sharks such as Viktor Kozeny’s Harvard Capital moved in and tore the meat out of Czech industrial Firms, leaving the carcasses for other investors to pick over. Whether Klaus wanted this to happen is still an open question. He has never expressed regret at the manner in which the Czech economy was reformed. Yet it is now several years behind Poland and Hungary, having been ahead at the beginning of the 1990s in terms of lightness of bank debt, productivity and technology.
Korean-style conglomerate
The banks, not only IPB – or Investicni banka as it was in those days – moved into the vacuum created by voucher privatization, becoming creditors and shareholders of Czech industry in a parody of the German universal banking model. German banks had capital and a credit culture, the Czech banks did not. IPB grew more like a horribly inter-connected Korean conglomerate, a chaebol, an empire built on debt-equity swaps.
Multilateral institutions looking at the Czech Republic became twitchy that structural reform and institutional development wasn’t accompanying the rebirth of capitalism. One gripe was Klaus’s failure to privatize any of the banks, despite his lionizing of free markets. Nor was IPB particularly looking for a foreign investor, being happy with the state’s minority share, or so it wrote in a strategy report to the CNB in August 1995.
Nomura was one of the pioneers in these early days of Czech capitalism. Dillard, the fresh-faced American front-man for Japan’s premier securities house, was for four years adviser to central bank governor Tosovsky, holding the bank’s hand at such times as the currency split with Slovakia. Nomura lead-managed the CNB’s debut Eurobond issue in March 1993.
Nomura launched itself into the privatization chaos, investing over the next decade in 187 companies in Czechia and Slovakia. One was Radegast brewery which Nomura bought from Bass of the UK, added to its controlling stake in another brewer, Plzensky Prazdroj, and Finally sold to South African Breweries in a deal valued at $629 million. Nomura came across IPB as an aggressive competitor in this game and they regarded each other with mutual contempt.
“So we were surprised when IPB picked us to structure an issue of global depositary receipts [GDRs],” recalls Dillard. Schroders, Morgan Stanley and Salomon Brothers were pitching for the business too. But Prochazka may have been particularly impressed by a very positive report on IPB by a Nomura bank analyst.
The GDR issue did not materialize but Nomura had another idea how IPB could raise foreign capital. On the same day, in October 1996, that Nomura wrote to IPB down-playing the GDR issue, it sent a letter of intent offering IPB a “strategic partnership.” Nomura would purchase Kr1.9 billion of new equity in the bank, assist in raising Kr7 billion of subordinated debt, help IPB develop a presence in the international capital markets, restructure and strengthen its balance sheet – including the creation of a holding company – and develop wholesale and retail banking products. “We believe that Nomura’s minority stake will increase the confidence of international investors in IPB and in the Czech banking sector generally,” wrote Dillard.
Three-and-a-half years later, Finance minister Mertlik (according to a local newspaper) would like to see Dillard’s head in an aquarium on his desk. Why?
About 15 months after Nomura’s Fiwrst letter of intent, the then interim government, headed by Tosovsky, allowed the Japanese investment bank to buy the government’s 36% stake in IPB.
It wasn’t a classic privatization. The state’s National Property Fund, which had once owned 47% of the bank, had found itself diluted by stages since 1993. That happened partly because the NPF refused to take part in all the bank’s capital increases (about 10 in the space of Five years) and partly because the bank took over one of the investment funds, IFRV, which had a 3% stake in IPB. Klaus-style capitalism appeared to welcome this kind of privatization by stealth and benign neglect. “There’s one thing you can say about this market,” says Bernhard Sperling, a director at Deutsche Bank in Prague, “it’s totally free.” Free to the extent of failing to protect the rights of minority shareholders and perhaps the interests of taxpayers and other stakeholders.
At one supervisory board meeting, in December 1995, National Property Fund chief Roman Ceska fought tooth and nail against dilution and the bank’s merger with IFRV which he said was most irregular and against the principles of corporate governance. But Ceska wasn’t supported by the Finance ministry, the CNB and the ministry of privatization (together with the NPF they formed the “gang of four” which steered Czech privatizations).
Pressure was mounting from outside, from the IMF, the European Bank for Reconstruction&Development (EBRD) and the EU, for the Czech Republic to reform in a more orthodox way and privatize its banks. Poland and Hungary had privatized their banks in step with the rest of the economy. Klaus had continued to use the Czech banks to bail out dinosaur industries.
Czech banks tended to take little responsibility for their major credit exposures and that, argued outsiders, was hampering the sector’s development.
In 1996 IPB was the obvious Fiwrst candidate as the government was already a minority shareholder. Former vice-chairman Prochazka, humbly sipping beer last month in Prague’s Palace Hotel, protests that, at the time, the state still called the shots: “They didn’t have the majority but in practice they had the decision-making power. Their influence was always visible at shareholder meetings.”
Unfortunately, a lot of the management’s major decisions were made without reference to any shareholders’ meeting.
Steady retreat
But the government could certainly decide where it wanted to sell the NPF’s stake. Prime minister Klaus made an official visit to Japan in September 1996, toured Kyoto as a guest of Nomura and came back supporting the securities firm’s bid to invest in IPB. By July 1997 the government had accepted Nomura as a candidate, perhaps not an ideal one because it was not a regulated commercial bank. Nomura, according to Dillard, steadily retreated from its earlier oVer of strategic partnership. This was a portfolio investment in a company that happened to be a bank. Nomura saw its investment rather as “a synthetic call on the Czech banking market,” says Dillard. If IPB thrived, so would Nomura’s portfolio stake.
But Nomura didn’t want to get involved in running a bank.
The government changed after November when Klaus’s coalition crumbled. Tosovsky became interim prime minister and the Finance minister was Ivan Pilip. But there was no deviation from the desire to sell the IPB stake. The new government made an attempt to Find a foreign bank as investor. ING took a look but offered to buy only a part of the business. One of the problems was that potential buyers weren’t offered the chance to do due diligence. As a minority shareholder the government couldn’t force IPB to open its books and IPB wasn’t volunteering much information. The NPF showed Nomura a certificate from auditors Ernst&Young that IPB’s net asset value was Kr147 a share, but at the last minute refused to commit to it, says Dillard. (It wasn’t a formal valuation, says Ernst&Young, it was a special audit just for the NPF.) Nomura was going into a blind sale, another reason why it didn’t want to take responsibility for any nasty holes or management shortcomings.
At a Five-hour cabinet meeting a few weeks before Nomura Finally bought in, in March 1998, Dillard says he gave the government a “health warning that we were only a portfolio investor”. At the time of the sale, says Dillard, “this was absolutely clear and we made the CNB announce it publicly.” The government was concerned that Nomura wouldn’t pass its voting rights to IPB management, and that it didn’t “Flip the stock.” Nomura was also anxious to show that it was “not mixing activities” and put its IPB stake in a special-purpose vehicle, a Dutch trust, Saluka Investments, but kept the voting rights.
Nomura undertook to hold the stock for “at least a year and probably until 2004.” The deal was vaunted as the Fiwrst Czech bank privatization and it was difficult not to see Nomura as a strategic partner of sorts.
Nomura and the government were even at this stage wary of each other. Nomura asked for an official assurance that neither IPB nor its management were under investigation. Nomura also asked the CNB to nominate a chief executive. “We had decided that the IPB risk profile had increased,” says Dillard, “and were backing away from any operational involvement.” The CNB appointed Jan Klacek to run IPB. Klacek was the head of economic research at the CNB and at the time was also de facto shadow Finance minister.
Dillard went on the supervisory board together with three other Nomura men: Mark Basten, from Nomura’s corporate credit department, securitization specialist Daniel Jackson and Eduard Onderka, who had been on IPB’s executive board from June 1997. But Nomura never had more than a third of the votes on the supervisory board. Petr Benes came from Nomura a year later to the IPB executive board to run investment banking although there was no dual contract. This wasn’t quite hands-off treatment. When Warburg Pincus came to IPB in 1994 with a proposal to buy in, it made clear this would be a venture-capital stake to maximize the return on investment for itself and other shareholders. That proposal came to nothing.
Nomura and IPB seemed to deserve each other.
It was a harnessing of two quite brilliant minds. Dillard at Nomura always seemed to be executing the next wizard deal, leaving his colleagues to pick up the details. He was famous for walking on and off the Prague-London plane without a stick of luggage, not even a page of documentation – carrying everything in his head. Prochazka too was renowned for keeping IPB’s big decisions and credit criteria exclusively in his own head, obviously to reduce the workload of endless internal committees.
But by 1998 IPB’s best years were behind it.
The Czech economy was in decline and was hit that August by a second whammy, the Russian crisis. Even more than the other big banks, IPB had loans to strategic Czech industries which probably would never be repaid.
According to Dillard, citing an assessment by PricewaterhouseCoopers, “95% of the provisioning gap at IPB related to lending initiated prior to the NPF sale to Saluka.”
Some of the loans had been recapitalized into shares. Prochazka, who was more wheeler-dealer and portfolio manager than commercial banker, found himself with a severe balance-sheet mismatch: short-term deposits on the right, distressed equity and non-performing loans on the left. “He never understood that you need capital to run a bank,” claims a Czech investment banker. The Czech National Bank was getting tougher on capital adequacy and provisioning. Dillard encouraged Prochazka to stop his wheeler-dealing and divert his energy to develop retail banking. This was a success story. IPB invested early in technology and training. It developed mortgages, building loans and insurance businesses which became market leaders.
Aggressive deposit-taker
“It was a Jeckyll and Hyde bank,” says CSOB chairman Kavanek, who after the takeover found an easy demarcation between the dying chaebol-like conglomerate and a vigorous Financial services operation. Stack at Ceska Sporitelna, only a few months in Prague, says a walk down a Czech high street showed him that the IPB branch was “the one you would give your custom to.” His Fiwrst reaction to IPB’s demise was “get me those people.” IPB was an aggressive taker of retail deposits, forcing competitors to respond. Now they can breathe easier. IPB was paying a premium to fund its underwater loan book and equity participations but no one denies that it built up an enviable consumer franchise. That is why CSOB began to eye it as much as two years ago.
In early 1999 IPB’s auditors, Ernst&Young, were struggling to make sense of the 1998 year-end balance sheet. From April, the CNB also sent in its people to do a spot audit. That lasted until June. The shareholders’ meeting was put back Five days while E&Y wrestled with the provisioning Figure, Finally producing it on June 11. Although IPB raised its provisions each year in absolute terms, the level after 1997 barely changed in proportion to its customer loans whose quality was hardly improving. Now there was the contentious issue of the defeased assets – a Kr30 million Cayman Islands trust, Tritton Development Fund, managed by MeesPierson and the bad loan vehicle NIPB.
The Tritton assets, mostly equities in ailing Czech companies, were securitized into units which IPB took back onto its balance sheet.
That in theory avoided the provisioning for illiquid assets demanded by the CNB, but in practice it did not. The CNB re-examined the structure during the summer and concluded that there was no mitigation of the risk: these were still illiquid equity positions that might fetch zero in a Fire sale. The CNB also disagreed with footnotes to the 1998 accounts.
One footnote assumed certain assets would be transferred at fair value to an open mutual fund, although to date only some of them had been moved. That was trusting the intentions of IPB management too far, the CNB said. The CNB was also uncomfortable about the sale of 11 IPB subsidiaries, including the insurance company IPB Pojistovna, to third parties in preparation for their transfer to the new IPB holding company. Those transactions were due to be completed in 1999. That also was too trustful of the good intentions of IPB management and the third parties, the CNB feared.
Ernst&Young says it was a coincidence that around that time it decided to buy out its three local partners, Richard Novak, George Vlach and Pavel Stefanovic, who had managed the franchise. They had done a great job in the early 1990s winning clients among their former communist pals who survived in industry. But as that group thinned out, Ernst&Young’s reputation took a beating: lots of its clients went bust – but then, it argued, it had more clients than its competitors.
E&Y’s operation in Prague was thereafter run by a Dutch partner. But Nick Davies, audit partner at E&Y in Prague insists: “We stand by our opinions in prior years. We feel we can refute any challenges.”
As CNB officials tried to penetrate IPB’s mysteries last June, they began to fear that it was already insolvent. The supervisors suggested that IPB increase its capital and in October they went in again to examine IPB’s main business areas. A shareholders’ meeting on November 16 voted an increase of Kr2.6 billion to Kr6.9 billion. But that was afterwards blocked by a minority shareholder.
The supervisors spent seven weeks in the bank and then submitted a report to IPB for comment, according to the law.
The CNB’s examination suggested there was a need for additional provisions and reserves of Kr40 billion. That was on February 25 this year. “It was my opinion,” says one supervisor, “that IPB was insolvent. But we have to convince the court. These people can bring experts who can prove whatever they want.” IPB sent back 270 pages of comments and 9,700 pages of appendices during March and April. It also said it planned to increase its capital by Kr13.4 billion. Again that was blocked by a single shareholder.
The CNB, it appears, didn’t have the courage of its convictions or dare to precipitate a crisis at a bank that was too big to fail. The problem was getting enough hard information on which to act. The CNB did not like the way Prochazka and his chums would Fiwrst devise special structures then ask for approval. “They always consulted the CNB after the event,” says one frustrated professional who dealt with the bank. Bank analysts, too, felt they never received enough information: “They would refuse to answer questions,” says one. “They had a habit of ducking out of meetings.”
A frustrated supervisor recalls a chart that he and colleagues drew at the CNB trying to understand IPB’s structure: “It covered a whole wall.” The CNB felt powerless, recalls another: “You couldn’t just say ‘we don’t like the structure, we’re withdrawing your licence.’ We had to ask questions and they always gave us answers. The problem was asking the right questions.”
“The supervisors aren’t half as smart as these people,” says a Czech investment banker.
Echoes Kurt Geiger, head of the banking development programme at the EBRD: “Where do you Find well-paid, highly-qualified supervisors who have the courage to withdraw banking licences? Supervisors don’t like crises. Even a good bank gets affected if a bad bank fails.” CNB governor Tosovsky didn’t have the ammunition last year to call IPB’s bluff. And somehow IPB’s top management survived.
In 1996, when Prochazka, the brains behind IPB, and Tesar, the front man, were held in custody for a month, suspected of embezzlement, and then released, they emerged “looking like heroes,” recalls a Prague-based investment banker.
Klaus believer
IPB was unpopular with bureaucrats and bean-counters but tolerated politically. Prochazka was a Firm believer in Klaus capitalism. He and Klaus had worked together at the former State Bank. But in November 1997 the government coalition partners abandoned Klaus because of a party funding scandal and he was forced to resign. Tosovsky’s technocrat government followed, then a social democrat-led coalition was formed, supported by an opposition agreement with Klaus’s party.
Tosovsky returned to the central bank.
The new Finance minister Mertlik began to show some determination to draw a line under Klaus capitalism and to privatize the banks properly. Favourite bank CSOB, which twice had loan losses subsidized by the government, was sold to Belgium’s KBC in June 1999. Ceska Sporitelna, the biggest savings bank, was sold in January 2000 to Austria’s Erste Bank, its bad loans graded and ring-fenced by government guarantees. Komercni banka, the last unprivatized big bank, disgraced itself in December with a Kr8 billion trade Finance scandal which the government had to clean up.
The government also put in new management and took Kr60 billion of bad loans off the bank’s balance sheet. Komercni banka is likely to be sold after September.
IPB was a special case – and no government favourite. The government was determined that its shareholders should not benefit from their bad investment decisions. “A 46% stake in a bank with negative net worth is zero,” says an irate central bank official.
But there is also the political dimension. The demise of IPB is surrounded by conspiracy theories. Theory number one is that the bank run was fuelled by those who wanted to cut off Klaus’s source of funding to bolster Tosovsky’s crack at the presidency in two years’ time. The best way to do this, according to the argument, was to de-politicize IPB by making sure it was sold to the Belgians.
But a second theory suggests paranoia about Nomura as an explanation for the behaviour of the Finance ministry and the central bank.
Nomura had come to be seen as the wolf in sheep’s clothing. It arrived as adviser to the government and as one of the midwives of privatization. But after it bought into IPB it seemed to develop schizophrenia about its investment. Nomura was a laisser faire partner until the bank was clearly in trouble. Then it tried to Find a replacement partner. At the same time it appeared to be making a killing from corporate Finance deals. It sold two Czech beer-makers to South African Breweries for $629 million. Nomura had put together controlling stakes in Plzensky Prazdroj (brewers of Pilsner Urquell) and Radegast by collecting shareholdings from IPB’s investment funds and elsewhere. Dillard’s investment banking genius was to spot the opportunity, put together two small breweries and sell them to a mid-size beer-maker with global ambitions – Nomura kept a 49% stake while SAB paid $321 million for 51%. But the Czech public, having Fiwrst applauded the deal, came to regard the headline Figure of $600 million as Nomura’s clear profit. Also, it wasn’t the bank’s only successful Czech deal that year.
The public perception was: not bad compensation for taking a stake in an ailing Czech bank for Kr3 billion plus Kr6 billion of new capital. Nomura could walk away from IPB and still be ahead on its Czech investments.
Czech Wnance oYcials were never comfortable about Nomura’s relationship with IPB, or who was behind Saluka or the many aYliates of the IPB empire. Was Nomura truly the beneWcial owner? “Saluka is owned by a trust, it’s not owned by Nomura at all,” says Dillard. “We loaned money to Saluka.” Yet the Czech National Bank had insisted that Nomura should not own and control a commercial bank or get involved in the board of directors; so apparently did Japan’s ministry of Wnance and the Bank of England.
Czech oYcials’ distrust of Nomura can be blamed on Nomura’s own ambiguous behaviour. It started as an IPB partner, distanced itself, then in trying to Wnd a buyer became a more active manager. “We were getting drawn into acting more and more like a bank investor,” says Dillard. “It was a quagmire, like Vietnam.” Nomura’s eVorts included a wild spoiling bid for Ceska Sporitelna this February. The message was: “Whatever Erste is paying, IPB will pay more.”
At around the same time Nomura says it began discussions directly with prime minister Milos Zeman. Zeman indicated to IPB CEO Klacek and Dillard that he would help out the bank only if it recapitalized in June. Nomura started working on a Kr20 billion to Kr30 billion recapitalization plan that required government involvement in a guarantee.
In April, Nomura suggested another desperate merger – of IPB with the cleaned-out Komercni banka. It seemed that Nomura and IPB – the two by now seemed indistinguishable – were determined to unload their problems onto someone else. Dillard seemed simultaneously to hold the keys of salvation and destruction. By the end of May this year he had become chairman of IPB’s supervisory board, sacked Prochazka and Tesar (chairman of the supervisor board since 1998) and was battling for a government guarantee and a fair valuation of the bank. With Allianz he practically had a deal in his pocket. But he didn’t reckon with a Werce determination, somewhere among Czech oYcialdom, not to let Nomura win the next round.
Allianz had been talking to the government since January about an IPB deal. There were increasing worries about the bank, including a brief run on its deposits in February. The public knew about a CNB investigation and the auditor warned the regulator about possible capital-adequacy problems. In March, Allianz brought in UniCredito as a potential banking partner and went forward with due diligence on the IPB insurance operation. UniCredito explored ways of gaining a banking licence in the Czech Republic so that it could steer the operations of IPB. One option was to buy the licence of Hana Bank, a defunct member of the IPB group.
In April, deputy Wnance minister Mladek asked Allianz/UniCredito representatives if they could have a deal ready by mid-June. An initial agreement was signed, says one person close to the negotiations.
So far, all Nomura’s conversations with the government, except with prime minister Zeman, had suggested the treasury wouldn’t put in a penny to clean out IPB’s loan book. Mladek and Dillard, sitting on the same conference panel, had the following frank exchange: Mladek: “We’d like to see Nomura make some commitment as a strategic investor.”
Dillard: “We are not a strategic investor. We didn’t have the beneWt of due diligence when we bought into the bank in 1998 and there has been no government guarantee for any loans, as there was for Ceska Sporitelna”.
Nomura did not want to put good money after bad. With a hole of at least Kr20 billion, Nomura said it needed the government to add a loan-loss guarantee. The government at the time was putting pressure on IPB to restructure its lending to heavy engineering firm CKD.
Nomura had another meeting with Zeman in May.
And on Monday June 5, Nomura presented Zeman with a menu of three options:
? The sale of Saluka’s 46.16% stake in IPB to the government’s workout vehicle Konsolidacni banka for one euro a share, and another 4% to 5% stake in IPB at the market price, with a view to transferring the shares to a strategic partner. The government and Nomura would jointly select the buyer.
? A straight sale of Saluka’s 46.16% for Kr7.1 billion, plus another 5% stake at the market price.
? Nomura arranges a Kr20 billion to Kr30 billion re-capitalization, with government guarantees on IPB loans to certain big Czech companies (such as CKD, Skoda Pilsen and Chemapol) until the 51% stake is sold to a strategic partner, either Allianz/Unicredito, or KBC/CSOB, or even Erste/Ceska Sporitelna.
Zeman was excited and called the last option a bomba (miracle). Dillard had told him that it should cost the taxpayer nothing if the sale was conducted professionally: in fact the shareholders would make a lot of money. “Zeman was on the phone to Mertlik as we left,” recalls Dillard. “We thought we had a deal, subject to terms being agreed.”
On Thursday June 8, Allianz struck a deal with Nomura to acquire IPB’s insurance business for some Kr3 billion to Kr5 billion. But Nomura needed UniCredito to acquire the bank as part of a comprehensive sale. Finance minister Mertlik asked UniCredito representatives how quickly the bank could take over management of IPB. Those close to the negotiations say that Allianz was days away from completing a deal and that UniCredito would have needed perhaps a few weeks. But the partners wanted to move together on the transaction.
That Thursday evening, however, there were rumours in the market that there would be a run on the bank. On Saturday, June 10, deputy Wnance minister Mladek was quoted in the newspaper Mlada Fronta as saying that the situation in IPB was “unstable.” If the public needed an excuse to panic, this was it. On Monday, the run began.
On the third day of the run, at Wednesday midday, Münkel of Allianz and Kavanek of CSOB were summoned to the prime ministry during a break in a cabinet meeting.
Allianz/UniCredito’s oVer was to inject capital, let UniCredito run IPB as an interim manager, and, if the government so wanted, it could then re-tender the bank. It required the government to guarantee an estimated Kr21 billion of bad loans and put them in a separate “bad bank.” CSOB was an alternative buyer but lacked the cash to compete in a tender.
The strategy of Kavanek, the lean, ascetic head of CSOB seemed to be to deal directly with the government. Perhaps he understood that treating with the unpopular Nomura would be the kiss of death. Kavanek seldom appeared at merger meetings between CSOB and Nomura/IPB. CSOB had not signed a confidentiality agreement to gain access to data, says Dillard, because of a clause in it which said it would have to write minutes of “any discussions with the government that could impact the sale”. Kavanek and Münkel learned about the third offer which Nomura had put forward.
Finance ministry and central bank oYcials considered Nomura’s offer on Thursday, the fourth day of the bank run, but they were deeply suspicious: Nomura’s offer was hardly transparent. Nomura would put the bank to the government for one euro. The loan portfolio would go to the state workout vehicle Konsolidacni banka. But to prevent a liquidator from blocking the deal, Nomura would sell only a part – a large part – of the enterprise of the bank: the shell bank would retain some assets. Nomura wanted those assets to be the Cayman vehicle Tritton but would not disclose Tritton’s contents, only the latest net asset value (NAV) of around Kr6 billion. “They could have had an update on the NAV on Monday,” Dillard complains.
Take one euro
Mladek was blunt, Dillard recalls: “He told us that recapitalizing IPB with any type of participation by the government was unacceptable. Our money was not good enough. The only deal that would work for the government would be the sale of IPB to Konsolidacni banka for one euro, and we should go away.” The Nomura team told Mladek that without other terms his oVer was “tantamount to expropriation.” Nomura later wrote to foreign minister Jan Kavan making the same point.
Forced administration had been mentioned regularly over the months but at the Czech National Bank it was seen as an emergency measure which should be avoided. The experience with Agrobanka, which went into forced administration in 1996, had not been good. Value in the bank seeped away while a buyer was sought. It was finally sold, cheaply, to GE Capital.
With the writing on the wall, IPB’s supervisory board wrote to the Czech National Bank that it would sell the bank to the government workout vehicle, Konsolidacni banka, for one euro. At 8:00pm and again at 9:30pm on Thursday, Mladek sent e-mails to Nomura with some requested amendments to Nomura’s term sheet. The messages suggested that some parts of the deal still weren’t clear. Mladek indicated that negotiations would resume the next day.
Then there was a cabinet meeting at which it seems all negotiated solutions were rejected in favour of forced administration the next day. But the decision was taken in secrecy. If the opposition party ODS got wind of the plan, especially any decision about who would buy the bank, there would be an outcry.
On Friday at 11:30am, Münkel of Allianz was informed by Mladek at the Wnance ministry: “None of your solutions will work.
We’re taking the bank under forced administration.” Simultaneously, central bank markets chief Ludek Niedermayer left a CNB board meeting to visit Kavanek at CSOB across the street. He wanted to know whether CSOB was ready to try to put together a blind transaction and take over IPB without any due diligence. Only if the government would guarantee the balance sheet risk, Kavanek said.
At 11:58 police in balaclavas went into IPB and installed Petr Stanek, compliance offcer of Raiffeisenbank Prague, as forced administrator. Stanek had experience of this role. The former central banker had been put into Agrobanka as forced administrator in 1996 and had stayed there for two tortuous years.
This time he was determined it would not take so long. All deposits, loans and other obligations of IPB were guaranteed. The run was halted. So was all negotiation with Nomura, Allianz and UniCredito. Whatever went on in discussions between the Wnance ministry, the central bank and Konsolidacni banka, which now had IPB’s loan book, everyone else would be excluded from them except Kavanek, his major shareholders and advisers.
Credibility gap
There are two possible explanations for this decision. One is technical: there was a run on the third biggest Czech bank. If uncertainty continued it could spread to other banks and become systemic. The public had to be assured that a solid bank with solid backing was opening on Monday morning. It is arguable that the solidity was already there with a government guarantee. But the bank’s management needed credibility too: the two most senior managers had been removed at the end of May. CSOB, backed by Belgium’s KBC, was the only potential partner that offered immediate stability and continuity. Several members of KBC’s supervisory board were ready to fly into Prague on Sunday to back an acquisition. A deal with Allianz and UniCredito was still weeks if not months away.
There was a legal risk that, during negotiations, some less transparent assets of the IPB chaebol would somehow disappear.
The second explanation is more psychological: mistrust, or worse, of Nomura. Nomura had become, justiWably or not, a pariah in the Czech Republic. Officials feared being outmanoeuvred, as they appeared to have been before. Why take the risk of dealing with Nomura when a friendlier counterparty is at hand?
Ultimately it was forced-administrator Stanek’s decision to deal only with CSOB.
Central bank officials would have preferred a more transparent, less behind-closed-doors procedure, perhaps a quick public auction between the two suitors. But such public tenders are likely to take half a year. There was always the risk of a court injunction – from Nomura, KBC, Allianz or a single shareholder – slowing things down. Better to have the deal done and dusted by Monday. That was the rationale. There wasn’t time to count the cost, politically and socially.
Ernst&Young partners, some having flown in from London on Friday, were asked for an early opinion on the state of IPB’s balance sheet – which they were supposed to have ready by June 26. But the answer came back “we have no opinion” – too many questions had been ducked or left unanswered. Earlier that week E&Y had suggested that, from the parts of the bank they could assess, the bank’s capital had gone. There was nothing for it but a more-or-less blanket guarantee from the state for whatever nasty shocks lay hidden in the IPB group.
Nevertheless the negotiations on the guarantees went on all Sunday night, with a near stalemate at 2am Monday when the central bankers threatened to walk out. Finally at 6am, Kavanek gained almost all he wanted. CSOB would take over the bank, initially for nothing. Retrospectively, on a valuation from two independent auditors, CSOB would pay 7% of 20% of the perceived value of any IPB assets which it chose to keep. (That might turn out to be around Kr20 billion, which is close to the Kr19 billion that CSOB had in its war chest. Some observers believe this isn’t a coincidence.) Everything else, bad loans, worthless equity or whatever, could be picked over and put to Konsolidacni banka. If at some point CSOB found the IPB takeover threatened its own existence, it could give the bank back to the government. Yet again the government was sterilizing the loan portfolio of a bank, leaving it little incentive to lend to corporate customers. This happened with Ceska Sporitelna, Komercni banka and CSOB. Stack and Kavanek protest that they do have incentives to lend, to build market share and maintain lending relationships.
Despite all the government insistence that it would not bail out a private bank, here it was underwriting all IPB’s bad loans, giving CSOB the right to pick and choose what it wanted and even return the whole bank if it found the job too much to handle. CSOB/KBC appeared to be the only winner, the recipient of a free banking and insurance franchise, with minimal financial risk. However, central bank officials insist that the government and the CNB “found a solution that didn’t destabilize the banking sector. At the end of the day it may be a relatively economical one as well.”
Finance minister Mertlik may have wanted to show the world, particularly the EU, that the Czech Republic could clean up one of its banks over a weekend and avert a potential systemic crisis. But to do so the republic appears to have reverted to a particularly Czech way of doing business – behind closed doors, with little transparency, shutting out others who might have paid considerably more for the assets. “There are at least 10 or 20 foreign banks,” thunders shadow finance minister Vlastimil Tlusty, “who would have accepted a free bank. It was as if I want to sell my car and my neighbour says ‘I’ll take it off your hands for nothing and by the way you must give me a guarantee.'” A debate in parliament on July 3 decided to set up a cross-party committee to look at the whole issue of IPB: the loss of state control, its sale to Nomura and its recent sale. The main protagonists prepared themselves for cross-examination but privately said little new information was expected to come out.
Czech officialdom was nevertheless uncomfortable about the treatment of Allianz and UniCredito and the deal done apparently behind their back. There was speculation in Prague that central bank officials (again reverting to the old Czech ways) would try to make it up to them by offering special treatment in the future.
Any sign of special favours, however, wouldn’t impress foreign players looking for a more transparent privatization process in the Czech Republic. In the meantime Allianz and UniCredito have made little fuss, taking a long-term view of their future in the country and not wanting to become embroiled in local politics.
Hunt the asset
In the weeks that followed, a frantic hunt ensued for assets caught in the transfer from IPB’s Byzantine former structure to its new holding framework. Title to some of those assets was in limbo because they were being held by third parties and were covered by call options: in the confusion some of the options had been allowed to expire. The problem arose because CSOB bought the enterprise, not the entire bank with its holding structure. That was done to avoid the wrangles experienced with the Agrobanka administration. But courtroom battles are anticipated and the outcome is uncertain, even though these assets clearly belonged to the group. “Czech courts tend to support the letter rather than the spirit of a contract,” warns one specialist.
Prochazka is more conciliatory: “I can’t say that CSOB has lost any companies, they simply complicated things for themselves. It would have been better to leave the holding structure intact.”
Does Nomura have the last laugh? In mid-August Nomura issued a press release saying that it had exercised an option to sell Saluka’s 46.16% holding in IPB to investment companies Torkmain Investments Limited and Levitan Investments Limited, managed and operated by MeesPierson. Nomura had not told the Czech government or any other party about this option. “We didn’t feel the need to tell anyone,” says Dillard. “It was a confidential hedge that we hoped would never have to be exercised.”
Nomura’s reason for exercising the option, says Dillard, was the realization that IPB’s shareholders were being given neither a fair deal nor insight into how IPB’s residual assets were being valued (the enterprise was sold to CSOB, not the bank itself). Some of those assets are held in the Cayman vehicle Tritton, which either was or wasn’t sold to CSOB. MeesPierson, now the proud owner, through Torkmain and Levitan, of 46.16% of old IPB’s shares, presumably has the best incentive to realize some value out of Tritton, which it also manages.
In theory MeesPierson is as well placed as anybody – and certainly better placed than Nomura, says Dillard – to extract value from the shell of IPB. To break even it would have to obtain more than the Kr153 a share that it apparently owes on the options, less any option premium that Nomura paid.
But the Czech Republic probably hasn’t seen the last of Nomura. Saluka retained a small shareholding in IPB, said Nomura ominously in its press release “and continues to reserve its legal rights.”
