9 banks may go bankrupt as result of domestic debt exchange – Report

theindependentghana.comMar 17, 2023 8:47 AM

The impact of the Domestic Debt Exchange Plan on the operations of nine Ghanaian banks could render them insolvent if the International Financial Reporting Standard (IFRS) 9 is enforced strictly.

Six banks, however, might not sustain any capital losses, while eight banks might sustain just slight losses.

A domestic debt exchange could have a significant impact on the balance sheets of 23 banks and their capacity to extend credit to the economy, according to a paper by banking consultants Dr. Richmond Atuahene and K. B. Frimpong. This is because the banks currently hold about 37% of all government securities.

These losses could be due to a combination of coupon or interest rate reduction, and maturity extension with below-market coupon rates.

“From the data, the capacity of the banking sector to absorb losses is lower not where it is well capitalised to absorb the estimated losses from the debt exchange programme. Ghanaian banks will not be able to absorb losses without having to resort to a recapitalization from the government, or resorting the shareholders and banks for recapitalization quickly to mitigate the risk of bank failure and also protect the stability of the entire banking system and the economy”, it said.

Below is the research

ANALYSING THE DOMESTIC DEBT EXCHANGE PROGRAMME AND FAIR VALUE ACCOUNTING IMPACT ON LOCAL BANKS’ SOLVENCY

(DR RICHMOND A. ATUAHENE AND K.B. FRIMPONG FCCA)

1.0 BACKGROUND

The Ministry of Finance invited on December 5, 2022 holders of 60 old domestic debts to voluntarily exchange ¢137.3 (US$14.3) billion domestic bonds and notes including E.S.L.A and Daakye Bonds, for a package of twelve new eligible domestic bonds. Under the debt swap or exchange announced on December 5, 2022, local holders including domestic banks, Bank of Ghana, Firms and Institutions, Retail and Individuals, Insurance Companies, Foreign Investors, Rural and Community Banks and SSNIT were to exchange ¢137.3 billion (US$14.3) worth of 60 eligible domestic bonds for 12 new eligible bonds maturing between 2027 to 2038.

Under the initial offer for bondholders with bonds maturing in 2023, the government promised four new bonds that were expected to mature in 2027, 2029, 2032 and 2037 with zero coupon rate in 2023, 5% coupon rate in 2024 and 10% coupon rate in 2025, which would continue till the maturity of last bonds in 2037. Initially, the Ministry of Finance stated that debt the exchange programme would affect local banks, Bank of Ghana, Firms and Institutions, Foreign Investors, Insurance Companies, Pension Funds, Rural and Community Banks and SSNIT but excluding Retail and Individual Bondholders. The debt exchange programme was extended to December 30, 2022 because could not achieve the 100% voluntary participation. After fierce resistance from trade unions about the inclusion of pension funds in the domestic debt exchange programme and for the lack of enough voluntary participation, the government announced the extension of the voluntary participation in the programme to January 16, 2023 with following modifications:

• Offering accrued and unpaid interest on eligible bonds and a cash tender fee payment to holders of eligible bonds maturing in 2023.
• Increasing the new bonds offered by adding new instruments to the composition of the new bonds for a total of 12 new domestic bonds, one maturing each year starting January 2027 and ending January 2038.
• Modifying the exchange consideration ratios for each new bond. The exchange consideration ratio applicable to eligible bonds maturing in 2023 will be different other from other eligible bonds.
• Setting a non-binding target minimum level of overall participation of 80% of the aggregate principal amount outstanding of eligible bonds.
• Expanding the types of investors that can participate in the exchange to include individual investor.

On January 16, 2023, the government extended the deadline for the domestic debt exchange programme to January 31, 2023, after another resistance by some creditor group particularly individual investors whom the government promised not to include in the programme.

The government made some modifications including:

• Offering accrued and unpaid interest on eligible bonds and a cash tender fee payment as a carrot to holders of eligible bonds maturing in 2023.
• (ii) Increasing the new bonds offered by adding eight new bonds to the composition of the new bonds, for a total of 12 new bonds, one maturing each year starting in January, 2027 and ending January 2038. The third extension of deadline for domestic debt exchange programme from  January 31, 2023 to February 7, 2023, for voluntary participation and also as the final deadline for institutions and individuals to sign up to domestic debt exchange programme. The government has made offer which includes the exchange of new bonds with a maximum maturity of five years instead of original 15 years and a 10% coupon rate to individual bondholders below the age of 59 years to encourage them to participate in the domestic debt exchange programme. Additionally, all retirees including those retiring in 2023 will be offered bonds with a maximum maturity of 5 years instead of 15 years and a 15% coupon rate per annum.

 Subsequent extensions of dates and payment maturities meant that the remaining stock was reduced from ¢137.3 billion to ¢130 billion. However, the eligible bonds as per memorandum meant an exclusion of pension funds and bonds that were subject to swap mechanisms for monetary and exchange rate policy operations. This then brought the eligible bonds tendering to ¢97.75 billion. Out of the total eligible bonds for tendering, ¢83 billion ($ 6.7 billion) was successfully tendered-accounting for about 85% of outstanding eligible amounts and meeting the target 80% as expressed in the memorandum of the exchange.

Nevertheless, the ¢87 billion (64%) that were successfully tendered represent only 60% of the original outstanding debt stock of ¢137.3 billion. The strategy employed by the Government of Ghana to achieve full participation for the GDX was aggressive. Although there was some financial sector consultation on expanding the range of instrument offering prior to crafting the exchange, the debt transaction offer was unilateral with a ‘take‐it‐or‐leave‐it’ approach.

With voluntary participation of only 64% (GH¢87 billion, not underpinned by strong fiscal consolidation, it will not necessary to reverse the adverse fiscal dynamics and reduce the debt overhang that has plagued Ghana for the four years and it will be difficult to achieve Debt to GDP ratio of 55% in 2028.

2. DATA ANALYSIS USING THE NPV OF LOCAL BANKS HOLDING OF GOVERNMENT BONDS AND NOTES.

According to Ministry of Finance (2022), the total government bond and domestic notes value of ¢137.3 billion with the local banks allocated ¢50.6 billion (37%); Firms and Institutions, ¢34.73 billion (25.3%), retail and individuals, ¢22.3 billion (13.9%), Foreign investors, ¢14.83 billion (10.8%); Bank of Ghana, ¢13.73 billion (10%); Rural and Community banks, ¢1.92 billion (1.04%); Insurance companies, ¢1.2 billion (0.09%) and SSNIT ¢55million (0.04%) excluding Pension funds ¢7.69 billion (5.6%) and Treasury bills valued at approximately ¢26.25 billion. 

From our data analysis showed that the impact of losses on bank balance sheets had been significant because government securities comprised a large share of bank assets. Any loss in value of government debt exposures had led to capital losses in financial institutions unless these have already been absorbed by provisioning and Mark-to-Market (MTM) accounting which for past years most banks were not applying the MTM. 

These recent losses could be due to a combination of coupon or interest rate reduction, and maturity extension with below-market coupon rates of 19.3%. The capacity of the banking sector to absorb losses had been lower, as the banking sector capitalization only to place three years ago. When banks are able to absorb losses without having to resort to a recapitalization from the government, the fiscal consolidation and/or burden-sharing by other creditors required to restore debt sustainability would be smaller

From our data analysis using the Net Present Value of the government bondholding of ¢50.6 billion (37%) of the total bonds, then the private sector could face severe challenges in the area of provision of new credit and extension of existing credit as a result of liquidity and solvency crisis in the banking sector. The impact of a domestic debt exchange on 23 banks’ balance sheets (and their ability to provide credit to the economy) could be significant as the Ghanaian domestic banks are holding about 37% of government securities.   

Any loss in value of government debt exposures will lead to regulatory capital impairment in banking institutions at the time of the restructuring unless these have already been absorbed by loan-loss provisioning and mark-to-market accounting which was never applied prior to the restructuring. Such reduction in the value of government debt portfolio could be due to any changes to the original contractual value of the debt security, such as coupon reduction from 19.3% to a weighted coupon rate of 9%, and maturity extension from 5 years to 15 years.

From the existing discount rate of 19.3 % with 5-year maturity period to the weighted average coupon rate of 9% new bonds with extended maturity period of 15 years, our data analysis showed estimated losses using Net Present Value of ¢41,315,326,692 would impact negatively on 23 banks’ solvency. For example, Bank B with bond holdings of ¢9,106,452,000, it is estimated that with discount rate of 19.3% using weighted coupon rate of 9% NPV estimated losses resulted in ¢7,435.494,850 from the total shareholders’ equity of ¢2,853,177,000 (December 2021), thus giving the negative net worth of GHC4,452,317,850 making the bank insolvent.

If the IFRS 9 is applied in stricter sense nine banks could be insolvent. From the data analysis only last six banks, R.S.T.U.V and W may not experience any capital losses while eight banks may experience mild capital losses. These losses could be due to a combination of coupon or interest rate reduction, and maturity extension with below-market coupon rates. From the data, the capacity of the banking sector to absorb losses are lower not where it is well capitalized to absorb the estimated losses from the debt exchange program.

Ghanaian banks will not be able to absorb losses without having to resort to a recapitalization from the government, or resorting the shareholders and banks for recapitalization quickly to mitigate the risk of bank failure and also protect the stability of the entire banking system and the economy. Capital shortfalls are more likely to emerge for a tail of weak banks like A, B, E, D, G, J, K and few others because of their higher share of exposure to government domestic debt relative to their capital.

With the estimated losses using the NPV of banks holding of government bonds, the domestic debt exchange could also have a negative impact on the capital adequacy ratio of banks. The conversion of short-term debt into long-term had increased the risk-weighted assets of the banks which could reduce their capital adequacy ratio. This could lead to decline in the financial stability of local banks and increase the risk of bank failures.

The decline in capital adequacy ratio would lead to a reduction in the overall financial stability of the sector. Though the Bank of Ghana as part of the domestic debt restructuring, announced a regulatory forbearance for banks, it is very important for shareholders and board of directors for banks to take steps to mitigate the negative impact of domestic debt exchange programme exercise on their capital in the balance sheets as their corresponding banks may not recognize the Bank of Ghana’s regulatory forbearance.