Power sector TFCs misleading banking performance

Pakistani banks may have been poor in doling out advances last year. But there is more to the story than meets the eye.
It appears the banking industry is at odds with the central bank as regards the treatment of power sector TFCs issued to ease the circular debt crisis.
The banks are required to place the unquoted TFCs under the accounting head of investments, which, in spirit, banks argue, being non-tradable in capital market can be classified as advances, because the features of such privately placed TFCs are similar to big ticket loans.
Presenting their case for the classification of the said TFCs, banks cite the International Financial Reporting Standards (IFRS), which states that "if the information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form".
And, this is exactly where the State Banks interpretation differs from that of commercial lenders. Central bankers opine that while the certificates cannot be traded in the market, they can, nonetheless, be bought or sold privately over the counter.
Likewise, they add, the nature of these papers isn that of a loan, because, unlike an advance, payments for these TFC weren made directly in the bank accounts of the power companies in question.
The question is, why is there so much disagreement about the treatment now, when in fact such elements should have been discussed, debated and clarified earlier.
Well, one part of the problem could be that commercial lenders weren pro-active enough to sort the problem at the time of the issuance of these TFCs.
Then again, historically, the treatment never held such significance as the quantum of unquoted TFCs was way low to disturb the key ratios of a bank. With the curse of the circular debt, however, things have become troublesome.
There were two TFCs, issued by government-led consortium, amounting to Rs165 billion by Pepco and Power Holding Company (PHC) last year. This was in addition to the credit disbursement classified as investment by discos and National Transmission and Dispatched Company (NTDC).
With mere Rs121 billion (4%) increase in reported advances during 2009 as per SBPs raw data, thanks to economic slowdown, the placement of well over Rs165 billion power sector credit to resolve circular debt substantially undermined the advance-to-deposits ratio and overstated the investments of banks.
This distorts the real picture of financial position of the industry and its ratios, as significant amount will be shown under the head investment than as loans and advances.
For example, HBL (the only big bank, which released 2009 results at the time of writing this note) issued credit of Rs43 billion to NTDC and PHC last year, whereas, its gross advances increased by mere Rs7 billion. Had these power related TFCs been classified as advances HBLs ADR would have been enhanced by 658 bps to 77.5.
Apart from the accounting treatment, this puts the reputation of line managers of these lenders under question. However, this is an industry-wide phenomenon.
By now its pretty much evident that the public sector entities have been eating the pie of private borrowers, therefore, both prospective employers of these managers and the banks shareholders should understand their position.
This is because, in case the IFRS requirements differ with present regulations, the provisions of and directives issued under the Companies Ordinance, 1984 and Banking Companies Ordinance, 1962 and the directives issued by SBP are supposed to prevail.
One can say whether the central bank will agree with the industry somewhere down the line or not. But surely, the investors need to tweak their banking valuations accordingly when making their decisions, whereas the banks should strike a better deal when the government offers TFCs for circular debt (currently nearing Rs100 billion) next time around.
Meanwhile, the SECP must start thinking on how to deal with the virtual absence of tradable corporate debt market.