Mon | Aug 10, 2020

Companies seeing red - Fincos rack up multibillion-dollar losses under double whammy of COVID and IFRS

Published:Sunday | May 31, 2020 | 12:27 AMNeville Graham - Business Reporter
Charles Ross, president and CEO of Sterling Asset Management Limited.
Charles Ross, president and CEO of Sterling Asset Management Limited.

In good times when markets are bullish, companies that hold stocks and bonds tend to report solid earnings, but when the market goes south, so can their bottom lines under the much-maligned accounting Rule 9 of the International Financial Reporting Standards, IFRS.

It’s why financial companies have been racking up losses in the billions and marking down their portfolios since March, when COVID-19 began taking its toll on the markets.

“The upshot of that is companies with large equities holdings, such as Mayberry, PanJam, Sagicor Select – both the manufacturing and financial funds – and others, would be immediately affected,” says CEO at Mayberry Investments Gary Peart.

Still, unless companies liquidate their holdings, the losses are all on paper – that is, they remain ‘unrealised’ – and value can be restored when market conditions improve.

The bad news is companies may see an erosion of their balance sheets, depending on the accounting treatment. The two listed Sagicor Select Funds, for example, both reported net losses above $1 billion in the quarter, and both recorded an equivalent reduction in equity on their balance sheets.

Mayberry posted a loss of $1.3 billion in the March quarter due to what the company explained to shareholders was “downward price movements on equities and bonds and lower trading gains, partially resulting from the impact of the novel coronavirus on the local and global financial markets in the first financial quarter of 2020”, according to its quarterly financial report.

Sagicor Select Funds – Financial made a loss of $1.47 billion; its sister outfit, Sagicor Select Funds – Manufacturing & Distribution, racked up losses of $1.09 billion. Both are indexed to sectors of the Jamaica Stock Exchange, and their losses come amid a 21 per cent decline in the stock market in the month of March alone, when the coronavirus was first detected in Jamaica, and 26 per cent in the first quarter.

“COVID came out of nowhere, and it has changed various economies, so nobody could predict the unforeseen or the extent of it. The reality is that within the space of three weeks, our market indices moved from where it was to below last year’s ­levels. Clearly, under IFRS rules, we have to account for that,” Peart said.

IFRS 9, which was introduced in January 2018, requires that financial assets on companies’ books be recognised for “fair value through profit and loss”, shortened to FVPL, or “fair value through other comprehensive income”, or FVOCI.

Public companies reporting on their performance are required to reflect the fair value of securities that they hold as at the end of a particular reporting period. This has to take into account the value of the security at the time of purchase and the highest or lowest value of the security during the period versus the present value of the security.

“It is a double-edged sword because if you say you will pass the gains through the profit-and-loss statement, and share prices are going up, it looks great,” said Charles Ross, president and CEO of Sterling Asset Management Limited.

“But if they are falling, in addition to booking the difference between what you bought at and what the price is now, you also have to book it at where it was when the price was up and where it is now,” Ross said as he explained the accounting complexities involved in valuing financial securities.

“Where you have structured notes, the accounting rules now require that any movement in those structured notes must go through your profit and loss, regardless of whether you are selling or holding,” he added.

The biggest hits to financial holdings to date have been reported by banking conglomerate NCB Financial, which reported a write-down of $9 ­billion on investments, and ­insurance conglomerate Sagicor Group Jamaica, which similarly said the toll on its holdings was $5 billion.

Both, however, still recorded healthy, albeit diminished, profit in the March quarter – Sagicor’s fell by more than two-thirds to $1.14 billion; NCB Financial’s was cut in half to $3.4 billion.

PanJam Investments, a property and investment conglomerate, recorded negative income from investments of $1 billion and barely made a profit of $5 million, which was a fraction of the $895 million of earnings recorded for the similar period in 2019. PanJam’s chief operating officer, Paul Hanworth, emphasised that the losses were unrealised.

None of the firms reviewed by the Financial Gleaner, most of which were fincos, escaped some form of fallout. Victoria Mutual Investments took a hit of about $1.3 billion on its investments and made a loss of $984 million at the bottom line.

VM Group Chief Investment Officer Devon Barrett, like Hanworth, said unrealised losses were expected in light of the market’s performance.

Sterling Investments Limited, which is managed by Sterling Asset, had a small profit of $4.58 million, but that was after a near $33-million unrealised loss on structured securities and equity investments and a $260-million unrealised loss on debt investment securities.

Tea manufacturer Jamaican Teas took a $508-million hit, which CEO John Mahfood said was the company’s share of the losses of investment subsidiary QWI Investments.

Ross sees the accounting rules for financial assets, which were developed in response to the financial debacle of 2008, as distortionary, saying they mask a company’s true profit performance.

“It’s going to make it very difficult to properly analyse what is happening in these companies because you will have these huge unrealised movements which have nothing to do with the fundamental underlying profitability of the company. They make the income statements very volatile,” he said.

Peart, however, characterises the swings as a natural outcome of market activity.

“We have to remember that technically, your stock exchange is a leading indicator, and in the event of a sell-off, the market is really saying, ‘We don’t expect these companies to do well further down the line’, and this is how accountants capture that,” he said.

Jamaica has been on lockdown to contain the coronavirus, but some of those restrictions will begin to be eased on June 1, when work-from-home orders will be allowed to lapse.

It marks the beginning of the reopening of the economy, and expectations are that the markets will slowly begin to rebound, for which there are already some positive signs that stocks may soon emerge from bear territory.

In April and May, the stock market experienced a mild rally. For April, the JSE Combined Index moved up 4.7 per cent, while the gains for the month of May, to date, are 5.7 per cent. However, the market is still down 24.5 per cent year to date.

Peart is already looking ahead to when the markets shrug off the effects of the coronavirus.

“We believe that Jamaica is going to rebound,” he said. “It may be a little weak for the next three months or so, but from there, it is up,” he said.