Fall of the Titans: The Story of African Bank & Lehman Brothers


In early August this year, African Bank, the banking arm of African Bank Investments Limited, received a 1.6 billion US dollar bailout by the South African Reserve Bank (SARB). This was subsequent to the bank’s collapse after it reported that it was expecting a headline loss of up to 600 million dollars for the 2014 financial year.

The announcement was also in conjunction with the resignation of its CEO Leon Kirkinis, which further pulled down its stock price. By the next day, African Bank’s stock price had plummeted more than 80 per cent. However, a combination of factors led to African Bank’s demise.

(READ MORE: Moody’s downgrades four South African banks)

Richard Fuld, CEO of Lehman Brothers, was crucial in building the firm particularly after it was tossed by American Express in 1994. Fuld was also instrumental in saving Lehman Brothers from the Asia financial crisis in 1997.  

Meanwhile, at the forefront of African Bank’s crisis was its CEO Kirkinis, who, after co-establishing one of the most important players in South Africa’s unsecured lending industry, fled the house as it burnt down.

Before his involvement in African Bank, Kirkinis was a merchant banker. In 1993, he founded Theta Investment Group with the aim of providing funding using capital markets, in an attempt to fill a gap that traditional banks could not. Theta Investment Group then bought African Bank in 1998.

In 2008, Kirkinis bought Ellerine Holdings Limited for just over 860 million dollars in order to synergise lending and consumer demand for credit in the furniture industry at the time. As the demand for credit for furniture increased, Kirkinis banked on what seemed to be a burgeoning opportunity.

However, the Ellerines furniture business was just breaking even. Soon after the acquisition, Kirkinis realised that it would take a long time for Ellerines to return a profit.

In September that year, investment firm Lehman Brothers filed for Chapter 11 bankruptcy, following an investment gone wrong.

Like African Bank, Lehman Brothers decided to bank on the 2003 and 2004 housing boom, purchasing five mortgage lenders such as BNC Mortgage, a subprime lender, and Aurora Loan Services.

Aurora in particular specialised in Alt-A loans, which are high risk, and are provided to those with lower credit scores.

In 2007, after Lehman Brothers’ stock reached a record 86.18 US dollars, problems started to brew for the firm as defaults on the subprime mortgages reached a seven-year high. Lehman Brothers was sitting with toxic loans, and its stock began to plummet.

Both Kirkinis and Fuld had some serious decisions to make in the six months prior to the collapse of their respective financial institutions.

There are many reasons behind why Lehman Brothers filed for Chapter 11, but perhaps the most important was the arrogance of the leadership at Lehman. If one wants to fully understand the complexities of the decision making behind the Lehman collapse, look no further than the nine volumes of the Lehman Brothers documents published on the Jenner & Block LLP website.

Looking at the surface, one can argue that prospective buyers and private equity firms wanted a similar guarantee to the one Bear Stearns got from the government when JP Morgan purchased their assets. However, it was more to do with Fuld’s pride. After being with the firm since 1993, he was simply unable to face the fact that his firm was worth far less than he thought it was, discouraging the Koreans and other prospective buyers from placing a bid.

Charismatic and optimistic is his approach, Kirkinis was enthusiastic in his idea that unsecured lending was the saviour in the lives of poorer people. The man has spent almost two decades promoting the idea that unsecured lending has a rightful place in any economy.

In a column published in the Financial Mail, Kirkinis wrote: “Unsecured loans enable countless ordinary South Africans to build their homes, educate their children and provide for themselves and their families when faced with unforeseen life events, like the death of a loved one.”

Kirkinis built a significantly large business and since its foray onto public markets, built real value for the economy, his shareholders and holders of the firm’s debt. As with Lehman Brothers, in the weeks leading up to its demise, ABIL had a significant market cap of over 1.2billion US dollars. The difference here is that Kirkinis, who made a measly 400,000 US dollars in basic salary over the last two years and who’s stake in ABIL is not worth more than 600,000 US dollars, is walking away with far less than Lehman’s CEO, who walked away with 500 million US dollars while the US tax payer was left with a bill of 700 billion US dollars to bailout the financial services sector.

The SARB’s bailout of African Bank was in the form of curatorship, which placed the bank in a similar situation to Lehman Brothers after the firm filed for Chapter 11 bankruptcy.

The SARB bailout involves a purchase of ABIL’s 1.6 billion US dollars book of non-performing loans (the “bad book”) for 41 cents on the dollar or close to 660 million US dollars. Of course the bailout does not benefit equity holders of the bank – they knew what they were getting themselves into when they decided to buy a share in an unsecured lender which also owned a furniture company. Having said that, ABIL’s retail depositors are protected and will continue to receive interest payments under supervision. These actions by the SARB prompted Moody’s to downgrade both African Bank and competitor Capitec’s long term senior debt before cutting ratings for South Africa’s big four banks.

Lehman Brothers wasn’t so lucky. Lehman had sent a number of negative signals to the market in the first half of 2007 when cracks in the subprime market began to appear. In April 2007 Lehman raised 4 billion US dollars and left market participants asking questions on why the bank would raise capital when its stock price was depressed. The 2,200 pages of the Lehman documents, compiled by the Examiner appointed to the Lehman Bankruptcy, indicate that Lehman was running out of options the week preceding the crash and until the zero hour, fought tooth and nail for a government bailout, or a facilitated sale similar to the one between Bear Stearns and JP Morgan earlier that year, where the US Federal Reserve would underwrite Bear’s risky assets. The Lehman house began to crumble when the Fed refused to give them a bailout citing that a Lehman collapse would not affect the broader economy and could be contained. Why didn’t the Fed help out Lehman Brothers?

After all, it took on Bear Stearns debt obligations so that JP Morgan could conclude its purchase of the firm. What’s more, AIG, Freddie Mac and Fannie Mae and a number of financial institutions received bailout packages during the financial crisis. So why let Lehman die? Lehman was foolish enough to blow itself up, but not big enough to take down the rest of the economy.

AIG, the mortgage giants and Bear Stearns on the other hand had much wider exposure to sketchy securities and the underlying mortgage crisis.  However, some have said that the inconsistency of dealing with both Lehman and Bear Stearns, particularly because of the fact that the US Fed provided JP Morgan with financing to buy Bear Stearns and neglected Lehman, set expectations for Lehman Brothers’ survival when there were none.

Eventually, Lehman’s bankruptcy became one of a number of symptoms of the global financial crisis.

Just two weeks before their demise, Lehman announced plans to dump 30 billion US dollars worth of toxic securities into a new “bad bank” called Real Estate Investments Global on 5 September 2008. About six or eight billion US dollars would come from selling 25 per cent of the firm to the Korean Development Bank, while 24 billion US dollars would have to come from outside investors.

In a stark comparison, the announcement made by the Governor of the SARB, Gill Marcus, which ABIL would be split into a good bank with a book value of 2.45 billion US dollars less portfolio impairments, while the bad bank, worth 1.6 billion US dollars would be purchased by SARB for 660 million US dollars. Given the infinite nature of reserve banks and the long term horizon they are able to take, the SARB could ultimately walk away with a 900 million US dollar profit, similar to the 9.4 billion US dollar profit the Fed made on the sale of Maiden Lane II & III assets, or in simpler terms, the AIG bailout.

Lehman Brothers was allowed to fail and the consequences are felt until today. While the underlying problems around corporate governance, accounting ingenuity and moral hazard are incredibly similar, the sheer scale of the Lehman collapse dwarfs the issues currently being faced in South Africa.

In May 2008, Einhorn publicised his most famous short—Lehman Brothers. Einhorn saw through the level three disclosures and knew it was just a matter of time before Lehman would implode. 

Jean Pierre Verster, Analyst at 36ONE Asset Management was just as vocal about his short strategy on ABIL. JP appeared on CNBC Africa’s Hot Stoxx in May 2013 and made a very bold “short African Bank & long Capitec” call. While JP may not claim to have timed it right, he did however make more than 9 million US dollars for his clients. 

Last week, JP appeared on CNBC Africa’s Tonight with Bruce and says that ABIL could be worth as little as 10 cents per share, should the Johannesburg Stock Exchange lift the suspension on trading African Bank’s shares.

Lehman Brothers was one of Wall Street’s leading Investment banks with equity and fixed-income sales, research and trading, investment management, private equity, and private banking businesses. However in 2006, 48 per cent on the firm’s income came from fixed income, while 15 per cent came from securitisations. Lehman has heavily invested in various structured investment vehicles including CDO’s, MBS’s and a number of other synthetic derivative products.

ABIL was almost exclusively focused on selling unsecured loans – which are not backed by collateral – to customers who often did not have an established credit history. It took few deposits and did not offer many traditional banking services.

Both African Bank and Lehman Brothers can be criticised for their use of leeway in how they portrayed balance sheet items.

In 2007, David Einhorn, founder of Greenlight Capital publicised Lehman’s use of disclosures around hard to price level three assets. It was then CFO, Erin Callan’s fumbled answers around Einhorn’s questions that led him to aggressively short the Lehman stock. Level three assets include those hard to value assets that are both hard to value and cannot be traded easily. Firms can use proprietary models to value these assets, giving them the ability to significantly inflate or devalue assets classified as level three. Post the Lehman bankruptcy proceedings, the examiner’s report indicated that the methodology used to value level three assets on Lehmans balance sheet were completely opaque.

Lehman extensively made use of Repo 105 transactions, which allowed it to temporarily remove securities inventory from its balance sheet and create a materially misleading picture of the firm’s financial position in 2007 and 2008. Repo 105 allowed Lehman to hide more than 50 billion US dollars and thus understate its leverage ratios.

While it’s still too early to conduct a post mortem on ABIL, sources told CNBC Africa that the models being used to determine provisions for non-performing loans at ABIL were not robust, citing that ABIL would only declare a loan non-performing after three missed monthly payments. Further, its lending criteria (like mortgage originators in the US, and ultimately the underlying securities Lehman owned) was not stringent enough.

In May 2013, Kirkinis told CNBC Africa that ABIL had seen an increase in advances even though new loans granted had decreased, indicating an increase in average loan size. Without doing the math, giving more money to people who can’t afford to pay you back cannot possibly be a sustainable business model. 

Additional reporting by: Wilhelmina Maboja