The year 2008, was a turbulent moment in the global economic and financial calendar, the global economic recession was raging on, but a few bright spots were shining. Focus Financial Services Zambia Limited was incorporated in 2008, as a private limited liability company, specialising in Invoice Discounting, Bridge Financing, Bills Discounting and Construction Finance. Focus Financial Services was part of the lustrous Focus Ironclad Group; comprising of the aforementioned, Focus Assurance, Focus Capital and Focus General insurance. Fast forward 10 years later, the company had imploded. Its meteoric rise and collapse could only be compared and paralleled to the US debacle of Long Term Capital Management that collapsed in 1998, however, one must acknowledge the fact that 1994, when LTCM was established were simpler and naïve times. These were days of ‘irrational exuberance’ – the good days should and might be there in perpetuity.
Focus was destined for success; the wooing of investors was continuous, and its corporate footwork was swift.
2014: Focus could not resist the usual display of financial engineering of capital market dynamics. Focus financial services announced a 400milion kwacha medium term note programme (MNTP) through the Lusaka Stock Exchange. The programme was trenched for a period of three years, with promised modest returns.
2015: By August 2015, Barclays Bank Zambia had extended a facility of 11.2 million dollars to afford the company an opportunity to finance small and medium enterprises.
2015: Towards the end of 2015, by October, Focus Capital, a subsidiary of the Focus Group had launched Ulendo RINP.Ulendo RINP or Ulendo, Road Infrastructure Note Programme. This was a multiple currency investment option, investors both corporate and retail could invest either in Kwacha or dollars. Focus Capital was to raise 6.5million Kwacha through the note, with a 7% return for dollar investors paid back semi annually and 24% return for kwacha investor per annum. Norsad finance company, an impact investor out of Botswana was to be the anchor investor taking up 30% of the investment during the first tranche. The Ulendo note programme was rated stable A by S&P and AA- by Fitch, highly investment grade note programme. Suffice to say, the Ulendo RINP was registered and approved by the Securities and Exchange Commission.
2016: Focus financial services had raised extra capital through a line of credit extended by Advanced Global Capital (AGC), a UK investment manager, specialising in financing invoices from SMEs. Focus financial services gobbled another financing window of 30 million kwacha.
2018: July 2018, was when the beginning-of-the-end. One of the subsidiary of the group, Focus Assurance was put into compulsory liquidation by the Pension and Insurance Authority using the Insurance Act no. 27 and chapter VII Cap 387 of the Banking and Financial Services Act. The company’s balance sheet was assessed, and its liabilities overweighed its assets. The domino effect started here.
Analysis and Lessons Learned
Systemic Risk: The Domino Effect
After the demise of Focus Financial Services, its now evident that, a financial institutions’ risk framework has to have a systemic risk factor embedded. A risk regulatory framework and provides a foundation for a resilient b system that will help avoid the build-up of systemic vulnerabilities. The framework will allow the system to support the institution through the economic cycles. The cyclical oscillations in the economy that had been seen in the Zambian real economy rendered that an institution follows some of the tenets of the BASEL III as promulgated by the Bank of International Settlements.
Adding macroprudential elements to the risk framework, by: introducing capital buffers that are built up in good times and can be drawn down in times of stress to limit procyclicality; establishing a large exposures regime that mitigates systemic risks arising from interlinkages across financial institutions and concentrated exposures; and putting in place a capital buffer to address the externalities created by systemically important financial institutions.
Liquidity risk is itself a factor
Focus Financial Services fell victim to a flight to liquidity. This phenomenon is common enough in capital markets crises that it should be built into risk models, either by introducing a new risk factor — liquidity — or by including a flight to liquidity in the stress testing. This could be accomplished crudely by classifying securities as either liquid or illiquid. Liquid securities are assigned a positive exposure to the liquidity factor; illiquid securities are assigned a negative exposure to the liquidity factor. The size of the factor movement (measured in terms of the movement of the spread between liquid and illiquid securities) can be estimated either statistically or heuristically.
Using this approach, Focus might have classified most of its long positions as illiquid and most of its short positions as liquid, thus having a notional exposure to the liquidity factor equal to twice its total balance sheet. A more refined model would account for a spectrum of possible liquidity across securities; at a minimum, however, the general concept of exposure to a liquidity risk factor should be incorporated in to any leveraged portfolio. Between the Ulendo note to a multiple lines of credit Focus had secured, it was vital to manage liquidity risk, measuring the spread between maturities of different classes of securities and positions.
Models must be stress–tested and combined with judgement
Focus at one point had two bond notes with almost the same horizon. The 400million kwacha medium term note programme and the Ulendo RINP. Research has shown that Correlations between bond notes of different credit quality would move together (a correlation of between 90-95% over a 2-year horizon). During the period these notes were traded, economy’s resilience had weakened, causing the correlation to drop. Stress-testing against this lower correlation might have led Focus to assume less leverage in taking this bet.
In the end then, it is regrettable that a company that intended to do good, forgot about the basic of the financial rules. Moral hazard crept up on them, and they created a monstrosity of debt. The fledgling company that had a DNA of success messed up!