In
2014, we first broached the idea that 8990's past due installment contract receivables (ICRs) problem was about to explode. Since then, past due and/or impaired ICRs ballooned from just 0.32% of total ICRs in 2013 to a peak of 18.85% of total ICRs in 2015. Since then, the company has managed to trim its receivables problem to 10.12% in 2016 and to just 2.40% in 2017. In 2018, the receivables problem worsened, almost doubling to 4.67% of total ICRs.
Total ICRs are also down significantly since 2017. In 2018, ICRs were just Php 17.6 billion, down almost 20% from Php 21.2 billion in 2017.
Reduced Disclosure
But the company failed to provide an aging analysis of its past due but not impaired ICRs for 2018.
Level 3 Assets
It also decided to emulate
Vista Land by classifying almost all of its ICRs as Level 3 Assets. Beginning in 2017, it classified Php 19.9 billion in 2017 and Php 16.1 billion ICRs in 2018 as Level 3.
What is meant by Level 3?
According to its Fair Value Hierarchy, 8990's Level 3 Assets are assets in which the inputs for those assets are not based on observable market data. The inputs for Level 1 Assets are market prices for those assets. The inputs for Level 2 Assets are more indirect. The exact definitions are as follows:
Level 1: quoted prices (unadjusted) in active markets for identical assets or financial
liabilities that an entity can access at the measurement date;
Level 2: inputs other than quoted prices included within Level 1 that are observable
for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from
prices); and,
Level 3: inputs for the asset or liability that are not based on observable market data
(unobservable inputs).
Now what exactly is an unobservable input to an ICRs of 8990? ICRs are essentially a loan from the developer (8990 Holdings) to the buyer so that the buyer can purchase the residential unit from the developer. The ICR is collateralized by the title to the property itself and is held by the developer until the ICR is paid off by the buyer. All the inputs are observable: the amount of the ICR, the monthly installment, the imputed interest rate, etc. The ICRs have to be simple enough for the buyer to understand what he/she is buying. Otherwise, if the ICRs are structured in a complicated fashion, the buyer will not buy the property. 8990 Holdings customers are simple end-users. They buy the homes they will live in. And most are not financially sophisticated buyers. So valuing the ICRs is not rocket science. The ICRs should be classified as Level 1. All of them.
Dearborn Resources Holdings, Inc.
In early 2018, 8990 Holdings sold a huge chunk of its ICRs to an entity called Dearborn Resources and Holdings, Inc. (Dearborn). The sale was without recourse. But the sale was much more complicated than a simple transaction. From 8990's 2018 Annual Report, we get this tidbit:
"On January 29, 2018, the Group entered into an agreement with Dearborn Resources and Holdings, Inc. (Dearborn) to sell its contracts-to-sell (CTS), with a total face value or principal amount of up to P10.0 billion, without recourse. Subsequent to the sale of the CTS, Dearborn shall be primarily responsible for servicing, administrating, and collecting these receivables. On the same date, the Group was appointed as the sub-servicer and the remarketing agent of Dearborn. Total amount of CTS sold to Dearborn in 2018 is P10.0 billion. The related receivable arising from this transaction amounting to P165.5 million is presented as part of Other receivables as at December 31, 2018.
On December 29, 2017, a loan facility agreement between Dearborn and certain lenders was executed to provide a loan facility in the aggregate principal amount of P1.4 billion for the purpose of partially financing Dearborn’s acquisition of certain CTS of the Group. Under the loan facility agreement, the Parent Company also committed to lend Dearborn the principal amount of up to but not in excess of P300.0 million which bears 16% interest per annum, payable monthly. The loan granted under the facility agreement is unsecured and has a term of five years counting from the date of initial drawdown. However, the principal amount of the loan and any related accrued interest will be due and demandable in the event of default. As of December 31, 2018, the Parent Company has already extended P314.0 million financing to Dearborn. Interest earned and received from this loan receivable amounted to P16.2 million, which is presented as part of Interest income under Other Operating Income in the 2018 consolidated statement of profit or loss (see Note 23.1)."
This disclosure raises a lot of questions:
- What is Dearborn Resources Holdings, Inc.? A firm with the ability to buy ICRS with a total face value of Php 10 billion has to be a substantially well capitalized firm. Is it a financial firm, a vulture fund, a subsidiary of a universal bank? It seems to have no website, no listed owners. It's an unknown entity.
- Were the receivables sold at a loss? How much cash did 8990 actually receive on the sale? The face value is Php 10.0 billion and the remaining receivable from Dearborn is Php 165.5 million. Maybe I'm not reading this correctly but the step-by-step mechanics of the transaction are not clear.
- Is Dearborn related to 8990? Do or did they have common stockholders?
- Why is 8990 lending Php 300.0 million to Dearborn on an unsecured basis if this is an arm-length transaction with a completely independent entity? 8990's management would not lend Dearborn Php 300.0 million unless they knew the Dearborn and its management well and they have had an existing relationship with that firm.
The more I look at it, the more Dearborn looks like an off-balance sheet vehicle designed to take problematic ICRs off 8990's books. It's an SPV (Special Purpose Vehicle) used by 8990 to defer or delay the recognition of losses on its ICRs. Such SPVs were used by a lot of Universal Banks to clean their balance sheets in the 2000s. (See
BSP's Ampaw Accounting System). And just like those banks, the value of those ICRs could be "ampaw" or puffed up.
Read:
Has the Philippine Real Estate Bubble Already Burst?
8990 Holdings, Inc.: The Case of the Disappearing Past Due Installment Contract Receivables
The Philippine Real Estate Bubble Has Already Burst for HOUSE (8990 Holdings, Inc.)
