37517 INTERNATIONAL FINANCE CORPORATION C O R P O R A T E G OV E R N A N C E Grupo Frutas – Corporate Governance Case Study #2 Summarized Facts Good Apples and Bad?: Financial Holding Company The Jardinero group refers to a collection of financial institutions all currently under the effective control of Mr. Carlos Jardinero. The group as a whole controls a significant percentage of the assets of the country’s financial sector and includes institutions in the banking, housing finance, mortgage banking, insurance and pension fund management businesses. Mr. Jardinero is a self-made entrepreneur who amassed his initial fortune in the construction industry (he was educated as a civil engineer). After building the largest real estate development company in the country in the 1960s, he entered the financial services industry by establishing a housing finance company, AV Manzanas. Later on, he purchased an insurance company, Seguros Durazno, on the theory that there would be cross-marketing opportunities. He purchased a controlling interest in a regional universal bank in the early 1970s, Banco Olivo. As the construction industry’s potential for growth began to wane in the 1980s and 1990s, Mr. Jardinero’s focus shifted increasingly toward finance, and he became the controlling owner of two more universal banks (Banco Banana and Banco Papaya) with nation-wide operations. (He remains, however, a major investor in a number of residential and commercial real estate projects.) Mr. Jardinero also achieved majority positions in a set of non-bank financial institutions (mortgage banking, insurance and pension fund management) through a series of purchases and mergers during the same period. In the mid-1990s Mr. Jardinero successfully won the bidding for the privatization of Banco Papaya, a large formerly state-run bank, with exposure largely to the housing and government sectors. While his earlier acquisitions were of sound institutions with reputations for good management, this last purchase appears to have been motivated by a desire to pre-empt competition in the financial sector. Banco Papaya’s previous existence as a state-run bank, and its continuing large exposure to municipalities with dubious credit has had a negative impact on the quality of its portfolio, its funding costs and its ability to attract and keep first-quality talent. Also in the mid-1990s, all the institutions in the Jardinero group, with the exception of Seguros Durazno and Banco Papaya, were organized under a single holding company, Grupo Frutas. The idea was to create a common brand and identity and eventually a vehicle to attract equity and debt capital from domestic and international  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 1 public markets. [See attached Background Information for a chart with the structure of the Mr. Jardinero’s holdings.] Although all the institutions are under the effective control of Mr. Jardinero, each of the banks, and several of the non-bank financial institutions, are listed companies with varying percentages of public float. Grupo Frutas also has public shareholders, as the result of a “test offering” of a very small number of shares through the banks’ own branches in 1999. The senior management of the individual institutions within the Jardinero group is largely home-grown. It was the policy of Mr. Jardinero to keep the existing management structure in place after taking control of an institution, to ensure continuity. The management teams of the institutions in Grupo Frutas were generally considered very qualified and professional prior to their acquisition by Mr. Jardinero. As such, they have continued to attract top talent and remain regarded as among the best managed financial institutions in the country -- market leaders in the provision of financial services. Mr. Jardinero has, however, played a very strong role in determining succession at the top levels of each institution, both within Grupo Frutas and in the other financial institutions he controls. The CEOs and the members of the boards of directors of each institution are selected with the approval of Mr. Jardinero and their remuneration is also determined by him. Each of the financial institutions of the Jardinero group has its own management team and board of directors. The boards are made up of qualified professionals (bankers, business persons, lawyers, etc.) independent of the management of the institution on whose board they serve. (Some are executives of other institutions in the Jardinero group). The boards meet regularly and often, are cohesive, and board members take seriously their obligation to protect the interests of shareholders in the soundness and profitability of the institution. This has been manifested in a focus on the board’s role in overseeing credit review policies and on each board’s function as the ultimate credit committee for that institution’s very large exposures. In the larger and more complex institutions, efforts have begun to broaden the mandate and capacity of the board, and to establish board committees to oversee other key risk management functions, including market risk, as well as accounting, audit and compliance. Grupo Frutas also has its own management and board of directors. Segundo Jardinero (age 46), the only son and heir apparent of Carlos Jardinero (age 79) serves as CEO of the holding. Its board is chaired my Jardinero Senior himself. The other members of the board include the CEOs of each of the financial institutions in Grupo Frutas (the CEOs of the non-Grupo Frutas members of the Jardinero Group participate routinely as guests). The board of Grupo Frutas meets on a formal basis every two weeks. On weeks when the board does not meet, the same members, plus one or two outside experts, assemble on an informal basis as an “Advisory Council” to discuss general trends in the financial services industry or economic developments in the country.  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 2 Accordingly, together with its alter ego, the Advisory Council, the Grupo Frutas board serves as a group-wide strategic planning committee and as a large exposure credit committee. According to Mr. Jardinero, it is the role of the holding company to determine strategic direction for the group as a whole, as well as for each constituent institution. It examines and analyzes exposures and other risks at the group level, sets group-wide policies, and determines exposure allocation among the group’s institutions. The management and boards of the institutions within the Jardinero group have a voice on credit decisions at the Grupo Frutas board, but in practice, the holding company board can prevent any subsidiary from undertaking an operation that would result in exceeding the group-wide exposure limits, or that would otherwise not be in the interests of the Jardinero group as a whole. Managing inter-group transactions, and arranging for the provision of common services to the group are among the functions of the Grupo Frutas management, overseen by its board. Over time, the management of Grupo Frutas has come to deliver services in common demand among its holdings (and Banco Papaya), including branding (“Frutas”), advertising, and certain procurement, data processing and IT functions. These services are charged out at “cost,” with transfer pricing determined, in practice, by Segundo Jardinero. It is anticipated that over time, the range of services provided by the holding to its subsidiaries will expand. The goals of the Jardinero group at this point in time are to build the Frutas brand so as to maintain market share, to improve operations and margins, and reduce over-all funding costs. Carlos Jardinero has approached IFC as a possible source of credit lines to one or more of the Jardinero group banks. Developing the Business Case – Case Study Session I In the first session we will ask you to simulate Steps 1 through 3 of the IFC Corporate Governance Methodology on the company in question. This will be done using the tools that we discussed at the close of this morning’s session. Please identify which of the paradigms apply in this case, locate the governance of the case company on the appropriate matrix, come up with a list of corporate governance risks and opportunities that you will share with the group and prepare a brief statement of the business case for corporate governance improvements at the company such as you would present to the client.  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 3 INTERNATIONAL FINANCE CORPORATION C O R P O R A T E G OV E R N A N C E Grupo Frutas - Corporate Governance Case Study #2 Background Information Table 1: Carlos Jardinero’s Holdings – Principal Investments Institution Assets Net Worth Profits (As a % of (As a % of (As a % of Group Groups Net Group Profits) Assets) Worth) Banco Banana 38% 42% 45% Banco Olivo 22% 20% 23% AV Manzanas 17% 12% 0%* Banco Papaya 18% 15% 7% Pension fund manager 1% 6% 11% Seguros Durazno 2% 3% 13% Leasing company 2% 2% 1% Table 2: Profit Profile - Breakdown of Profits by Institution Investment % owned through Direct Grupo holdings Frutas Banks Total Financial Sector Banco Banana 8.5% 65.2% 73.7% Banco Olivo 8.9% 75.4% 84.3% AV Manzanas 13.5% 67.7% 16.8% 98.0% Banco Papaya 100.0% 100.0% Pension fund manager 20.0% 60.0% 80.0% Seguros Durazno 100.0% 100.0% Leasing company 79.6% 7.6% 87.2% * 0.37%  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 4 Table 3: Carlos Jardinero/Grupo Frutas Holdings Carlos Jardinero GRUPO FRUTAS (GF) CJ: 98% (Public float: 2%) Banco Banco Banana Banco Olivo AV Manzanas Pension fund Leasing Seguros Papaya (BB) (BO) (AVM) manager company Durazno (BP) GF: 65.2% GF: 75.4% GF: 67.7% GF: 20.0% BB: 45.2% CJ: 81% CJ: 100% CJ: 8.5% CJ: 8.9% CJ: 13.5% BB: 35.0% BO: 34.4% BB: 9.2% BO: 25.0% GF: 7.6% BO: 7.6% Total: 73.7% Total: 84.3% Total: 98.0% Total: 80.0% Total: 87.2% 2  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 5 INTERNATIONAL FINANCE CORPORATION C O R P O R A T E G OV E R N A N C E Corporate Governance Case Study #2 Grupo Frutas - Role Play Scenario: Carlos Jardinero originally approached IFC as a possible source of credit lines to one or more of the Jardinero group banks. However, in the course of initial discussions, Segundo Jardinero raised the possibility of a long-term loan at the Grupo Frutas level, combined with a modest equity investment in the same. According to Jardinero Junior, the valuations of Grupo Frutas shares in the domestic market indicate that there is substantial market discount from their inherent value. He believes this is due to a combination of two factors, the small existing public float, and market concerns about corporate governance. It is his idea for Grupo Frutas to do a capital increase of approximately 10-15%, with roughly half offered to the public, and the remainder sold to IFC. IFC’s participation as a large minority investor with a reputation for expertise in corporate governance would, according to Segundo Jardinero, serve to assure the market that Grupo Frutas is well-governed and that shareholders are treated equitably. In the medium term, this will result in a higher domestic market valuation and prepare the company for an eventual international IPO. IFC has agreed to go ahead with due diligence for a long-term loan at the Grupo Frutas level. Before considering the equity investment, IFC management has asked that the project team meet with the owners, managers and other interested parties and agree on a set of conditions that would protect the Corporation’s potential equity stake, along with its reputation for promoting good corporate governance among its clients. Roles: Carlos Jardinero, Majority Owner and Chairman of Grupo Frutas Segundo Jardinero, CEO of Grupo Frutas and heir apparent of Carlos CFO of Grupo Frutas – trusted advisor of both Jardineros CEO of Banco Banana CEO of Banco Papaya National Bank Regulatory Authority Investement Officers  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 6 INTERNATIONAL FINANCE CORPORATION C O R P O R A T E G OV E R N A N C E Corporate Governance Case Study #2 Grupo Frutas – Instructor Notes In analyzing this company, the astute investment officer must anticipate several potential problems: Structure of Jardinero Group 1) The fact that the controller of Grupo Frutas is also the owner of a set of less-sound financial institutions (Banco Papaya and Seguros Durazno) is a risk for minority shareholders of Grupo Frutas. In the event of capital and other difficulties with Banco Papaya, Mr. Jardinero will be tempted to shift business opportunities to Banco Papaya to prop it up. Or inter-bank transactions, or cross-lending to troubled Banco Papaya clients could accomplish the same thing. 2) Strategic decision-making and limitation of credit exposure for each institution is made at the holding level, even though each institution has a different set of ultimate shareholders. Minority shareholders of the subsidiary financial institutions can complain that business opportunities and optimization of profitability are sacrificed for the benefit of the holding and the controlling shareholder. What the constituent elements of the Grupo gets from the holding and what it gives up should be explicit and understood. 3) The provision of services by the holding to the subsidiaries provides opportunities to shift value among the subsidiaries of Grupo Frutas and between Grupo Frutas and Mr. Jardinero’s other holdings. 4) Mr. Jardinero’s real estate interests present the possibility of related- party transactions. Other related-party transaction issues are: intra-Grupo transfers; pricing between the holding and its subsidiaries; and deals between Grupo Frutas entities and Banco Papaya and its customers. Boards of Grupo Frutas and its Subsidiaries 1) The Board of Grupo Frutas is composed exclusively of the people it should be charged to oversee – the senior management of the financial institutions of the group, its controlling shareholder, and the senior management of Mr. Jardinero’s other financial investments. Before the governance of Grupo Frutas can be credible in the international markets (or even domestically) it will need a board whose composition and structure are appropriate for a financial holding company. This will require the inclusion  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 7 of directors who are independent of senior management at least, and preferably independent from the controllers as well. 2) The Boards of the individual financial institutions have not taken responsibility for overseeing key areas of risk management, beyond serving as a senior credit committee. Market and operational risk issues, along with oversight of accounting, controls, audit and compliance (anti- money laundering) functions would be logical areas where a subsidiary board should be active. The efforts to introduce audit committees should be accelerated. 3) A Grupo Frutas-wide conflicts policy is needed. As part of this, each board of a subsidiary should be required to review and ratify related- party transactions to ensure they are carried out on an arms-length basis.  International Finance Corporation (IFC). All Rights Reserved. This case and all accompanying materials may be used only with the express written permission of IFC. Contact: Mike Lubrano, Corporate Governance Unit +1 202 473-7891. CORPORATE GOVERNANCE 8