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BLUE FINANCIAL SERVICES LIMITED - Quarterly Update

Release Date: 02/02/2016 11:25
Code(s): BFS     PDF:  
 
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Quarterly Update

BLUE FINANCIAL SERVICES LIMITED
Incorporated in the Republic of South Africa
Registration Number: 1996/006595/06
JSE Code: BFS
ISIN: ZAE000083655
(“Blue” or “the Company” or “the Group”)


Quarterly Update

Shareholders are referred to the announcement published on the Stock Exchange News Service (“SENS”) since
26 June 2013, whereby shareholders were advised of the Company’s voluntary suspension of trading in Blue
Securities, as well as the various quarterly update and other announcements published on SENS since then,
whereby shareholders were updated on the developments at Blue.

It is important to remind shareholders that Blue had to be turned around from a state of total collapse in 2010.

To provide context to this update we would like to remind shareholders that the Group is a pan-African financial
services provider that strive to be an enabler of progress, upliftment and improvement in people's lives. Holding
the belief that every person across the African continent has the right to financial empowerment, Blue aims to
uplift its customers, as well as achieve a positive social impact in the communities it serves.

Blue currently has investments in eight African countries that provide retail financial services to customers.
The countries are Botswana, Ghana, Malawi, Namibia, Swaziland, Uganda and Zambia. It should be noted that
the investment in Nigeria is a small minority stake that will be further diluted as set out in this announcement.

As previously reported the Group has ceased lending in Kenya, Lesotho and South Africa. The investments in
Kenya and Lesotho are in the process of being formally liquidated and the investment in South Africa is being
held for sale in terms of IFRS 5 (discontinued operation) as it has been decided to dispose of this entity as it is
not core to the business of the Group. The board is currently deliberating the best process to follow in the
disposal.

In addition it has a holding company in Mauritius through which all investments other than Namibia and
Swaziland are held.

Since December 2010 Blue has been recapitalised with an aggregate amount of ZAR1, 319 billion consisting of:
- The subscription by Mayibuye Group (Pty) Ltd (“Mayibuye”) through a suite of agreements including the
   Amended and Restated Subscription Agreement (“Subscription Agreement”) to the value of ZAR163 million;
- In terms of the Debt Rescheduling Agreement (“DRA”), R1,156 billion as follows:
  o The first conversion of debt into equity through the Early Conversion Agreement to the value of
      ZAR275 million;
  o The second conversion of debt into equity through the Second Early Conversion Agreement to the value
      of ZAR406 million;
  o The final conversion of debt into equity or de-recognition of the liability to the value of ZAR475 million,
      the details of which will follow more fully hereinafter.
In addition to the above and as a condition, amongst others, for the conclusion of the Subscription Agreement,
the Blue Claims Purchase Agreement (“BCPA”) was concluded with an existing securitisation insolvency remote
vehicle (not part of the Group) called Leonox Investments (Pty) Ltd (in liquidation) (“Leonox”).

Forensic Investigations

Subsequent to Mayibuye subscription to a majority shareholding in Blue in December 2010, Mayibuye appointed
Horwath Forensics (“Horwath”) to investigate and report on the events prior to December 2010. The report
identified fraudulent actions perpetrated against Blue in respect of which Blue has, where necessary, instituted
legal action to recover its damages. Additional details in this regard are provided later in this announcement. In
previous SENS announcements, this forensic report was commonly referred to as the ‘first forensic event’.

Reference was also made in the previous SENS announcements to the ‘second forensic event’. This resulted
from certain transactions identified in May 2013 which necessitated the appointment of Horwath to investigate
these transactions and provide clarity as to their consequences. The report identified certain transactions in
respect of which Blue was not involved but which had a direct effect on Blue financially and also resulted in the
delay in publishing financial information. Additional details in respect of this is also provided in this
announcement.

Finalisation of Annual Financial Statements
The audits for Botswana, Ghana, Nigeria have now been fully completed for all periods up to December 2014
and it is anticipated that Zambia will be fully resolved during February 2016.

The audits up to December 2014 for Namibia, Malawi, Swaziland and Uganda is anticipated to be completed by
end of March 2016.

The 2012 audit for the discontinued South Africa investment still needs to be completed by Deloitte which is
anticipated to be completed by March 2016. No further audit work will be done on Kenya or Lesotho as the
companies are being liquidated.

The Group will recommend to the shareholders to appoint SizweNtsalubeGobodo (“SNG”) to attend to the
Group consolidated audit for December 2015 which is anticipated to be published by June 2016.

An application was lodged by a minority shareholder in an attempt to obtain a court order forcing the completion
of the audit and publication of the financial statements of the Company. The Company re-emphasises its desire
to finalise the audit and publish its financial statements as soon as possible but are in the hands of the auditors
on completion.

As communicated to the market through the previous SENS announcements, the finalisation of the annual
financial statements for the year ended February 2013, and all subsequent years has regrettably been delayed
due to the impact of the following factors:

- Leonox-matter

The recapitalisation of Blue by Mayibuye during the 2011 financial year was premised and conditional, as stated
above, on the conclusion of the DRA and the BCPA.

As previously reported, the DRA is a recapitalization agreement whereby an aggregated amount of up to
ZAR1,156 billion of funder’s debt would be converted to equity. It was, however, a delayed recapitalization as a
three year period was given during which an attempt would be made to rehabilitate impaired debts. The
objective was for the impairment reversals caused by rehabilitated debts together with cost reductions to
decrease the negative net asset value and as such reduce the amount to be converted from debt to equity upon
expiration of the DRA. Although Blue did not have to effect any capital payments during the term of the DRA, it
was required to make monthly and/or quarterly payments in redemption of the interest accruing to the various
capital amounts. In other words, in the event that the retained earnings position could not be improved –
excluding the new capital injected by Mayibuye of ZAR163 million - the entire debt would be converted to equity
and no capital payments would be required. Conversely, should the position have improved then some of the
capital components of the debt would, in terms of the DRA, have to be repaid. The exact amount of which would
have been determined at the end date through the distribution process.

Further to the above, the BCPA was concluded in order to generate sufficient liquidity for the Group in order to
effect payment of the interest required by the DRA.

It is important to note that, should Blue not have sufficient liquidity to pay the DRA lenders the required interest,
it would constitute an acceleration event which would result in the end date being accelerated to an earlier date
from the scheduled date of 31 December 2014. If the end date was accelerated, it would be extremely beneficial
to Blue as it would be saved from making further interest payments under the DRA.

The BCPA was in essence a securitization transaction in terms of which Blue Financial Services (South Africa)
(Pty) Ltd (“Blue SA”) and certain other South African subsidiaries could offer to sell assets to Leonox. The offer
and sale of the assets in terms of the BCPA was governed by a significant control process which was under the
control of an agent of Leonox.

Fraudulent activities were detected in April 2013 (“Forensic Event”), which led to Mayibuye, the Housing Impact
Fund of South Africa (“HIFSA”) and Blue commissioning a forensic investigation by Horwath.

The delay in the finalization of audited results of Blue mostly relate to the uncertainty that the Forensic Event
brought about based by the materiality of the transactions so being investigated.

Due to the complexity of the Forensic Event, the first forensic report took approximately fifteen months to
conclude and was issued in August 2014. Unfortunately, although this report allowed Blue further insight into
the relevant matters, it left sufficient grounds to believe that further work was required to fully understand the
relationship not just between Blue and Leonox, but also between Leonox and HIFSA and various ancillary
matters. As a consequence, five additional reports as well as a review of certain payments were commissioned
from Horwath after which Horwath issued their final report in November 2015.
It has now been confirmed that Blue was not involved in the fraudulent transactions/activities forming part of
the Forensic Event. It has also been confirmed that Blue did not benefit from the fraudulent
transactions/activities. As a consequence of the fraudulent transactions/activities as well as breaches in terms
of relevant agreements, the Group has suffered considerable damages and in this regard have taken the
necessary action to recover such damages.

The damages which were incurred are, inter alia, as follows:

o The BCPA was concluded as part of a suite of agreements that worked together with the DRA. On a simplified
  interpretation and as stated above, interest payable by Blue in terms of the DRA could only be effected if it
  could securitise debt through the BCPA, a fact known to all concerned. Failure to securitise assets through
  the BCPA, which was in the discretion of the above-mentioned agent, would inevitably have led to a failure
  by Blue to fulfill its payment obligation in respect of the interest under the DRA.

   In that event the debts under the DRA, including such unpaid interest, would be converted into equity, as
   agreed to by all parties and the shareholders of Blue. Blue would therefore have no obligation to use cash
   resources obtained through the recapitalisation to pay interest.

   The appropriate process in respect of the offer and sale process as dictated by the BCPA was not adhered to
   by the agent of Leonox. This resulted in the sale of assets which would not have occurred if the appropriate
   process had been followed. If the appropriate process was followed the acceleration of the end date to the
   DRA would have occurred sooner.

   This and other related issues have caused Blue to issue a summons for ZAR209 million against the agent of
   Leonox in addition to filing a claim with the liquidator of Leonox.

o As a consequence of the non-compliance by the agent of Leonox with the prescribed process in respect of
  the offer and sale of the assets, and as determined by the forensic reports, although transactions did take
  place between the parties, there could not have been a transfer of ownership in respect of the sale of assets
  by Blue SA to Leonox. As a consequence thereof, assets in terms of which ownership was previously thought
  to have transferred, had to be re-recognised in the books of the Group. This process is still the subject matter
  of significant litigation.

- Debt Rescheduling Agreement

As mentioned previously the DRA was a key condition to the recapitalisation of the Group by Mayibuye in 2011.
The DRA is in effect a recapitalisation agreement in terms of which the surfeit of assets versus liabilities is
converted into equity at the Company level at the termination of the term of the DRA. Although the DRA was
originally intended to have an end date three years after its execution, the signatories to the DRA have, under
certain conditions, the right to accelerate the end date. The effect of accelerating the end date is that the
conversion of the surfeit of assets versus liabilities is accelerated. In August 2013, Blue Ltd received notice from
the lenders under the DRA of their intention to accelerate the end date as contemplated in the agreement. In
terms of the notice, the end date was designated to be 6 September 2013.

In terms of the above, Blue submitted to the lenders a Distribution Plan as well as a Conversion Plan in December
2013 and a second, revised version based on the outcome of the forensic reports obtained post the Forensic
Event. Upon review of the Distribution Plan and the Conversion Plan, the DRA lenders, through the constituted
lender committee, filed a notice purporting to be a dispute. Blue has now concluded that there is no actual
dispute on the Distribution Plan. Failure by the DRA Lenders to file a dispute and to timeously exercise their
rights in respect of the allotment of shares has resulted in Blue not being required to issue any shares to the
DRA Lenders. Blue will further derecognise the liability as at December 2015 as the only basis for a claim that
the DRA Lenders have now in terms of the DRA is against impaired loans after taking consideration of Blue’s
costs.

Shareholders were previously advised on litigation individually instituted by Banc ABC Botswana, Banc ABC
Zambia and Standard Chartered Bank to enforce their respective interpretations of the DRA. In respect of the
litigation in Zambia Blue will provide further clarity on the full implications of the result of the appeal in the
Zambian High Court by way of a SENS update during February 2016.


UNDISCLOSED LIABILITIES AND OTHER ISSUES

Warranty Shares

In terms of the Subscription Agreement concluded on 31 August 2010, a fundamental condition for the
subscription was that Blue would be able to demonstrate a positive net asset value (“NAV”) after taking account
of the subscription amount. In order to make allowance for undisclosed liabilities which could reduce the NAV
or result in a negative NAV that may be identified post the subscription, the Subscription Agreement included a
number of warranties by Blue in favour of Mayibuye.

Following the subscription, facts and circumstances emerged that constituted breaches in the warranties
provided and which negatively affected the NAV of Blue. Accordingly Mayibuye lodged claims arising from such
breaches to the sum of ZAR187 million which included a variety of different individual non-disclosures relating
to:

- The most significant of the non-disclosures was in relation to Withholding Taxes, VAT on imported services
  as well as penalties and interest for non-payment of these taxes;
- The reduction of assets:
    o loan book reductions caused by:
         - the overcharging of interest in Lesotho and Namibia;
         - overstating the Botswana book due to so called system conversion errors.
   o loan claim reductions as most of the Nigerian loan claims had to be written off.
- A variety of previously unrecorded obligations to creditors were identified. These expenses were all incurred
  before the Subscription Date and were either not recorded or incorrectly recorded in the accounting records.
  The most significant of these were Blue Cell, Roedeb and Standard Chartered Bank.


These claims were subsequent to the relevant processes being followed, settled in the amount of ZAR150
million, in full and final settlement.
In terms of the Subscription Agreement, the warranty shares were allotted and issued to Mayibuye at an issue
price per warranty share equal to the 30 day volume weighted average price (“VWAP”) per Blue ordinary share
as at 12h00 on the business day immediately preceding the date on which Mayibuye first notified Blue of its
claims. The 30 day VWAP per Blue ordinary share was calculated at 26.46 cents; however, the share price per
Blue ordinary share as at the date of the issuance, being the 26th of February 2013, was 14 cents. This has
resulted in a benefit of R70.6 million for minority shareholders in settling the warranty claim which represents
the 12.46 cents differential between the share price of 14 cents at the 26th of February 2013 and the issue price
of 26.46 cents. That implied that the dilution effect for minorities were reduced from the ZAR189 million to an
effective ZAR79, 40 million.

Blue Microfinance Bank Limited in Nigeria (“Blue Nigeria”)

At the start it should be noted that all shareholder transactions of banks in Nigeria is subject to the approval of
the Central Bank of Nigeria (“CBN”).

A shareholders agreement was originally concluded in terms of which Intercontinental Bank PLC, a bank
registered and incorporated in Nigeria (“ICB”) held 35% of the issued ordinary shares in Blue Nigeria; and Blue
Financial Services (Mauritius) Limited (“Blue Mauritius”), a wholly owned subsidiary of Blue, held 65% of the
issued ordinary shares in Blue Nigeria. The capital contribution given by Blue was the equivalent of 8, 3% of the
total equity and its partner provided 91, 7%.

During 2011, Access Bank PLC, a bank incorporated and registered in Nigeria (“Access”), acquired the majority
stake in ICB and indicated that it was looking to dispose of its equity stake in Blue Nigeria once the shares that
it believed it was entitled to was transferred to it. CBN, however indicated that an acquisition of Access’s equity
shareholding by Blue Mauritius would not be approved, and a sale of the Access shareholding would only be
considered if it were to a third party i.e. not Blue or Blue Mauritius. CBN did agree that Mayibuye would be
viewed as a third party.

In order to satisfy all the regulatory rulings and requirements imposed by CBN, the following transaction
structure was agreed between Blue, Mayibuye and Access:

• The shareholding structure is to be amended such that Access will own shares representing 91,7% of Blue
Nigeria and consequently Blue Mauritius would now only own 8,3%; and

• Mayibuye will purchase, all the ordinary shares held by Access for a cash consideration of 450 million Nigerian
Naira (equivalent to USD2,861,667 or ZAR25,520,400 respectively, calculated using the spot rates as at 5
February 2013). This amount reflects the revised shareholding percentage imposed by CBN, being 91.7% of the
value of Blue Nigeria as agreed upon by Mayibuye and Access.

This transaction was approved by CBN on the 30th of October 2012.

As a result of the reduced shareholding in Blue Nigeria, and as previously reported the Group has derecognised
Blue Nigeria as a subsidiary with effect from the financial year ending February 2013.

In a further and subsequent transaction Mayibuye has disposed of its equity to Integer (Pty) Ltd (“Integer”)
Integer in Nigeria has started a rights issue to recapitalise the bank. Blue will not follow their rights and as a
consequence will be further significantly diluted.

Forensic Report on post December 2010 events

As referred to herein above, Blue commissioned Horwath to provide a forensic report in respect of the events
prior to December 2010 which identified various fraudulent transactions in respect of which Blue suffered
damages.

In terms of the findings of the aforementioned report summons was issued against ABSA bank for an amount of
ZAR35 million together with interest in respect of amounts paid to them in settlement of what was identified as
a fictitious loan account. ABSA bank has joined the former Chief Executive Officer (“CEO”) Dave van Niekerk to
these proceedings. The finalisation of the litigation is still pending and it is anticipated that the matter will be
heard during August 2016.

TURNAROUND STRATEGY

Despite the significant setbacks experienced by Blue during its turnaround journey, specifically the undisclosed
liabilities of ZAR189 million, the Leonox matter, the decline of the credit market in South Africa and the legacy
issues surrounding Nigeria, Lesotho and Zambia, the Group had no alternative other than to use proceeds of its
advances book to fund its operational activity and to manage any and all cash flow mismatches accordingly.


The Group had the following as turnaround objectives:

- reducing the cost base significantly;
- changing the operating model from a centralised model to a decentralised one;
- creating a track record of successful impairment management in respect of its lending products with new
  capital raised since December 2010;
- migrating to a more robust loan platform; and
- raising funding once the aforementioned objectives had been achieved.

In respect of the above objectives all but the last have been achieved and as such the Group has:
- created an efficient distribution- and collection infrastructure across the African continent on a localised
    (per country) basis;
- reduced the operating costs from 2011 by more than 80%; and
- achieved a low impairment on the loan assets produced on and after 1 March 2011 of less than 3%,
    equating to an impairment of less than 1% year on year.

The effort placed into developing the aforementioned infrastructure over the last three and a half years has
provided the Group with substantial experience and knowledge in respect of conducting a business as a micro
lender in Africa.

  FURTHER SIGNIFICANT EVENTS DURING THE PERIOD WHERE FINANCIAL STATEMENTS WERE NOT PUBLISHED

  The following events should be taken note of:

  Attempted Recapitalisations

  Between April 2014 and May 2015 Blue approached various key corporate shareholders and stakeholders,
  including lenders under the DRA, to establish if they were prepared to participate to recapitalise the business of
  Blue through a rights issue process. The recapitalisation process required the lenders under the DRA to abandon
  their dispute and to convert their debt into equity.

  Unfortunately the lenders under the DRA were unwilling to acquiesce which made the process in respect of a
  rights issue fail.

 In a further attempt to recapitalise the business or raise debt, Blue investigated ring fencing all litigation and
 disputes. Subject to legislation Blue was considering dividing its subsidiaries into two categories, which, for ease
 of reference, will be referred to as “bad bank (BB)” and “good bank (GB)”.

  This process would then imply that the entities that are part of GB would all become subsidiaries of a new 100%
  held subsidiary of the Company, potentially registered and domiciled in Mauritius. Once the above was done,
  the following was intended to apply:

  -    In respect of GB:
  i.   Blue would distribute the shares in GB to its current shareholders as a dividend in specie;
 ii.   GB would be listed on the JSE; and
iii.   The shareholders of GB would then conclude a rights issue with underwriters.

  -    In respect of BB:
  i.   A distribution plan would be drawn to repay existing obligations;
 ii.   Non-viable entities would be closed or disposed of; and
iii.   Entities involved in litigation would continue with that for the benefit of shareholders.

  Unfortunately, the aforementioned recapitalisation plan could not be proceeded with as again key stakeholders
  other than Mayibuye did not support this process.

  During May 2015 the board approached key shareholders to establish if they would be prepared to provide
  bridging financing to Blue to enable it to commence new product development as well as development and
  implementation of a new loan system. As Blue had to continue to maintain its existing loan book in order to
  ensure that it was able to continue to pay its operating expenses, the need arose for Blue to replace its loan
  system due to various reasons ranging from technical reasons to the inability to support the aging system. Senior
  executives of Blue also insisted on support for their continued participation in Blue’s management.

  Unfortunately the key stakeholders were not prepared to participate in funding initiatives of Blue. This resulted
  in a lack of certainty in respect of job security amongst staff members including senior executives. As a
  consequence a number of senior executives, including but not limited to the Chief Financial Officer, Johann de
  Wet, submitted their resignations.
The only stakeholder who was prepared to assist was Mapula Solutions (Pty) Ltd (“Mapula”).

Mapula is the majority shareholder in Mayibuye and as such on an indirect basis the biggest shareholder in Blue.
It is further a related party with a common director in Blue and Mapula being Johan Meiring who is also the Blue
CEO.

Mapula through its 100% held subsidiary Integer Proprietary Limited (“Integer”) assisted as follows:

- In order to meet its financial obligations in respect of certain operating expenses, Blue had to obtain loan
  advances from Cycas Investments (Pty) Ltd. (“Cycas”). Cycas is an associated company to Integer. This loan is
  secured with the equity held by the Group in Blue Ghana.
- It developed a new SaaS system which has been implemented and Blue is now running on this platform. In
  this regard, license agreements have been concluded between Integer and the respective Blue entities for
  the use of the system in question; and
- In respect of the resignations of most of the senior executives, it offered employment to some staff.
- The net result of the assistance for Blue was a decrease in costs, access to a robust new system that
  significantly strengthened is ability to distribute whilst it managed to retain access to some of the key senior
  staff.


Auditors
Currently Deloitte are still appointed as the auditors of Blue and will remain in office until they have completed
and signed off the 2012 company financials. Deloitte have previously indicated that they will not hold
themselves appointable for the subsequent financial periods. In light of the financial statements outstanding it
was not possible to appoint auditors for the subsequent periods until such time as those audits were resolved
and signed off. The directors would like to recommend SizweNtsalubaGobodo to be appointed as Blue’s
auditors.

Related Party Liabilities and Terms of Repayment
The Blue Group is currently indebted to various members of the Mayibuye Group with a total amount of ZAR69,
476,935.55. Shareholders are reminded that Mayibuye has securities for the repayment of its obligations.
Further communication regarding the repayment will be provided to shareholders during February 2016 once
the terms have been finalised.

Closure and liquidation of Blue Kenya Ltd
As indicated, subsequent to the recapitalisation by Mayibuye in 2010 it became aware of undisclosed liabilities
which was significant in Blue Kenya Ltd. As a consequence of these insurmountable circumstances the Group
has decided to liquidate this investment.
Closure and liquidation of Makhulong Multi Finance (Pty) Ltd (“Blue Lesotho”)
Blue Lesotho has been continuously involved in legal proceedings regarding the reinstatement of government
payroll deductions. Based on a variety of circumstances, a strategic decision was taken to discontinue all lending
in Lesotho, to fully impair the entire Lesotho book and to only focus on collecting the outstanding book in
Lesotho. Under the circumstances the Group have further decided to liquidate this investment.


Johannesburg
2 February 2016

Designated Adviser
Grindrod Bank Limited

Date: 02/02/2016 11:25:00 Produced by the JSE SENS Department. The SENS service is an information dissemination service administered by the JSE Limited ('JSE'). 
The JSE does not, whether expressly, tacitly or implicitly, represent, warrant or in any way guarantee the truth, accuracy or completeness of
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indirect, incidental or consequential loss or damage of any kind or nature, howsoever arising, from the use of SENS or the use of, or reliance on,
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