Cytonn: A Brutal Lesson on Risk and Finance

The hidden risk of investments

The Stage is Set

On 14th March 2018, a Financial Advisor from Cytonn Investments reached out to me on LinkedIn and pitched a high-yield investment product known as Cytonn Project Notes (CPN). The product offered 20 per cent interest per annum for a minimum of KES 1 million investment locked in for 3 years. We discussed the pros and cons over a few days, but I needed additional information since I had never heard of Cytonn. I poured myself onto the internet to research the little-known company. I landed upon a highly charged discussion on the investment discussion website Wazua. Two camps debated on the Cytonn offer. Pro-Cytonn debaters were made up of current investors and anti-Cytonn made up of analysts who preferred not to invest.

The bone of contention lay in the 20 per cent per annum offered by Cytonn. The analysts quipped that it is unrealistic to achieve such returns in the Kenyan market, other funds haven’t been able to get similar returns. On the investor side, the call to invest lay in the idea that Cytonn exploited a real estate financing gap by jumping the banks and raising capital straight from the public, therefore offering a 20 per cent annual return. The real estate market in Nairobi grew at a fairly good rate and the plan seems sound. On the contrary, the analysts questioned why other developers and funds haven’t figured out this funding scheme, the answer was a simple lack of imagination.

Armed with the information, I checked back with the Financial Advisor from Cytonn. My concern lay with a guarantee on the returns. I was sold on the promise that the investment is backed by real estate development and the worst-case scenario would be the sale of the property to recover the funds. At the time, I was building a small nest of savings from my day job. Over six years, I did manage to save a little more than KES 1 million. It was time to put the shillings into action. The risk felt manageable, so I wired KES 1 million to Standard Chartered Bank as instructed by the Financial Advisor. Three years down the line, I would learn a brutal lesson about risk.

The Risk

For two and a half years, I received the interest bi-annually, on time and straight to my bank account. It feels good to receive money when you did not wake up and go to work for the cash. In total, I received about KES 500,000 (minus taxes) in two and a half years. One month into the end of the three-year lock-in period, Cytonn send an email to all investors to effect that the principal amount and interest will not be redeemable. The amount would be bundled up and rolled over for another six months. It was right in the heart of the pandemic, I was out of a job and needed the money urgently to take care of other pressing concerns.

The six months came to an end and the investment rolled over for another six months (without interest) until finally Cytonn convened a meeting with investors to announce the company can no longer pay out both the interest and principal amount — the fund has to be restructured. In the period that I was enjoying the interest, I had managed to convince my chama to sink in KES 500,000 into Cytonn since it seemed a sound investment. Now, I had to explain the risk to everyone in the group… the chama never got to enjoy any interest.

Knives were sharpened and every investor baying for the blood of Cytonn’s top management. The analysts at Wazua finally had their big laugh. Vindicated by the declaration of insolvency of Cytonn’s high-yield products, the analysts poked every dumb person who trusted their hard-earned cash to Cytonn’s scheme. Chaos erupted, single mothers cried, social media went berserk, those who could afford a lawyer took to the law, and those who could not surrender to fate.

The Game

Did Cytonn do anything illegal? NO. The company managed to exploit a law in the CMA (Capital Markets Authority) Act that allowed them to source funding from the public without any oversight. By not having overt requests for funds i.e. through advertisements, Cytonn could target “high net worth individuals” (suckers) via platforms such as LinkedIn and present the offers.

Apparently, all capital sourced by the public MUST be subject to CMAS regulation. This includes the central bank when it advertises for bills and bonds. The solicitation of CBK is subject to scrutiny by CMA. However, in Cytonn’s case, the law allowed for non-scrutiny.

Lessons

1. Time manipulates risk: If I were to go for a short-term offer with Cytonn (6 months to 1 year), I would have recovered the principal. Whatever is safe today is risky tomorrow.
2. You are at the bottom: There is a tier of debtors. Just like you have ordinary shares and preferential shares in shareholding. There are preferred lenders and ordinary lenders. In this case, the preferred lenders get paid first in the situation of a liquidation.
3. There is always a fool in a transaction: in the asymmetry of information, one party involved in a transaction has more information than the other party. When there is a hidden information imbalance in a transaction, the party with less knowledge incurs more risk.

One of the questions I ought to ask about Cytonn is the liquidity ratio of the company. This is a measure of a company’s ability to pay short-term loans. Banks are mandated to maintain a capital adequacy ratio to allow for servicing withdrawals. Since Cytonns CPN product was not regulated by CMA there was no need to maintain a liquidity ratio.

On 23rd January 2023, the High Court ordered the liquidation of Cytonn’s high-yield product. Under a fire sale, it is estimated the investors would only be able to recover 14% of the principal. In addition, the liquidation process would take about 6 years.

It turns out the folks at Cytonn know a lot about finance jargon and very much less about risk. They funded long-term projects with short-term capital. Time manipulates risk!