Tuesday, August 24, 2010

Gulf Finance House - 1H10 Financials: Now You See It Now You Don't -- The Magical US$137 Million Provision

GFH has finally posted its 2Q10 interim report.

Let's get straight to the heart of the analysis and our headline, Note 15:
"During the period, the Group's credit enhancement amounting to US$ 102 million issued to financial institutions against credit facility arrangements for a project managed by the Group were enforced by the lenders due to contractual defaults by the project company.  Further, based on the Group's assessment of the likelihood that another project will be able to meet the financing when they fall due, the Group has estimated that its financial guarantee of US$ 35 million may be enforced.  In accordance with the requirements of IAS #37, Provisions, Contingent Liabilities and Contingent Assets, the Group has recognised a provision of US$ 137 million towards these liabilities until revised/ renegotiated terms are agreed with the lenders of the project companies.  The Group has recognised an equivalent amount of reimbursement right which has been included in other assets (note 8)."
Presto, changeo with a bit of Accounting Magic a potential US$ 137 million addition to 1H10's net loss is transformed into an asset!  What's even more astounding is that these projects that cannot meet their debt commitments (to the apparently impatient lenders) will nonetheless be able to honor GFH's reimbursement claim upon them.  Now that is truly magical!

(Side Note:  According to my copy of KPMG's Third Edition of "Insights into IFRS" page 635 commenting on IAS 37.35 (about the recognition of Contingent Assets), KPMG states:
"When realisation of a contingent asset is virtually certain, it is no longer considered contingent and is recognised.  In our view, virtually certain generally should be interpreted as a probability of greater than 90 percent."
Unfortunately, I don't have the latest edition so I would caveat that there may have been some new thinking on the topic of what constitutes "virtually certain".)

Taking this amount to the income statement would roughly triple GFH's loss.  It would also breach the US$400 million minimum shareholders' equity covenant.  But there's one more adverse effect making this US$137 million truly a "triple threat".

As we learn in Note #2 during the discussion of the going concern issue, GFH's capital adequacy ratio at 30 June was 12.92% - leaving little room for maneuver or in the words of KPMG "which restricts the Group's ability to absorb further losses or undertake additional exposures".   (Note to KPMG:  You need to amend the reference in your report to the matter of emphasis from Note #1 to Note #2.)

And I suppose -- to add a fourth reason -- such a loss and such consequent events might make a difficult capital raising exercise just a "wee bit" more difficult.

Where there is a need and a will, there is a way -- as the old saying goes.

Turning to the rest of the financials:
  1. Note #5: US$115.4 million (95%) of 1H10's US$121.4 million of Placements with Banks and Other Financial Institutions is pledged against commitments and facilities of projects of the Group.   And so should be excluded from liquidity.  You'll notice it is in the Cashflow Statement.  Some might suggest that proper presentation would be to have these amounts in Other Assets.  And well they might but to no apparent avail.   Some of this cash may be pledged to those adversely affected projects discussed in Note #15.
  2. Financing Receivables US$14 million decline (which took place between FYE09 and 1Q10) is still a mystery to me.  It's not in the cashflow statement so it must have been offset against something else?
  3. Receivable from Investment Banking Services declined from US$85.3 million at 1Q10 to US$40.5 million at 2Q10.  I can find a provision of US$20 million but am unable to locate the remaining US$25 million in the cashflow statement.  Another magical offset?
  4. Note #6:  Assets held for sale include Bahrain Financial Harbour Company (US$175 million), $50 million of GFH's long outstanding Receivable from Sale of Investments (now reduced to US$44.5 million and carried in Other Assets) plus US$35 million of Financing to Projects.  The first two items will be settled "against receipt of consideration in the form of cash and land plots."  Well, when you can't pay cash why not settle your obligation with a highly valuable piece of (no doubt) blank land.  The upside potential is, well, enormous, especially at current depressed prices! 
  5. Other Assets - As noted above there are reductions of some US$85 million (See Point #4 above), against the introduction of reimbursement rights of US$137 million whose collection is no doubt at least virtually certain if not certain to a much higher degree.
  6. Note 9 updates on the financing.  The LMC US$100 million facility (US$80 million outstanding) carries a "profit rate" (read interest rate of 8.5%!).   The rescheduled West LB facility a 3.75% profit rate (reduced from 5%).  This facility is now secured by GFH's shares in Khaleeji Commercial Bank, which no doubt explains why the promised sale of this asset suddenly was postponed.  Perhaps, the collateral will be sufficient cover to prevent an impairment under IAS #39. Also of note during 2Q10 some "wise" and brave lender has provided a US$16.64 million Murabaha financing due in November 2010.
  7. Note #10:  Some 69% of Other income (1H10: US$8.6 million) is composed of income declared because certain liabilities were no longer payable (US$4.2 million) and from recoveries of project expenses (US$1.7 million).  
All in all quite a performance in 2Q10.  For those curious that's not a reference to financial performance but the magic of accounting.

3 comments:

Vanguard said...

why is the West LB interest rate reduced in your opinion? I know of a lot of our subsidiaries who shares we have pledged as security and we know they are not even worth the paper they are printed on. Are the shares of Khaleeji so liquid that collateralizing them reduces the interest sorry profit rate.

Is LMC the KFH subsidiary floated to help companies out in liquidity crunch by giving them soft sharia compliant loans at a nominal profit rate of around 8.5%? Is the loan subordinate to West LB loan or the interest rate is high because it is unsecured?

by the way, the label shafafiah is very apt

Abu 'Arqala said...

Vanguard

A very good question. Hard to know. The lenders would seem to have had the upper hand.

Perhaps, they thought the credit risk was so great that getting collateral was a good idea and worth the trade.

If this "puppy" goes down, there isn't going to be much left among the rubble. So getting decent collateral could be a way to ensure recovery. Rather than some of that highly valuable land that GFH is getting for it stake in BFH Co or some half built duff project or half baked unbuilt project, Khaleej might have looked pretty solid. It's unlikely that the CBB would let a retail bank go down. They bailed out Bahrain Saudi when it got into trouble.

As to liquidity, the BSE has rather limited liquidity. It would take years to unload KHCB there. But a stake this size might be sold to a strategic buyer.

LMC is a Bahrain based company owned equally by Bahrain Islamic Bank, Dubai Islamic Bank, the Islamic Development Bank, and Liquidity Management House. LMH is a KFH subsidiary.

As to the labels, GFH has on more than one occasion pledged itself to transparency - something that is second nature to any Islamic financial institution. Whether it's the same case with an "Islamic" one, اعلم الله

Abu 'Arqala said...

Vanguard

LMC website

http://www.lmcbahrain.com/