Thursday, September 30, 2010

Reuters: How Dubai Got Serious?

An interesting report from Reuters:  How Dubai Got Serious.

A deliberate choice of headline?  Or perhaps an unintended indication that at one point Dubai was not serious?

To whet your appetite some quotes.  My comments follow each quote.
The auditors' task is to investigate exactly where the money went, who lined whose pockets, and what other financial landmines might lie in store. Forensic audits at state-linked firms, such as Dubai Holding, are part of a wider corruption probe that has targeted senior figures from Dubai's boom years.
Lots of commissions to track down to say nothing of more simple misappropriations.
Abu Dhabi's ascendancy began in the wake of 2008's global credit crunch. Reports about debt trouble in Dubai's flagship companies had been circulating within government from as early as 2005, though most people seemed happy to ignore them. In 2008, the end of a six-year oil-fueled boom burst Dubai's real estate bubble while the global financial crisis left the emirate unable to refinance looming debt obligations.
Lenders merrily rolling over loans and pretending everything was OK.
 "The announcement was a disaster for Dubai. They were told 'don't worry, Argentina has done this, Venezuela has done it. People forget and they start lending again.' But what they didn't take into account was that those are real economies. This is not a country.
Ouch!  But right on target.  Not a country in several ways. 
"Nakheel's books were so screwed up it wasn't even funny."
"No-one knew the magnitude of what was owed, then the complexity of it," the former adviser to Dubai World says. "A lack of experience -- and ego -- made it hard to admit defeat."
And still make it so for the "Dubai's back" crowd.
Almost two-thirds of Dubai World's debt is held by six banks, four of them British: HSBC, Lloyds, Royal Bank of Scotland, Standard Chartered, and local lenders Emirates NBD and Abu Dhabi Commercial Bank.
Another great moment in banking!  There's no fool like and old fool.  And then there are bankers.
"They believe that now the problem is solved," says the former Dubai World adviser, who is critical of creeping complacency just a year after the crisis. "The problem is not solved, they still owe the same amount of money. They will have to pay the same amount, only a little later."
See above "We're back".

The Investment Dar - Changes to Restructuring Plan?


Al Qabas reports that this Wednesday, TID held a meeting in Dubai with the Creditors Co-ordinating Committee and Ernst & Young.  This is the first meeting between the CCC and E&Y.  Earlier the CCC had submitted a letter to E&Y asking that it look out for the interests of lenders as well as the owners of the Company.   

As you'll recall, E&Y has been tasked by the Central Bank to perform the technical study required under the FSL as part of the CBK's determination of whether to recommend that the Special Court make the final decision to either allow TID the protection of the FSL or deny it.  So E&Y is working for the CBK and not the lenders or the owners/borrower.

What's intriguing is that the article also mentions that the CCC has been pressuring the Company to inform it of changes and amendments in the restructuring plan which were made without the knowledge of the lenders.  If you've read earlier posts here, you'll recall that I mentioned in March that the FSL gave the CBK the right to impose additional conditions on the borrower and amend the plan in order to improve the probability of the borrower's performance.  

In this situation, the CBK holds the trump card.  It's "yes" vote is necessary for obtaining entry under the FSL.  Given that a liquidation under local laws would be messy and greatly reduce recovery prospects, both TID and the lenders are going to find it difficult to say "no" - though I suppose they can try to negotiate.   The CBK can counter by citing the report of E&Y - the independent experts asked to assess TID's financial condition and the plan.

It's also important to note that Al Qabas' account is only as good as its sources.  Last July the newspaper reported that E&Y was submitting a "final" report.   Though I suppose one possibility is that E&Y's report at that time said that the Company's  financial condition meant the original plan wouldn't "work" and needed to be modified. 

Absent a direct link into the creditor group, we'll have to wait to see what develops.  If any creditor out there reads this as an invitation to comment, he'd be right. Or, if the creditor prefers, make contact outside the blog via our contact form.

The article also mentions that during the  meeting Brother Adnan, TID's Chairman/CEO, reportedly advised the lenders that he had consulted God before founding the company.  «استخار الله ثم اصدر اوامره في تأسيس شركة تحوي بعض الاصول» .  Subsequent events would appear to confirm that he failed to maintain subsequent contact for management advice.  Or perhaps ignored what advice he did receive. Or perhaps he got a "wrong number" in his original contact

Some of the creditors expressed their disapproval over some of the decisions that Mr. Al Musallam had taken.  After a closed debate, he left the meeting and did not return, leaving the CCC and creditors with an advisor.  Some creditors are reported to have objected that the advisor had no legal status. He was not an officer of TID.  He retorted that he had a position in one of the external entities (whatever that means).

Things aren't going well.  

It seems that relations between TID and its lenders are difficult.  Mr. Al Musallam should remember that during the rescheduling the lenders will be poking their noses into his business.  While the restructuring covenants are no doubt "arranged with the greatest of care in the hopes that the cashflow soon would be there", there will be times when interpretations of meaning will arise.  Disgruntled creditors can read things more strictly if their backs are up.

Damas - Standstill Extension Signed


Damas announced another remarkable bit of progress and as well yet another "vote of confidence" from its lenders in its proven business model.

Here's the PR from Nasdaq Dubai this morning.

Following the announcement by Damas International Limited (the "Company") on 19 September 2010 that the steering committee of the Company's lenders had, in principle, approved an extension of the standstill agreement to 30 November 2010, the Company announces today that the Company has signed an amendment agreement dated 30 September 2010 to the standstill agreement dated 24 March 2010 (as amended pursuant to two amendment agreements dated 27 April 2010 and 13 July 2010 respectively) between the Company and the steering committee so as to formally extend the standstill to 30 November 2010.

A Company spokesman commented that "the agreement of the steering committee to the standstill extension shows once again the confidence that the bank lenders have in the restructuring process and the strength of the underlying business model of the Company".
If you believe the press release, and I hope you don't, Damas has scored yet another vote of confidence from its lenders.
 
Actually, it has not.
 
If there was a vote of confidence from its lenders, it is when they agreed the extension not when they signed the agreement.  Not when they signed to document that agreement.  Sorry, Damas, you only get one vote from this.
 
But more importantly this is actually a vote of no confidence in the local legal system. 
 
Rather than say no and refuse an extension.  Lenders realized that recourse to local courts would greatly diminish their already worrisome recovery prospects.  So they went along with another extension on the 19th and signed it today.

Wednesday, September 29, 2010

Kuwaiti Rules

MP Waleed Tabtabai, Majlis Al Umma Al Kuwait

In Saudi it would be half the beard as well.

As part of my commitment to you my readership, I will begin growing a mustache after I obtain  the necessary green light from Umm Arqala.

AlGosaibi v Maan AlSanea - New Venue The US Congress


If you've been following the continuing dispute between AHAB and Mr. Al Sanea, you know from reading Frank Kane over at The National that the latest "round" is scheduled for a new venue - the US Congress. As a side comment, if you're not reading The National already, you should.

As per the schedule, the hearing was held on September 28th at 4:00PM.  The prepared testimony of the four witnesses can be found here at the US House of Representatives' Financial Services Committee.  The listed topic is terrorism finance.

Among those giving testimony was Eric L. Lewis, Esquire, of the Washington DC office of Bachman Robinson & Lewis.  As you'll see from the attached biography, he has an extensive background in investigating financial crimes.

His prepared remarks are here.

Interestingly in his description of his experience and current assignments (page 1 paragraph 2), he does not mention his current assignment and that of his firm for AHAB - though it is clear later in the testimony that there is this link.  I'm confident this was an oversight and was corrected when he read his statement this afternoon.

His comments do not deal with terrorism per se, but with what he feels are serious defects in the provision of correspondent bank accounts which terrorists might exploit.  I am sure that just by perhaps a fortuitous coincidence his remarks might also help the case of his client, AHAB, in their legal battle with Mr. Al Sanea.

In that regard he focuses on what he alleges to be criminal activity by Mr. Al Sanea.  As always, let's stop to note that to this day Mr. Al Sanea continues to deny any improper or illegal behavior.

His argument is that there were repeated critical failures of know-your-customer due diligence ("KYC") by the American Bank that opened  the main US Dollar clearing account for AHAB's Money Exchange Division in NYC.   He notes that the Money Exchange advised the American Bank that it anticipated a volume of US$15 billion per year through its account.  As Mr. Lewis notes, this amount was out of proportion to the business conducted by the Money Exchange - which he places at US$60 million per year.  He also comments that the total of remittances from the Kingdom were about US$21 billion in 2008.  Therefore, it would be unrealistic for the bank to make the assumption that AHAB Money Exchange had the preponderant a share of the remittances business in the Kingdom as it operated from a single office in the Eastern Province.

Mr. Lewis identifies four red flags which he asserts were missed by the American Bank: (a) a high risk region and country (b) a money remittance business which accepts business from "walk in" customers where he asserts the Money Exchange's KYC would be non existent or weak, (c) massive transactional volume, and (d) a transactional volume vastly disproportionate to the customer's ostensible business.

As a side comment, I'd note that these requirements reflect the due diligence standards established by the FATF in its 40 Recommendations.  Recommendations 5, 7 and 11 are the relevant ones.

The Financial Action Task Force is an inter-governmental organization set up  by to combat money laundering and the financing terrorism.  It does not have any legal enforcement powers.  Rather it sets global standards, monitors individual countries' compliance therewith, including naming and shaming non compliant jurisdictions (which triggers additional AML procedures under the 40 Recommendations).  It also serves as a clearing house for the exchange of expertise and information on money laundering. The FATF has also issued Nine Special Recommendations on Terrorism Finance.

Summing up what he sees as a failure of due diligence, he states (page 3 paragraph 4):
"Yet, in this case, our investigation revealed no evidence of any significant due diligence or AML investigation by [American Bank] of the Money Exchange in connection with the opening of the [American Bank] account in 1998, or really at any time after the opening of the account - even after the imposition of much more strict anti-money laundering  and know-your-customer requirements after the tragedy of 9/11."
On page 4 paragraph 2 he levies another serious charge:
"Literally at the same time it was under investigation and was negotiating this settlement with the DA’s office, [American Bank] was in communication with the Money Exchange, which was running about a $20 billion  annual volume at that time. [American Bank] asked the company to change its name to something without the words “Money Exchange,” which might be a red flag to [American Bank's] auditors or compliance officials. [American Bank] also asked the Money Exchange to cease engaging in walk-in money remittance business. But this aspect appears to have been perfunctory and not to have been followed up. The Money Exchange simply proffered a new name not suggestive of money remittance services—it went from “Ahmad Hamad Algosaibi Brothers Money Exchange, Commission and Investment” to “Ahmad Hamad Algosaibi Brothers Finance, Development and Investment.” It went right on doing walk-in remittance business. Its enormous movement of funds through its account at [American Bank] remained unchanged. The truth is that if [American Bank] had done its due diligence, it would have been immediately obvious that the throughput in the account actually had nothing to do with any money remittance business. And even the $15 billion a year predicted transaction volume was substantially exceeded. So [American Bank] failed to ask why a money exchange would need to process $15 billion per year and went it started to process in excess of $20 billion or $30 billion per  year, it failed to ask why there was an additional $5 or $15 billion per year in transactions. On a per  transaction fee basis, this was all good, no-risk business for [American Bank].”
As we look at the issue of the American Bank's requirement that the Money Exchange change its name, the major pieces of public evidence in that regard - of which I am aware - are from the submission by AHAB's counsel  (by an attorney from Mr. Lewis' firm) in NY Supreme Court Case 601650/2009 - Mashreqbank v AlGosaibi.  These are exhibits #16 (Document #93) and #19 (Document #96).  You can read these for yourself by going to the NY Supreme Court's website at http://iapps.courts.state.ny.us/webcivil/FCASMain.  Perform an Index Search using the CRN 601650/2009 and follow through until you find a tab for e-filed documents (at the lower right hand of a screen).

Exhibit #19 (pages 7-8) contains a memo dated 12 June 2006 from Mr. Mark Hayley to Mr. Al Sanea relaying his account (I haven't seen any document which purports to relay the American Bank's account) of a meeting with the American Bank:
"The Money Exchange must not act or be perceived to act as a money service business.  Accordingly, no walk in business can be accepted, even if the customer is well known to us (e.g., Saad, AlGosaibi and Aramco staff).

Instead we must have a full account relationship with every customer requiring to transfer money and every account relationship requires full KYC documentation and compliance.

According to [American Bank], perception is also important and the words "Money Exchange" in our name could be seen by the regulators as an indication of money service activities.  Therefore we need to change our name."
This document can be read in two ways.

In the first - favorable to the American Bank - they are telling AHAB that the Money Exchange can no longer operate as a money exchange.  That it must terminate business of that nature.  And as a result should change its name so that there is no suggestion that it is engaged in that business.  Presuming that it did of course eliminate this business, then it would be highly appropriate for the entity to change its name.

In the second - unfavorable way - the document can be read to imply that the change in name is cosmetic designed to circumvent the bank's internal audit and controls.   That the entity would continue to perform money transfer services but for account holders.  Under this theory, since the ME was not licensed as a bank or investment company, it would remain a money exchange.

There are really two fundamental issues here:
  1. What is the business this entity is engaged in"  Is it a money exchange firm?   Is it operating as an unlicensed and unregulated bank?  Is is something else?  
  2. What is the legal status of the entity?  When I was a rookie banker (who dealt with the Money Exchange and other AHAB entities), I knew that it was a division of the AHAB Partnership.  That it did not have a separate legal identity.   That's a critical matter for a banker as it affects one's rights under the law.  Important as well in determining who had the right to sign to commit the entity to a legal document, to sign a payment order.  And important for issues like ultra vires defenses.
The memo is crystal clear.
"Since we call National Bottling a "company" it would not be inconsistent to call the Algosaibi Investment Division a "company".  By calling ourselves Algosaibi Investment Company we could explain that this is the first step towards eventual incorporation following the grant of a bank of investment company license.

This new name will not change our constitutional position as a division of Ahmad Hamad Algosaibi & Brothers Company -- Partnership.  Our letterhead should continue to disclose this -- see attached.”
The memo then notes that they should obtain a CR for the Investment Company.  Another key point:  one does not need to be a separate legal entity to obtain a CR in the Kingdom.  Caveat banker.

Exhibit #16 contains a memo from Mr. Hayley to Mr. Al Sanea dated 14 July 2006 which contains Mr. Hayley's account of a 3 July  meeting with the American Bank.  That memo notes that:
  1. KYC Anti Money Laundering procedures must be revised to eliminate any "walk in" business and that a draft (apparently incorporating same) was sent to the American Bank. 
  2. The account name must be changed to Ahmad Hamad Algosaibi & Brothers Company.  (Note that's the Partnership name - a legal entity unlike the Money Exchange.) 
  3. The Money Exchange name must be changed.  "This is necessary even if our account with [American Bank] is maintained in the Partnership name."
Again it is possible to read this document in a manner favorable to the American Bank.  The client has told  it banker that it has ceased walk in business and has provided that banker a draft internal document. which reflects this.  Thus, meeting the American Bank's requirement.  The account is to be registered in the name of the Partnership - a legal entity.  References to "money exchange" are being removed to conform to the facts and thus to avoid raising false issues.

We don't have the full set of information that Mr. Lewis does so there may be other documents and evidence he has which enable him to draw his conclusion.  So at this point from what we have here the jury is out.  But the American Bank at this point does appear to have a reasonable case.

There are a couple of other points from his testimony.
  1. The American Bank advised that the original account opening records were lost in the 9/11 tragedy.  Rather poor form in record retention and security.   Certainly not in compliance with FATF Recommendations, but then as is pretty well known the US was fairly relaxed about these matters prior to 9/11.
  2. On page 5 Mr. Lewis asserts that "Awal Bank was a creature of Al Sanea's fraud and was, further, the bank of choice for the children of a foreign head of state who appeared to be using Awal Bank to launder funds."  The BD64,000 question here is whether his bank was an active conspirator.  Or whether it was being taken advantage of by these third parties.  I cannot think of a single major USA bank or UK bank that has not been fined by a regulator for lapses in implementing proper AML procedures.  If that's the case with Awal - a lapse in procedures, then they are in the company of many household name financial institutions from the "Developed" West.  If they were an active participant, the company they keep is a much much smaller circle of banks.
One last bit to cover and we're done:  the presumed profitability of the account that caused the American Bank to short circuit due diligence (taking Mr. Lewis allegations at face value).

How do correspondent banks (like our American Bank) make money on an account?

Generally, it's through a combination of per item charges (debits, credits, payments, account statements, etc) plus some fixed charge for maintaining the account (a required minimum balance or a yearly fee).

Let's look at the item which drives the overwhelming bulk of the per item charges:  payment charges.

The per item charge is independent of the amount of the payment.  A payment for $100,000 costs the same as one for $100,00,000 - all other things being equal.

So what drives the per item price for a payment?
  1. The manner in which the instructions are delivered to the correspondent bank. Payments delivered in machine readable form (through SWIFT or the correspondent's proprietary payment system - often PC based) are preferred because they do not require as much effort to process as those which are not in machine readable or electronic form.  In the latter case, the correspondent has to employ staff to take the non machine readable instructions from the client, input them into the payment system with of course the obligatory checking of the payments by a second employee to make sure they've been entered properly.  So pricing for manual payments is much higher than electronic ones.  
  2. There is a further distinction for electronic payments - whether they are straight through or need to be repaired.  To go "straight through" the payment system, payments need certain codes for the receiving bank, the beneficiary etc.  If the client (here Algosaibi) inputs all this information correctly, then the NY correspondent has little to no operational work.  If not, then a member of the correspondent bank's operations staff has to enter this information. Note that with a straight through payment if sufficient funds are in the client's account, the payment is released without any manual intervention by the correspondent.  If there are insufficient funds, a credit officer may have to make a decision whether to release the payment or not.  Generally, there is no charge for credit approval.  So as you'd expect, straight through payments not requiring any "repairs" are priced lower than electronic payments requiring repairs.
Let's make some assumptions and see what sort of revenue (note revenue not net profit) the American Bank may have been making on the Money Exchange account.
  1. $20 billion in payments through the account per year.  Since Algosaibi did not start out with $20 billion in the account, they'll need to arrange cover for these payments by having credits of US$20 billion. 
  2. Each payment and credit at US$25 million.  That's 800 of each.  We'll also look at the highly unlikely scenario where each is US$1 million.  That means 20,000 of each. 
  3. US$5 per payment and per credit.   We'll also look at higher levels.  A not very likely US$10 per item.  And a totally unrealistic US$50 per item.   One further fussy note.  Generally, credits are not priced the same as payments.  They're priced lower because they come to the correspondent in  electronic form.  And if there's a problem with applying the payment, the correspondent charges fairly hefty "investigation" fees.  What's the point you ask?  There's a lot of excess in my pricing. Credits are probably much much less than the payment price.
  4. Other charges of $1,000 per month.  This should more than cover the miscellaneous per credit, per debit, account statement mailing, etc. 
  5. A fixed charge of US$100,000 per year.  This should be well above what the American Bank required. 
  6. Since Mr. Lewis mentioned that the same bank had been fined US$7.5 million for running a Latin American account through which over US$3 billion was transferred during 4.5 years,  we'll use that as the minimum fine.
What are the results?

Scenario 1:  Payment and Credit Size US$25 million

Per Item Charges$5 Per Item$10 Per Item$50 Per Item
800 Payments$4,000$8,000$40,000
800 Credits$4,000$8,000$40,000
Sub Total $8,000$16,000$80,000
Fixed Charges
Account Fee$100,000$100,000$100,000
Miscellaneous $ 12,000$ 12,000$ 12,000
Sub Total$112,000$112,000$112,000
GRAND TOTAL$120,000$128,000$192,000

Comments:
  1. Here we're using $25 million per item which is realistic for the sort of business the Money Exchange was conducting.  And this certainly fits with the data in the account statements disclosed as part of Mashreqbank case. 
  2. With this assumption the accounts have fairly modest total revenues, even at the completely unrealistic price of US$50 per item.  
  3. If you think my assumptions are too low, double the results.  It's still hard to see a rational businessman running the risk of a US$7.5 million fine - which might be much larger given the amounts transferred through the accounts.  And not only is there the fine but also the damage to one's business reputation.  The dangers to one's franchise can be very serious.  Riggs Bank is a cautionary tale.
But maybe I'm being too generous.  So let's look at another scenario.

Scenario 2:  Payment and Credit Size US$1 million

Per Item Charges$5 Per Item$10 Per Item$50 Per Item
20,000 Payments$100,000$200,000$1,000,000
20,000 Credits$100,000$200,000$1,000.000
Sub Total $200,000$400,000$2,000,000
Fixed Charges
Account Fee$100,000$100,000$100,000
Miscellaneous $ 12,000$ 12,000$ 12,000
Sub Total$112,000$112,000$112,000
GRAND TOTAL$312,000$532,000$2,112,000

Comments:
  1. Frankly, this is a highly unrealistic scenario.   I've included it to show that even an outlier like this does not generate sufficient revenue to take risk. 
  2. Only if one combines it with the even more improbable US$50 per item charge do we get anywhere near a risk taking point. 
  3. But the simple fact is that when the account was being used banks were fighting to get a piece of business from AHAB - then one of the Kingdom's most prestigious groups as was Mr. Al Sanea's companies.  So US$5 per item is probably the high point for payments.  The pricing per item may even have been lower.  Hard to see this account being so lucrative that a bank would take a risk like this.
Conclusion: 
  1. Correspondent accounts just aren't that lucrative .  
  2. Many of the major correspondent banks are feeling the pressure of AML regulations  and are highly sensitive not just to regulatory fines but to the risks of lawsuits by third parties (as happened to the Arab Bank's New York Branch).  And so they are reducing exposure by throwing marginal customers out.
  3. That being said, bankers often do very stupid things. And sometimes bankers don't work for the best interest of their firms.

Tuesday, September 28, 2010

"We're Back" - Part II: "Back to the Future"

Two Unnamed Lenders Unsuccessfully Attempt to Retrieve Their Loan

We're back indeed!

Seems Limitless needs another six months

Guess lenders should have figured out that when the borrower's name is Limitless, there could be all sorts of related problems with amounts and repayment.

I can't wait for the sequel.  This plot has got at least a couple more runs.

ذكرى الرئيس الراحل


زعيمنا .. حبيبنا .. قائدنا
عندي خطاب عاجل إليك
من أرض مصر الطيبة
من الملايين التي تيمها هواك
من الملايين التي تريد أن تراك
عندي خطاب عاجل إليك
لكنني لا أجد الكلام
الصبر لا صبر له
والنوم لا ينام

***

الحزن مرسوم على الغيوم .. والأشجار والستائر
وأنت سافرت ولم تسافر
فأنت في رائحة الأرض .. وفي تفتح الأزاهر
في صوت كل موجة، وصوت كل طائر
في صدر كل مؤمن، وسيف كل ثائر
عندي خطاب عاجل إليك
لكنني لا أجد الكلام
الصبر لا صبر له
والنوم لا ينام

***

يا أيها المعلم الكبير .. كم حزننا كبير
كم جرحنا كبير
لكننا نقسم بالله العلي القدير
أن تحبس الدموع في الأحداق
ونخنق العبرة

***

يا أيها المعلم الكبير .. كم حزننا كبير
كم جرحنا كبير
لكننا نقسم بالله العلي القدير
أن نحفظ الميثاق ونحفظ الثورة
وعندما يسألنا أولادنا
في أي عصر عشتم ؟
في عصر أي ملهم ؟
في أي عصر فاجر ؟
نجيبهم .. نجيبهم
في عصر عبد الناصر ..
في عصر عبد الناصر

Monday, September 27, 2010

Rumor: Hassan Al-Ammari Resigns from International Investment Group


Citing an interested source (one with a connection to IIG) Al Watan reports that Hassan Salim Hassan Al-Ammari has resigned from IIG's board due to the lack of co-operation from the Chairman/MD, Dr. Abdulaziz Bader Al Jena'ai.  According to Al Watan's source, Hassan has been unsuccessfully asking for financial and other information for some nine months.

Hassan represents Al Baraka Investment and Development Co (which owns about 5.21% of IIG).

IIG has been suspended from trading on the KSE for failure to provide financials for both 1Q10 and 2Q10.  The last financial it did supply was FYE09 which showed a loss of KD36.5 million versus a KD21.5 million loss the year earlier.

You can read more on IIG by using the tag International Investment Group for earlier posts.

Time for a Visit to the Optometrist?


Dubai is back in business and the emirate's vision is unchanged, His Highness Shaikh Mohammad Bin Rashid Al Maktoum, Vice-President and Prime Minister of the UAE and Ruler of Dubai, told Bloomberg Television on Sunday.
Corrective lenses may help this condition.

Begin with the top line, Your Highness.

(Being a Shaykh means you never have to admit a mistake.  If you can read this from 5 meters, your Vision truly is 20:20).

Markaz: Review of Kuwait Investment Sector

 Renovation of Yet Another Proven Business Model In Progress
(Or, Perhaps, A Half Built Mega Project)

Markaz has issued “Kuwaiti Investment Firm Sector Taking Stock Two Years After the Crisis”. The report is an update to one they issued in June 2009.

As usual, good analysis and commentary.

You can obtain a full copy of the report by sending an email to info@markaz.com referring to the title above.

In the interim, some key points from the report.

Let’s start with Markaz’s Conclusion:
“The investment sector in Kuwait has a long way to go on its path towards health especially in light of the Central Bank’s increased oversight on the sector, which may lead to reduced activity among some firms that need to clean house. Given how unpredictable and difficult the sector’s assets are to value, it is difficult to predict the future performance of the sector, especially given the wide variance in case-by-case health.

We are optimistic that 2010 will show a further narrowing in bottom line losses, though we remain skeptical of a return to profit. Not only will companies be looking to offload more of their investments, booking impairment losses in the process, but regional/global equity markets have shown lackluster performance for the year, which may have an adverse impact on both the firm’s quoted investments in addition to the AUMs (thereby reducing fee income), all of which will put downward pressure on the bottom line.”

Historical Performance

I’ll start by noting that the report does not cover all investment companies in Kuwait. It is based on a set of 34 listed companies of which only 28 have reported for 2009. The missing reports include The Investment Dar – which hasn’t issued a financial since 31 December 2008. Nonetheless as with many such studies, it gives a good macro picture.

Earnings in KD millions.

20052006200720082009
945281846(810)(778)
  1. The graph in Markaz’s report gives a good pictorial sense of the variance.
  2. In lieu of a graph, let’s look at statistical measures. All of which are rounded to the nearest integer. The Mean Income over the five-year period is KD97 million. The Standard Deviation (Sample) is 852 and the Standard Deviation Population (762). The SD is between 8x and 9x the Mean. That gives an idea of the variability of income. 
  3. During the first three heady years of hefty profits, no doubt equally hefty bonuses and dividends were paid based on reported income -- largely non cash capital appreciation. Many of these payments also no doubt financed by “wise” lenders - who are now left holding the proverbial bag.
Asset Classification

IFRS 7 requires that companies disclose the basis for the valuation of assets held for sale (similar to FASB 157).
  1. Level 1: Based on quoted market prices in active markets for identical or similar securities. 
  2. Level 2: Based on observable market data – either direct or derived. 
  3. Level 3: Inputs into valuation models are not observable market data.
Markaz’s set of companies assets are distributed as follows. Amounts in KD millions.


FVTPLFVTETOTAL% TOTAL
Level 1264   535   799  34%
Level 2213   365   578  25%
Level 3236   708   944  41%
TOTAL7131,6072,321100%
% Total Investments31%  69%100%  ----

As Markaz notes, the IASB allowed companies to “move” assets from the then inconvenient FVTPL (Fair Value Through Profit and Loss) classification to FVTE (Fair Value Through Equity) which neatly “solved” earnings problems in a time of decline in values.  And, no doubt, achieved its goal of fooling more than a few "wise" investors and lenders.

It would be interesting to see how many Kuwaiti firms availed themselves of this exception to manage their apparent earnings.

It’s not surprising that overall there is a concentration in Level 3 assets given business models. And one could point to firms in the “Developed West” with similar concentrations. But out of national chauvinism I won’t point but merely link.

Appendix 1 lists the ratio for some 32 firms. There’s wide variance.
  1. Gulfinvest International and Al Qurain have 100% of their assets in Level 1.   Noor 85%.  Bayan 84%. Coast 72%. 
  2. On the other hand, National International Holding has Level 3 assets at 87%, First Investment at 70%, Al Safat and Al Mal at 67% and Global at 55%.
The Kuwait Investment Firm Sector in the GCC

Markaz notes that the KIFS dominates the rest of the GCC. No one is bigger. No one fell with a larger thud except two Bahraini-based firms in 2009. Markaz provides some income statement data for Fiscal 2008 and 2009 plus 1H10. What would be even more illuminating would be sector balance sheet size.

Leverage

The new Central Bank of Kuwait regulations impose a maximum 2x leverage ratio on the sector. Even after the debacles in 2008 and 2009, the KIFS’ leverage ratio (Total Liabilities/Total Equity) is a “comfortable” 1.84. It’s only when one starts drilling down into the details that one sees the variance.

Below my calculations based on FYE 2009 financials as in Appendix 2.

FIRMLEVERAGE (TL/TE)
Kuwait Finance and Investment8.32x
Aayan Leasing and Investment5.96x
The International Investor5.88x
Global Investment House4.12x
International Investment Group3.57x
IFA3.29x
Aref Investment Group2.78x

Note: I have not adjusted the above for minority interests – so these are not strictly speaking Central Bank leverage ratios as will become apparent later when we review Markaz’s calculations, though the number of firms with significant minority interests is limited.

When Aayan’s substantial minority interests of KD42 million are eliminated from the calculation the Leverage Ratio jumps to an eye popping 14x (using the financials reported on the KSE).

Asset/Liability Mismatch

Details are on page 7 of the report. Briefly, conventional firms are more balanced than “Islamic” ones. The former with S/T debt of 40% versus S/T assets of 49%. The latter with S/T debt at 79% versus S/T assets at 36%. But this is largely due to the greater progress made in restructuring conventional firms. (Also note this data excludes The Investment Dar).

Review of the Top Five

Markaz then reviews the top five firms: Global, Aref, IFA, TID (using 2008 data) and Aayan.

Here in tabular form are the results of Markaz’s review of these firms’ compliance with the newly imposed Central Bank of Kuwait regulations.

FIRMLEVERAGE RATIO"QUICK" RATIO
Global Investment House  4.11x17%
Aref Investment Group  2.78x16%
IFA  3.28x  9%
The Investment Dar*  4.97x   2%
Aayan Leasing and Investment13.90x  7%
CBK Regulations  2.00x10%

*TID calculated using 2008 financials.

Markaz then discusses these five firms’ financial position.  If you want a quick insight into them and the investment firm sector in general, this report is a must read.

Sunday, September 26, 2010

HSBC: Restrictions on Global under its Restructuring

The Short Fuse on Global's Restructuring

Al Qabas has a summary of a recent HSBC report on Global's restructuring.

The main point and the reason for the picture above is the repayment schedule:  10% of the principal in Year 1, 20% in Year 2 and a crushing 70% in Year 3.  The result of the unrealistic short three tenor. 

I've commented on this before, but that won't stop me from saying it again.  It's highly unlikely that Global is going to be able to meet the repayment schedule even with one or two small miracles coming its way.   With the short fuse and the extensive trip wires (by way of covenants below), the spectre of a second default has to be haunting Global's management and shareholders.   It will probably also give pause to clients being solicited by the firm for new business.  

The banks should be worried as well.  One can argue that a short leash increases their protection.  But too short a leash is not good either  - particularly when you want the dog to hunt.  A bit more breathing room - say two more years - and their potential headaches may be much much less.

Restrictions include the customary limits on distributions (dividends), taking new loans, making capital expenditures as well as a requirement that at a minimum the value of assets must be 0.75 times the amount of the loan.  Global is required as well to maintain capital adequacy at 5% until June 2011 at which point the ratio increases to 7%.

Just rounding out the article.  As has been mentioned earlier, the lenders got a 1% flat restructuring fee.  And a 0.25% extension fee from the date of default to the date of the agreement.  Both fees capitalized into the existing pre restructuring loan amounts.  The lenders also have the right to convert their debt to equity if Global doesn't repay 40% of the debt in the next two years.    That last condition coupled with a restriction on dividends seems to me to pretty much make the raising of any new capital a moot point.  Unless of course they're irrationally exuberant investors.

Commercial Bank of Kuwait Terminates S&P Ratings


On 23 September, S&P announced it was withdrawing from rating CBK at the bank's request.  In line with standard operating procedure for rating agencies, S&P gave a final rating.
S&P affirmed its 'BBB/A-2' long- and short-term counterparty credit ratings on Commercial Bank of Kuwait
(CBK) with a stable outlook. 
The rating agency said it had bumped up CBK's rating by one notch to reflect that it was a systemically important bank and that the likelihood of government support was high. 

Then it went on to say that it estimated CBK's distressed loans at 20% of the total loan portfolio.  And that provisioning needs are likely to weigh heavily on the bank in the next two years.  

It's clear from that language that CBK is not providing current data.  Either the deterioration in the loan portfolio is sudden or S&P just got an inkling.  In any case, not a sign of the sort of candor one would expect between issuer and rating agency.

I suspect the ongoing problems in the loan portfolio and S&P's likely future focus on them were the reason for the bank's "excusing" the agency from further rating duties.

Some thoughts:
  1. CBK is not alone in its aggressive business posture.  This suggests that other banks may be experiencing increases in their distressed loans.  CBK as the proverbial canary in the coal mine.  The banking system had just under 10% at FYE 2009 - already a distressed scenario.  
  2. This a rather short-sighted though common reaction.  Shoot the messenger for delivering bad news.  Pretend that everything is OK. The problem is that CBK's loan portfolio will not recover miraculously.  Future earnings statements will reflect the provisions.  And the fiscal year end report will reflect the percentage of distressed loans.  Frankly, this just looks bush league.  
  3. In addition,  Fitch and Capital Intelligence rate CBK as well - and both have downgraded the bank earlier.   If distress continues, they are likely to do so again. And this leaves CBK then in the distinguished company of Dubai Inc.  Perhaps, not exactly the sort they should be palling around with at present.

US Congress to Investigate Middle East "Money Laundering"

For A Cleaner Clean

Frank Kane at The National reports that the US Congress will hold a hearing tomorrow on US$1 billion of money transfers from the Middle East through the USA over the past six years in connection with claims of money laundering.  
 
As you'll note from the article, a central part of the claims seems to relate to the dispute between AHAB and Mr. Al Sanea.  
 
The Al Gosaibis continue to accuse him of wrongdoing and he just as steadfastly denies any impropriety.

It will be interesting to follow the testimony to see what emerges.

Those who follow other blogs may recall the February 2009 reports of the discovery of US$ 5 million  in a Dubai laundromat.  If anyone out there has an update, I'd be interested in hearing.

Deloitte Survey on Islamic Banking


You may have seen press reports on a recently released Deloitte survey on Islamic banking.  In at least a couple of cases press reports implied that Deloitte was issuing calls for certain actions to be taken. What I think is the more appropriate characterization was that it was reporting the views of participants in its poll.

The poll itself appears to be a fairly standard exercise  - highly familiar to those of a certain rank in the business world who have email.  One receives a questionnaire and is asked to fill it out. I'm guessing the response rate is not high.  And in many cases the responses are crafted by someone junior to the "business leader".

Deloitte surveyed 40 IFIs and Islamic finance executives across the Middle East.  Well, actually with a focus on Saudi Arabia, Bahrain, UAE, Qatar and Lebanon (page 6).  Surprisingly, Kuwait - the home to KFH and other IFIs - is not included.  

It seems highly unlikely that the results of Deloitte's poll like others of this sort are statistically significant, though they do provide an impressionistic insight into issues.

Let's go to the survey.   

First Deloitte's summary.

Several key themes emerged in the results of this survey.  The first is a fair consensus on the need for an effective regulatory framework and good governance. The survey findings emphasize the importance of introducing new or revised regulatory measures–chief among them being Islamic accounting standards and risk management.  A second theme is the importance of adopting best practices and transparency in financial reporting. A great deal of the present industry shortcomings and performance shocks can be attributed to a lack of practice consistency and regulatory compliance. The necessity of adjusting investment strategies through diversification is a third theme of this report. A final theme is the need for investment in human capital and talent development to cope with the growth and industry challenges.
Now some details.

A.  Areas Requiring New Regulatory Action to Ensure Compliance and Best Practice
  1. Islamic Accounting Standards - 61%
  2. Risk Management - 61%
  3. Corporate Governance - 58%
  4. Shari'a Standards and Compliance - 55%
  5. Bank credit exposures -45%
  6. Conduct of Business and Professional Excellence - 42%
(AA:  It seems to me that the last point can be viewed as responsible for many of the shortcomings embodied in the above.  The smart ethical fellow doesn't need a rulebook to know what to do and to do it).
 
B.  Adequacy of Regulation of Islamic Finance
  1. Over regulated - 3% 
  2. Appropriately regulated -31%
  3. Under regulated - 66%
(AA:  And Deloitte apparently didn't survey Kuwaiti entities!!)

C.  Best Form of Shari'a Regulation
  1. Firm specific Shari'a boards - 43%
  2. A single regional Shari'a board -57%
(AA:  The single regional board model is used further East - Malaysia, Pakistan - as well as in the Sudan).

D.  Extent of Risk Management for Islamic Financial Products
  1. Exists in our organisation - 50%
  2. No specific Islamic risk management - 50%
Responses to this question further ranked risks in order of importance:  credit risk (66%), operational risk (60%) and market risk (53%).

E.  Do IFIs Lag Conventional Banks in Risk Management?
  1. Yes -    63.4%.
  2. Same -  20.0%
  3. No -      16.7%
F.  Corporate Restructuring and Capital Adequacy
  1. More than 50% of IFIs said they need more capital.
  2. 57% said that it was likely they would restructure a current Islamic debt over the next 12 months.
(AA:  Unfortunately, Deloitte did not provide more detail on the response to the second question.  This seems very very high.  I guess that it's either a problem with the sample or with the definition of "restructure".  Perhaps, this includes some non distressed rollovers or refinancings??)

G.  Change in Business Models
  1. 66% said that they expected a change in business models in the near future.
(AA:  Not surprising given the problems with previously "proven" business models).
 
H.  Most Relevant Business Models for Islamic Finance
  1. Retail - 45%
  2. Wholesale - 24%
  3. Domestic - 14%
  4. Cross Border - 10%
  5. Corporate - 7%
(AA:  A couple of interesting points here.  First, no mention of Islamic investment banking.  Second, a very low number for corporate bankingAgain I wonder if this is a problem with the sample or the construction of the question / set of options).

I.  Real Estate Exposure
  1. 66.7% of IFIs have REE up to 20%.
  2. 18.5% between 21% to 40%. 
  3. 7.4% between 41% to 60%.
  4. 3.7% between 61% to 80%
  5. 3.7% between 81% and 100%.
The survey covers additional sub topics on those listed above as well as a few other topics.