Monday 25 January 2010

1-3




Now is as good a time as any to say "argh" I suppose.

But, on to Wednesday.  Red and White!

Saudi Mortgage Law on the Way?

So says the Gulf News quoting Bloomberg quoting HE Muhammad Al Jasser, Governor of SAMA.

It might come as a surprise to many out there but there is substantial unmet demand for housing in the Kingdom.

This law will facilitate the mobilization of real estate finance, particularly for residential housing.  It will also provide alternative investment opportunities for local financial institutions.  

In 2006 Unicorn Investment Bank in Bahrain teamed up Standard Bank and the IFC to launch the first ever securitization of housing receivables in the Kingdom.  Here's the IFC's write-up on the transaction. It was a modest sized deal of some US$18.5 million.  But followed by further deals by UIB in 2007 (US$600 million and US$1,000) for Dar Al Arkan.  Here is the portal page to UIB's press releases on these transactions, if you're interested.

Saudi Capital Markets Authority Levies Fine on CEO of Sadafco



The Saudi Capital Markets Authority announced it had fined the CEO of Sadafco SAR 50,000 for disclosure of "inside information" on the company's 1Q 2009 earnings.  If I'm not mistaken the CEO of Sadafco is a non Saudi.  No name was given in the announcement and so I'll refrain as well from providing a name.

Of late the CMA has been increasing the pace and rigor of its monitoring and enforcement actions.

Sunday 24 January 2010

Kuwait: Central Bank Governor Tells Investment Companies There Are Only Two Choices: Debt Restructuring or The Financial Stability Law



AlQabas reports  that the Governor of the Central Bank of Kuwait delivered a short and sharp message to Kuwaiti investment companies at his last meeting with them.

He is reported to have told them that they have only two choices in front of them.  Accordingly, they should abandon pleas for increases in liquidity, the lowering of interest rates, or the purchase of company assets.

Instead they have to choose from one of the two courses of action:
  1. Agree a rescheduling with their lending banks.  Some investment companies have done this which proves it is not impossible. It's incumbent on other firms to begin this process.
  2. Submit themselves to the Financial Stability Law mechanism.  He noted that to date there have been no cases so one cannot say what the results will be.  
He criticized companies for failing to confront and disclose their current situations.  A fact that he related to the size of their problems.

What's clear is that many of these companies are still in denial about the extent of their problems.  And that they are in the typical borrower's "delay and pray" mode.  If I don't formally recognize the problem, it doesn't exist.  Maybe a miracle will happen.  Asset values could reach their previous heights.  The government will launch a bail-out.  Sadly, this has happened enough times in Kuwait to make this a credible strategy.  A profound sense of citizen entitlement - even when unjustified - is one of the legacies of a "rentier" state.  And of course, local banks who funded these wise investments similarly are looking for a way out of the predicament.  So there are two sets of voices calling for a government "rescue".

Dubai World's Consolidated Assets More Than Twice Its Consolidated Debt: So What?

 
 

You've probably seen the press reports carrying the "good news" that Dubai World's assets (even after the market decline) exceed US$120 billion and could therefore easily "cover" its debt of US$57 billion.  Here's one sample.

The original article is here in Al Ittihad.

As you might expect, I've got some comments on the headline.  More on that later.  In the interim,  two words neatly sum up my reaction: "so what?"

But first to the real meat of the article: a discussion of the restructuring negotations.

Quoting an unnamed source, the article states that DW has been involved in intensive negotiations with its creditors and has achieved "tangible progress" during the past 25 days.  Creditors have reportedly shown "positive reactions" to the proposals submitted by DW.  The Company is concentrating its efforts on convincing creditors of the high probability of success because of two key factors.  Sadly, only one of them is mentioned in the article - the durability of its real estate and investments assets which have begun to demonstrate recovery of value recently.  The strategic nature of investments was noted.  That would I suppose make the financings that support them "strategic" as well as the repayments.  I am not certain, though, if the margin on such a loan would be strategic or just tactical.  One hopes that DW does not consider itself a "day trader".

The article then states that DW is focusing restructuring on its two "real estate" subsidiaries: Nakheel and Istithmar (?: I think Istithmar has wise investments in a variety of non real estate ventures).  Specifically mentioned as being excluded were Dubai World Ports, JAFZA, and Dubai Drydocks - all of which are recording "excellent operating results despite the world financial crisis which has affected world trade and transport."  Hopefully their bottom lines (net income) are doing equally well.

No mention of a formal request for a debt standstill.  No mention of any sort of draft proposals.  It still seems to me - despite this article - that progress is painfully slow.  And largely at the "touchy - feely" stage.  With nothing concrete to respond to, bankers are of course going to evidence all sorts of "positive reactions", especially if the coffee is good.  Or reactions that might be interpreted as positive because since they have nothing in hand concrete, they have not rejected anything.

Of course, such negotiations are not going to be conducted in the media.  It's going to be difficult enough herding the creditor cats.  But one would expect that some news beyond this rather superficial account would be in the press if really serious results had been achieved.  In that regard, it seems to me that securing the debt standstill is a key initiative.  This should be the easiest to achieve of all that will have to be done.  Once done, it is a visible milestone.  An accomplishment that gives a bit of psychological momentum to the process.  We've seen the opposite of this effect at The Investment Dar - where the standstill process has been a negative rather than a positive.

That being said, Mr. Birkett is an expert in this field so clearly I am missing something. I sure hope so.

Now to my comments.

It makes no sense to talk about the consolidated assets of Dubai World versus its consolidated debts unless those assets are going to be applied to the US$22 billion of debt to be restructured.  To do that Dubai World needs to take certain steps.  If it does not, then lenders to Nakheel or Istithmar have cold comfort from assets at Dubai World Ports or any of DW's other subsidiaries.

Why?  Two words (actually five):  "A will and a way"

The Will:  The article itself reconfirms what DW has said earlier.  It is restructuring these companies. The other companies and their assets are outside the restructuring.  Just as the fact that Shaykh Mohammed is the owner of DW does not mean that his personal assets are available to pay or support the restructured debts.  DW has evidenced no desire to make these assets available. 

The Way:  But, more importantly, is the way this would be accomplished.  In that regard it seems there may be some confusion about a very fundamental issue:  the difference between an economic entity and a legal entity.  Understanding this distinction is critical to understanding the "way".

Consolidated financials do not represent a legal entity, they represent an economic entity.  DW Group is not a legal entity.  The legal entities in the Group are the various subsidiaries (and their subsidiaries and so on) and the parent company - Dubai World Holding.  The Group is a combination of all these legal entities into an "economic" entity. From a legal standpoint it is a fiction.

Legal entities - not economic entities - own assets.  Legal entities - not economic entities  -enter into contracts, including those for debt. It is the wise lender indeed who understands precisely what assets  the potential borrower owns.  And then reacts appropriately to that understanding.

As a holding company, Dubai World legally owns shares in Dubai World Ports, Nakheel, etc.  It does not directly own the assets of these companies.   Those companies do.  And, if they are holding companies, this same pattern repeats itself.

At each subsidiary level there are a variety of legal relationships and requirements governing those assets.

First, in a liquidation, each and every creditor of that subsidiary gets paid back before the shareholder gets a single fil.

Second, any transfer, pledge or other disposal of an asset owned by that company (the subsidiary) is subject to the completion of legal steps as required by the local law in the jurisdiction where that company is incorporated and where the asset is legally domiciled.  This is both a matter of corporate law (which governs how corporations conduct their affairs) and of laws setting forth the legal requirements for a sale, pledge, etc.  For example, if a US company owns an asset in England, then both US and English law will govern what is needed to be done to dispose of or otherwise deal in that asset. In some cases assets may be subject to additional requirements, such as those imposed by financial exchanges (stock markets), etc.

Third, contracts can create new requirements beyond those mentioned above.  For example, any sensible lender puts covenants in its loan contract restricting the borrower's ability to pay dividends or to transfer, sell  or pledge its assets.   Loan agreements typically include financial ratios (debt to equity) etc. which the company must maintain.  To do so the company has to take or refrain from taking certain actions.  A properly structured set of ratios can impose all sorts of constraints on a company - constraints that if enumerated might require volumes. 

Some hopefully illustrative examples.

Let's look at the 2008 financial report of JPMorgan Chase.

Total consolidated assets (of the economic entity, the JPMC "Group") are an impressive US2.2 trillion. (page 131).  Total assets (of the legal entity JPMC, the holding company) are US$436 billion (page 225).  20%!  As you look at these assets, you notice "Investments in Subsidiaries" is a major category.   It is here that JPMC the Holding Company's ownership (through equity shares) in the separate legal entity JPMorgan Bank, NA is reflected. 

And, it's important to note, that at these subsidiaries, the same pattern may apply.  Think of DW's subsidiary, Istithmar.  It owns a variety of investments, Cirque de Soleil, Barneys, etc.  Each of which is a separate legal entity.  In fact, it probably owns these companies through one or more intermediate holding companies (for tax and other reasons).  When Istithmar's NY hotel got into trouble, lenders were not able to force Istithmar to pay (as it had apparently not given a guarantee for the hotel's debt).  Nor could they attach assets at the Cirque  - taking, say, the lead acrobat or his safety net.

How then does a lender get access to the assets?

An indirect way is to get the holding (parent) company to give its guarantee.   This establishes the holding company's obligation to pay the loan if its subsidiary does not.  However, it gives only an imperfect and indirect access to the assets.  The lender is an unsecured creditor of the holding company, which as indicated above has its main assets in shares of other companies.  If the holding company defaults, the lender can take possession of the holding company's shares in the subsidiaries.  However, as a shareholder, the lender still remains subordinate to all the creditors at those subsidiaries.   In effect the lender has merely "stepped into the shoes" of the shareholder.

A "better" way is to get the subsidiaries themselves to provide a guarantee.  In this case then the lender becomes a creditor at the subsidiary level and has the direct  lender's access to the subsidiary's assets along with all other creditors of that subsidiary.

There are a variety of issues involved in implementing these two previous steps.  The most important of which is establishing the legal basis for the giving of the holding company or the subsidiary's guarantee  so that it is legally binding on the subsidiary.  "Consideration" in English or "US" law terms.  Other issues would be the existence of any restrictions put on the subsidiary by its existing creditors to prevent just such actions - out of their own concern to maximize their share of the company's assets.

Orion Holdings Overseas - "Unauthorized" Trading and Corporate Governance "Shortcomings" Led to Collapse



A bit more information has come to light about the causes of the meltdown at OHO via an article in The National: at least US$20 million of unauthorized trades in gold and other commodities including oil.

That sounds familiar.
"It's hard to understand how this happened.  If OHO's main lines of activities were brokerage, fund management and technology, that is a great deal to lose in this period, even given the economic meltdown.  Was OHO taking proprietary positions that turned against it?  Was it trading in oil?  Or other commodities?  OHO was a member of the Dubai Mercantile Exchange."
However, a "mere" US$20 million in losses should not have caused the collapse of a company which  was valued at some US$263 million in February 2008.  The losses would have had to been more, a lot more.  Or it would have to be that the company had a lot of assets whose ultimate value proved to be much less than their carrying value. Or some combination of these and perhaps other factors.

That's not the only thing in the article that I'm having difficulty getting my head around.
  1.  Shareholders' Blame Game - This seems to contradict the statement that "management was gambling with the firms' money".  Unless of course some shareholders felt that management was acting on the instructions or with the acquiescence of some of the other shareholders.  And were therefore asserting that that shareholder had a liability to make them whole.  Otherwise, it would seem the shareholders would have a very compelling shared interest to protect their dwindling investment by cleaning house of the culprits in management.  There is also the "testimony" from Shuaa that it was not involved in the management of the company.   Was no other shareholder?  Not even the largest? If so, what then is the basis for Shuaa's legal action against  the Chairman and Petra? 
  2. Risk Management Report - The article seems to question whether the Board saw the report.  The Chairman says that he resigned in protest of the Board's failure to respond to the report.   It seems plausible that before resigning he would have raised the topic with the Board.   And then it would seem equally plausible that they would have asked to see the report if they had not.  One might also wonder if Sami Boujelben wouldn't have "rung up" the board members as part of the professional discharge of his duties.  Now, if at his resignation, the old Chairman did not agree to allow other parties to select his replacement, his resignation did not diminish his company's control over the number of seats on the Board and thus over OHO. It was then only a matter of changing a face.  Another set of questions regarding corporate governance and risk management focuses on the losses themselves.  Once they occurred, did the Board not receive and review financial reports?  Did the CEO or CFO brief the Board on the financials, including the losses?  If the Board wasn't getting periodic copies of and verbal reports on the financials, then there are some rather potentially difficult questions for the Board about how it implemented corporate governance.
What is presented raises more questions than it answers - at least for me.

The shareholders of OHO are primarily institutional investors.  They are not small unsophisticated retail investors hoping to turn a quick buck on their shares so they can buy a refrigerator (as one punter on the Dana Gas IPO told the press in Bahrain).  Thy had placed serious money on the table.  It was evaporating.  They did nothing? 

It seems there must be something more to the story.  Just as the US$20 million loss doesn't fully account for the financial distress the company now finds itself in, the corporate governance  related comments here don't seem to as well.

Another interesting bit from the article and that is the assessment that Shuaa over reached in its private equity investments and will be retrenching to focus on more core business of brokerage.

Finally, other investments as well as the general market trend are responsible as well for the decline in Shuaa's share price. It's not just OHO. When Shuaa issues its year end detailed audited financials, it will  hopefully be possible to quantify in part the relative contribution of each investment to the provisions and the loss.  No doubt,  the debacle involving the convertible and Dubai Group also played a role. 

"Mastermind" Attempts to Defraud UAE Central Bank

A thoroughly engaging story of an Asian "mastermind" who attempted to defraud the Central Bank of the UAE.

I remember watching Mastermind India on the TV.   Sid Basu.  The Hot Seat.  Your time starts now!   Even the losers were formidable.

Nothing like this story. 

I think the appropriate reference is "The Weakest Link".

Saudi Zain - Just What Did It Miss? Financial Covenants Not Payments



You've probably seen reports that Saudi Zain missed "commitments" under its US$2.6 billion  equivalent "Islamic" facility.  The natural assumption was that these were monetary commitments, e.g., principal or interest payments.

On Saturday, Saudi Zain's CEO, Saad AlBarak, told AlArabiyya that Saudi Zain missed certain EBITDA targets mandated by the facility.  Zain's lenders have waived the breach of the covenants in 2009 and required the company to provide a revised set of targets for 2010 for their approval.

EBITDA is bankerspeak shorthand for earnings before  (the payment) of interest, taxes, depreciation and amortization.  EBITDA is an attempt to capture the ongoing operating cashflow of a company.   Loans and other debts are settled with cash not net income which is accrual based and can often differ significantly from the firm's actual cashflow.  

Lenders include covenants like EBITDA targets as requirements in loan agreements for two reasons.

First, they provide a set of monitoring tools of the company's performance.  In this  case, the EBITDA targets help lenders to determine if the company is earning enough money to settle its obligations, including their loans.  

Second, since these are covenants, a failure to meet them by the company constitutes an event of default under the facility.  In that case banks have the right (but are not obliged to) to declare the borrower in default and accelerate the due date of the loan.  There are two reasons for using such covenants.  First, the covenants and the threat they might be used will focus the borrower's management on doing their utmost to make the company perform.  Second,  if the borrower does not meet the target, the banks have the right to accelerate the loan, if they want.  In such a case they can  require immediate repayment before value in the company is eroded.

It really does pay to be careful with press releases that contain disclosure that one has missed a covenant.  For some inexplicable reason the market gets excited about that sort of thing.  And when the wording lacks clarity the market imagines the worst.  It's also doubly important when one's auditor has included a matter of emphasis statement in his report as this should make any sentient creditor nervous. 

One might state that this sort of poor communication shouldn't happen.  As an old hand in the region, AA has gotten to the point of just hoping that it doesn't occur.

Mr. Obama's War



I read with alarm the news in the press that President Obama has declared war on bankers.   Apparently a sudden shift in his previously benign policy.  It seems that he now proposes imposing limits on the activities that banks may engage in as well as taxes on and other measures affecting bankers' compensation.  Joining in this coalition of the willing in at least  some of the theaters of operation are not only stalwart allies of the recent past but even some  of those previously feckless elderly Europeans.  Or at least so I am told.

The generally sober financial press that I read is beside itself with dire warnings.  It appears our very way of life may well come to an end.   Once again the lights in London and perhaps all of Europe - or at least their financial districts - are going out. I've read stories of huddled masses of bankers yearning to be free, setting sail from London for Asia to escape tyrannical taxes.  In these darkest of days, a few brave (financial) patriots have mounted the ramparts.  Suitable jeremiads  thunder from the editorial and op-ed pages as well as from what are labeled the news columns.  In the temples of finance, high priests perform ancient and powerful rituals over the entrails of distressed subprime loans and derivatives to cure this blight.  The books of Adam Smith are scoured for the right incantations, ignoring as usual the inconvenient "bits". 

Nearer to home, dark rumors have begun to circulate - a Kadaververwertungsanstalt for bankers has opened.  Since I don't have a subscription to either The Times or The Wall Street Journal, I haven't yet seen conclusive proof that it is in operation.   But then neither have I seen that it is not. And that perhaps is the most disturbing thing of all.

As a result, as a member of the banking guild, I am being more circumspect than usual when I leave my home and leaving more infrequently.   And, while at home I listen carefully for the black helicopters, though I am told they are very, very quiet.

On the other hand, much of the accompanying editorial comment in these same papers says that Mr. Obama cannot achieve victory.  Clever bankers will find ways around these new rules as they did the old.  Apparently, a populist surge holds little prospect of success.  Since the syndication of American Idol, there is little chance of a sahwa.  Rather than "stay the course" the only course of action these defeatist voices advocate is the immediate, unconditional and unilateral withdrawal of US forces from Wall Street. 

I am of two minds on this.

As a banker, the message that our way of life is not really under a serious threat at all is admittedly a comfort.  I also take solace in the demonstrated gap between previous rhetoric and reality.   

But, as a citizen,  I do worry that if we do not fight them over there on Wall Street we may end up  fighting them over here - on Main Street.  Any sign of weakness or hesitation is sure to embolden this already fearsome foe. 

Yet, all this remains quite confusing.

On the one hand, I am told this unjust war will lead to the end of the happy world we now know.  And therefore am suitably scared as I believe is every good citizen's duty.

On the other hand,  I am assured that it is all just a meaningless exercise that will be thwarted by the genius of the free market.  And, if needed, by the timely insertion of one or more brigades of the 101st K-Street Rangers equipped with the latest in both "smart" and "stealth" donation technology.

It is hard to know what to do. 

Caution would seem to be a wise tactic at the moment.

I am keeping a low profile.

I may grow a beard.  Or shave one off.

Saturday 23 January 2010

Borse Dubai - More on US$2.5 Billion Loan and Its Implications



A slip at Suq Al Mal.  In my last post I didn't deal with the background to the US$2.5 billion  loan.  And its potential implications. 

As I like to say, often the details of the story are more or equally interesting  as the story itself.  I should pay more attention to what I say.

With that as background, here goes.

First, where did this loan come from?

In 2007 both Nasdaq and BD submitted bids for OMX, the Swedish exchange.  BD topped Nasdaq's US$3.8 billion bid with one of its own for US$4.0 billion.  Subsequent negotiations among the parties led to BD and Nasdaq agreeing a strategic partnership.   BD was to sell the shares it had acquired in OMX to Nasdaq while at the same time purchasing from Nasdaq some of its shares in the London Stock Exchange and taking an interest in Nasdax/OMX.  When the dust settled, BD owned 19.9% of Nasdaq OMX and 22.2% of the LSE.  Nasdaq acquired OMX.

To finance the deal, BD incurred obligations (which included a guarantee facility) in the aggregate amount of US$3.8 billion equivalent. 

In February 2009, BD announced it had successfully raised US$2.5 billion to refinance these earlier facilities.  At the time this was touted as a sign that credit was available to Dubai Government linked entities, even though on less favorable terms than earlier.

How successful was the US$2.5 billion refinancing?

The earlier financing was multi-year and carried interest rates between 0.7% and 1.3% per annum.

The new financing was at 3.25% per annum (roughly 2.5X taking the maximum margin on the old facility).  The tenor of the new facility was for one year as opposed to the multi-year tenor on the previous.  Though the new loan gave BD the option to extend the loan another year.

Even with the higher margin and shorter tenor, the refinancing was only completed because government owned banks in the UAE joined the deal.

The participating banks included Bank of Baroda, Dubai Islamic Bank, Emirates Bank International, HSBC, Industrial and Commercial Bank of China (Asia) Limited, ING Bank London Branch, Intesa Sanpaolo Dubai Branch, National Bank of Abu Dhabi, Skandinaviska Enskilda Banken, The Bank of Tokyo-Mitsubishi UFJ, Ltd. and Union National Bank. 

What does the recent extension of maturity tell us about the acceptability of Dubai Inc credit in the market?

The cost of BD exercising its option was 0.75% of the loan amount.   I'm guessing this was paid up front.  This effectively represents an increase in the margin to 4%.  (Technically, assuming the fee is in advance and interest is normally paid in arrears, the effective margin on the loan is 4.025% p.a.).  If BD were able to borrow at a rate lower than 4%, it would have.   It did not.  Probably there were no real takers for a new loan because it would have made sense for BD to pay above 4% to secure term financing.

The refinancing hasn't really solved BD financing's "problem".  It has merely been pushed out 12 months.  Since the loan finances long term presumably strategic investments, it should be financed with term debt.  But there is more at stake here than short term refinancing risk. Or finance theory.

Why? 

Because of the rescheduling of Dubai World. 

If a rescheduling deal is not struck, it is unlikely that there will be banks willing to make a new loan in to a Dubai Inc entity.  And thus this loan will loom as a potential second rescheduling.  And complicate refinancings of scheduled maturities at other Dubai Inc entities.  And the raising of new financing for new projects.

If, on the other hand, as some commentators appear to believe, Dubai can dictate the terms of the restructuring, banks are going to react with pronounced shyness on new loans to avoid getting shorn again.  A lesson they should remember for at least two years.  And there will be the same implications for refinancings and new financing as above. 

Dubai Inc is, therefore, under intense pressure to conclude a reasonably acceptable restructuring quickly. 

So far there have been no apparent signs that Dubai is moving forward with any concrete action. 

Perhaps it is working feverishly behind the scenes to craft a deal.  Perhaps it hopes to jam the banks. by waiting until the last minute and hoping the pressure of an artificial deadline will cause them to roll over.  Perhaps it doesn't realize how critical time is.  Perhaps, it's just overwhelmed an the enormity of the task.  Perhaps I'm missing something. 

If it is not already doing so,  the Emirate needs to begin to move forward smartly (in both senses of the word) right now.

Ring in the Old: Part 1: Suq Al Manakh - The “Boom”

Symbol of the Suq Al Manakh Building

As promised earlier, a bit of background on the Suq Al Manakh market ("SAM").

The Previous Crisis: The Kuwait Stock Exchange 1977
In 1976 the (official) Kuwait Stock Exchange ("KSE") witnessed a dramatic increase in value. The market rose 135%. Some 176 million shares were traded versus 172 million the year before and 37 million in 1974.

Stocks were traded on both a cash and post dated check basis. Cash payments were at the current stock price. If the buyer wanted to pay in the future, he gave a post dated check. That is, the check would be dated for a date in the future. In effect the seller was granting a bi-lateral loan. The check would be for cash price of the shares (spot price) plus an agreed premium – effectively the interest rate on the loan. And just as in the typical "hire purchase" scheme, the seller delivered the goods (in this case the stock) ahead of the payment.

It's important to mention that in most GCC countries writing a check without cover isn't just a matter of bad accounting. It is an offense punishable by imprisonment. If one's account does not have sufficient funds and the bank refuses to pay the check and returns it to the presenter (in bankerspeak it "dishonors" the check),  jail beckons. On the other hand, if it allows the overdraft and creates a loan, jail vanishes. Generally dishonored check cases are relatively simple matters to adjudicate. The dishonored check is presented.  On its face it is both conclusive evidence and one's admission ticket to jail.

It's very important to understand the critical role of post dated checks in causing the crisis. The fundamental difference is that post dated checks operate outside the banking system. They are purely private transactions.

Within the banking system there are checks on the creation of credit. Authorities place limits on the total amount of lending a bank can undertake based on a leverage ratio.  At that time total assets to total equity.  Often they also set a loan to deposit ratio. Total loans may not be more than  some percent (usually less than 100% - at least in prudent jurisdictions) of total deposits. They also set maximum lending limits to individual obligors expressed as a percentage of capital - usually no more than 25% and more often 10% to 15%.  They specify the types of assets that may be taken as collateral.  In addition the banks have their own credit underwriting process. While as repeatedly demonstrated in Kuwait, this process has been deficient in many respects, it was still a hurdle to be crossed by a would-be investor.

As a purely private non banking form of credit, post dated checks were not subject to Central Bank of Kuwait restrictions on their creation. No ratios, no limits, nada. In theory the amount of loans that could be created was infinite. All that was required was a pen, a stock of checks and the acceptability of one's good name.

On the KSE this led to a dramatic increase in liquidity. With easy cash, investors could make a lot of wise investments. As noted earlier the market rose 135% in 1976.

In 1977 the KSE crashed. Shares declined roughly 40%. There was a severe knock on effect in the Kuwaiti economy.

The Kuwaiti Government took several steps to address the crisis. It bailed out investors by buying their positions at the lowest price during the 2.5 month period preceding the crash (which was the absolute peak of the market). The cost was KD150 million. As well, the Government temporarily suspended the creation of new Kuwait stock companies (KSC's) and halted the trading of other GCC shares on the exchange. However, no prohibition was put on the founding of closed Kuwaiti stock companies ("KSCC's"). At the time that seemed reasonable since by law the shares in KSCCs are not allowed to be traded until three years after the date on which the company was officially founded (the "lock-up" period). The authorities also placed fairly strong restrictions on the use of postdated checks, given their role in the crash.

The Suq Al Manakh
These moves restrained trading opportunities on the official exchange. Investors wanted to invest. Punters wanted to punt. So an alternative market sprang up in the Suq Al Manakh complex (whose front door is the masthead picture on this blog). The building itself is like many of the older small "shopping" malls in the GCC. Lots of small offices and shops. The ground floor was primarily real estate brokers – another local investment passion.

Because the trading of Kuwaiti stock companies (KSCs) was restricted to the KSE, the SAM specialized in the trading of Gulf Companies (companies established in other GCC states, primarily the UAE and Bahrain) as well as KSCCs. You will note that from its inception the SAM was engaging in what were illegal activities – the trading of KSCCs prior to the end of the three year "lock-up" period.

The SAM began operations sometime during the summer of 1979. As with the original KSE, real estate brokers were the first share brokers on this "exchange".

A major flaw was that there was no official regulation or oversight of the SAM, not to say that the KSE was then or is now known for its robust oversight and regulation. This not only affected the quality of securities traded on the market but also the practices associated their promotion as well as more mechanical operational issues. There were no uniform settlement and clearing procedures. There was no centralized record keeping system. Most trading was bi-lateral and dependent on the practice of the broker used. Deals were documented in the form of IOUs, post dated checks, and various other records of uneven quality and clarity. This lack of agreed trading procedures was later to greatly complicate matters when the SAM collapsed.

Like the KSE in 1976, trading was on a cash or a post dated check basis. At the beginning, the premium on such checks, the amount over the cash price reflecting the "interest" on the loan, ranged from 40% to 60% p.a. Clearly expected increases in the price of the stock had to be more than the certain premium for this method to be used. To "protect" themselves, purchasers of shares often immediately sold the shares they acquired in the spot market and used the cash received to buy other shares which they then sold on post dated check basis. Maturities were set so that their new sales would mature prior to the maturity of their own postdated check obligation. As such, they would have the funds to settle that obligation plus a neat profit. This works flawlessly as long as the market keeps moving up and as long as their counterparties fulfill their obligations.

While post dated checks had fueled a significant growth in liquidity in 1976, now they caused liquidity to explode. Liquidity drove prices to unbelievable heights with 100% returns not uncommon. Price increases of course "proved" just how great the investments were. Trading increased. Substantial (paper) profits were declared. Trading ramped up further. Even the KSE was affected.

Little focus was given to fundamentals. Investors demanded new investment opportunities. Kuwaitis began incorporating companies in other Gulf states (primarily UAE as well as Bahrain) to satisfy the demand. At the end of the market some 40 or so of these "Gulf Companies" were traded on the SAM. New Kuwaiti Closed Share Companies were created. Many of these began as real estate companies. At least that's what their founding documents said. But seeing the great opportunity in the financial market they quickly began investing in and trading shares. (Remember this point for later). Most of these firms had no business, no assets, no income, and no profit. Many published no financials. Yet, prices continued to climb. At one point the SAM and the KSE had trading volumes in excess of the London Stock Exchange.

My favorite story is that of Gulf Medical, a non Kuwait GCC company, which IPO'ed during the height of the frenzy. Originally founded as a real estate firm, things didn't work out so well in that endeavor. So the owners rebranded the company and offered its shares on the SAM. It was 2,600 times oversubscribed. After launch, it quickly went up approximately 790%.

Now in the Gulf when you subscribe for an IPO, you are required to make a deposit for the full amount of your subscription. How does one finance such large "tickets"? Well, one's banker is one's friend – at least until the due date of the loan. Banks happily advanced funds requiring only a small cash deposit. They knew that their loan was largely secure because the investor was likely to get only a small fraction of his requested amount. If the downpayment were equal or greater than that amount, the bank had nothing to worry about. And, as everyone knew at the time (except one really smart guy at the National Bank of Kuwait), this time it really was different. So even if the investor got all the shares, he could simply sell them and liquidate the loan. If not, the bank would take the shares, sell them and repay the loan. The bank then saw a risk free loan, though it did not offer the client the risk free rate on the loan for some inexplicable reason. As attractive as the interest was, the subscription fees - generally taken on the full amount of the subscription – were even more mouth watering. (Remember that bit of the deal economics: the fees dwarf the interest on what are essentially two week loans). At the end of the subscription period, the investor got his allotment. The bank had the excess funds returned to it and settled the loan after deducting its interest. Everyone was very happy.

As you probably have guessed, investors' practice of oversubscribing led to even greater levels of oversubscriptions. It was a bankers' (and fools') paradise.

With this sort of a compelling financial story and after careful and sober analysis, many of the local banks began lending against shares. Generally to "investment" companies so they could make a wise investment in these shares. And some highly creditworthy individuals. Many of whose most bankable collateral was their excellent family name. What excellent collateral these stocks proved to be. At least initially. With each passing day their prices increased. The collateral coverage on the loans increased. Why one might even increase a loan against this collateral so that one's client could make more wise investments.

Only one bank kept its head, the National Bank of Kuwait. From what I've been told it was Abu Shukry (Ibrahim Dabdoub) who recognized the irrational exuberance all around him for what it was and kept his bank out of the party. Even though the music was playing, Abu Shukry didn't dance. Other banks were not so restrained.

Accompanying the "boom" in the market was a boom in the premia. From 40% per annum to 70% then 80%. By 1982 the premium had risen to 200% and before the end of the saga 400%.

Everything was going really well. Or so it seemed.

A footnote on numbers: Since record keeping was not one of the Suq Al Manakh's strengths, many of the statements involving numbers are no more than estimates.  I've seen articles that state with certainty that 42 Gulf Companies were traded on the SAM. Absent a central clearing system, I'm not sure how one can know with the level of certainty required to use that degree of precision.  The same with premia on what were essentially bi-lateral deals.  The premia were whatever the two parties agreed. So I've used formulations like "about", "roughly", and "approximately" to indicate that these are not hard and fast numbers.

Friday 22 January 2010

Adeem Investment Company - The Work Continues


Copyright Ricardo Liberato Used Under Creative Commons License

It's not a suprise that a big project takes a long time to accomplish. But it's going to really be something when it's done.

Earlier posts here and here and here.

Mabruka Ya Iqbal - Arab World's Youngest Female Medical Student



Copyright The National Newspaper Abu Dhabi


Here's a great story.


A young Lebanese girl from the Beka'a - hardworking and bright - is soon to be the youngest female medical student at Weill Cornell Medical College in Qatar.
“I’m an example: I’m a woman, but still I made it,” she said. “If you have the motivation and you have the abilities, no one’s going to stop you, whether you’re a woman or a man.”
Let us hope that no one stands in the way of her dream or any others out there.

Boubyan Bank Statement on Lawsuit Against AlAbraj Holding


In its "Disclosures" section, AlQabas has two lines giving Boubyan Bank's reason for the lawsuit.  The Bank took the action because AlAbraj stopped settling its debts with Boubyan, which the Bank states total KD 45.2 million in aggregate - owed to both the Bank and some of its clients.  Boubyan also notes that in addition to raising the bankruptcy petition against AHC it has filed a "responsibility complaints" against some of AHC's former board members.

You'll recall that in its statement to the KSE, AHC had described its debts as recently having been reduced to KD39 million.  It's not clear why the difference.  Is AHC referring only to principal, while BB is including interest?   Earlier post here.

In any case, what is clear is that BB appears to be the major and perhaps only real creditor of AHC.

Thursday 21 January 2010

Lightning Storm Hits Burj Khalifah






I am told by those who claim to know that the storn lasted over one half hour with repeated "strikes" on the Burj.  You can see the tip of the lightning arrestor above the top of the Burj. 

As far as I know, "Reverend" Pat Robertson has not yet commented. 

Boubyan Bank Lawsuit Against Al Abraj Holding


Al Abraj Holding Company Kuwait issued a press release on the Kuwait Stock Exchange today (text below) regarding press reports that Boubyan Bank had filed a bankruptcy case against it for non payment of loans.

In its press release AHC makes the following points:
  1. The loan from Boubyan was made in order to purchase a majority stake in International Leasing and Investment Company.
  2. The loan was secured by the shares in ILIC. 
  3. With the decline in shares, the cover of the loan by the shares was less than agreed.
  4. Given that fact and that the company stopped servicing its debts, BB resorted to a court case. 
  5. The Company received no formal advice/warning of the case from BB nor any official notice from the Court.
  6. Recently ILIC reduced its debts from KD 51 million to KD 39 million.
A bit of background on ILIC.

Islamic Development Bank Jeddah and Abraj are listed as the two main shareholders but I don't know recent percentages of holdings.  The Company states that it operates according to Shari'ah principles in providing leasing services.  It also makes investments in other companies.  This seems to be a major activity.

You'll recall that ILIC is one of the six companies suspended from trading on the KSE, due to failure to release financial statements.  The Company has not published its fiscal year 2008 nor any interim statements for 2009.  In May last year it announced that the Central Bank of Kuwait had given it permission to hire Citibank as a consultant "as a specialized consulting agency, to examine and evaluate the company development and suggest the appropriate solutions".   
The Company is clearly in financial distress. 

Many of the names in its portfolio are Kuwaiti companies.  And many of those are known to be in distress.  There was an interesting phenomenon in Kuwait in the period just prior to the crash in 3Q08.  Many industrial and other companies in Kuwait were making their profit from wise investments in the KSE rather than their core businesses.  And that profit was largely based on increases in the carrying value of investments rather than ongoing cashflow.   Money was borrowed from banks eager to increase their business to make these investments.  And when they turned out to be an apparent wise idea, more money was borrowed to make even more investments.  Banks were similarly eager to increase their business even more.  A true meeting of commercial interests.

And, as though familiar with Kuwait know, there is often a  "network" of related  individuals and companies who trade shares not only to make a profit but also to prop up share prices.   And perhaps  in so doing keep local bankers happy with their collateral values as a result.  The recent story of Nafais is just one example.  For those who read Arabic, AlQabas has an account.  For those who don't here's AlphaDinar's take.

Unfortunately, when the KSE "retreated", many an investment company ship was left stranded.  And many a local banker felt his ankles get wet.  Some their knees.  A few their thighs.

While it's unclear just how AHC reduced its debt by KD 12 million, one might understand that BB felt left out, which may be another motive for its lawsuit.  If one isn't servicing one's debts, how does one reduce indebtedness roughly 24%? 

To close out the story on Boubyan.  Like many other financial institutions in Kuwait, BB is increasing its capital.  BB by 50%.  583 million new shares are being issued at 155 fils (55 over par value).  The rights offer will take place between 24 January and 7 February for shareholders of record as of 21 January.

AHC press release below.  

[8:33:52]  ِ.ايضاح من (ابراج)بخصوص ما نشر فى احدى الصحف المحلية امس ‏
يعلن سوق الكويت للاوراق المالية بان شركة الابراج القابضة تود ان توضح ‏
بخصوص ما نشر فى احدى الصحف المحلية امس حول رفع بنك بوبيان لدعوى افلاس ‏
ضد الشركة ،تفيد الشركة، بان مديونيتها لبنك بوبيان ناتجة عن شراء الشركة
لحصة الاكثرية بالشركة الدولية للاجارة والاستثمار وقد كانت هذه المديونية ‏
قد تمت تغطيتها بشهادة اسهم تغطى الكفالة البنكية مقابل القرض وبسبب ‏
انخفاض اسعار الاسهم تم كشف التغطية الى ما دون المتفق عليه وبسبب ‏
توقف الشركة عن سداد اقساط القرض فقد لجئ البنك الى القضاء لتحصيل ‏
القرض علما بانه حتى تاريخ هذا الكتاب لم يصل اى اخطار من بنك بوبيان ‏
او من قبل المحكمة رسمي بخصوص القضية المشار اليها .‏
وتفيد الشركة بان اجمالي القرض كان 51 مليون د.ك تقريبا وصل بعد التسديدات ‏
الى 39 مليون د.ك تقريبا .‏
 

Wednesday 20 January 2010

4-2 & Top of the List


CFA Kuwait Holds CFA Charter Award Ceremony


Copyright Arab Times Kuwait

I've written before about the role of institutions in promoting the development of markets.  

A very important element of that process is developing skilled ethical professionals to operate the financial infrastructure created.  In fact it is the critical element as has been shown recently with the  financial crisis in the West. 

The CFA Institute plays an important role in developing such professionals in the finance world.

Earning the right to use the CFA Charter requires three years of graduate level study and the passing of three rigorous examinations as well as practical work experience. It's a very high honor.

CFA Kuwait, a relatively new local society in the GCC, held an awards dinner for new CFA charterholders in Kuwait.

Ibrahim Dabdoub, the dean of bankers in the GCC and a bankers' banker - a sadly vanishing breed, presented the certificates.  (He's seated in the middle of the picture.)

Standing on the far left is the dynamic M.R. Ragu, SVP of Research at Markaz Kuwait.  He was instrumental in the founding of CFA Bahrain as well as CFA Kuwait.  Wherever he goes, if there isn't a local society, there soon will be.  So congratulations are in order to M.R.

A Tale of Two Countries - Dubai and the USA


Copyright GulfNews Dubai

Dubai may have the world's tallest building and the only indoor ski mountain, but here in the USA we have the smallest yet representation of the Burj Khalifah.   Sic transit gloria mundi . 

That is, until, I suppose some "Westerner" carves it on a grain of rice.  

At least we don't have to worry that Dubai will take our national debt record from us. 

Istithmar - David Jackson - "Action Jackson"

Frank Kane at The National's take on Mr. Jackson's career at Istithmar.  I'm guessing that his reference is to Detroit and not Chicago.  The former to a 1988 "action" movie.  The latter to a member of the Chicago "Outfit".

If the analysts at RGE are right about the leverage he employed, I'm sensing a honorary citizenship from a country "up North".   If the award is made soon enough, David may get his personal loans forgiven.  You have my implicit guarantee on that.

With leverage at this level, it's hard to see how even a modest recovery in prices  from the crisis induced decline could led to "attractive value" for Dubai World.  Any recovery would go first to the lenders to make them whole on principal plus interest before DW would see any cash.  That means they would have to go to roughly 90% of original cost. 

That's a bit of a climb from the values mentioned in the article.  And when buyers have a sense that a seller is motivated the pressure on price is downward not upward.