Insights into the GCC Markets from Markaz’s “Golden Portfolio” Report

In April 2008, Markaz issued its first report on the "Golden Portfolio" – the various stocks held by GCC government owned enterprises ("GOEs"). On 7 September it updated its analysis with data as of 5 July 2010.

The report tracks the holdings of 51 GCC GOEs in GCC stock markets.

The following two charts summarize the macro snapshot (original chart on page 2 of September 2010 report).

First, the number of companies in which investments are held.

COUNTRY	NUMBER OF GOEs	NUMBER OF COMPANIES HELD	TOTAL NUMBER OF COMPANIES	PERCENT
Saudi Arabia	10	47	140	33.6%
UAE	10	29	110	26.4%
Qatar	8	18	45	40.0%
Kuwait	10	42	194	21.6%
Bahrain	9	20	44	45.5%
Oman	14	23	127	18.1%
TOTAL	51	179	660	27.1%

Second, the value held expressed in US$ billions.

COUNTRY	VALUE OF GOE INVESTMENTS	TOTAL VALUE OF MARKET	PERCENT
Saudi Arabia	$109.7	$314.6	35%
UAE	$ 28.3	$ 97.2	29%
Qatar	$ 26.0	$ 97.7	27%
Kuwait	$ 11.7	$ 90.9	13%
Bahrain	$ 3.5	$ 16.4	21%
Oman	$ 2.7	$ 16.7	16%
TOTAL	$182.0	$633.5	29%

This data gives an idea of the relative government presence in local markets. It also shows the relative sizes of markets.

But if you drill deeper into the information on the country tables, what you learn is that: 

1. In Saudi Arabia, 5 companies held by GOEs account for 38% of total market cap. One company SABIC over 21%. 
2. In the UAE, 5 companies held by GOEs for roughly 42% of market cap. One company, Etisalat, almost 23%. 
3. In Qatar, 7 companies held by GOEs for 47% of market cap. One company, Industries Qatar, for 15%. Another Qatar National Bank for another 15%. 
4. In Kuwait, 8 companies for almost 44%. (If you're wondering, the group does not include NBK which is a market heavy weight in its own right). With Zain at 19%. 
5. In Oman, 5 companies for 35%. One, Omantel, for 14%. 
6. In Bahrain, 4 companies for a whopping 69% of the market. One, Batelco, for just short of 20%.
   

By contrast Exxon Mobil (the largest single stock) represents roughly 2.6% of the NYSE's US$11.7 trillion in July 2010 market value. HSBC just short of 7% of the LSE's US$2.7 trillion of value.

"So what?" you might ask.

1. Modern portfolio theory ("MPT"): Where a handful of companies dominate the market, market risk may be swamped by specific risk. What sense does it make to use the tools of MPT, e.g., CAPM, betas, etc in this context? 
2. Conflict of Interest: But there's more. Where the government has significant holdings in companies, even if this shareholding is less than a majority, it may exercise effective control. In such situations, companies may be managed with national strategic goals more important than maximizing shareholder wealth. 
3. Liquidity: Government strategic holdings reduce free float. The consequence is reduced trading which limits price discovery, increased share volatility (small transaction "tickets" have a disproportionate effect on price) and limited liquidity (the ability to exit one's position).
   

The implications are pretty clear but I think often not really thought through by market participants. And so probably not fully reflected in prices.

Gulf Finance House - Plans to Increase Capital By Up To An Additional US$300 Million

GFH announced on the BSE today that its Board had decided to recommend that shareholders approve a n up to US$300 million increase in capital.   The Board has delegated executive management to take the necessary steps.  A shareholders meeting will be called in the near future as soon as the required regulatory approvals are received.

Investcorp to De-List London GDRs

Today Investcorp announced on the Bahrain Stock Exchange that it intended to de-list its London GDRs citing as a reason:

In the period since the Secondary Listing of the GDRs, there have been significant changes in financial markets and the pattern of trading shares. The volume of GDRs traded on the London Stock Exchange over the last 12 months has been minimal and Investcorp does not believe it is cost effective to maintain the Standard Listing on the London Stock Exchange.

Zawya Dow Jones quoted an Investcorp spokesman who noted:

"While Investcorp continues to have a wide range of international shareholders, in changed market conditions the secondary GDR listing in London simply no longer adds value in terms of additional liquidity or research following," a spokesman for Investcorp told Zawya Dow Jones Thursday.

A review of the periodic reports of the Bahrain Stock Exchange reveal the following "extensive" trading in the shares of Investcorp on the BSE:

1. 2009 Annual Trading Bulletin:  For the entire year, there were just 2 transactions for 548 shares representing 0.069% of the outstanding shares of Investcorp.  (Investcorp has 800,000 outstanding shares of common stock). The total for both transactions  was BD307,529, roughly US$814,952. By contrast in 2008, a total of 1,431 shares (0.179% of outstanding common shares) were traded (30 transactions) for BD1,462,491 (US$3,875,601) and in 2007, a total of 5,905 shares (0.738% of common shares) (32 transactions) for a total of BD5,509,677 (US$14,600,644). 
2. 1Q10 Quarterly Trading Bulletin: 1 transaction for 550 shares in an amount of BD308,651, roughly US$817,925).
3. 2Q10 Quarterly Trading Bulletin:  No trades at all.
4. July 2010 Monthly Report (the latest on the BSE):  No trades.
5. To be clear none of the above constitute trading even 1% of  Investcorp's shares.  This pattern of light trading is to be crystal clear not just an issue with the shares of Investcorp but is pretty widespread on the BSE, which is why Investcorp devised its GDR program back in 2006.

So, I find it a bit hard to take this story at face value. Certainly Investcorp is not in dire financial straits and therefore does not need to cut expenses at the cost of reducing liquidity for its shareholders.  Is the problem one of the market price.  If the shares trade on the LSE more frequently, they may drift lower.  Liquidity can work two ways with stock prices.

Here's a link to the Investcorp GDR page at the LSE.

A few interesting other items:

In April this year, Investcorp announced it had signed a deal with two holders of Investcorp GDRs to buy them at US$5.00 per share.  In case you're wondering that's about US$0.24 over the offer price announced today, but then markets are down since April.  Interesting that having had a problem raising common equity not so long ago that Investcorp would be buying back common equity.  Wouldn't it make more sense to buy back expensive preferred stock?

If you recall, Investcorp has a special approval from the Central Bank of Bahrain to hold up to 40% of its outstanding shares as Treasury Shares.  And if not, it's outlined on page 28 in Investcorp's 2009 Audited Financials.  That is, just coincidentally, the free float on Investcorp's shares which you'll see outlined on the same page.

I wanted to check what level of Treasury Shares that Investcorp was holding but couldn't immediately find their Quarterly financial reports on their website.  Can anyone out there help me?

Gulf Finance House Secures Extension of US$100 Million West LB Facility

GFH announced on the BSE today that it had secured an extension of the US$100 million "stub" remaining from the US$300 million West LB syndicated murabaha.

The "new" facility is for a tenor of two years with a further one year extension at GFH's request.  The "profit rate" (interest rate) is reportedly lower.

This helps GFH avoid an immediate crisis as the full US$100 million was due this month.

An interesting question, if the banks have refinanced GFH because it could not pay and have reduced the interest rate, do Paragraphs 58 and 59 of IAS #39 require that the lenders book a provision?  See here for an earlier discussion of the requirements of IAS #39.

Gulf Finance House - Obtains Permission to Delay Release of 2Q Financials Until 16 August

GFH announced on the Bahrain Stock Exchange this morning that it had obtained the consent of the "regulatory authorities in Bahrain" to an extension of the time required to present its 2Q10 financial statements.  GFH has up to 16 August to issue the financials.  And since its Board will meet on 15 August to approve the financials, it appears that the release date will be next Sunday or Monday.

No reason was given for the need for the extension which is for a relatively "short" period.

There are two reasons that spring to my mind why such a delay would be required:

1. The extension of the roll-over of the US$100 million stub from the West LB syndicate which comes due this week has not been finally agreed.   If true, this could reflect some hard negotiating on deal terms and pricing.  Or perhaps a slow moving lender "thinking carefully" about its decision.
2. Its external auditors need for more time to complete their review of the 2Q report. This could be related to questions on the value of assets or income.  Equally clearly it could be related to the roll-over and the strength of the comments in their review "opinion" if roll over is or is not achieved.

These are not the only potential causes.

There could be some that are rather benign:

1. Inability to get a Board quorum until then for some reason, 
2. Unavailability of key audit firm personnel.   
3. The need to first finalize Khaleej Commercial Bank's 2Q report.  Though since its Board meets tomorrow the results should be known by now and could be included in GFH's financials for release the next day - Wednesday or Thursday.

However, I suspect these are not the cause but rather it's one of the first two above - which indicates the stress under which GFH is operating.

Global Investment House - Poor Performance of Funds Highlighted Why?

AlQabas has an interesting article on YTD performance through 25 June performance of funds domiciled in Bahrain.  Global has I believe some 12 or so funds listed on the BSE.

For the record, the results were:

1. European Stock Index Fund down 9.8%
2. US Stock Index Fund down 7.52%
3. Energy and Petrochemical Industries down 6.32%

Other firms similar negative performance is mentioned.  

1. SICO's Gulf Stocks Fund is down 6.53%
2. TAIB's Bank's MSCI-based GCC Stocks Fund (Islamic) down 5.77%.

Interesting article because of the focus on Global - and the performance of just three of its funds.  In an environment where other fund managers are incurring losses as well.  

Gulf Finance House - Press Release on S&P Downgrade

Pass the smelling salts!

There it was today an announcement on the BSE.  None so far on the DFM or on the KSE - but it's still early in the day only 08:12 EDT here.  And Dubai and Kuwait are a lot further from GFH's HQ in Manama than the BSE.  

Oh, wait, I see.  

GFH is responding to a letter from the BSE asking about the downgrade. 

According to the press release, GFH's Board decided last week to terminate the ratings relationship but to allow Executive Management the discretion as to when to terminate.  

The press release clarifies:

"In the meantime the Executive management would like to focus on the recovery plan and the restructuring then will decide to implement the withdrawal".

Since GFH seems to have decided to implement the withdrawal on or before  the day the rating was released, less charitable souls than AA might infer some lack of communication within the firm about critical events.  

Perhaps, certain information is shared on a "need to know" basis.  As with the shareholders?  A key issue may be in the determination of "need".  

As always AA stands ready to provide a public service.  

Here's the link to the Central Bank of Bahrain's Capital Markets Regulation "Disclosure Standards".   The appropriate "chapter and verse" is Article 32 "Ongoing Obligations Immediate Disclosure".    It does quite a nice job of defining "need to know". And the timing of "letting them know".

Gulf Finance House - Finally Issues Official Statement to Stock Exchange on US$100 Million Rescheduling

When the interests of investors are at stake, you can always count on GFH to take the same prompt action it always does to make sure they are fully informed.  In this case even working over the 4 July holiday!

You'll recall that on 30 June Ted Pretty was quoted in the press that GFH had agreed a rescheduling with the West LB syndicate and that it was in the final stages of documentation.

Today a formal announcement appeared on the Bahrain Stock Exchange.  I didn't see announcements on the DFM or the KSE, but then again the 4 July holidays in those jurisdictions may be responsible.

GFH's 1 July reply to the Bahrain Stock Exchange's letter of 30 June apparently was not sufficiently comprehensive and so this additional message apparently was required.

As Ted Pretty has stated previously, there are serious responsibilities for an institution like GFH.  Responsibilities matched by GFH's commitment. 

"GFH is a flagship institution in Bahrain and the Islamic financial sector and we are committed to working hard to set a better example as a model participant."

And for those who may still be prone to misinterpret this sequence of events, I'll requote the remarks of GFH's Chairman upon the issuance of 1Q10 financials which should set the record straight.

"The Board has taken a very prudent approach in declaring this result and is committed to continuing transparency in the way we do business."

Comforting words indeed.  The flag flies high.  Despite the fact that Arabic has no capital letters, that is I believe how one spells  شفافية  with a capital  ش .

Another remarkable though ultimately saddening disclosure was the implicit confirmation that GFH has been forced to abandon its "proven business model" for another.  As the press release notes, the new maturity on the West LB syndicate will give GFH time to "double its current efforts to transform to a new business model".   

Unspoken by GFH was the reason for need for that change.  

Here at Suq Al Mal we're not shy about confronting issues and speaking truth to power.  And so we'd note that as per the analysis of many experienced market experts (GFH, TID, GIH, a wise Southern Shaykh to name just a handful), it was the global financial crisis.  And, as always, we take this most appropriate occasion to point out that this expression is most properly in lower case lest it be confused with any specific institution.

Gulf Finance House - In Final Stages of Restructuring US$100mm West LB Syndicate

There are press reports (Gulf Daily News and Reuters) quoting Ted Pretty, CEO, of GFH that they are in the final stages of refinancing the "stub" US$100mm from the earlier US$300 mm West LB led-syndicate.  As you recall, they repaid US$200 mm of the loan on maturity in February and then rescheduled the remaining US$100 mm for payment this August.

Whether this reflected the lenders' desire to keep GFH on a very short leash, irrational exuberance on the part of GFH's management regarding the potential for sale of its highly marketable and valuable "non core" assets, or some other serious delusion on the part of GFH or its creditors wasn't clear at the time.  And is still not clear.

What was clear at the time is that barring a miracle, GFH was not going to be able to make the payment.

This time a more sensible two to three year rescheduling is apparently being contemplated.  According to the GDN article, GFH and its creditors are in documentation.  If this is correct, then the deal terms are set.

What will be interesting to see is the impact on pricing.  The six month extension resulted in a five-fold or so increase in pricing.

Also what is clear from all of this is that GFH's rather low stock of credibility has been depleted even more.  

The Company really doesn't do itself any favors by making unrealistic pronouncements (US$420 mm in asset sales) or reversing course as with the on again off again sale of its interests in Khaleej Commercial Bank.  

Adding to its problems, if S&P holds true to its earlier position, GFH is in line for a downgrade.  A particularly unwelcome development as it seeks to rebuild its market position.  Particularly with clients.

On a positive note, this more sensible rescheduling does offer substantial relief to demands on its cash flow.  As well as a third chance to move forward. And also looking forward probably no American baseball rules here.

It also  will also give the folks at GFH another opportunity to use their demonstrated talents for writing press releases.  I can see how this successful rescheduling might just demonstrate yet again (as if another demonstration were needed) the confidence of GFH's lenders and the market in its proven business model, leading position as the premier GCC Islamic Investment Bank, as well as its promising future. Smaller minds may just see it as lenders accepting the inevitable if they want to maximize their recovery.  But then these are minds without the "vision thing".

I'll also be looking tomorrow morning for the announcements on the BSE, KSE, and other exchanges regarding this material development.

Gulf Finance House - Badr Al Subaiee Resigns from Board

GFH announced on the BSE today that Bader Al Subaiee (Chairman and MD at KIC) had resigned from its Board. 

And that it will be discussed at the upcoming shareholders' general meeting.

I haven't seen anything in the press on this and wonder if it's related to GFH's ongoing problems or is a personal matter.

Ted Pretty Resigns from Khaleeji Commercial Bank

A very puzzling announcement by KHCB on the Bahrain Stock Exchange today.  Ted Pretty resigned from the Board. 

Putting aside the fact that it took three weeks for KHCB to bring this news to the attention of the BSE, it would seem that GFH would want a senior officer on the Board since it appears to have reversed its decision to sell its 37% stake in the Bank.  There is no announcement on his replacement.

Could this mean that it has changed its mind again?  US$120 million in looming debt repayments could be a compelling reason.   

Is Mr. Pretty too busy at GFH to give KHCB the attention it deserves?

Or is Mr. Pretty headed for a less stressful position?

Gulf Finance House Sets the Record Straight and Answers Mis-Informed Naysayers

Sadly, there's been a lot of negative press out there, which as GFH has taken the trouble to point out yet again is pretty much misguided.  And this seems to be the week for setting the record straight as another Bahraini banking personality - now absent from the country - did just a few days ago.

You may have seen misguided quotes like this earlier:

Asset sales are likely therefore to be critical over the next 12 to 18 months.  GFH is unlikely to develop sufficient cash flow from operations to repay US$120 million this year and pay roughly an additional US$30 million to US$45 million in operating expenses.  And I am low balling those expenses.

As Ted Pretty notes:

"GFH is a landmark institution in Bahrain and across the Middle East and North Africa region and does not deserve the recent attacks by certain sections of the international media," he added.

"The recent comments about GFH are ill-informed and I am concerned about their sources and the motivation behind them which directly challenge the Islamic financial system and the regulatory oversight of our institutions. Bahrain is a strong vibrant financial centre.

From what I've seen some of these comments are not so much attacking  the practice  of Islamic banking as what is perceived as  the malpractice of Islamic banking.

And

"Every global investment bank has had to review its business model, adjust its liquidity profile and reassess its investment projects and GFH is no different.

Indeed, though one might note that not every global investment bank or regional investment bank for that matter has rescheduled its loans, had a massive loss, and embarked on selling off a material portion of assets which suddenly became "non core".  And is in the position of having 67% of the rescheduled debt due in the next three months. 

And 

The bank exited its investment in Bahrain Financial Harbour for a total consideration of $262m, which included a cash consideration of up to $40m which will help enhance GFH's liquidity position as it builds the business around its new strategy of becoming a creator of Islamic financial institutions in the region and beyond.

Indeed it did.  It sold the BFH Company which owned the land.  Emar apparently didn't want the land and so gave it back to GFH as part of the US$262 million consideration.  So what that means is GFH received US$222 million in consideration in land which if I'm considering things properly it owned before the sale.  

They often say (and are generally correct) that success in investment banking requires intellectual skill, hard work and marketing prowess.  Selling yourself your own property and claiming a great success fits into one of these three for sure.

Hopefully, with GFH's explanation, the unfounded and unwarranted criticism of the bank will end.  That seems only fair.

Gulf Finance House - No Sale of Khaleeji Commercial Bank

In announcements on the Bahrain Stock Exchange, GFH officially replied to the two AlQabas press reports referred to in my earlier post.

The first concerns GFH's plan to sell Khaleeji Commercial Bank. 

Here GFH states that it is in the process of  amending its capital management program and that this involves increasing its stake in KHCB.  And that it will advise the KSE when this process is complete -- completion of studies and receipt of necessary approvals.

It should be noted that this press release was in response to a letter sent today (13 May) by the BSE.

The second concerns the "reply" to GFH's auditors on the "going concern" assumption.

GFH disavows the AlQ statement noting it is the opinion of the newspaper.

Gulf Finance House - Not to Sell Khaleeji Commercial Bank Stake?

AlQabas quoting Reuters quotes Ted Pretty, Group CEO at GFH, that GFH is not considering selling its  37% stake in KHCB, but rather increasing it.  Apparently, as part of planned foray into retail and commercial banking in Bahrain and the region.

Since GFH desperately needs to sell assets and since KHCB is likely the most attractive of what it has to offer for sale, it's hard to understand the business rationale here.

Obviously, there's more to this story that just this news item.  Was GFH successful in selling some other assets?  Has an old or new shareholder suddenly agreed to invest capital?  Was GFH unable to find a buyer for its interest?  Perhaps, a 37% stake isn't sufficiently attractive to a potential investor in KHCB who may want to ensure control over management?

Gulf Finance House - Comments on 1Q10 Financials

GFH has posted its 1Q10 financial on its website.  That has to be a record.

Let's take a quick look.

Going Concern/Matter of Emphasis

Here's what KPMG had to say in its Review Report.

"Without qualifying our conclusion, we draw attention to note 1 in the interim financial information which discusses material uncertainties relating to the Group's liquidity position and regulatory capital adequacy, which, may cast doubt about the appropriateness of the going concern assumption used in the preparation of the interim financial information."

And here's the relevant portion of note 1.

"As at 31 March 2010, the Group's had accumulated losses of US$ 440.173 million and, as of that date, its current contractual obligations exceed its liquid assets.  As a result, the ability of the Group to meet its obligations when due depends on its ability to achieve a timely disposal of assets.  Further, the regulatory capital adequacy ratio of the Group as at 31 March 2010 stood at 13.97%, which restricts the Group's ability to absorb further losses or undertake additional exposures.  These factors indicates the existence of material uncertainties which may cast significant doubt about the Group's ability to continue as a going concern."

Comments on Financials

I've already made some comments.  So rather than repeat them here, I'd invite you to first take a look here and then follow below - where the comments elaborate on that earlier post.

Capital and Liquidity

KPMG had a similar "matter of emphasis" in the company's 31 December 2009 audited financials at which time it should be noted that GFH's CAR was 12.91%.  So, clearly, some improvement on that score.

Unfortunately, as is pretty common practice, there is no note in the interims on CAR.  And note 41 in GFH's audited FYE 2009 financials does not provide a lot of detail on the components of risk weighted assets ("RWA").  One particular issue is understanding why at 2009 they are almost twice total assets as per the balance sheet.  Also the determination of Tier 1 capital isn't clear.  It's shown as US$381.5 million as compared to nominal capital of US$433 million.  Deductions for subsidiaries?

What we know is that CAR was 13.97% as of 31 March 2010.  If we assume that we can use the changes in equity since then to compute a new regulatory capital, then we come up with roughly US$392 million. Which gives RWA of US$2.8 billion.  Or some 2.15X nominal assets.  More detail would be very useful in sorting this out.   I suspect that's not going to be forthcoming.

Also as I commented earlier, it's hard to understand why any rational investor would be converting the Deutsche Bank murabaha into equity given GFH's situation and the market price of its share.  It occurs to me that this could be a convenient device for capital infusions.  There is no need to call an OGM to issue additional shares and the holder can decide when and how much capital to "contribute".  Perhaps just enough to keep the CAR out of the CBB's "red zone" and to avoid tripping covenants.  At this point, only about US$28.3 million remains.  And as I hope you'll recall (who says optimism is dead) from one of my much earlier posts, the DB transaction was issued at a discount.

As to liquidity as I pointed out in my earlier post, GFH's 31 March 2010 cash of US$21.5 million gives scant margin to cover operating expenses and interest, much less the US$100 million in principal due in August and the US$20 million in principal due in September for the debts rescheduled earlier this year.   Note that roughly US$140 million of "Placements" are blocked to support potential contributions by GFH to fund projects.  So a first glance at the balance sheet might suggest a more robust liquidity position than actually exists.

Asset sales are likely therefore to be critical over the next 12 to 18 months.  GFH is unlikely to develop sufficient cash flow from operations to repay US$120 million this year and pay roughly an additional US$30 million to US$45 million in operating expenses.  And I am low balling those expenses.

But what is even more perplexing is note 7 where we learn that  during the first three months of 2010 GFH has bought back US$15 million of its sukuk maturing in 2011.   Given the near term demands on cash, it boggles the mind to think that they would be using precious limited liquidity for such a purchase.  Even if it is at a discount.  Also when one looks at the relative cost of GFH's debt, this debt is the cheapest by far.  The US$100 million is Libor plus 5%.  The LMC rescheduled facility an eye popping 8% flat.  While the 2011 sukuk is at Libor plus 1.75%.  Perhaps, GFH is helping a friend exit?  I have a similar  question on the rational reason why a company in GFH's position would purchase US$35 million in Treasury Shares during 2009.   And one cannot help but wonder did GFH's lenders not impose any conditions on prepayment or purchase of debt?  Could they have missed so obvious a covenant, especially since GFH has shown a penchant for buying this particular debt back?

Balance Sheet

Other than the comments above regarding the 2011 sukuk and the "Placements", some additional points.

1. No movement on the US$85 million Investment Banking Services Receivable.  You'll recall that GFH wrote down roughly half of this in 2009.
2. Other assets Financing Projects is up a US$1.5 million.  Seems small to be additional funding.  Is this interest?  And if so, it would be very interesting to know how much of this amount is accrued unpaid interest.  As I noted earlier, it's unlikely that FP are going to be a source of cash in the near term.
3. Investors' Funds declined by US$50 million though I only see US$29 million in the Cashflow statement. 

Income Statement

1. Roughly US$5 million of investment banking income was from related parties.  The comparative figure for 1Q09 was US$46.5 million.  With related party business a firm can enjoy dramatic savings on marketing costs.  Sometimes even on underwriting and due diligence.  Well, at least initially.
2. As I noted in my earlier post, cash is going to pay GFH's running bills and its debt repayment.  So far cash generated as a percentage of income is relatively low.  Of course, this is early going.  But then the US$120 million in debt maturities is "early" as well.

All in all GFH is in a tough spot.  Let's hope that management's apparent optimism isn't misplaced.

Gulf Finance House Responds on Auditors' Matter of Emphasis on "Going Concern"

Update:  GFH denies issuing this statement.  Let's see if AlQ replies.

According to AlQabas GFH has issued a statement on its auditors' matter of emphasis on management's assumption of GFH as a going concern.

GFH's well reasoned argument is reported to consist of the following:

1. This sort of thing is a part of internationally accepted auditing principles.  Unspoken apparently is the idea that auditors are always doing this sort of thing - making a mountain out of a mole hill because of some silly "principle".
2. 1Q10 results demonstrate clear improvement.  
3. And the results are really "distinguished"  ( نتيجة مميزة )  given the difficult times.
4. The improvement reflects the hard work of executive management who have reorganized operations without the need for additional provisions.

I glad that GFH has taken the time to set the record straight.  

After hearing these powerful arguments, I'm sure many of you will have a hard time taking the auditors'  apparent "box-ticking" quibble about lack of liquidity or weak capital adequacy seriously.  I know I don't.

In any case, in the interest of fairness, I'll be looking for additional commentary from GFH tomorrow on this topic - though I don't know how much piling on of logical firepower GFH's poor auditors are going to be able to withstand.

Gulf Finance House - 1Q10 Results Continuing "Transparency"

In GFH's announcement of 1Q10 results, Mr. Essam Janahi, Chairman, stated:

"The Board has taken a very prudent approach in declaring this result and is committed to continuing transparency in the way we do business."

This wouldn't be the first time that Mr. Janahi has publicly recognized the virtues of transparency.  Nor do I suspect it will be the last.  And if you were reading my post of yesterday carefully, you will notice that I highlighted this continuing commitment to transparency.  Or as we like call it here on SAM  كلام شريف

A noble goal.  One which of course an Islamic bank would have no trouble keeping.

I believe that GFH will be announcing tomorrow one small matter - almost too trivial to mention.  Oh, well, let me mention this since I've already typed this much of the post.

Seems that GFH's accountants added a matter of emphasis to their review report noting that while they did not qualify their opinion they called attention to Note 1 which discusses the lack of fundamental certainty about management basing preparation of the 1Q10 financials on the assumption that GFH is a going concern.  The auditors cited concerns about liquidity and the adequacy of the company's capital.

Now, I am sure that many of you out there are probably saying that I am being overly harsh.  This is not the sort of thing that need be disclosed in the press release.  After all, the company releases its financials and a seasoned investor will go first to the auditors' report.  So disclosure is made.  Indeed.

But, it seems when getting ready to send in its 1Q10  financials to the BSE, GFH inadvertently forgot to  include page 1 with the auditors' report.  As you might expect from the time it took to update GFH's ratings page on its website,  they haven't yet gotten around to loading the financials on the website yet.  All that's there is a copy of the newspaper ad.

We'll see tomorrow whether the disclosure of the matter of emphasis is in response to a letter from one of the exchanges.  Or whether GFH belatedly realized the small oversight and is releasing the info unprompted.

However, rather than leave on a negative note, I'll close with this quote from Group CEO, Ted Pretty:

“GFH is a flagship institution in Bahrain and the Islamic financial sector and we are committed to working hard to set a better example as a model participant. Islamic finance has excellent growth prospects and GFH is well placed to take advantage of this growth.”

 The commitment to set a better example as the flag bearer of Islamic finance is admirable.

Gulf Finance House - 1Q10 US$7.5 Million Loss

GFH has posted press releases on 1Q10.   English language here.   Arabic here.

And summary financials here.

Hard to do an in-depth analysis based on a one page "newspaper" announcement.

Nonetheless, some preliminary comments.

GFH's liability restructuring defused an imminent threat, but only "just". Of the US$180 million restructured, US$120 million comes due this year. US$100 million in August and US$20 million one month later.

Barring an asset sale miracle, it's probably likely that these amounts - or substantially all of them  - are going to have  rescheduled.

But that's really only a small part of GFH's problems.  The central issue for GFH still remains whether its  "proven business model" can generate sufficient cash to pay the light bills.   Debt repayments can be stretched out, but if you can't make the operating expenses it's very difficult to continue in business.

Based on 1Q10 numbers, it's hard to be optimistic.

A very quick and admittedly crude estimate is that GFH has a quarterly minimum cashburn rate of  somewhere around US$ 12 million to US$15 million before other cash drains, e.g.,  customer deposit withdrawals, repayment of interbank deposits, project funding, etc.   GFH's ending "cash" at 31 March 2009 was US$21.5 million.

While it's early in the hoped for turnaround, so far cash income generation is still lagging.  In 1Q10, cash operating income was roughly one-third of the declared US$18.5 million in accrual income.  Less than 50% of the minimum estimated cash burn.  Only a "timely" sale of Investment Securities (US$21.l2 million) saved the cash position which was US$21.3 million at 31 March 2010 as per the Cashflow statement.

Apropos of Ted Pretty's comment about new products, one has to ask what products customers are going to be comfortable buying from it.  Will they be willing to give GFH money today for products to be delivered in the future?  Would the Central Bank be wise to approve GFH selling such products?  If not, then the deals have to be spot - customer cash against an existing asset.  That will require a lot of volume to generate significant profit.  Can GFH move US$100 to US$200 million in product?  What sort of margins can it generate on such sales in this environment?  And with its own name a bit tarnished?

So it appears that asset conversion not income is the key in the near term - probably the rest of 2010 and perhaps the early part of 2011.  

So let's take a look at some of the sources and uses of cash.

1. Placements - Shown as US$156.7 million with Cash of US$5.4 million.  Looks like comfortable  liquidity.  But roughly $140 million of these are pledged for projects so liquidity is weaker than  it  appears. That pledge was disclosed in Fiscal 2009 financials.  And you get a hint here in the 1Q10 Cashflow statement - where only US$16 million of Placements are considered "cash".  Without the 2009 note, you wouldn't know if that's due to tenor or because they're pledged.   
2. Investment Banking Receivable - No change since 31 Dec 2009.  This bears watching for timing and probability of collection.  GFH had written roughly half of the IBR off during 2009.
3. Other Assets -  Recall that roughly US$188.3 million of this is project costs funded.  So return of principal is dependent on sale of the projects.  Assuming the best regarding ultimate value, probably not a likely near term event.  This category also ties back to the Placements.  If GFH can extract itself from future obligations to fund, then US$140 million or some portion of Placements could become liquid.  But might that risk the US$188.3 million already invested and carried here? 
4. Investors' Funds are down roughly US$50 million.  The Cashflow appears to only account for US$29 million.  Hopefully the notes will explain.  The question here is whether customers are withdrawing funds - which could add another cash drain burden.

In this context it's hard for me to understand the continuing conversion of the murabaha.  I really don't see an economic rationale.  One thing that does occur to me is that this is a device to provide equity to the company - with amounts and timing of contributions at will.  Perhaps to avoid triggering covenants in debt agreements.  Once converted the shares could be sold back into the market - taking a loss on the conversion but still perhaps a price to be paid for keeping the company operating.  If anyone out there has a thought on this topic, I'd be very interested.

Gulf Finance House - 1Q10 US$7.5 Million Loss

GFH announced its 1Q10 earnings: a US$7.5 million.  Here's the report from AlBilad in Bahrain.

As you'd expect management tried to put the best face on the results by noting the improvement  over 1Q09 and the disastrous 4Q09.   The progress cited is a cut in expenses by 45% to prior quarter - unclear if it's 4Q09 or 1Q09.  I'm guessing the latter.  As well as that there were no additional provisions.  Then a comment that the earnings release was in the spirit of transparency which the Bank has followed in the conduct of its activities.   Hope was expressed that 2Q10 would should continued improvement.

The former arguments were made by Essam Janahi.  Then Ted Pretty took the press release "floor" noting   that cost cuttings had saved US24.5 million in expenses.  And that the firm was launching new products which would contribute to future earnings.   That's the key issue for GFH - driving the revenues line.  There's only so far one can go with cost cutting.

To be fair there's been some progress.  But GFH still has a rough road ahead of it.  Key will be rebuilding customer confidence in its ability to deliver.

There's nothing on GIH's website yet.  When the financials are released, I'll take another look.

International Investment Group Issues Clarification - It's Business As Usual

Today IIG issued a press release on the Bahrain Stock Exchange (Arabic) and NasdaqDubai (English).

The press release notes that in addition to engaging KPMG Advisory WLL IIG has hired the Law Office of AlWaqayan, AlAwadhi and AlSaif (local Kuwaiti law firm) and DLA Piper (international law firm).  It is also looking to set up a committee (the NasdaqDubai press release uses the more elegant word "forum") to negotiate with creditors.   

As noted before, an interim report from KPMG is expected at the end of May with the "final" at the end of June.  As per my earlier post, this appears to be a rather preliminary report.

Now creditors would be naturally concerned when their obligor misses  the payment of what some might characterize as  a relatively trivial sum of US$3.4 million for interest. 

Notwithstanding the above announcement IIG wishes to confirm that IIG's and its associated businesses continue to trade on a normal basis and the day to day operations of such businesses have not been effected by the above event.

While an interesting definition of what is "normal", this belated entry into our competition is clearly not strong enough to cause our distinguished panel of judge (AA) to reverse the earlier award to Dr. Adnan Musallam and TID.   Though I suspect there will be additional opportunities for further entries as time passes.