Strong Evidence No Discount for Gulf Holdings on Villamar Sukuk Repayment to GFH

AA Solves Another Case by Applying Non-Euclidean Geometry

As you’ll recall, in 2018 GFH purchased the Villamar Sukuk—on which Gulf Holding KSC Kuwait is obligor--from AlRajhi at a discount of some USD 77.8 million from its face value (roughly USD 203 million).

In its FY2018 financials GFH declared a gain of this amount.

In looking closely at GFH’s financials, I thought there were two possible structures for the “settlement”:

1. Option 1: GFH reduced the debt amount, GH to pay USD 125 million
2. Option 2: No reduction in debt amount, GH to pay full USD 203 million.

Based on that June analysis, I assessed that Option 2 was the more likely settlement mechanism. You can read the June blogpost here for the detailed argument for that view.

But as often is the case, GFH’s financials didn’t provide all the information necessary to make a conclusive determination.

An apparent dead end. But not really.

Additional “Evidence”

Gulf Holdings publishes financials.

If GFH offered it a discount on repayment, that should show up in GH’s 2018 annual report.

If it doesn’t, then there is further indication that Option 2 is the settlement mechanism.

As it has done in the past, GH included its financials in the shareholder package for its FY 2018 Annual General Meeting.

According to those financials:

1. The principal amount of the sukuk is unchanged.
2. As per Note 25, there has been no material change since the date of the financials (31 December 2018) and the date of the external auditors’ report (23 April 2019).

If discussions were ongoing for a reduction, then these should be mentioned in the “subsequent events” note. 

That increases my confidence that the sukuk is being “settled” under Option 2: GH to pay full value.

However, it is possible that GFH and GH did not begin negotiations until after 23 April. But again I consider this unlikely.

There was another open question from my June analysis regarding the potential need for a provision. The Sukuk was non-performing and AlRajhi sold it at a 38% discount. That would seem to be a strong indication that the Sukuk was impaired.

So how could GFH be confident enough persuade itself and its auditors to (a) book the entire USD 77.8 million gain in 2018 and (b) treat the Sukuk as unimpaired.

AA overlooked the fact that the sukuk is secured by Villamar Project assets.

GFH is the “natural”--perhaps the only—realistic buyer for these assets. Arguably it is also the potential buyer best placed to extract full value from the assets.

In any sale GFH and GH (controlled by GFH) would enter into “arms length” negotiations to set the price.

Now some out there might be thinking: “But, AA, this gives GFH the opportunity to potentially manipulate the sale price to its advantage to ensure it ‘collects’ 100% of the Sukuk thus justifying the USD 77.8 million ‘debt settlement gain’. It would be able to bury any shortfall in the value of assets acquired where that amount will be hard to detect”.

To those doubters I say that AA is highly confident that GFH will acquit itself in this transaction applying the same standards of ethics for which it is well known.

Regarding a potential sale of GH assets, according to the GH’s 2018 AGM package, shareholders were to be asked to approve the recommendation of the Board of Directors for a strategic sale of Residential South Real Estate Development Company SPC (RSREDC) and the owner of the Villamar project for a total value of US $ 52,466,853 US $ 47,466,853 / cash (US $ 5,000,000) and authorize the Chairman or his designee to take all necessary actions to complete the sale and transfer of ownership.

As I translate the Arabic AGM notice, the sale price appears to have two tranches: a cash tranche of USD 5 million with the remainder non-cash. Perhaps in partial settlement of the Sukuk?

You can check my translation by using the link above to find the AGM Agenda Point 6 on page 5.  If I've missed something, please set me straight.

I haven’t yet found any press release or other announcement about a sale.

But one appears to have taken place.

If I’ve read the information at www.sijilat.bh correctly, ownership in RSREDC (CR 59128-1) was amended in November 2019 from Gulf Holdings Kuwait to GFH Asset Company Cayman Islands.

Anyone out there with info, please post a comment.

Bahrain Middle East Bank - Fatally Wounded Barring an Unlikely Miracle

Bring Out Your Dead.  And Your Near Dead Too.

Since last July ever so often I would check to see if there was anything new on The Curious Case of Bahrain Middle East Bank.

After some months, fatigue set in. I missed BMB’s release of its “missing” 2018 financials.

Belatedly I’m catching up.

Late November BMB released its 3Q18 unaudited financials and its FY 2018 audited financials. BMB’s auditors did not issue an opinion.

Why?

Two factors: massive losses and apparent fraud.

Losses

Through 3Q18 net losses were some USD 193 million, reduced slightly to USD 189 million for the full year.

At FYE2018 Total Liabilities exceeded Total Assets by some USD 113 million due to provisions on USD 195 million in non-performing related party exposures.

A rather dismal picture summarized in the following (all figures as of FYE 2018):

1. USD 189 million loss represents 95% of Total Assets.
2. Negative equity of USD 113 million.
3. CAR is a negative 142.9%.
   

Apparent Fraud

So was this the result of a few bad commercial decisions? Investing in WeWork, taking a flier on Softbank?

No.

According to Ernst and Young, during 2018 the new Board discovered that certain exposures were to or for the benefit of a related party and not to independent third parties.

As of FY 2018 that USD 190 million in exposure was composed of direct loans, interbank placements, and securities.

While the latter two amounts were with independent third parties, there were side agreements that secured benefits from them to the related party. No further details. Perhaps as collateral?

There is an additional USD 4.6 million in accrued interest not included in the amounts above, bringing the total to USD 195 million.

Related Party Exposure

What do we know about the related party exposure?

From Director’s Report in the English version of the FY2018 AR, we know that the related party is related to a major shareholder not a member of management.

There are only two major shareholders AN Investment (ANI) (owned by the Turkish “Three Amigos”) and Al Fawares Kuwait.

I believe the related party is AN Investment (80.77%) not ALF (14.48%).

1. Recall that the ALF directors appear to have been warned—presumably by the CBB--and were able to resign before the CBB “fired” the Board. Unlikely if ALF is the culprit.
2. In the Directors’ Report in the 2018FY AR, the parties under investigation are listed as the former Vice Chairman (Mr. Solak), CEOs and CFOs. No investigation of the Chairman (which ALF held) is mentioned.
3. It would seem unlikely that ANI as the predominant shareholder would allow ALF to engage in self-dealing at a level that would risk ANI’s entire investment.
4. The related exposures are all in Turkey. I don’t believe ALF has any ventures in Turkey.

Who is the related party?

The terms “TFC” or “TFC Group” are used to refer to the related party in the Directors’ Report cited above.

I assume “TFC” is an abbreviation for “trade finance counterparties” which was the term used in BMB's press release in 2018 regarding the CBB prohibitions on the bank.

Why?

Not only does the CBB have restrictions on related party transactions but also has a limit on the maximum amount of risk that can be taken on a single entity or group. 

BMB’s exposure to "TFC" is well above that limit.

One might be able to make a case that a single entity or group wasn’t a related party, but it would be pretty hard to disguise exposure of this amount to a single party. The exposure would have to be divided among several ostensibly “independent” entities with each entity’s exposure below the single party limit.

From the “Minutes” of BMB’s 2018 AGM held 6 January 2020, we learn that:

1. The entire exposure is in Turkey.
2. There are multiple exposures to various trade transactions. Not to a single obligor.
3. BMB is working “alongside a consortium” of other creditors to recover the amount, hoping to secure a pledge of collateral. But that no restructuring agreements have yet been signed. And it is too early to determine ultimate recovery.

BMB FY2018 AGM and EGM

The first two AGM meetings proposed for 23 December and 30 December 2019 did not reach a the required quorum of shareholders attending and so did not take place.

Under Bahraini law, there is no minimum quorum required for a third AGM.

That’s good because the 6 January 2020 AGM was attended by just 0.04% of shareholders. You read that correctly. Not even 1%.

Clearly, ANI facing potential legal exposure wasn’t interested in attending. Nor was ALF or the ultimate beneficial owner of the ALF shares as it would no doubt face questions on how it “missed” the fraud.

Thanks to the question of Shareholder Khalil al Mirza (162,000 shares) we learned more about the related party exposure (as outlined above). With 162,000 shares he appears to represent almost all of the shares attending at the AGM save for holders of very small amounts.

There was one other significant-but not unexpected-bit of “news”.

Typically at AGMs, the shareholders vote to discharge the Board Members from liability for their actions during the fiscal year in question.

BMB’s Agenda Item #7 specifically referred to the discharge of the current directors. Shareholder Mohammed Abdul Rahman (1 share) asked if the prior directors were being discharged and was advised that none of the previous directors (this would include ALF’s two directors) were being discharged.

The EGM was not held because of lack of a quorum at all three meetings proposed: 23 December, 30 December, and 6 January.

The key item for the EGM was to take a decision on what to do in light of the losses which trigger compulsory remedial action under Bahrain’s Commercial Companies Law and the bank’s Articles of Association. 

With losses this large as a percent of equity, there are only two options for BMB: raise capital or wind-up the bank.

BMB Prospects- Little to None

The Bank is wounded very likely fatally.

This is now the second scandal resulting from fraud that clouds the Bank’s name. And BMB’s reputation never quite recovered from the commercially related losses in 1999 and the subsequent multi-year restructuring that followed.

Hard for me to imagine any serious equity investor interest.

There is no obvious institution that might be compelled to step up. For example, an existing shareholder. 

Rather an entirely new investor will have to be enticed to commit capital.

Other than the banking license, there don’t seem to be any positive enticements at the Bank.

BMB doesn’t currently have a viable line of business, a significant market position or a valuable customer base. 

Its reputation is less than sterling.

A new investor will have to make a significant capital contribution.

First to meet the CBB’s minimum shareholders’ equity requirement. That will involve at a minimum some USD 213 million to restore equity to CBB’s minimum of USD 100 million for a wholesale bank.

Second, cash will also be required to fund the creation of a new LOB.

While BMB may recover of all or a good portion of the related party exposure, on a best case basis that is likely to be a multi-year exercise.

It may well be that the Bank's auditors and the CBB may accept a write-back of some of the loss after a restructuring is signed, thus, lessening the required capital contribution.

But that will not alleviate the need for cash now to invest in its business.

Customers and financial institutions are likely to have little interest in dealing with the Bank. Lack of FI support will limit BMB’s ability to use leverage to increase its assets and ideally ROE, conduct trading activities etc.

Speaking of banks, recall that there is a single “regional” financial institution (SRFI) that BMB owes some USD 127 million for interbank deposits taken. The SRFI is in line to bear the brunt of any shortfall in recovery.

It seems pretty clear that this SRFI has been “legally” trapped in BMB.

That leads to the suspicion that it is not an FI that most financial investors would want to do business with.

The size of the amount owed by the Bank to the SRFI also presents a problem.

Paying it off either in full or in stages would require a significant commitment of cash. That would reduce funds for investment in BMB’s LOBs.

A potential new investor is likely to consider all of this more unwelcome “hair” on an already hirsute BMB.Or the final straw on the camel's back.

At this point barring a miracle, BMB’s fate appears sealed.

Update Gulf One Investment Bank Bahrain

Last December while commenting on the ongoing woes of Dana Gas, I mentioned that there were other firms in even worse shape and cited Gulf One Investment Bank in Bahrain.

It’s time to take another look at G1 as AA ventures off his well worn path of larger institutions in Bahrain.

As per its 2018 annual report, G1 has extended its string of losses in 2018 to five years.

Over the period from FYE 2013 (its last profitable year) through FYE 2018, G1 has:

1. Lost (but not in the sense of misplaced) approximately USD 92 million in equity, a 69% drop from FYE 2013.  Driven primarily by cumulative net losses of some USD 82 million over the period.
2. Suffered a decline of approximately USD 79 million in investments, a 73% drop from FYE 2013. Driven primarily by USD 57 million cumulative net losses in Investment Income.

You can see the details in G1’s 2018 and 2017 Annual Report both on Page 8.

This is rather a dismal record.

But Gulf 1's Board is confident in the future as evidenced by these quotes from the MD&A section of the 2018 Annual Report.

“The Bank made important strides in 2018 towards repositioning its business on a sustainable path, including expanding its income-based business and realising value from its private equity portfolio. In particular, the Board has undertaken a critical review of the challenges facing the Bank and is now evaluating significant structural changes that would put the bank on a stronger footing without affecting the range of activities it currently undertakes.”

So far the important strides have yet to be reflected in the financials.

As to the critical review, лучше поздно, чем никогда.

And again.

“The bank’s journey towards the realization of the value of its private equity investment continues into 2019. This process will have a favourable impact on the Bank’s ability to grow its successful income generating investments to take the bank to profitability and growing shareholder value.”

With cumulative losses of some USD 57 million in investments the bank’s journey towards the realization of the value of its private equity portfolio would seem to a very long term journey.  It will take some rather incredible multiples to cover these losses and generate an appropriate return.  But then 千里之行，始於足下.

 A few other observations.

Regulatory Issues

It pays to read the auditors’ opinion carefully.  In the section “Report on Other Legal and Regulatory Requirements” tucked away in the third bullet point is the phrase “except for the matters discussed in note 1” we are not aware of any violations of ….

The violations in question are:

1. Accumulated losses exceed 50% of paid-up share capital.  Resolution can be by an increase of paid in capital (raise new capital) reduce paid in capital to offset the accumulated loses, or wind up the firm.I’m guessing that of the three shareholders would opt for the second – a capital reduction. If that option is chosen, then G1 would have a short respite, if losses were to continue at the levels of the past five years.
2. But there's a wrinkle that complicates this strategy. G1 has insufficient shareholders equity. Central Bank of Bahrain Rulebook Volume 1 LR-2.5.2B requires wholesale bank licensees to maintain minimum total shareholders’ equity of USD 100 million.

G1’s Board has decided to surrender their wholesale banking license in favor of Category 1 Investment Firm.  There are no set amounts for minimum capital required for this license.  Rather the firm and the CBB will agree an amount based on the firm’s business. 

As I noted in December, G1 has no borrowings. There are no deposits taken from other banks or from individuals or corporates.  Its miniscule USD 7 million in liabilities consist of internal accruals.

Shifting from a bank to an investment firm seems to make eminent sense.

Other signs of distress.

1. The last press release on G1’s website is from 2012.
2. The last weekly update if from 2014.
3. The last research bulletin is from 2013.

Central Bank of Bahrain Compliance Enforcement Reports

In case you missed it, I certainly had until just recently, the CBB is publishing annual “Compliance Enforcement Reports” which provide information on actions taken by the CBB to enforce regulations.  

This is a good source of information on the types of violations that occur as well as trends year to year.  Of interest—AA certainly hopes—is the section that names violators and provides a generic description of the violation.  But this is only for some violations.  You’ll see some of the firms that have appeared on this blog as repeat offenders in the CBB’s  reports. 

Reports for 2018, 2017, and 2016 have been posted.  The 2016 report has some data on 2015.  If the past is any guide, reports for this year will be issued in January 2020. 

AA was particularly gratified by two items in the 2018 report both appearing on Page 9.  

First, the CBB levied a fine (which was upheld on appeal) on a BSE listed company that had provided a clarification to an overseas exchange, where it is cross-listed, regarding the content of a news article published in that overseas jurisdiction about the listed company’s operations.  This clarification was disseminated on the overseas exchange’s website without the same on Bahrain Bourse’s website, which was only published by the listed company, a day after, in response to the CBB’s instructions.   

Faithful readers of this blog (that would be AA) will recall a characteristic AA rant about a failure by GFH to provide the same information on its 3Q10 financials on the BSE as it did in the UAE.  

And AA’s appeal to the CBB to change disclosure rules to require the same. 

As outlined in the CBB’s  2018 report, this requirement exists as per Section OFS-5.1.19 of Rulebook Volume 6 Capital Markets.  It appears to have been imposed in January 2014, though it may have existed elsewhere in another rulebook.  

Here’s chapter and verse of OFS-5.1.19.  

For Bahraini issuers who made an offer or listed their securities outside Bahrain, and for overseas issuers who made an offer or listed their securities in Bahrain, all information of importance to shareholders made public about the issuer in other markets must be made public in Bahrain, whether or not disclosure of such information would otherwise be required by the CBB.    

Note that this requirement includes the "making of an offer" and not just listing on the BSE.

Second, the CBB sanctioned an unnamed individual investor for market manipulation during 2018. 

GFH 2016 Results: Settlement Assets

It Depends ...

This is the third in a series of three posts on GFHFG’s 2016 earnings.

Today’s post looks at GFH’s US$ 464 million out-of-court settlement.

What precisely did GFH get?

Well for one thing, not a dime or even one fils of cash.  

Instead GFH got illiquid hard-to-value assets, primarily real-estate.  

GFH’s 2015 financials state that “The fair values were determined by independent external professional firms using a combination of market and income approaches, as appropriate for each asset”.  Determining fair value of illiquid assets like these is no easy matter (euphemism of the post).  Different assumptions would lead to different “fair values”. 

Time will tell whether GFH gets more or less than the current carrying value.

For details let’s turn to note 19 in GFHFG’s 2016 financials which contains key information.

If you look at the auditor’s opinion, you’ll see that GFH’s auditor used a “matter of emphasis” comment to call attention to this note.  Presumably they felt it was critical information for readers of the financials. So exploration of the note is worthwhile for just that reason alone.  But we’ve got another purpose:  determining what was received and what the impact and implications of that receipt are.

The following table is based on note 19.

Litigation Settlement - USD Millions
Development Property		$118
Investment Property		$192
Unlisted Equity Securities		$9
Investment in Associates		$28
Other		$117
Total		$464

Let’s take a closer look.

Development Properties—US$ 118 million. As per GFH’s financials (page 21), “Development properties are properties held for sale or development and sale in the ordinary course of business. Development properties are measured at the lower of cost and net realisable value.”   As per note 8, the properties are in UAE, Bahrain, and North Africa.   There appears to be no cashflow from these assets until they are sold.  Note that in 2016 GFH sold DP with cost of US$ 43 million and declared a profit of US$ 46 million.  Of which some US$38 million remains uncollected as of 31 Dec 2016 (note 11). 

Investment Properties—US$ 192 million (net of financing).  As per GFH’s financials (page 21), “Investment property comprise land plots and buildings. Investment property is property held to earn rental income or for capital appreciation or both but not for sale in the ordinary course of business, use in the supply of services or for administrative purposes. Investment property is measured initially at cost, including directly attributable expenses. Subsequent to initial recognition, investment property is carried at cost less accumulated depreciation and accumulated impairment allowances (if any). Land is not depreciated.”  I didn’t see a disclosure of the amount of revenue from IP.  Any revenue associated with the IP acquired via the settlement would accrue only from October.

Unlisted Equity Securities—This amount is so small as to not be worthy of attention.

Investment in Associates—The US$ 28 million in value is ascribed to 20% interest in Global Banking Corporation Bahrain and 33.33% of  Ensha Development Company Bahrain.  Another small irrelevant amount, except those who follow the financial sector in Bahrain might question the ascription of value to GBC and wonder what this means for valuation of the larger amounts in the “windfall”.   

GBC’s 2015 audited annual report repeats the going concern qualification in the 2014 report (note 2.1). The auditors state that GBC’s Board decided in May 2014 not to undertake any new business and dramatically reduced staff from 31 to 10, including key management and risk control positions.  As in 2014, 2015 note 6.1 discloses that there is material uncertainty about the full recovery of one of GBC’s investee companies.  GBC reported losses in fiscal 2014, 2015, and for the first nine months of 2016.  

Since GFH does not show separate values for GBC and EDC, it’s not possible to determine the value ascribed to GBC.  AA would not expect GBC to have much, if any, value from continuing operations.  Even though GBC reduced staff to 10 and has no interest expense (GBC is essentially funded by equity and non-interest bearing accruals), it still cannot generate a profit. 

So any value ascribed must be liquidation value.  Taking values in 3Q16 financials for investment properties (real estate assets) and bank deposits at face value, 20% of GBC would roughly equal US$ 14 million, though liquidation values—particularly for real estate-- can often be much less than carrying values.   What would happen to values in liquidation is anyone’s guess.  I couldn’t find anything on Ensha either but both are relatively small amounts in the grand total.

Other Assets—US$117 (net).  This includes three assets related to Al Areen, including the Lost Paradise of Dilmun Water Park, and the British School of Bahrain.  Note 19 provides additional information on the determination of the value.  Some US$55 million of the US$212 million gross value of assets roughly 26% is “goodwill”.   

My impression is that the LOPD is not a major cash generator but would welcome readers’ comments.  There was an article back in 2010 or 2011 in the GDN with expectations for 180,000 patrons for the year.  There doesn’t seem to be any news reports more recent.  Nor could I find any financials or financial data.  Not surprising because it’s not a listed company. 

Looking at the summary financials for all of the US$ 117 million in other assets, it’s a bit troubling to see so little cash and cash equivalents on hand given the US$ 32 million in deferred revenue (payments made by customers for services to be provided).  This money has apparently been spent but the services not provided yet and expenses likely need to be paid, e.g., teachers' salaries. 

Some closing observations.  

The settlement did not include the payment of any cash to GFH.   There’s nothing like cash to settle an obligation.  Clear value is received.  Cash can be easily employed for acquisitions, funding development of one's existing lines of business, etc.

So what explains the absence of cash?

When one take assets in lieu of cash, one takes a residual risk that asset values may go down as well as a chance for upside appreciation.

There are two reasons for taking assets in a settlement. 

1. The payer doesn’t have sufficient cash and assets are the best the payee can do.  
2. Or the payee knows the assets are dramatically undervalued presenting an opportunity for an additional gain. 

AA suspects the first is the explanation.  The inclusion of GBC, Ensha, and the equity securities--all minor amounts--indicate that value was short and had to be topped up with some minor assets.  And in the case of GBC a troubled asset whose value is most likely based on a liquidation scenario.     

If the assets were dramatically undervalued, the payers would have sold some of them and thus been able to give less in value to GFH minimizing the decline in their own net worth.

These assets do not appear to generate substantial cash flow or profit, though there is insufficient information in the 2016 financials currently issued.  Perhaps the Pillar 3 disclosures for 2016 which are likely to be included in the “glossy” annual report will shed more light.

In light of this analysis of the “windfall”, what are we to make of GFH’s pronouncements about its performance, the success of its 2014 strategy, and prospects for the future?

When I read GFH executive management comments, I also see assertions that somehow receipt of illiquid hard-to-value assets somehow has dramatically improved GFH’s fortune, positioning GFH to “accelerate” its strategy. 

But how? 

GFH isn’t sitting on a cool half a billion in cash which it could use to fund acquisitions or to expand its lines of business.   The windfall doesn’t seem to generate stable cashflows that might fund such expenditures albeit at a lower level.   Nor are lenders likely to find these assets suitable collateral against which to advance loans in significant amounts.  Realization (sale) of these assets is likely to require time.

In addition GFH’s underlying business hasn’t been transformed as 2016’s results show.  And that’s even if one discounts the full amount of the impairment allowances taken.  To top it off the strategic talk sounds strangely similar to the pre-2014 strategy.