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.

Global Investment House - Shareholders' Meeting Approves KD100 Million Capital Increase, Elects New Board and Deals with Shareholder Objections

AlQabas has an article on GIH's 4 May shareholders' meeting.  As well, GIH has posted a press release.  The AlQ article has a bit more detail, including an account of one shareholder's representative who raised several objections.

AlQ began by noting that Khaled AlWazzan was no longer on the Board.  If you don't recall, AlQ had reported his resignation last week which GIH denied.  This is AlQ's "I told you so" moment.  A tricky  issue. Technically, he did not resign.  He just did not stand for re-election.   Though I suppose one could argue that not standing for election was an effective resignation.  Point to AlQ for calling that Khaled was leaving the Board.  Also Shaykh Abdullah Jaabir Ahmad AlSabah, representative of the Public Institution for Social Security did not stand for re-election.   Nor was any Board member elected to represent Social Insurance.

  

The OGM and EGM agreed all the proposed agenda items. AlQ considers these the most significant:

1. No distribution of profits for 2009.
2. Annulment of the previous shareholder resolution to raise KD150 million in new capital (15 June 2009) and its replacement with a resolution to raise KD100 million at a price of KD0.105 per share.  (Book value is KD0.133 per share).  The extra five fils to cover issuance expenses.  The rights offering to be in a single tranche.
3. Grant the Board the power to delist from any stock market the company is listed on.  

Ms. AlGhunaim, the Chairwoman of the Board, said that there were no plans to delist from any market. Nor had the Board undertaken any study in this regard.  The resolution is a precautionary move so the Board will have the power.

She continued that the reduction in the capital raising by KD50 million was done so that small shareholders would be able to cover their allotment.  She expressed confidence that the strategic shareholders would participate.  She also commented that the company was in discussion with many parties about participating.  Apparently in response to a question, she said that one option was for banks - both creditors and non creditors - to participate.  This has been discussed earlier in connection with a debt for equity exchange - which would of course lessen the repayment burden on GIH.

Ms. Al-Ghunaim also noted that GIH was a great buy trading currently at levels not seen since its founding 11 years ago.  And that shareholders knew well what a great deal it was.  That the company enjoyed a great reputation, confidence, etc.  

Also it appears that some shareholders must have expressed concern about GIH closing some of its funds.  She noted these were closed either because they were no longer appropriate investments in the current environment.  Or that their specified terms had finished.  She assured that GIH was ready to pay any fund holder his money at any time and in any condition if that was in accordance with legal conditions.

A representative of a Canadian shareholder then launched into a series of formal objections.  I suspect that Kuwaiti company law has a procedure similar to other GCC states.  Under these provisions a shareholder must formally record any objections to the conduct of the company's business.  Once these are formally recorded in the minutes of the shareholders' meeting, they legally exist and the shareholder may then seek to take further action.   As you'd expect, when a company has a difficult year or when it has gone through a corporate "transition" like a difficult restructuring, shareholders are more likely to voice objections and criticize management than when times are good. 

Here are the points that he reportedly raised:

1. The annual report he got was missing three pages which contained important information.
2. There was a lack of disclosure about the subscribers for the GDR issue considering the fact that they own 35% of the total capital of GIH.  This doesn't appear to have been addressed but perhaps the answer is so as not to embarrass shareholders who paid KD0.995 per share and saw 90% of their purchase price vanish.
3. GIH does not but should have an Investment Committee to find profitable business opportunities and generate returns for its shareholders and to pay off the debt.
4. GIH should pay dividends for 2009 from reserves as it is allowed to under Kuwaiti law.
5. In the rescheduling exercise, the management was more focused on protecting the rights of creditors than the shareholders.
6. The 5% fee for the expenses associated with the Rights Offering will be a burden on the shareholders.

The Board answered these objections as follows:

1. The missing 3 pages were an oversight.  The full report was sent to shareholders and available on the KSE website.
2. The Investment Committee functions are contained within other already existing committees.
3. Re dividends, the Company needs to pay 30% of principal this year and so has to focus its efforts on successfully repaying its debt.  A reason why it is increasing capital KD100 million - which also will serve to help increase revenue.
4. The Rights Offering fees are justified given that leading local firms and world class names like Deutsche Bank and HSBC will be involved.  AA:  I'd note that the fees for the GDR were about 1.9%.  The proposed fees for the previous approved but not executed KD150 million RO were 10%.   5% is probably a very good price considering that the sale is going to be a tough one. 
5. There were some comments meant to reassure shareholders about GIH, including one on the rescheduling that it won "Most Innovative Deal 2009".  This statement like the one about the shares being a great deal because the price is the lowest in 11 years is a great example of making lemonade from lemons.
6. At the end of the article you'll see some comments about assets under management.  There's a typo.  It should be KD1.7 billion. Not million.  AA:  GIH has a very good franchise in asset management.  And as pointed out by GIH's Board, an endeavor that does not require a large amount of capital.

Another notable shareholder question was why GIH hadn't taken provisions against the US$250 million deposit with National Bank of Umm AlQaiwain (AlQaywayn in AA's transcription).   Because GIH's legal advisors recommended against it.   I'm guessing perhaps even more importantly because GIH didn't want to reduce its KD162.8 million in capital.  That would probably trip covenant triggers under the restructuring, hurt GIH's capital adequacy ratio, and make the Rights Offering more difficult.

As it is, GIH has reduced the RO by KD50 million.  I think less out of a concern for small shareholders being able to cover their allotments than to reduce the amount so that the issue is more likely to be successful.  Raising KD90 million or KD100 million against a KD100 million RO will look a lot better than raising the same amounts against a KD150 million RO.

Any RO is going to be a tough slog.  GIH has been trading below par since 15 April and has been trending downwards.  It closed 5 May at KD0.090.  It is therefore unlikely that small shareholders will have any interest in buying new shares for more than they can buy "old" shares in the market.  So the Board will have to schedule the RO to a more propitious time.

At the end of the shareholders' discussion, it's common for the Chair of the meeting, presumably Ms. Al-Ghunaim in this case, to say something on the order of "We've addressed shareholder objections and questions".

I'm guessing this happened and prompted the representative of the Canadian shareholder to pipe up again with a comment that if these clarifications were given in foreign countries, large amounts of money would have to be paid.  Apparently, frustrated, Ms. Al-Ghunaim is reported to have said "O Abdul Munim, O Abdul Munim, let us finish..."  As the AlQ article reports, enough shareholders clapped to show support for her attempt to silence Abdul Munim.  I'm taking from this comment that he probably was quite vocal in the meeting - more than is apparent from the article.  AlQ ends its article by saying that Ms. Al-Ghunaim did not finish her sentence.  Unclear if Abdul Munim did as well.

As to the new Board, here are the names:

• Mrs. Maha Al Ghunaim representing herself
• Mr. Marzook  Al-Kharafi representing Al Kharafi Group
• Mr. Alan H. Smith representing Al Bareeq Holding Company
• Dr. Hj Mohammed Amin Abdullah representing Berlian Corporation (Brunei)
• Mr. Bambang Sugeng Bin Kajairi representing Reem Investment Company (Abu Dhabi)
• Mr. Ali Al-Wazzan representing Jassem Al-Wazan Sons Group of Companies
• Mr. Hamad Tareq Al-Homaizi representing himself
• Ofoq Arabian Real Estate Company (substitute)

Generally, when directors are said to be representing this or that company or person, you can infer that these entities are significant shareholders.   However, the KSE does not show any of any of these.  The mandatory reporting threshold is over 5%.  On the subject of shareholders, you'll notice about 18.5% held by BNY Nominees Ltd and Bank of New York Nominees.  These are the GDRs.

International Investment Group Appoints KPMG Advisory WLL Kuwait as Financial Advisor

Today IIG Funding (the Issuer) and Deutsche Bank (the Delegate) issued separate announcements on Nasdaq Dubai related to the payment default on IIG's US$200 million sukuk.

Basically, these are as required by the legal documentation governing the transaction.  Both parties must notify certificateholders of their right to vote for a dissolution (a minimum 25% of certificateholders must so vote) in order for the two parties to be required to take action.  They must also receive indemnification satisfactory to them from certificateholders for taking such action as well.

Deutsche Bank mentions that IIG has engaged KPMG Advisory WLL Kuwait as a financial advisor.  Here's DB's quote of an extract from a letter it received from IIG.

The Obligor has appointed KPMG Advisory W.L.L., Kuwait ("KPMG") in relation to carrying out an independent business review exercise for the Obligor, preceding a detailed financial restructuring engagement at a later date. KPMG's scope of work will include preliminary assessment of the company's present financial position and the possible options to meet its obligations.

This will involve:

• a study of the cash position, debt obligations (servicing and repayments) and cash flow requirements (short to medium term); 
• understanding of the timing and extent of expected cash inflows; 
• analysing the Obligor's cost structure and investment portfolio and understanding the management's strategy and intent regarding the same;  
• carrying out a high-level desktop valuation analysis of the Obligor's significant group  companies/investments as at 31 March 2010 or as at any other agreed cut-off date;  
• performing sensitivity analysis on the base forecasts provided by the management;  discussing actions (if any) taken/planned by the management; and  
• identifying the key gaps and issues the business faces and recommending alternative options and next steps.

The intention is that an interim report will be provided by 31 May 2010 with a final report available by 30 June 2010.

Some comments.

1. First of all the scope of work is typical "accounting firm" speak.  All the major steps are set forth, including the initial understanding of the company's position. 
2. Right now what the above describes is the first stage in a two stage process with the second stage involving detailed advice on the formal restructuring. 
3. Since the sukuk is secured by certain investments (investments in affiliates and available for sale investments) more than a desk top study will need to be done at some point as these are a key source of cashflow to IIG.  

International Investment Group Kuwait - Additional Background

Given the news item about IIG's problems, let's take a closer look at IIG.

In case it wasn't clear from the details in my previous post, IIG is a finance company in Kuwait that operates "in accordance with Islamic Shari'ah principles".   To quote further from its website:

At IIG, we firmly believe that Shari'ah principles and transparent corporate governance is essential to building and maintaining public trust. We at, IIG are guided by our values to maintain the highest level of integrity, treat everyone with dignity and respect, focus on our customers and demonstrate excellence in all we do.

And I think that quote quite nicely sets the stage for what follows.

Let's start with the Sukuk.  It is listed on NasdaqDubai where you can find a variety of documents including the Offering Circular.

A few details on the US$200 million sukuk:

1. Maturity 10 July 2012.
2. Quarterly Periodic Distribution Amounts (every calendar quarter on the 10th) at 6.75 per cent per annum.
3. Mudarabah structure.
4. Principal repayment can be either in cash or IIG shares.  5,754.25 shares per US$10,000 of face value or approximately US$1.73 per share.  IIG currently trades at 44 Kuwaiti fils per share, roughly US$0.15.
5. As disclosed in IIG's 2008 annual report (the last issued), the sukuk is secured by  (a) available for sale investments (approximately KD0.4 million out of the total portfolio of KD17.5 million), composed predominantly of  unquoted shares, and (b) investments in affiliates (approximately KD54.3 million out the total portfolio of roughly KD76.6 million).
6. Kuwait Financial Centre ("Markaz") acts as security agent.
7. In the event that IIG Funding doesn't pay back, the certificateholders can call upon IIG to purchase the certificates at their nominal value plus "interest".  If IIG fails to pay, then the certificateholders can pursue the collateral through the Trustsee/Delegate.
8. Typical Dissolution Events ("Events of Default").
9. Upon the occurrence of a Dissolution Event, an early termination can be triggered by the positive vote of 25% of the certificateholders.  This accelerates the maturity of the sukuk.
10. Certificateholders have an individual right to "put" their certificates to the obligor (Section 6.5 a).  The voluntary put date is 10 July 2010.  An investor with a minimum of US$10 million can put the his certificates to IIG Funding for redemption.  So if one is an investor who wants to establish a legal right against IIG as a direct creditor but can't persuade other creditors to vote for an Early Dissolution, this could be the way out.  Of course, as noted above, the investor needs to have a minimum of US$10 million to tender.  Failure by IIG Funding to pay the put amounts would appear to trigger another Dissolution Event so certificateholders would get another vote.  The Delegate (Deutsche Bank) also has the right to take action without a vote, since the Trustee,  IIG Funding, has delegated its powers to do so to DB.

A few other things from the Offering Memorandum.

From Page 100  A Verbatim Quote on Shareholding

"IIG has been a publicly listed company since November 1997. The table below sets out information in relation to holdings of 2 per cent. or more in IIG’s shares as at 1 May 2007:

Shareholder	# of Shares	Percentage
Kuwait Clearing Company(1)	37,953,500	11.93%
Al Tawfeeq Company for  Investment Funds Ltd(3)	23,745,200	7.75%
IIG – portfolio holdings(2)	18,745,845	5.89%
Arab Banking Corporation (B.S.C.)	18,686,119	5.87%
IIG(4)	14,616,533	4.59%
Gulf Monetary Group	14,302,800	4.50%
Al Madar Finance & Investment Co.	11,721,250	3.86%
Grand (Real Estate)	7,370,680	2.32%

Notes:

(1) This company acts as a nominee for shares held on margin accounts to facilitate forward trading.

(2) These are shares held by IIG as portfolio investments for third parties, see ‘‘Businesses – Asset management’’.

(3) This company is part of the Al-Barakah Group in Saudi Arabia which was one of IIG’s founding  shareholders. IIG’s Vice Chairman also holds board and management positions with companies in this group.

(4) These are treasury shares. IIG is permitted to hold up to 10 per cent. of its paid up capital as treasury shares."

AA;  IIG owns 17.54% of Grand.

As of today, IIG lists the following as major shareholders as per the KSE.

1. Arab Banking Corporation 5.63%
2. AlBaraka Company for Development and Investment, 5.21%
3. Gulf Monetary Group Bahrain 8.2%  (Interestingly, on the BSE website it's noted that IIG owns 50.12% of GMG.  Investors Bank with 27.66% is the only other major shareholder shown).

Turning to  IIG's 2008 annual report (2009 is not yet released):

1. I didn't see IIG's investment in Gulf Monetary Group mentioned  in the 2008 financials so this must be a 2009 or 2010 event.
2. The term "related party" is used more frequently in IIG's annual report than the word "interesting" is used in this blog.   And that's not only interesting but also quite a record.  As per Note 22, some 38% of total assets are with related parties, including substantially all of the company's liquidity.  Note 6 states that IIG held KD71.2 million of collateral against the KD34.5 million in wakala and  murabaha payables. to related parties.  The nature of the collateral is not described.  As Note 22 assures, all related party transactions are approved by the shareholders at the annual general meeting.  Unclear if this is a retroactive approval.
3. There seems to be a significant amount of cross shareholding between IIG and its investments and other related parties. Grand, Gulf Monetary Group,  
4. One would expect no less in Kuwait, I suppose.  And equally one might make the argument that when you've got good business partners, whom you know and trust well, it's just natural to do more business with them.  And the same with investments. 

The Investment Dar – “Out of Breath” in Its War on Many Fronts

Update:  AlQabas had a more upbeat assessment in its Monday 12 April issue.  Here' s the link to my post.

So says AlQabas. 

First, let's review what AlQ had to say. Then some comments.

AlQ cites the following issues:

1. TID's 2008 audited financial report remains "frozen" at the Central Bank of Kuwait which refuses to approve it. Reportedly this is leading to a loss of confidence among many creditors that the restructuring plan will be implemented. 
2. The legal case by AlMasar Leasing – involving debt in excess of KD10 million – poses a threat to creditor acceptance of the restructuring plan. AlMasar is close to the implementation of the judgment in its favor and has obtained a precautionary block on assets sufficient to repay the debt. TID has filed an urgent challenge (motion) to stop the implementation of the order. The Court is reviewing TID's motion. Legal sources say that there are fears that the creditor alliance will disintegrate if AlMasar's judgment is upheld and enforced. That other creditors will see courts as a way to get their money back "early". 
3. The legal struggle with Commercial Bank of Kuwait over Boubyan Bank remains unsettled. AlQ says that in its weekly meeting held right before the end of last week TID took the pulse of the Creditors' Coordinating Committee about a potential negotiated settlement to this dispute. Details were not discussed. The goal was to determine if there were any creditor objections. If not, then TID has a green light to proceed. 
4. Also at the same meeting the CC discussed whether to retain the Chief Restructuring Officer in the coming phase or replace him. Three international firms reportedly have submitted proposals as well as the existing CRO. Details of the four proposals were reportedly not discussed.
   

Now to the comments.

1. Indeed TID has to be a bit short of breath with all the battles it is facing. Clearly, this case is quite different from that of Global Investment House. The key difference is a lack of confidence.   The Central Bank isn't confident in the financials.  Dissident creditors apparently think expensive and messy court cases offer a higher prospect of recovery than the restructuring - though they could be hoping to prompt a buyout by other creditors if they threaten to destroy the restructuring through their recalcitrance.  The rest of the creditors clearly want a monitor at TID.  All this makes for a very fragile situation.  
2. Why hasn't TID's audited 2008 financial report been released? Why is the Central Bank refusing to sign off? Presumably, TID's auditors, the local affiliates of KPMG and PwC, have completed their audit. Unless there is a substantial problem in their opinion (say an adverse opinion or a disclaimer), they have signed off on the "numbers". If the latter is the case, the Central Bank  would appear to be saying it doesn't trust the audit work of two major firms.  Ouch!  This is not just a slap at TID but also at these two firms.  
3. Why doesn't TID just give the Central Bank what it wants?  Quibbling over numbers would seem rather silly when the patient is  barely alive in intensive care.  The rumors are that the Central Bank is demanding additional provisions and reductions in the carrying value of assets. Seems simple to just sign on the dotted line. - whatever the results.  Historical statements from 2008 are just that history.    It's hard to see there being a major impact on the banks.  They have their own advisor's (Morgan Stanley's) cashflow focused analysis on the best path to recovery. And without any audited financials a significant number of them have decided that the restructuring is the "best" deal for them.   And, as I've written before, this looks a lot like a disguised liquidation.   So how would adverse financials change that?  The diagnosis would remain the same.  And the conclusion very likely the same.  A fire sale by a liquidator is not a good recipe for recovery. 
4. It must be is that the additional amounts are so large that they pose a serious problem.  Negative shareholder equity would probably  greatly complicate recourse to the Financial Stability Law if not make it impossible. The FSL is designed to rehabilitate companies.  Not to provide cover for a  liquidation. No clear cut Chapter 7's need apply. Similarly, there could be other problems.  A law that if losses exceed a certain portion of  paid in capital, the firm must raise more or enter formal liquidation.  Sometimes problems like these can be solved by having an Extraordinary General Meeting of shareholders vote to use reserves (share premium, mandatory and voluntary reserves to offset retained losses).  Presumably, if it were that simple a matter then  TID would take the step.   If it's a need for additional new equity, that's probably something that shareholders probably aren't particularly keen to do right now.  So the battle on the financials is to prevent getting into a worse situation.
5. The real issue with AlMasar would seem to be it's formal objection to TID entering under the protective wing of the FSL.  There are other creditor cases out there, e.g. BLOM.  Yes, AlMasar has the "block" on some assets.  But if TID is successful with the FSL won't that solve its legal problems, especially those in Kuwait?  So isn't the FSL objection the key? The AlQ article is silent on this topic. 
6. Also the comment about AlMasar success leading other creditors to similar action is probably correct in one sense.  But, if all the creditors rush for the exit, the ultimate recovery is going to be  affected.   If any bank's creditors and depositors suddenly asked for their money back, no bank could pay them back immediately. Not Deutsche Bank.  Not National Bank of Kuwait.  And TID is very very far away from being in NBK's very strong position. The best recovery is going to come from a controlled process.   Hopefully, the banks have figured this out by now, though I suppose in a panic logic is the first casualty.
7. Boubyan turns not only on the relative strength of the two parties' legal positions but more importantly on the ability of the weaker party to tie the shares up in court for years and years.  In terms of legal advantage, I think the legal definition of the transaction is  critical  If the  original transaction is considered a sale, then CBK owns the shares which it bought at a bargain price.  TID had the opportunity to buy them back but failed to do so.   Tough luck.  Unless in consideration of "equity" the Court allows TID the opportunity to go "back in time" and complete the repurchase.  In which case, it would make abundant sense for the banks to lend TID the money.  Lend $200 million, get shares worth $400 million, sell them to NBK and  put a cool $200 million  extra into TID's estate.  If it is a secured loan, then CBK owes TID  the excess of the realization proceeds from the collateral over the  repayment of the loan.   In which case  the result is the same as the Court sanctioned "time travel" mentioned above.   In terms of waiting, Commercial Bank probably has a less urgent need for the cash than TID.  Luckily for CBK, NBK is running the show at Boubyan so the likelihood of something going really wrong going there is fairly low.  That should put a floor of sorts under the share price - assuming there are no legacy problems from before NBK's stewardship began. And make waiting a bit more palatable, though there are signs that shareholders at CBK aren't particularly happy now - if AlQ's account of the recent OGM is accurate.
8. The debate over the continuing role of the CRO is pretty clear evidence of the creditors' continuing lack of confidence in TID's management. Under the restructuring, they are taking TID's assets into companies they will control (assuming that AlQ's earlier account of the restructuring is correct).  Yet, they still seem to feel they need an on site minder at TID.   Usually in a restructuring the creditors would form a committee to monitor the borrower.  Or perhaps require an accounting firm to do periodic reports to confirm the borrower was discharging its obligations.  Both of these mechanisms on a post facto basis.  That is, the creditors check on the borrower after the fact -  to review its conduct in the last quarter.  It seems that with TID the creditors want a monitor for  "real time" monitoring.  With the assets in separate (from TID) holding companies,  it's unclear just precisely what the CRO will monitor.  Will he run those holding companies?  And how will his position fit in with that of the Central Bank "monitor"?  Especially, since if TID is successful in getting under the FSL umbrella, the Central Bank is probably going to have a monitor  in the company to keep an eye on things.  This isn't a trivial matter since the expense isn't trivial.  The creditors are in effect saying we're willing to pay a price to make sure we keep an eye on TID's management.

Gulf Finance House - Deutsche Bank Converts Another US$5 Million to Shares

GFH announced on the BSE that Deutsche Bank had converted another US$5 million to GFH shares under the convertible murabaha agreement concluded 10 September 2009.  The conversion price is US$0.38 per share. 

The last trading price on the BSE was US$0.245 per share. 

Here's an earlier post that might shed light on this transaction. 

GFH is still not showing any major shareholder on the BSE "Major Shareholders' page" and only has disclosed itself (Treasury shares) and Shamil Bank as holding more than 5% of the shares.

So what's happening to the GFH shares that Deutsche converts?

So far, if my tally is correct, US$55 million out of the US$100 million issue (for which Deutsche paid US$80 million) has been converted.  The issue must have been done for clients of Deutsche Bank since DB is not showing up as a major shareholder in any disclosures I've seen.  Either that or DB is selling the shares as soon as it gets them. 

Ithmaar Bank Rights Issue - Only 52% Take Up

Ithmar Bank announced on the BSE that on 28 March it had held its Ordinary General Meeting of Shareholders.

Tucked in the announcement were the results of its recent Rights Offering. 

“The subscription period ended on Thursday, and we are pleased to report that the rights issue has raised $103 million,” said Ithmaar Bank Chief Executive Officer Mohamed Hussain.  “The Offering was an opportunity for current shareholders to further consolidate their stake in Ithmaar Bank – and the fact that it proved so successful is testimony to our shareholders’ unwavering faith in the Bank’s potential,” he said.

Sounds good.  What wasn't mentioned was that the Offering was for US$199.3 million.  That means a 52% take-up.  Not exactly a roaring success.

Ithmar was hampered by two things:

1. A US$235 million loss for Fiscal 2009.
2. The fact that Bahraini Companies Law does not allow a company to offer its shares for less than par value.  Ithmar's par value is US$0.25 per share.  It last traded at that level on 19 October 2009.  It currently trades at about US$0.19 per share.  A difficult sale indeed.

Ithmar had hoped to raise US$400 million to finance its conversion to a retail /commercial Islamic Bank from an investment bank.  The first leg has not gone so well.  

It's hard to imagine that a US$200 million or US$300 million (if they try to make up the reduced up take on the Rights Offering) mandatory convertible sukuk is going to fly off the shelves.  Unless, Deutsche has another client?

Deutsche Bank v The International Banking Corporation

This post reviews documents submitted in the action commenced by Deutsche Bank against The International Banking Corporation in the Supreme Court of New York (Case Index # 601471/2009). This case has been stayed following TIBC's filing of a petition under Chapter 15 of Title 11. Chapter 15 provides for USA recognition of insolvency or reorganization legal proceedings in other countries.  When that recognition is given then all legal proceedings in the USA are stopped pending the outcome of the foreign case.

As before I recommend that you review the documents yourselves. You can do this by going to the NY Supreme Court website and using the above Case Index Number to search. As you progress from page to page, look for the button for e-filed documents. This earlier post has some instructions on how to navigate the NYSC website.

While this case has been stayed, it does provide a bit of additional information, though this is more just on the existence of the debt.

Here are DB's allegations:

1. On 6 April 2009, DB and TIBC entered into two equal forward US$/Sterling foreign exchange transactions.  DB was obligated to pay TIBC US$59,762,440 and TIBC to pay DB Sterling 40,000,000 value 8 May 2009. 
2. These were not "split" value date transactions. Both parties were to settle on the same day. So there is nothing unusual. These appear to be "garden variety" forwards. 
3. DB delivered on its side of the transaction by paying the funds to TIBC's account at HSBC New York. 
4. TIBC did not pay the Sterling DB.
   

DB is claiming a total of US$74,232,440. 

1. This is equal to the US$ side of the defaulted FX forward plus termination fees estimated at US$14,470,000. 
2. There isn't a detailed explanation as to how this latter amount was calculated. I presume it refers to DB's cost of closing out other forward FX transactions with TIBC and represents the difference between the contractual rate with TIBC and the market rate at closeout. 
3. Clearly, since TIBC has defaulted on the two 8 May settlements, DB has no desire to make additional payments since it believes (and probably rightly so) that TIBC would not honor its side of these transactions. 
4. The dealing relationship between the two banks is documented by an ISDA Master Agreement which gives either party the right to terminate any outstanding deals if the other to the agreement fails to perform. The Master Agreement also provides that the defaulting party must pay the "break" or "replacement" costs of outstanding deals which the other party cancels as a result of the default as well as any legal costs related to enforcement of the MA.
   

There's not a lot more to note here.

Gulf Finance House -The Curious Cases of the US$100 Million Deutsche Bank Murabaha and The 4Q09 Purchase of US$35 Million in Treasury Shares

In an earlier post today I noted that Deutsche Bank had converted another US$10 million of its US$100 million murabaha bringing the total converted to US$50 million.  Since the conversion was being done at US$0.38 per share and the market price is much less, I wondered what the economic motive for such a transaction could be.

This seems to be a more complicated issue than I originally thought.

Let's rewind the video tape and go back to that magical date of "2 November/2 October 2009".   GFH announced that it successfully raised US$300 million in a rights offering and would soon have announcements that it had raised "US$450 million in fresh capital in just over a month".

On 15 November 2009, it announced that it had successfully placed a US$100 million convertible murabaha with Deutsche Bank.  "The announcement is the latest success in the broader GFH liquidity and capital management plan that includes rights issue subscriptions of over US$ 300 million dollars, the partial sale of Qinvest to Qatar Islamic Bank for approximately US$ 51 million and the planned placement of the first US$ 100 million convertible murabaha with Macquarie Group."   While the placement with Macquarie didn't go forward, not an inconsiderable achievement for one month's work.  Recall that the issuance of the convertible occurred before made its first of several downgrades of GFH.  At that happy time GFH was rated investment grade.

In Note 16 to its 2009 financials  GFH states that the proceeds of the US$100 million murabaha were US$80 million.  Right about now if you're like me, you're wondering what happened to US$20 million from the US$100 million deal announced.  That certainly was the impression I took from GFH's earlier press release.  They had obtained financing of US$100 million.  US$100 million of new cash from the fine people at DB.

So where is the "missing" US$20 million?

Is it the requirements of IFRS which makes one strip out the embedded option in the convertible?  But then  the US$20 million should be reflected somewhere else on the balance sheet.   I can't find it.  I do see US$1.226 as the equity component of the transaction.  But that still leaves a lot unaccounted for. And one might not use the word "proceeds" in describing this transaction.  The proceeds would have been US$100 million.  So this probably isn't the case.

Was this a murabaha facility of up to US$100 million?  That is, is the US$100 million the aggregate amount which DB can take down in several tranches?  The term "proceeds" might be used in this case, but one would expect that surely if this were a partial drawdown, it would have been disclosed.   كلام شريف  would be the operative phrase I think. 

Or did GFH issue a discounted instrument?  That is, the face value of the instrument issued reflects the cash to be paid at maturity for both principal and interest.  If one takes US$80 million at 8% per annum for three years, the future value is over US$100 million.   But I'd note the period appears to be less than three years: the announcement was 15 November and the maturity is 12 October 2012.   But then this can't be the case because wouldn't  كلام شريف  require that the bank say it had placed US$80 million rather than say it had placed US$100 million?  Or clarify that this was a discounted instrument? After all one doesn't typically count the interest on a non discounted bond as part of the capital raising.  It would seem to me that an issuer would want to be very clear as to just how much was raised, especially if iitwere in the "red zone" in terms of financial condition,

So, maybe I'm missing something here.  Or maybe GFH's disclosure is a bit incomplete.  

Anyone out there with the answer or an opinion, please chime in.

That leaves one more curious item:  GFH's 4Q09 purchase of US$35 million in Treasury Shares.  And to my mind this one is much more perplexing than the DB murabaha.

During 4Q09, GFH bought 93,806,001 of its own shares at an average cost of about US$0.37 per share. (For those of you who care, at the beginning of the year it held 8,448,808 shares purchased at an average cost of US$2.06 clearly from much happier days). GFH did not purchase any Treasury Shares in the First, Second or Third quarter of 2009.

Now this purchase is really hard to fathom: 

1. GFH acknowledges it has a liquidity problem - revenues are way down and upcoming debt maturities loom.  And this problem is at its highest point of intensity during 4Q09 - a time when no doubt GFH either has decided or has some inklings of the massive provisions it is going to take and the rather severe loss it is about to report.
2. GFH is required under its US$1 Billion Sukuk  Program to maintain US$400 million in consolidated tangible net worth.  GFH wound up at year end 2009 with roughly US$433 million in consolidated tangible net worth.  (The  US$17 million in good will at year end 2008 was written off in 2009.)  US$433 million doesn't appear to leave GFH with much breathing space relative to this covenant.  And a breach of this covenant could trigger an event of default and a potentially life t threatening acceleration of the maturity of the Sukuk (US$302 million outstanding at year end 2009).  
3. At the end of 2009 GFH had Basel II Capital Adequacy ratio of 12.91% dangerously close to the Central Bank of Bahrain 12% threshhold.  A fact that caused its auditor to raise an "emphasis of matter" in its audit opinion on the year.  Note a very rough calculation indicates that if GFH had not purchased these Treasury Shares, its CAR would be close to a very much more comfortable level of 14%.  A low CAR attracts all sorts of perhaps unwelcome attention from the Central Bank of Bahrain.  Potential restrictions on new business.  As well as demands for immediate remedial action.

So considering all these factors, what could be the possible motive for GFH  to buy Treasury Shares? 

This act weakens liquidity. It weakens its Basel II Capital Adequacy ratio.  And it leaves it potentially close to a breach of a covenant on a US$302 million outstanding Sukuk at a time when it is struggling to reschedule 2010 maturities.  All the more surprising because the Sukuk matures in 2011 and has a relatively benign  profit or interest rate on it - when compared to the market price for GFH debt. 

And that's why I wonder if somehow these two curious cases are connected.  It's hard to understand why one would decapitalize the bank at the very time that capital and liquidity are required.

Gulf Finance House -Deutsche Bank Converts Another US$10 Million to Shares - Stealth Exit from GFH?

 

GFH announced on the Bahrain Stock Exchange today that Deutsche Bank had converted another US$10 million of the murabaha to shares in GFH.  That's another 26,315,789.

Since the conversion was done at US$0.38 per share and GFH's shares are trading at  US$0.25 on the BSE and about US$0.01 to US$0.02 more per share on the KSE, it's seems logical that this conversion is a way for DB to exit its exposure to GFH.  

That's at a 28% to 32% discount.   And that frankly conversion doesn't make much sense.  If one wanted to make a "wise" investment in GFH shares, one could buy them on the open market now and when one got repaid from the murabaha have roughly 30% more shares.

I'll be waiting to see the 31 March 2010 financials to see if GFH has increased its Treasury shares in 1Q2010.

At this point based on previous announcements I've seen, DB has converted US$50 million in total for 131,578,946 shares which would give them just a whisker less than 7% in the bank which should require they be disclosed as a major shareholder.  Earlier post here.  As of today they are not shown as a major shareholder on the BSE website.  But then neither is the 26 November downgrade of GFH by S&P (the first of several downgrades) yet reflected on GFH's website.

And on that basis assuming that DB is still holding all the shares it converted it would have a paper loss of US$13,815,790 (assuming a current share price of US$0.275).   Hard to believe that DB would keep piling on loss upon loss.  This has to be a way to get out of the credit for them.

Gulf Finance House - Update on Rescheduling US$300 Million West LB Facility

AlAnba'a Newspaper (Kuwait) reported the following on 8 February:

1. The West LB-led syndicate had agreed to GFH's request to reschedule US$100 million of the $300 million due 10 February for six months.
2. GFH and West LB were in discussion about a US$50 million Sukuk with a two year tenor (maturity  June 2012).
3. Last week GFH was in discussions with various private sector parties in Kuwait and the Gulf seeking a US$100 million loan to be secured by real estate and shares.  (Note most of GFH's facilities are so secured). These were undertaken as a back-up to the West LB discussions. Status of these negotiations is unclear - whether they achieved anything and whether or not they are continuing.
4. Whether repayment of the US$100 million will come from GFH's capital increase last year or from expected profits from GFH's investments (which AlAnba'a says were US$500 million last year).

Today GFH issued an announcement in reply to a request from the BSE about the 8 February article denying that it was in discussion with West LB over a new US$50 million Sukuk.

Some thoughts:

1. First it's a pretty good assumption that GFH is on the "watch list" by the authorities.  A press report is published in Kuwait on 8 February.  The same day the BSE writes to GFH asking for a clarification.  This enhanced supervision is a major takeaway.  The regulators are concerned about GFH's situtation.
2. Second, it's probably not unreasonable to assume that if GFH were sitting on a pile of cash, the West LB lenders would insist on full payment of the amount due them tomorrow.  So where did that US$450 million go?  Well US$200 million is going on Thursday. No responsible institution is going to pay away all of its cash.   There are bills to pay.  GFH has been running about US$35-$40 million in operating expenses per quarter, though this will now come down as the US$200 million payment will reduce interest expense.  Balance that against cash inflows and you'll see the need to conserve cash:  revenues have pretty much dried up.  In 3Q09,  operating revenues were a paltry US$5.9 million.  And you'll recall I had raised earlier the perplexing fact that Deutsche Bank was converting its facility into stock in GFH.  Could that have been related to a cash outflow? When Fiscal 2009 financials and 1Q10 financials are released, we'll be able to understand better GFH's cash position and what the cash was used for.

Gulf Finance House - US$300 Million Syndicate Negotiations in Process - Default Looming?

The press is full of speculation that GFH is negotiating with West LB over an extension of all or part of its US$300 million loan which is due for payment 10 February.

The company had not previously commented on the rumors in the market and so this morning the Bahrain Stock Exchange temporarily suspended trading.

GFH issued a rather anodyne press release today which provides the following information:

"In reference to a recent news article, GFH would like to confirm that it is having discussions with West LB (the syndicate manager) in London in relation to the terms of its syndicated facility. GFH further confirms that it will immediately announce the results of such discussions in line with the disclosure requirements of the Central Bank of Bahrain and Bahrain Stock Exchange. The total amount of the facilities, the terms of which are under discussion, amount to $300 million due on February 10, 2010.”

At this point while all details are not available, it's a pretty safe guess that GFH is not negotiating with West LB over whether it will make full repayment via check or wire transfer.  And there would be little need for a covenant waiver (motivated by a ratings downgrade) if payment is going to be made within 8 days.

The press release is also yet another example of "disclosure" by a "Shari'ah-compliant" financing institution.

I guess when you're Shari'ah compliant you adhere to a different but much higher standard of rules.

Reminds me of another "Islamic" bank that capitalized just six and one-half years of pre-operating expenses when it opened which were used to give those who "incurred" these "expenses" some $10.2 million in equity (9.2% of the shares) in the Bank.  I asked an accountant at the firm that audits them  what accounting principle justifies the capitalization of six and one-half years  pre-operating expenses.  He responded it was "Islamic" not conventional accounting and since he only audited conventional banks, he couldn't really answer my question.  The Bank also paid cash US$12 million in fees to consultants and others in connection with the raising of the equity.  Since only US$101 million was actually raised from third parties, the cost of raising the equity was just short of 12%.  Of course, one would have to compensate someone for raising equity in an "Islamic" bank since that was quite a "hard" thing to do when the funds were being raised.  If on the other hand, there was great excitement in the GCC about stocks and the markets were booming, then it might seem exorbitant.  As they say, "God knows".

And for those of you tracking the performance of Deutsche Bank's investment in GFH which they purchased at US$0.38 per share.  The closing price of GFH is US$0.29.  With over 105 million shares, that translates into a paper loss of  roughly US$9.5 million.

That assume of course, that DB is "still holding".  They might have sold.  

Some speculation.  If I saw a rescheduling coming and had a chance to get out, I would.  The shares offer a convenient way out without creating any messy footprints.  Convert debt to shares, then sell the shares.   There is sufficient volume in the Kuwaiti market that one could do this quite easily over say a couple of weeks.  If there is a loss, it appears in one's financials as a trading loss not an impairment or provision on a loan. One might face an ethical dilemna if one's clients were in the credit.  Whose portion do you self first?  The clients?  Yours?  Pro-rata?  As noted above, this is one option a creditor might take in a deteriorating credit.  There is no reason to suspect that Deutsche Bank is engaged in this sort of behavior, which by the way would be perfectly legal. 

UAE Noor Bank Calls for More Support For Banking Sector - Central Bank Says Not Now

 

Today's The National quotes Hussain al Qemzi, the chief executive of the Dubai-based Noor Islamic Bank as saying that UAE banks need another AED20 billion (US$5.4 billion) to AED 25 billion  (US$6.8 billion) to help shore up their financial positions.  The Federal Government has already provided some AED 120 billion (US$32.7 billion).  It's unclear if Mr. AlQemzi is calling for a capital (equity) injection or additional liquidity support.

To put his request in context according to the 31 December 2009 statistics published by the Central Bank of the UAE, total bank equity at year end (before current year profits) was some AED231.4 billion (US$63.1 billion).  And monthly provisions are running just over twice the lower amount (AED 20 billion).

In a separate article the Governor of the Central Bank of the UAE was quoted as saying at the opening of Deutsche Bank's Branch in Abu Dhabi: "There is no need for more liquidity injections for the time being," Al Suwaidi told reporters. 

Same market, two views.  

It would be interesting to know what the basis for Mr. al Qemzi's view is.  That is, how he got his precise figure.

Deutsche Bank Converts US$10 Million of Murabaha Loan to Gulf Finance House Shares

GFH announced on the Bahrain Stock Exchange today that DB had converted US$10 million of the earlier US$100 million murabaha financing it had provided GFH into shares.  DB will receive 26,315,789 shares.   This is in addition to its November conversion of US$30 million into 78,947,368 shares. Unless I've missed a conversion, DB now owns 105,263,157 GFH shares.

That would give DB roughly 5.7% of GFH.

DB may be building a strategic stake, though if this is the case it has a long way to go.  It may have a client interested in GFH.  Or it may see the shares as a trading investment.   GFH is listed on the Bahrain Stock Exchange, Dubai Financial Market, Kuwait Stock Exchange (Ticker 813), and the London Stock Exchange.

If it is a trading investment, liquidity will be important.  Let's take a look at how GFH trades on these four markets.

On the BSE, during 2009, the average monthly trading volume in GFH was roughly 5.6 million shares and the average monthly US$ value of US$4.3 million.  In only six months were more than 2 million shares traded.   In 2008 roughly 80 million shares were traded (1.2x 2009's volume) for a total value of US$234 million.  That's roughly just short of 9 million shares a month and US$20 million per month.  Yesterday (18 January) less than 900,000 shares were traded with the largest ticket 220,000 shares.

The story on the Dubai Financial Market is better but still in the "cold comfort" zone.  In 2009 257 million shares traded with a total value of AED417 million (roughly US$114 million).   This is 3.8 times the BSE volume and 2.2 times the value.   But it's not just a question of number of shares and values, it's also a question of frequency of trades.  In 2009 GFH's shares traded on just 80 days.   In 2008 the trading volume was a negligible 1.2 million shares for AED 16.6 million (roughly US$4.5 million) with 74 trading days.  GFH listed on the DFM - I believe - in mid 2006.

Trading in GFH's GDRs on the London Stock Exchange is even more modest both in volumes, values and days traded.

At this point, there is scarcely enough liquidity to deal with DB's position.

But, the story is thankfully quite different up North.  On the Kuwait Stock Exchange, during the first six months of June 2009 (The last report published by the KSE for 2009 is June.  Unclear what why no later reports were issued) some 3.32 billion GFH shares changed hands for KD1.65 billion (US$5.76 billion).  Yes, that's not a typo.  It's billions not millions.  Trading is daily and in substantial amounts.

How's DB's investment been doing?

Well it depends on which part of the glass you focus on.

DB acquired its shares at US$0.38 per share as per the terms of the Murabaha financing.

GFH's closing price yesterday (18 January) was US$0.345 per share.  That translates into a paper loss of US$3.7 million or a -9.2% return from inception.

If one is an optimist, one would note that yesterday's close was up US$0.03 from the previous day, resulting in a gain of roughly US$3.2 million.  Or more precisely a reduction in the loss from inception from US$6.8 million to US$3.7 million. (Rounding).

A bit of trading/price history:  at 31 December 2007, GFH traded at US$3.35 per share and at 31 December 2008, US$0.92 per share.

Gulf Finance House Bahrain Makes US$300 Million Provision for Dubailand / Legends Project

GFH issued a press release earlier today in which it advised that it had made a US$300 million provision for its investment in the Legends Project - part of the multi billion US dollar "Dubailands" complex.

GFH was one of the pioneer developers of mega real estate projects in the GCC - Bahrain Financial Harbour - benefiting it is said from business relations with important personalities.  From Bahrain it quickly spread its wings across the MENA region with similar projects and then beyond.  It's specialty was what it billed as "infrastructure development".

The business model was the typical "Islamic" banking mark-up model and GFH generated some 80% of its income from these projects.

Before the global problems of 3Q08, the bank was beginning to try and diversify away from over dependence on real estate.  Since then, the bank has been struggling to develop a new business model.  This is evidenced by the comment in the press release on Dubailand.  When a firm starts talking about the disposal of "non core assets", it's a pretty good bet (though not 100% certain) that there are problems in the business model.

That being said, it successfully raised US$300 million in new capital this "2 November/October", a US$100 million convertible murabaha transaction with Deutsche Bank 15 November, plus an earlier sale of the bulk of its shares in QInvest (Qatar) plus an planned $100mm convertible murabaha with Macquarie.

As a result the bank has increased its liquidity, though it faces debt maturities of US$350 million in 2010, US$100 million in 2011 and US$175 million in 2012.

Recent changes in management are probably related to the change in strategy as well as strengthening of the management team.  The previous CEO was only in place five months before departing.  It's  probably worthy of comment that his successor though as Acting CEO,  Ted Pretty, was previously with Macquarie.  Here's his bio from his earlier appointment.

The International Banking Corporation Bahrain Files For Chapter 15 Protection in Manhattan

Bloomberg reports that TIBC has filed under  Chapter 15 of Title 11 (Bankruptcy) of the US Code seeking protection from creditors.

As pointed out in the article, Deutsche Bank and Mashreqbank had obtained orders of attachment against TIBC assets in the USA.

Through this filing, TIBC seeks to provide legal protection against those two banks and any other creditors who might try to seize its US based assets.

Not surprising.

Two bits of news in the article.

1. First, for those who may have missed the news earlier: Ernst and Young has been engaged to investigate the business of the bank.  This relates to the allegations by AlGosaibi that Mr. AlSanea was engaged in improper transactions with the assets and companies of the AlGosaibi Group.TIBC's auditors are PwC.  Also Awal's.
2. The filing also reported assets of US$ 4 billion and liabilities of US$2.6 billion as of 31 July 2009.  At FYE 2008 (the last officially issued financials) the comparative numbers were US$3.8 billion and US$2.5 billion.  One would expect that financials would have been updated for any dimunition in value unless the nominal value of assets is being reported.
   

Deutsche Bank - No Exposure to Dubai World

As per Reuters, Henry Azzam disclosed at a conference today.

Restructurings & Islamic Financing - Part 1

No, this post isn't a reflection on Surah Al-Baqarah Ayah 280, though perhaps that would make an appropriate topic for a future post.

Rather it's about some of the wrangling that has occurred about the legal nature and thus the legal status of "Islamic" deposits and loans versus those of conventional banks to borrowers in corporate distress.

As you might expect, in such situations legal status matters quite a great deal as it affects the payment of obligations.  At these critical times, creditors are looking to maximize the recovery of their obligations.  Borrowers are looking to avoid being needlessly harmed.  At that point the law can be a convenient tool to protect one's interests (and principal too!).  This is also usually the first time the parties to the transaction have really seriously focused on legal issues.

Because of the teachings of the Islam (prohibition against interest as well as other matters,) Islamic financings have different structures and thus different legal documentation than non-Shari'ah financings.  Many of these structures are of recent invention and application.

By contrast, even in the Muslim world, non-Shari'ah financing instruments have been used for a long time.  Therefore, they have been tested in a variety of court cases from simple breach of contract to corporate distress situations - reorganization, administration, and liquidation.   The  law is fairly well defined and ample precedent exists in common law countries.  Where the civil code prevails, the code has been amended, as necessary, in the light of experience.

By contrast Islamic financings have not yet been rigorously tested, particularly in the furnace of corporate distress and bankruptcy.  This is changing.  Two recent defaults on Sukuks (The Investment Dar and Sa'ad Group) will be the test cases (sorry for the pun) on this instrument.   Other defaults (Bahrain International Bank in 2002, The Investment Dar in 2009, etc) have tested and will test other Islamic financing structures.  But this process has only begun.  The robustness of Islamic financing structures will only be established after several rounds of such testing.

This post (the first of a planned series on this topic) will deal with short term financing.

To focus the discussion on what I hope are key details, I'll look only at financial institution distress.

When an Islamic financial institution wants to lend funds to another financial institution, it does not place a deposit as say Deutsche Bank might with HSBC at least not in the outward form.  But both place a sum of money for the same tenor and earn the same interest rate.

Two structures are commonly used:

1. Wakala
   
2. Murabaha
   

To place the discussion in context, let's first review a conventional non-Shari'ah deposit.  The depositor places funds with the bank and is paid an agreed  interest rate.  The bank takes the depositor's money and funds a loan, an investment, etc.   The bank's obligation to repay the deposit is completely separate from the performance of the asset (loan, investment, etc.)  If the bank makes a duff loan, it still owes the depositor his money back.

Islamic deposits take a completely different legal form.

Under a Wakala (fiduciary) contract, the bank acts as the client's agent (Wakil) in selecting an investment to be made with the funds.  The client is the principal (Muwakkil) in the investment transaction.  Therefore, repayment of the client's funds is conditional upon the performance of the asset.  If the investment turns out to have been bad, the client  loses his money, unless the Wakil  has been negligent.

This form of Islamic deposit appears equivalent to a non Shari'ah trust account.  Based on that legal interpretation, it would not be part of the assets of the bank.   In the event the bank went into liquidation,  those assets would not be part of the bank's estate in bankruptcy.

By contrast  the assets funded by a conventional deposit would be part of the bank's estate.  And  the proceeds from those assets would  be shared among all creditors according to their legally established priority for repayment.

Under a Murabaha (cost plus financing) arrangement, the bank (the Purchaser) and its client  (the Seller) agree to trade goods - usually commodities.  The bank acts a purchasing agent for the client, buying commodities (often non precious metals) from one party and arranging a forward sale of these commodities to another party on behalf of the client with payment to be made on a deferred basis.

If you relate this structure to a conventional deposit, the time between the spot purchase and the deferred payment is the tenor of the deposit.  The difference between the cost of the purchase of the commodities (the deposit) and the deferred sales price (cost plus profit) is the profit margin.  In conventional banking this would be called the interest.

Now let's take these two concepts into the world of corporate distress.

First, Murabaha transactions.

When Bahrain International Bank ("BIB") encountered problems in 2002, its creditors' initial assessment (which by the way turned out to be too pessimistic, I am told) was that  they would recover  only 15% of the face value of their obligations.

As one might expect,  this concentrated a lot of minds that previously had apparently been highly unfocused on credit and legal issues.  Some clever non-Shari'ah creditors came up with  a way to get their claims preferred over the Islamic creditors.  If successful in this endeavor, they would enhance their recovery to 25% to 30%.

How could they do this?

Most legal jurisdictions have a special bankruptcy regime for banks which gives depositors and lenders priority over certain other creditors.  Some of the conventional banks argued that the Murabaha transactions were sales and purchase contracts not deposits.  And, thus, their own deposits should be paid first with any money left over (the expectation was there would be none) used to settle these non deposit "commercial transactions".  As you can see from the structure and legal contract described above, there is some merit to this argument.

For their part, the Islamic banks vigorously defended their transactions as deposits.  To do otherwise would be to take a loss.

The Central Bank of Bahrain refused to entertain the non-Shari'ah creditors' argument.  The Murabaha transactions were treated as deposits.  Whether this was solely a legal decision or whether public policy considerations (preserving Bahrain as an Islamic banking center) played a role is not clear.  Given the language in the Murabaha contracts, one could well imagine the basis for  a contrary decision.

Now, let's look at Wakala transactions, where the shoe is on the other creditor's foot.

Currently, The Investment Dar Kuwait ("TID"), an Islamic investment firm, is in the midst of a  very difficult KD 1 billion (US$3.5 billion) restructuring. Some Islamic banks and other creditors which have placed funds with TID on a Wakala basis are arguing that these are really fiduciary transactions.  Therefore, they are not part  of TID's assets.  As such, they should not  be shared with creditors of TID.   Rather they   should be returned immediately to the Islamic banks.  An article in the 11 October issue of AlQabas includes language which suggests that this interpretation is supported by the Central Bank of Kuwait ("CBK") 

As an aside, AlQabas is a newspaper.  It is not the CBK.  Nor is it a court of competent jurisdiction.  Time and proper authority will determine the status of these transactions.

Given that often the most bitter fights in a restructuring are among creditors themselves rather than between creditors and the borrower, the BIB and TID stories suggest potential areas of dispute between Islamic and non-Shari'ah creditors.  And depending on the particular structures used apparently ammunition for each side to get its claims preferred.