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.

India: Moody’s and ICRA See “Subdued” Prospects for India’s Banks

Sometimes Even When You See Something Clearly, You Think It Wise to be Indirect

Just when I was recovering from The National Bank of Ukraine’s festival of euphemisms about PrivatBank, along come Moody’s and its Indian affiliate ICRA to once again remind AA that his attempts are easily upstaged. 

In a report released on 9 January, Moody’s and ICRA summarize their conclusions about the country’s banking sector with the phrase “see subdued prospects for India's banks“.

Why is AA “skeptical” and inclined to a stronger term than “subdued”?  Perhaps “dismal”?

Three factors.

First, Indian banks—particularly public sector banks or PSBs—have a reputation for under-reporting NPAs.    Favorite techniques were refusal to recognize NPAs, disguising bad loans via restructuring and/or making new loans to pay interest on past due loans.   Former RBI Governor Raghuram Rajan launched a “crackdown” in 2015 to curb under-reporting of NPAs. 

Performance suffered.  The decline was chiefly due to increased provisioning in 2016 and the related impact on net interest margin.   According to RBI’s Report on Trends and Progress of Banking in India,  Operations and Performance of Scheduled Commercial Banks Table 2.1, banking sector return on assets for 2015/2016  was 31 bp and ROE 3.59% compared to 2014/2015’s ROA of 81 bp and ROE of 10.42%.   Public Sector Banks—some 70% of banking assets--fared even worse with negative ROA and ROE in 2015/2016.  

Second, Indian banks have also traditionally under-reserved their declared NPAs with provisions averaging roughly 40% of total NPAs.   According to RBI Handbook of Statistics of the Indian Economy Table 65, 2015 reserving levels were at 46%.   Unreserved NPAs were some 20% of 2015 capital (Table 64). 

It’s hard to tell what happened in 2016.  Much higher provisions were taken, but more loans were recognized as NPAs and restructured loans are now to be included in that figure.  What’s the net effect?   

Sadly, RBI data on NPAs is available with a roughly 12 month lag.   See Table 65 in the RBI’s “Handbook of Statistics”.  Latest figures are from September 2016.  Other RBI reporting has detailed bank-by-bank analysis but the latest data appears to be March 2016. 

Without RBI statistics on both NPAs and provisions, it’s not possible to determine if the provision coverage has increased because both NPAs and provisions have increased.  

Third, low provisioning levels are particularly important because NPA recovery is traditionally very low in India.  According to RBI’s Report on Trends and Progress of Banking in India,  Operations and Performance of Scheduled Commercial Banks, Table 2.2,  in 2016 Indian banks recovered roughly 10% of NPAs versus 12% for the previous year.  

What this means is that recoveries are unlikely to make up provisioning shortfalls to any meaningful extent.   Provisions then are more critical than in jurisdictions where average recoveries are in the 40 to 50% range. 

It’s hard for AA to imagine that during 2016 Indian banks cured decades of bad practice and bad underwriting.  Trump Tower like Rome wasn’t built in a day, though it is by some Twitter accounts better.  And banking sector cleanups generally take more than a single year. 

Moody’s/ ICRA seem to agree. In their press release, they project single digit ROE for 2017 and 2018 and note large capital needs particularly among PSBs. 

A case of JPMorgan “Jakarta” fever?  Or euphemism?  

And finally a tip of AA’s enormous tarbush to ICRA SVP Karthik Srinivasan for combining “dent” with “profitability matrices”.  See link to Moody’s / ICRA press release. Shabash!

Gulf Finance House - Draft Terms on New Sukuk = 23% Annual Return

 Choose Your Door Carefully.  Some Deals are Better than Others.

As you recall, GFH announced with great fanfare its plan to raise up to US$500 million in new capital.  If you don't, here's an earlier post.

I've just gotten a copy of the draft term sheet for the Sukuk from a reliable source.

First, a recitation of the terms:

1. Type - Convertible Murabaha Facility
2. Status - Senior Unsecured Debt
3. Maturity - 3.5 years
4. Profit Payment (aka Interest Rate) - Indicative 12% per annum!
5. Conversion Price - US$0.31 per share
6. Incentive Structure - If conversion election made before 31 December 2010, last 2.5 years Profit Payment in shares at US$0.31 conversion price.

Before the commentary, two very important caveats:

1. GFH's shareholders have not approved the issuance.  GFH's first OGM and EGM failed for lack of a quorum.  
2. The terms sheet is marked "indicative" meaning it's not binding, but rather serves as a basis for discussion/negotiation with potential investors. 
3. Nonetheless, these terms provide a window into what GFH's board and management believe will be necessary to secure investor interest.  In that regard, I'd note that the accompanying investor presentation (a future post will comment on that) states:  "Some commitments already received from Chairman, strategic investors, and related parties".  So you can be pretty sure that GFH has drawn on these disinterested parties to set market-based terms.

Now to the commentary.

1. Assuming a take and hold investor who does not elect conversion until after 31 December 2010, the promised return (IRR basis) is roughly 23% per annum. 
2. 12% of that return composed of cash (the "interest payments").   It's hard to see GFH earning sufficient returns to have much left for shareholders after the interest payment is made.
3. 11% of that from the discount on the shares (assuming the shareholders approve the 1:4  reverse split and GFH trades at 4 times its current US$0.125 per share.  A rather substantial dilution of existing shareholders.
4. The total promised return reflects the weak financial condition of the company when it has to offer essentially private equity like returns for its debt.  Of course, the actual return will depend on GFH's performance which may indicate a market judgment on the probability of such performance.
5. It also establishes what might be considered an "unfortunate" benchmark for GFH's debt issues. Particularly, when one considers this is apparently an early offer to potential investors.  And as we all know the first price in the suq is not the last.

Gulf Finance House to Ask Sukuk Holders for Three Year Extension

Reuters is quoting an unnamed GFH spokesman that the Bank intends to ask the holders of its US$200 million Sukuk issue (US$137 million outstanding) to roll the Sukuk on its original terms for three years.  That is, to extend the maturity from 2012 to 2015.

I'm not sure if "chuzpah" is an Islamic banking term, but it would sure seem to apply here.  The Sukuk is currently trading at around just a whisker over 50% of face value.

I'd also note that earlier this week GFH formally stated that it had not issued the information the Gulf Daily News report that it intended to either (a) sell assets to  US$90 million in debt next year or (b)  reschedule debt.   If you recall the original GDN article, there was a third alternative mentioned - which was extinguishing debt via asset transfers.  Interestingly enough, what is mentioned in the GDN article is precisely what I see  on page 13 in the copy of GFH's October 2010 "Return to Growth" Presentation to investors which I recently obtained. 

It is, I suppose, indeed sad that someone is issuing presentations using GFH's highly respected name in such a fashion.

As to pricing for GFH debt, please see my soon to be issued companion post on the draft terms for GFH's proposed new Sukuk.

Damas - New AED 614 Million Agreement with Abdullah Brothers

Damas announced on Nasdaq Dubai that it had revised its agreement with the Abdullah Brothers regarding the amounts they owe to Damas.

One key item is the fixing of the price of the 1,840,250 grams of gold the Brothers stole from the Company at AED 256 million.

Presumably, this has been set so that Damas is not disadvantaged.

Setting the amount owed is a key step.  Collecting it may prove a bit more difficult.

Gulf Finance House 3Q10 Financials: A Train Wreck

Studio Lévy & fils  1895
When You Turn the Corner Make Sure the Track Goes There

Get out your magnifying glasses and join me in reading the full 3Q10 financials that GFH submitted to the Dubai Financial Market Wednesday morning. Since I've got my soapbox out for a later tirade, I might as well take this opportunity to suggest to the  DFM that they invest a few dirhams in upgrading their electronic imaging system for faxes they receive. There really is no good reason in this day and age that the output cannot by A4 size.

Looking at the financials we see from Note 12, that GFH's US$115 million loss was primarily caused by provisions. Some US$101 million of them. But not provisions for investments. Rather US$60.5 million for an investment banking service receivable. And US$36 million from the sale of investments. I guess if one sells assets of "volatile" quality, one might expect some "volatility" in the receivables from the sales.

That being said, GFH has continued to maintain in its Other Assets the US$134 million "magical asset provision" and US$161.8 million in "Financing to Projects".

Another unfortunate trend is operating income which is running US$60.7 million negative for the first nine months of 2010 as compared to US$36.7 million for the comparable period the previous year. This is due to a collapse in revenues. On the cost side GFH has actually done quite nicely in bringing costs down.  But, if one can't pay the light bills from operations, it's hard to see a bright future.

As a result of the net loss, GFH's CAR has slipped below the 12% minimum set by the CBB. In the financials, KPMG coyly states in Note 2: 

"Further, the capital adequacy ratio of the Group as at 30 September 2010 was below the minimum required by the regulatory ratio …"

No quantification is given. We don't know if GFH just missed the ratio and has a CAR of 11.99%. Or, if it's CAR is 1.9%. You might think that the auditors would consider it important to quantify this shortfall. It certainly is a bit of "material" information that stakeholders would like to know. And more importantly should know.

If like me that's what you think, you're disappointed by KPMG's apparent lack of action on this point. They were silent on this topic. And they did not force GFH to disclose this information in a note to the financials. It's unclear if this is due to desire not to embarrass its client. Or slavish adherence to some accountant's taqlid as to the wording used for "emphasis of matter".

Note to Central Bank of Bahrain: It might be a good idea to specify in Module PD that when the CAR regulatory threshold is breached, the Licensee state the resulting ratio with details of the calculation. And if anyone from the CBB is reading this, I'd reiterate my earlier suggestion that Module PD be amended to require that Licensees report on the BSE the more detailed of (a) what Module PD requires and (b) what they are required to report on other exchanges. There is no reason that Bahraini investors should get second rate incomplete information which is available to investors in Dubai or elsewhere.

We don't have all the information required to calculate GFH's CAR at 30 September 2010. But we can make some estimates which should give a pretty good directional sense of the CAR.

The Table below summarizes these:

	30-Jun-10	Case A	Case B
Regulatory Capital	US$   363,220	US$   248,220	US$   114,229
Total RWA	US$2,811,417	US$2,683,417	US$2,549,417
CAR	12.92%	9.25%	4.48%

Notes & Assumptions:

1. 30 June 2010 CAR is as per GFH's Basel II Pillar 3 Disclosure. 
2. The key assumption is that there is no real significant change in Regulatory Capital or Total Risk Weighted Assets (Credit, Market and Operational Risk) except for the adjustments specified in the two "cases". These adjustments are made from the 30 June figures reflected above. This is a simplifying assumption so the ratios derived will not be exact but should be "close enough" to get a good sense. 
3. Case A: US$115,000 (the 3Q10 loss) is deducted from Regulatory Capital and US$128,000 is deducted from Total RWA at 100%. 
4. Case B: US$134,000 (the "magical asset" provision) is deducted from both Regulatory Capital and Total RWA. And again at 100%.

And if you have any doubt about the realisable value of any of GFH's other assets, like those Project Financings which may very well be to the same firms whose financial condition caused their bankers to pull the GFH guarantee, it's not too much of a stretch before the CAR is negative.

The results are to say the least not encouraging. It's hard to see how even the "Prettiest" words could convince even the "wisest" of investors to put equity into this firm.

The Gulf Daily News is reporting that they've seen a GFH "Investor Presentation" in which GFH states it intends to sell assets to raise cash to pay back some US$90 million in debt maturing next year or restructure that debt. In further discussions with GFH, the GDN was told that other options being considered were an IPO of some of its mega projects (North Africa and India) or perhaps giving creditors land, shares or other of GFH's highly valuable assets. There is a danger with the latter for creditors. As the choice assets are stripped from GFH's balance sheet, remaining creditors are left with lesser ones to settle their debts. The only option not mentioned here was putting a brick from one of these projects under EJ's pillow in the hopes that the Real Estate Jinn would put US$500 million under his pillow.

It's hard to imagine a "wise" creditor putting funds into GFH. 

And it takes a bit of "optimism" to see a real future for GFH. 

You can find more posts on GFH by using the Label "Gulf Finance House".

Gulf Finance House 3Q10 Financials: GFH Continues to "Turn Corner". But Unfortunately Into Oncoming Car

Not sure how GFH will spin this, but they've announced a loss of US$115.1 million for the 3Q10 making the loss for the first nine months of the year US$162.8 million.   And, no, the optimistic US$134 million of reimbursement rights remains on the balance sheet.  So this loss is due to other problems,.  The reimbursement problem has yet to be acknowledged - which means of course that GFH is in a "world of trouble".

As a result, Shareholders' Equity is at US$303 million, well below the US$400 million TNW covenant.  As well as breaching the Central Bank of Bahrain minimum  CAR requirement.

More later when I have time.

Footnote for the Central Bank of Bahrain.
As usual, GFH has released the absolute minimum on the BSE, while releasing its entire 3Q financial on the DFM.   It's unclear why Bahraini investors should be disadvantaged.  Perhaps time to revise the regulation to require that if a firm is required to disclose more on another exchange, then it disclose the same on the BSE.

I will make no comment about the ethics of a firm that engages in such selective disclosure, particularly one that claims to follow the teachings of a noble religion.

More on Awal Bank Chapter 11 Filing

Updated for comments on Chapter 11.

Here are some additional details on Awal's filing.

1. The case number assigned by the Bankruptcy Court of the Southern District of Manhattan is 10-15518-alg.  Awal's previous Chapter 15 filing has case number 09-15923alg.
2. As indicated by the "alg" at the end of the case number, Justice Allan L. Gropper has been assigned this case.
3. The Bank is being represented by Brown Rudnick LLP who filed the Voluntary Petition for Bankruptcy under Chapter 11.
4. The filing was authorized by Awal's Administrator, Charles Russell, LLP.  Presumably before proceeding CR obtained the no objection of the Central Bank of Bahrain who appointed them.  I think this is a pretty strong indication that the CBB has decided to proceed with the liquidation of the Bank.  Note:  A Chapter 11 proceeding is of course a reorganization not a liquidation.  The latter is Chapter 7.  Chapter 11 allows the debtor to propose a plan for dealing with its existing obligations - either payment in full, in part, conversion to equity, etc.  Post implementation the debtor continues as a going entity (e.g., Continental Airlines).  So what I mean here is that the CBB has decided to proceed knowing it will cause the lenders some pain.  That in turn means the situation is beyond repair.  And that the Bahraini authorities have decided to "bite the bullet" and take the reputational damage that will come from such action. 

As part of its filing, Awal Bank made the following statements:

1. After the payment of various expenses including that of administration, there will be no funds available for distribution to unsecured creditors.
2. Estimated creditors are between 50 and 99. 
3. US assets are above US$50 million up to and including US$100 million.
4. Estimated debts (worldwide) are over US $1 billion.  (This is the largest amount provided on the Bankruptcy Filing Form).

As required on the Filing Form, the debtor lists its top twenty unsecured creditors.  No amounts are provided though.

Here they are in the order of appearance on the Form:

1. Abu Dhabi Commercial Bank, Abu Dhabi
2. Abu Dhabi Islamic Bank, Abu Dhabi
3. AlGosaibi Money Exchange, Saudi Arabia
4. Bank of Montreal, Canada
5. Bayerische Hypo-und Vereinsbank, United Kingdom (London Branch)
6. Bayerische Landesbank/Bayern LB Germany
7. Boubyan Bank, Kuwait
8. Calyon Corporate and Investment Bank, United Kingdom
9. Commercial Bank of Kuwait, Kuwait
10. Commercial Bank of Qatar, Qatar
11. Commerzbank Global Equities AG (formerly Dresdner Bank) Germany
12. Commonwealth Bank of Australia, United Kingdom (London Branch)
13. Fortis Bank, Belgium
14. Gulf International Bank, Bahrain
15. HSBC, Australia
16. HSBC, United States (NY Branch)
17. HSH Nordbank AG, German
18. JP Morgan, United Kingdom (London Branch)
19. Kuwait Finance House (Liquidity Management House), Kuwait
20. The International Banking Corporation, Bahrain

If you're wondering about TIBC (which also filed under Chapter 15 in 2009) taking a similar action, a  court hearing is scheduled under their case next week Tuesday (26 October).  Stay tuned.

Awal Bank FIles for Chapter 11 Bankruptcy in US

In terms of recovery all venues are likely to be highly inconvenient.

Update:  See subsequent post.

According to news reports on Bloomberg, on 21 October Awal Bank filed for Chapter 11 bankruptcy in the Southern District Court of Manhattan listing assets of between US$50 million to US$100 million and liabilities of  more than US$1 billion. 

That would not seem to augur well for creditors.  Though it should come as no surprise. 

Earlier Awal had filed under Chapter 15 of the US Bankruptcy Code.  That Chapter is used when a company asserts its proceedings are taking place under a foreign jurisdictions laws and procedures broadly equivalent (in fairness) to US procedures.   It will be interesting to see what arguments were advanced for moving the proceedings to the USA.  Forum non conveniens?

Gulf Bank Kuwait - On the Mend. No More Loans to Saudis.

A banker's memory is a wonderful thing.  
Even the most painful experiences can be forgotten. 

Michel Accad gave an interview at the Reuters Middle East Investment Summit in which he made the following points:

1. 3Q10 is the turning point in GB's two year strategy to rebuild.  
2. Each subsequent quarter will be a relative improvement over the previous.  
3. By 3Q11 the rebuilding will be done (apparently one quarter ahead of time) and the bank will move to strengthen its income generation or its geographic coverage.
4. The goal is to increase local market share from today's 12% to some 16% in five years.
5. After 3Q10, the Bank will not need to provision as much but will continue to do so for precautionary reasons (rather than need).
6. The Bank has decided not to make any loans to Saudi clients for at least 3 years.  No doubt a reaction to its troubles with AlGosaibi and Saad Groups.  
7. Instead it will, however, make loans to foreign investors for their projects in Kuwait. And no doubt concentrate on its high quality Kuwaiti clients.
8. As of 3Q10, the Bank has successfully reduced its non performing loans below 20% of the total portfolio.  That's a lot of "Saudi" clients, it appears.

International Investment Group - Update from Delegate on IIG Funding Sukuk (Hint: No Good News)

Deutsche Bank as the Delegate on the above transaction issued an announcement on Nasdaq Dubai advising that:

1. IIG had advised that it was awaiting ministerial approval of its new board so that they could vote to release the KPMG study to certificateholders who had signed a confidentiality agreement.
2. The Paying Agent advised it had not received the funds for the 12 October payment.
3. Certificateholders reminder of Dissolution Events and that they need to vote to accelerate.
4. That IIG has not honored the claim served under the Purchase Undertaking.
5. That the Delegate is not obliged to take actions unless indemnified to its satisfaction.  Apparently, it has not been.

Dubai Sovereign Bond: "Pay to Play"

An article in the FT today reports that bankers were told that lead underwriters on Dubai's recent US$1.25 billion sovereign bond were told that in order to be considered they needed to make loans to the Emirate.  Supposedly a two-year loan for some US$300 million priced at Libor +300 bps.

A couple of observations.

First, this is a pretty standard request, particularly from a client having a bit of a problem.  Just as the good banker is taught to seek to increase his "share of a customer's wallet" in good times, borrowers especially those currently out of favor in the market look for their bankers to be understanding in more difficult times.  In both cases there's a lot of talk about the importance of relationships.  How strong they are.  Sentiments said with no doubt more sincerity than the average politician's promise.  But just as meaningful for that.

Second, Dubai's Sovereign Bond was "priced to place".   Dubai could not afford to have this transaction fail. With a bond, a low price means the interest rate was set higher than it needed to be.   Pretty much the same rationale as IPO pricing.  Under price the security by a bit so that the offer is successful.  And then  as the share rises in initial trading, you've got a good story for the company and the investors.    

I've seen estimates that Dubai's pricing may have been as much as 0.75% to 1.0% higher than required.  The underwriters who "sat" on a substantial portion of their allocations may not too far in the future have large capital gains - though probably not until after issuance of the DEWA bond.  If they've placed it with clients,  as some will have, then they will derive some relationship benefits there and can use those to secure additional business from those clients.    Just as the investment firm that can allocate IPOs to its customers gets something back.

For HSBC and Standard Chartered with major domestic operations in the UAE, being seen as a good friend is a useful thing.  If indeed SC's threat to move its corporate headquarters to the more tax and regulation friendly shores of Dubai is more than mere posturing, another good reason.

Finally, there's probably also a very hard headed calculation here - that it's going to be some time before Dubai regains full market access.  Amounts are likely to remain limited  and increasing only slowly.  Pricing will probably improve even slower.  As the thinking goes, there are opportunities for profit here.

And of course, there is one other factor in play:  banker and investor ADD.

Do bankers have short memories?

Excuse me, could you repeat that, I've forgotten what you asked. 

Gulf Finance House - Capital Reorganization and Raising - A Look "Behind the Curtain"

"Pay No Attention to the Man Behind the Curtain"

GFH published the agenda for its shareholders' general meeting on the capital reorganization/raising to be held 31 October.  So far only in Arabic on the DFM and on the KSE (copy below so you can follow along).  Strangely not yet on the BSE.

As the picture above suggests, by looking behind curtain we can get a real understanding of what's going on.

In brief the key points are:

1. The capital reorganization and US$500 murabaha are being structured to make them as attractive as possible to new investors.  That means that existing shareholders are being substantially diluted through a variety of clever means - which might not be apparent to most readers of the agenda for the shareholders' meeting. 
2. A share swap transaction between Mr. Janahi and GFH which seems designed to strengthen GFH's creditworthiness as well as provide some much needed "relief" on the CAR both in terms of risk weighted assets and potentially equity.

First, let's look at what's immediately visible:  the agenda for the shareholders meeting.   Shareholders are being asked to:

1. Approve a share swap between GFH and its Chairman/Executive CEO, Mr. Esam Janahi.  In return for his 104,923,734 shares in Khaleeji Commercial Bank ("KHCB"), GFH will give him 100% of its shares in AlAreen Company for Leisure and Tourism (whose main asset is the Lost Paradise of Dilmun Water Park in Bahrain) plus US$3 million.  The latter either in cash or Treasury Shares of GFH. 
2. Reduce the number of GFH's issued shares from 1,896,332,565 to 474,083,141 in a reverse 4:1 share split.
3. Reduce the paid in capital from US$625,789,746.45 to US$142,224,942.375.  A difference of US$483,564,804.075. 
4. Reduce the par value of shares to US$0.3075 from US$1.32.
5. Approve the issuance of up to US$500 million in a privately placed convertible murabaha through a special purpose company set up by the bank or established at its request.  (That is, the SPV will lend to GFH.  It will obtain its funding from various investors.)
6. The profit rate ("interest rate") on the murabaha to be the "market rate" according to the rate and formula established by the Board of Directors shortly before issuance.  Such profit rate to be payable in cash or additional GFH shares.
7. The conversion price to be between US$0.31 and US$0.40 per share - with the rate of discount not less than 20% to 40% of the market price of the shares - but not below the nominal share price.  The conversion price to be set by the Board shortly before issuance.
8. A tenor of 3.5 years.
9. Conversion at investors' option with right of Board to offer an early conversion "incentive" according to conditions the Board will set.  Note that means that the murabaha does not count as equity for either regulatory (CAR) or accounting purposes until it is converted.  For the latter, only the embedded equity option is counted as equity under IFRS.
10. Waiver of pre-emptive right of shareholders to new equity.
11. Authorization for Board or whoever it appoints to take necessary legal steps to implement and for Chairman or whoever he appoints to sign the necessary legal documents.
12. Conversion of GFH's share register to electronic form according to the rules of the Central Bank of Bahrain and the BSE.

Now a look behind the curtain via some hopefully informed analysis:

A.  Share Swap - KHCB for GFH

1. GFH gets several benefits from this transaction.
2. Immediate strengthening of GFH's creditstanding.  KHCB is a better asset than the Water Park, which is why the West LB syndicate asked for the former.  Probably better earnings and better future.  The Water Park like the Riffa Golf Course, no doubt, looked like a very "wise" idea on paper.  In the real world, it's probably not.
3. Regulatory relief on the CAR - a matter of great importance to GFH who sit right on the edge.  The first way this comes is by moving this "puppy" (the water park, which is risk weighted in the GFH's CAR calculation) to someone else's kennel (balance sheet).  In return GFH gets KHCB, increasing ts holding from 36.99% to 46.99%.  Currently, GFH partially consolidates  KHBC, and, thus,  it doesn't have to worry for CAR purposes about fluctuations in KHCB's share price - which has dropped by roughly 50% since last year this time.  Since KHCB's CAR is roughly 31% as at 30 June 2010, the impact on GFH's Risk Weighted Assets and thus its CAR should be positive.
4. As you'll notice, the US$3 million owed to Mr. Janahi can be paid in cash or GFH shares.  So there's a potential boost to equity if the latter can be used to settle this amount.  Treasury Shares are deducted from Shareholders' Equity at their cost. What this means is that if GFH gets more than zero in proceeds from the sale or conversion of Treasury Shares, the amount of its Shareholders' Equity will go up by the amount of the proceeds received.  This happened in 2Q10 where GFH sold US$29.1 million (original cost) of Treasury Shares for US$7.6 million and recognized a US$7.6 million consequent increase in Shareholders' Equity.  While admittedly a small card in the scheme of things, this could be just the thing that helps GFH keeps its head about the 12% threshold in a close situation.   As I suspect the 2Q10 Treasury Share sale was.
5. And, to round things out, a footnote on KHCB.  Without qualifying my opinion about the  credit benefit of acquiring KHCB, I call your attention to Note 3.4 in KHCB's Basel II Pillar 3 Disclosures as of 30 June 2010, which shows that some 24% of its Islamic Financing Assets are past due.  According to that information, some 42% of the past dues (BD47,385 - which is the total amount of the past due loans not just the past due installments which  are BD10,487) are up to 30 days late.  Proceeding cumulatively, 51% up to 60 days, and 72% up to 90 days.  According to KHCB's risk classification system, some 59% of the past dues are rated Credit Grades 1-6.  Personally, I would have thought a past due loan  would automatically go on the "watch list" (Credit Grades 7-8) but then I don't have the details of KHCB's loan portfolio including collateral.  In any  case those concerned with KHCB should keep an eye on this area to see if there is deterioration or improvement in the future.

B.  Capital Reorganization

1. Under the Bahraini Commercial Companies Law of 2001, GFH is obliged to take action now that accumulated losses are 75% or more of paid in capital. Approved methods for rectifying this situation are:  (a) reducing paid in capital by an amount sufficient to offset the losses and/or using other equity reserves (share premium, statutory or voluntary reserves), (b) raising additional capital and (c) a combination of (a) and (b).  Generally, financial institutions use Method (c).  In some cases a bank might get away with merely offsetting the losses against existing capital - assuming its pre-reorganization CAR were robust.  GFH's is not so it must do both.
2. As you'll notice, GFH is not using its reserves.  Why? Very simply put:  the path it has chosen is designed to make the murabaha more attractive to investors.  Under GFH's plan, they will get more of the total shareholding of the Bank for each dollar they contribute.  
3. 1H10 financials  provide the details of the components of GFH's capital.   If GFH were to use its US$206 million share premium and US$85 million statutory reserve  (total US$291 million), it would only have to "use" US$192 million of paid-in-capital.  Thus, leaving original shareholders holding US$433 million in common equity instead of US$142 million. 
4. To take control, the new money would have to put in US$433 million plus $1.  Under GFH's reorganization plan it only needs to put in US$142 million plus $1. 
5. Similarly, if the new investors put in the full US$500 million, under GFH's plan they get 78% of the total equity.  If the reserves were used as outlined above, they would only get 54%.
6. Clearly, there is a conflict here.  Existing shareholders want to be diluted as little as possible.  New shareholders want the most value for their new dollar.  Sadly for the existing shareholders, including the even "wiser" ones who invested in late 2009, their money is already spent.  The new and presumably much wiser investors need to be persuaded to part with their money.  GFH has set  the reorganization and the terms of the murabaha to make it as easy as possible to get the money that it desperately needs.

C.  US$500 Million Murabaha

1. Use of an SPV as the lender can be quite a useful device in shielding the identity of the new lenders/shareholders, particularly if the SPV is not incorporated in Bahrain.  It will depend on how much transparency the CBB wants to demand here and how far it can push this Bank which has an important and powerful friend in Bahrain.
2. One would expect the market rate for unsecured GFH debt to be rather hefty.  And the value ascribed to the option on GFH shares much less so.  The Board will price "at market" - which will mean in effect what investors demand. 
3. The approval also provides for a discount from market price of between 20% to 40%.   This is where the reverse split comes to play.  There is nothing in the Bahrain CCL that requires this as part of the capital reorganization.  I suspect GFH is hoping that  the reverse split will work a bit of magic on their market price.  Over the past two weeks, GFH has traded at KD0.033 (roughly US$0.11) per share.  A 4:1 reverse split should bring the price to say US$0.44 per share - allowing the Board to discount the conversion price to say just a whisker over par to make the transaction even more attractive. 
4. "But wait there's more" as they say on the late night TV ads for the ShamWOW!  The Board is allowed to offer an incentive (terms unspecified in the approval) for an early exercise.  That allows an even greater discount to attract new investors.  So, if the conversion price is set at a whisker over par, can the Board issue shares below par through this device? 
5. You ask about the hapless existing shareholders?  Well, GFH already has their money and needs more.  So they are out of luck.

KSE announcement below.

[12:17:53]  ِ.اجتماع الجمعية العمومية العادية و غير العادية لبيت التمويل الخليجي
يعلن سوق الكويت للأوراق الماليه بأن بيت التمويل الخليجي أفاده بأنه
سوف يتم عقد جمعية عمومية عادية و غير عادية للبنك في الساعه 9 من
صباح يوم الاحد الموافق 31-10-2010 في فندق منتجع و قصر العرين
وقد طلب البنك ايقاف التداول على اسهمه في السوق اعتبارا من اليوم
الاحد الموافق 17-10-2010 وحتى اشعار اخر حيث حصل على موافقة ‏
مصرف البحرين المركزي على ذلك .‏
هذا وسوف يتم خلال الجمعية العمومية مناقشة ما يلي
أولا : جدول اعمال الجمعية العامة العادية
ِ1- المصادقة على محضر الاجتماع السابق .‏
ِ2- المصادقه على معاملة استبدال الاسهم بين بيت التمويل الخليجي و رئيس
مجلس ادارته السيد /عصام جناحي و التى سيتم بموجبها تحويل حصته في المصرف
الخليجي التجاري ش.م.ب بالكامل (104.923.734 سهم ) الى بيت التمويل الخليجي
مقابل الحصول على حصه البنك في شركة العرين للترفيه و السياحه ش.غ.خ و ‏
البالغه 100% (جنة دلمون المفقودة) بالاضافه الى مبلغ 3 ملايين دولار تدفع
اما نقدا و / او بواسطة اسهم خزانه بيت التمويل الخليجي .‏
ِ3- الموافقة على تغيير سجل مساهمي البنك من سجل عادي الى الكتروني ‏
وفقا لاحكام مصرف البحرين المركزي و سوق البحرين للأوراق الماليه .‏
ثانيا : جدول اعمال الجمعيه العامه الغير عاديه ‏
ِ1- المصادقه على محضر الاجتماع السابق .‏
ِ2- التباحث في والمصادقه على دمج الاسهم الصادرة لبيت التمويل الخليجي ‏
بمعدل 4:1 لينتج عن ذلك تخفيض عدد الاسهم الصادرة من 1.896.332.565 سهم
الى 474.083.141 سهم .‏
ِ3- التباحث في والمصادقه على تخفيض راس المال المدفوع من 625,789,746.45 ‏
دولار امريكي الى 142,224,942.375 دولار امريكي بسبب الخسائر المتراكمه ‏
ِ(سيقدم المدقق الخارجي السادة كي بي ام جي بيانا مستقلا يتعلق بتاييدهم لهذا
التخفيض ) .‏
ِ4- التباحث في والمصادقه على خفض القيمة الاسمية الجديدة للاسهم والتي ‏
ستبلغ 1.32 دولار امريكي بعد الدمج و تخفيض راس المال المدفوع المشار اليه
في البندين 2 و 3 من بنود جدول الاعمال الى 0.3075 دولار امريكي .‏
ِ5- التباحث والمصادقه على قيام بيت التمويل الخليجي من خلال اية شركة
غرض خاص يؤسسها البنك او تؤسس بناء على طلبه لاقتراض ما يصل ‏
الى 500,000,000 دولار امريكي من خلال مرابحة تمويليه قابلة للتحويل
الى اسهم بناء على البنود و الشروط التاليه :‏
ِ- معدل ارباح يحدد وفقا لسعرالسوق ووفقا للمعدل والصيغه المحددة من قبل مجلس
الادارة قبل وقت قصير من تاريخ السحب . يمكن دفع  هذا الربح نقدا او في صورة
اسهم عينية في بيت التمويل الخليجي .‏
ِ- سعر تحويل يتراوح من (0.31 دولار امريكي الى 0.40 دولار امريكي) ‏
ِ(بمعدل خصم لا يقل عن 20% الى 40% من القيمة السوقيه في اعقاب
الدمج بحيث لا تقل عن القيمة الاسمية للسهم) فيما سيتم تحديد السعر النهائي ‏
من قبل مجلس الادارة قبل فترة قصيره من تاريخ السحب .‏
ِ- مدة تصل الى ثلاثة سنوات و نصف .‏
ِ- غير مضمونه و لكن قابله للتحويل بمحض خيار المستثمر الى اسهم في بيت
التمويل الخليجي قبل انتهاء المدة ووفقا للشروط التى يحددها مجلس الادارة.‏
ِ- حافز التحويل المبكر لتشجيع المستثمرين على التحويل الى اسهم قبل
نهاية المدة وفقا للشروط التى يحددها مجلس الادارة .‏
ِ6- منح التنازل عن حق الاولوية الخاص بمساهمي بيت التمويل الخليجي ‏
فيما يتعلق باصدار اسهم عادية جديده سيتم اصدارها عند تحويل تمويل المرابحه
وفقا لبنود الفقرة 5 من جدول الاعمال .‏
ِ7- تخويل مجلس الادارة و/او من ينوب عنه للقيام بجميع الاجرءات الرسمية ‏
المطلوبه و الصحيحه لتفعيل تمويل المرابحه بما في ذلك دون حصر تحديد و/او
تعديل شروط المرابحه والمستندات الاخرى ذات العلاقه .‏
ِ8- تخويل رئيس مجلس الادارة او من ينوب عنه بالتوقيع على تعديل عقد
التأسيس و النظام الاساسي نيابة عن المساهمين امام كاتب العدل فيما يتعلق ‏
بالتغييرات في راس المال لتعكس ما تقدم .‏
علما بأنه في حالة عدم اكتمال النصاب القانوني لهذه الجمعية سيكون الاجتماع ‏
الثاني يوم الاحد الموافق7-11-2010 في نفس الزمان والمكان وفي هذه الحاله ‏
ستسري احكام الماده 57 من النظام الاساسي للبنك. وفي حالة عدم اكتمال النصاب
القانوني في الاجتماع الثاني ، سيتم عقد اجتماع ثالث يوم الاحد الموافق ‏
ِ14-نوفمبر-2010 في نفس المكان و ذلك بسريان احكام المادة 57 من النظام
الاساسي للبنك . ‏