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| It's a small world after all, and for some even smaller |
It’s been five years since Global signed its first
restructuring agreement and three years since its final settlement with
creditors.
How is Global doing?
What are its prospects for the future?
The first question is the subject of this post. I’ll cover the second in a companion post.
Catching
Up with Global
When last I posted, Ms. Maha was Chairman, GIH had
published financials showing about KD 1 billion in assets, and the firm was
touting its first rescheduling deal with its creditors.
At that point, commenting on the deal’s principal
repayment terms—10 percent the first year, 20% the second year and a whopping
70% the third year—I noted that:
“It's highly unlikely that Global is going to
be able to meet the repayment schedule even with one or two small miracles
coming its way. With the short fuse and the extensive trip wires
(by way of covenants below), the spectre of a second default has to be haunting
Global's management and shareholders.”
Not surprisingly in mid-2013 GIH negotiated a second
rescheduling deal that gutted the firm: almost all of GIH’s “fine” assets were
transferred to creditors in settlement of the debt. Because the assets weren’t that “fine”, the
creditors took a 70 percent stake in the “rump” GIH. For a variety of reasons, the firm focused
its business strategy on fee-based not balance sheet intensive business. Ms. Maha was replaced as Chairman, though she
remains on the Board as Vice Chairman and retains a role in management.
Review of 2015 Performance and Financials
Overview
The structure of GIH’s revenues and expenses indicates a
high probability of future earnings volatility. Normalized expenses are 140% of
AUM related revenues. Non AUM LOBs can’t
consistently generate enough revenue to cover the remaining expenses and
generate a meaningful profit. They are market sensitive (volatile) themselves
and more importantly lack scale. They
are more “hobbies” than substantial LOBs.
Besides these structural earnings problems, I noticed a
few things in the loan portfolio and murabaha receivables worthy of comment. Nothing that is life threatening.
Income and Expense
Net Income:
Global earned KD6.5 million in 2015 versus KD6.4 million
the year before. However, 2015 net
income was bolstered by a (non-cash) write back of KD4.3 million of loan
provisions. Without this “timely”
reversal, net income would have been a much lower KD2.2 million.
Revenues:
Fees and Commission Income accounted for 89% of total
revenues in 2015 and 66% in 2014. Within
this category, AUM related fees account for some 80% of revenues, and represent
a relatively stable revenue stream. The
other key fee-generating LOBs-- brokerage and investment banking-- each generate
about one tenth of the AUM fees but are more volatile.
In 2015 Global benefited from KD 1.8 million in FX
translation gains (KD 2.2 million in 2014) due to depreciation of the KD
against the US dollar. Not a stable core
revenue source.
Net interest income contributed KD 1.6 million.
Fair Value Through Profit and Loss a loss this year of
KD1.5 million vice KD0.8 million in positive revenue the year before.
Expenses:
Excluding loan provisions and impairment losses, Global’s
average expenses are about KD 14 million a year – 140% of its stable AUM
related earnings.
Structural “Problem” with Earnings
That’s a problem because Global’s other fee-generating
LOBs (chiefly brokerage and investment banking) are market sensitive and more
importantly lack the scale to consistently
generate significant revenue to both cover
expenses and generate a profit. Growing
earnings by growing assets is constrained by policy and no doubt as well by limited
market access.
Global then is forced to rely on one-offs such as continued
depreciation of the KD or provision write backs to turn a reasonable
profit. Note that if there had been no
FX translation gain in 2015 and no write back of the provision, Global would
have had a modest profit.
Balance Sheet
As mentioned above, a couple things caught my eye in the
loan portfolio and murabaha receivables.
Loan Loss Provision Write Back
According to GIH’s 2015 annual report note 13, the write
back provision for credit losses “for the year
include KD 3,292 thousand (2014: KD 130 thousand) written back as a result of
settlement agreement with a borrower.”
Note the term “settlement agreement”. GIH did not restructure the loan. The amount
was not repaid in cash. Rather the bank took securities to settle the loan as
is clear from an analysis of the firm’s cashflow statement and note 11. The absolute increase in assets in note 11 is
much more than the amount shown on the cashflow statement.
A single customer was responsible for 77% of
the write-back. A quick scan of annual reports back to 2012
suggests--but does not prove--that GIH has held this provision since at least
2011.
The same note states: “Loans are granted to GCC companies and
individuals and are secured against investments in the funds and securities
held in fiduciary portfolios by the Group on behalf of the borrowers.”
Why didn’t GIH seize and realize the
collateral long ago? Why hasn’t done the
same with the borrowers representing the KD 5.9 million in unused provisions?
One explanation might be that legal processes
in Kuwait are painfully slow. Thus, GIH
was legally unable to seize the collateral and extinguish the loan, but rather
forced into prolonged negotiations with the borrower.
That the reversal came at just the “right”
time to protect earnings is certainly a remarkable coincidence. Perhaps difficulties in 2015 caused
management to redouble its efforts to collect.
Perhaps a long period of negotiation finally came to a close. From the financials, it does not appear that GIH
gave the borrower a discount on the asset swap.
Loan Portfolio:
Is there room for more earnings positive settlements with
borrowers?
Net loans are KD 1.6 million = gross loans KD 7.5 million
less provisions of KD 5.9 million (note 13).
That KD 5.9 million would appear to be able to fund a few
“timely reversals”.
Particularly because Global holds KD17.8 million (fair
value) collateral as per note 25.2.2 page 57.
That’s 240 percent coverage of the gross amount of the portfolio. One might argue and AA certainly would that
there doesn’t appear to be a compelling reason to hold a loss reserve when
collateral coverage is so high.
But there’s more.
Global is accruing interest on the gross portfolio
because KD 490K in accrued interest in 2015 equates to a whopping 21% per annum
yield on the average net loan portfolio. (Simple average of 31 December 2015
and 2014 amounts). It’s a more
reasonable 4.8% on the average gross portfolio.
To accrue interest, Global would either have to be
receiving cash or have almost certain assurance of payment of the
interest.
The cashflow statement shows that Global did not receive
cash payments in 2015 for about KD 500 million of interest accrued that year,
an amount very close to the interest accrued on these loans. Of course, the KD 500 difference could well
relate to other interest bearing assets.
It could relate primarily to the loans but be due to timing difference: the interest payment was received after 31
December 2015. If cash is being received
and Global holds such an excess of collateral, how does it justify maintaining
the reserve to its auditors?
On the other hand, if Global is accruing interest—but not
receiving cash—, its justification is likely based on asserting that collection
of interest is almost certain given the collateral it holds. If the interest is
secure and again the collateral so much larger than the principal, then it
would seem the principal is also secure and no provision is needed.
All this suggests to AA that Global has some
“dry powder” for future contingencies.
Murabaha Transactions
Global is earning a princely 5.28% per annum
on these one year transactions (note 12).
Not many good investments offer such a return for a one year tenor. Kudos to GIH for finding this consistently
attractive opportunity—5.24% in 2014, 5.3% in 2013, and 5.45% in 2012.
One would think that such rates would come at
the cost of higher risk, but the provision is a modest KD 123K on some KD 3.1
million.
One thing did catch my eye. Note 25.2.2 page 57. The murabaha receivables were more than 180
days past due (but not classified as impaired) as of 31 December 2015 and as
well at 31 December 2014. I didn’t see a
reference to collateral for these transactions.
Of course, AA has been around the block a few times on “Islamic” banking
transactions and knows that in addition to careful structuring (technically حيل) “Islamic” finance is one area of the
faith where miracles occur with a dazzling regularity.
Notwithstanding the above, perhaps a
provision of some sort would be warranted.
And could be accomplished by a simultaneous reversal of some of the loan
provisions and booking of an equivalent amount as provision for the
receivables. But of course الله اعلم
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