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.

Insolvency of PrivatBank Ukraine: Euphemisms Abound

Моя Україно,За що тебе сплюндровано, За що, мамо, гинеш?

Would his anger be tempered today by knowledge that the perpetrators are Ukrainians? 

AA doubts it.

Now to the post.

AA prides himself on his skill in using euphemisms to describe financial weaknesses and ethical slips. 

This Tuesday The Bloomberg lit up with news that The National Bank of Ukraine—the country’s central bank—announced it had declared PrivatBank insolvent and that Ukraine’s Government would assume complete ownership. 

By way of background, Privatbank is the largest bank in the country.  It is privately owned with two biznesmen—described by some as “oligarchs” but always as “pro-Western”—holding over 90% of the bank’s shares. Besides his many business ventures, one of them, Mr. Kolomoiskyi, has been accused of funding the Azov Battalion.

As I read the speech by the Governor of The National Bank of Ukraine and other news, I was in utter awe at her and her colleague’s command of euphemisms. 

Professional honor compels me to acknowledge their skill.  Frankly my own efforts seem rather small and paltry in comparison.  Therefore, I offer a humble tip of AA’s enormous tarbush to Governor Ms. Gonatraeva and to NBU First Deputy Chairman Yakiv Smoliy.  

First, to the Chairman’s 19 December speech reported at The NBU website in English.  Strangely, AA was unable to find the Ukrainian language version. Italics courtesy of AA.

Inspections and stress tests carried out by the NBU revealed that PrivatBank had capital shortages. As of 1 April 2016, the bank had capital shortages amounting to UAH 113 billion, which, apart from crisis-related factors, were caused by imprudent lending policies pursued by the bank. As of 1 November 2015, related-party loans accounted for 97% of the bank’s loan portfolio, totaling UAH 150 billion.

Now for the comments: 

1. Capital “Shortage”:  As per its 3Q16 financials, Privatbank had some UAH 30 billion in capital and total assets of UAH 271 billion.   Given those amounts, calling a UAH 113 billion capital deficit— which is equivalent to 380% of equity or 42% of total assets—a “shortage” is like calling The Grand Canyon a “river valley”.  Or 2008 a “recession”.  Technically correct to be sure, but somehow the full picture is lost.
2. “Imprudent” lending policies:  When a bank needs to raise new capital equal to 380% of existing capital or equivalent to 42% of total assets, one doesn’t need a lot of financial analysis to figure out that lending standards left quite a lot to be desired.  The good folks at Bloomberg had a slightly different translation “ill-considered loan policy” which is an even better euphemism. 
3. “Related Party Loans”:  When related party loans are 97% of loans and 4 times the maximum limit set by The NBU, such behavior seems to rise to a level well above “imprudent” or “ill-considered”.  AA might apply descriptors such as “patently immoral” and perhaps even “criminal”.   That being said, AA is not familiar with the legal status of Ukrainian banking regulations.  It may be that they only rise to the level of “suggestions” sort of like the Pirates’ Code, which seems apt given the location.  On a positive note, lending to oneself has certain advantages in streamlining the underwriting process.

But at SAM we never fail to be “fair and balanced”. 

So let’s let Privatbank speak for itself.

As per its unaudited 3Q16 financials, Note 13 shows the bank’s related party exposure as minimal only UAH 8 billion down from about UAH17.8 billion at 31 December 2015.    

One note, there is no auditor’s review statement in the 3Q16 financials and so it’s impossible to know if they were reviewed (but not audited) and whether these are IFRS statements. I believe they are not.  

Privat’s IFRS AR for 2015 shows a higher figure for related party loans roughly twice the UAH 17.8 billion above (see note 31) but quite a long way from 97%.  PWC’s local firm did qualify its audit report but related to collateral seized on past due loans and the economic/security situation in the country. 

Beyond that Interfax Ukraine reported that

“Oleksandr Dubilet, who had headed PrivatBank (Dnipro) for a long time prior to the decision on its nationalization, has said the National Bank of Ukraine's (NBU) statement on 97% of insider loans in PrivatBank's portfolio of corporate loans is exaggerated.”

Also that

"At the same time, NBU First Deputy Chairman Yakiv Smoliy said the share of loans to related parties in PrivatBank exceeds 90%.  At the same time, he stressed this cannot be classified as withdrawal of funds from Ukraine."

What FDC Smoliy appears to be saying is that the related party lending scheme cannot be “classified” as a ruse to loot the bank and transfer the loan proceeds offshore.  This may be the biggest “euphemism” (one last attempt by AA to score a point) in the story. 

A side note on the dickering over percentages.  

Corporate loans comprise some 74% and 84% of total gross loans as of 3Q16 and 4Q15 so the key question is whether the percentage is of “total” loans or “corporate” loans and of course whether the percentage is being figured against net or gross loans. 

But when a bank is in this range, the exact figure is in some sense meaningless. 

What’s the practical difference between 75% and say 97%?   The bank is bust and its management and board have some explaining to do at the very least.