Nahkeel Bondholder Group Opposes Standstill

Today's Financial Times article.

I'm not sure if this is "news" in one sense.   Like haggling for a rug in the suq, the smart buyer doesn't take the first price offered. 

Dubai World and Nakheel may be forgiven (at least initially)  if they made certain assumptions about the bondholders' reaction.  Many previously successful borrowers actually believe that they hold a privileged place in the market even if they have bad news of a  standstill or rescheduling.   Our lenders will understand they think.  They don't realize that the lenders' knee-jerk reaction  to such news will take them from hero to zero.   Another complicating factor is there have been changes in the composition of  sukuk holders.  The heavy selling of the certificates between the end of August and November (just prior to the announcement). was not relationship banks buying additional certificates.  Rather they were unloading  what they had.  Many of the new faces - as I presume QVT is - are  likely to be  transaction oriented investors with no relationship to protect vis-a-vis Dubai.  And so less likely to be as sympathetic as the former.  They could well be a convenient screen for relationship banks to hide behind.  Though as well they could be a thorn in  the banks' side.  The banks have other exposure which will have different conditions and legal protections.  So they will have an entire "package" to consider where the transaction oriented investors with only a single bond to worry about will have a different set of priorities and considerations.

In any case, it seems a group representing 25% of the bondholders (by amount) has formed to oppose the standstill.  As per the typical contract, if 25% vote for an early termination of the sukuk,  repayment is accelerated. So despite its small number, this group has significant power.

I'll be taking a look at the Offering Circular for the issue to see if there's anything in the sukuk that gives them leverage.   Of course, one leverage creditors always have is to complicate the life of the obligor via bad publicity and obstruction if nothing else.  This is particularly important when a borrower needs to raise new money or roll over existing debts - as is the case with Dubai. 

On that score later today, I'll be commenting on the proposed 1Q 2010 US$2 billionn DEWA sukuk after I've stoked the engines with some Cafe Najjar.

Unusual Trading in Nakheel US$3.5 Billion Sukuk Shortly Before Restructuring Announcement

AlQabas reports (apparently quoting a Dow Jones item) that there was an unexpected bout of trading in Nakheel's US$3.5 billion sukuk.

The source is Data Explorers (a company that tracks pledged stocks and bonds) who noted that approximately 75% of the holders of the sukuk sold their positions between the end of August and end of November - when markets still anticipated payment December 14th.   At this point the sukuk was trading at 110% of nominal value (there is a 9.5% premium over the "face" amount at redemption).   There were no visible signs of distress.  All the talk was that the bond would be settled at  maturity. 

The question then is why the persistent selling.  How did owners know it was a good time to sell?

After the announcement, the price of the sukuk fell to 40% of nominal.

It would be very interesting to know who the buyers were. 

The article also goes on to say the QVT Financial LP had hired the law firm of Ashurst to represent them.  When placed in 2006, 100 or so investors purchased the sukuk.  Half of whom were banks.  40% from the Middle East and 40% from Europe.

Qatar Islamic Bank QR54 Million Exposure to Dubai World

QIB announced on the Doha Stock Exchange that its exposure to Dubai World is QR 54 million  (US$ 14.8 million) reflecting participation in an "asset backed" Sukuk issued by Dubai World with maturity 2017.

At 30 September 2009, QIB had roughly QR7.8 billion  in shareholders' equity.   This exposure is then not problematic.

Three comments.

1. I believe this may be the Dubai Ports 6.25% Sukuk.  If so, this is probably a better obligation to hold than say Nakheel.  It's surprising that QIB wasn't more specific.
2. As we've seen from some of our forays into Sukuk analysis, there is not always recourse to the underlying assets.  So the term asset backed should not be read to imply that necessarily there is collateral.
3. The comment about financial impact means that QIB is taking changes in value in the sukuk directly to its equity in the "fair value reserve" account there.  Thus, these changes do not pass through its income statement.
   

Islamic Financing & Restructuring Part III - Golden Belt Sukuk 1 (Saad Group)

This is the third installment in my series on Islamic Financing and Restructuring.

Today's it's the Saad Group's turn, specifically, Saad Trading Contracting and Financial Services Company (a limited partnership formed in Saudi Arabia) ("Saad") and Mr. Maan AlSanea.

Our "kit" is a bit lighter than our last excursion (TID Global Sukuk 1) as all I could find was the Offering Circular ("OC").   The OC is well done - no doubt a combination of Bahrain legal requirements and the professionalism of the parties involved in the transaction.  The Risks Section is  particularly robust and clear. 

Just in case, you left the AAOIFI principles behind on our last journey, here's another copy.

And before we start, just one disclosure.  While I watched Boston Legal carefully, I am not a lawyer so don't rely on this or earlier comments as legal advice.  What follows is based on practical business experience not legal training.  If you want Denny and Alan, you will have to hire them.   And probably for this transaction you'd be better served by Nigel or Neale.

Short details on the transaction:

1. US$650 million in principal.
2. Five year maturity with Periodic Distribution Amounts (in a non Shari'ah compliant transaction that would be called interest) paid every 15 May and November at Libor plus 0.85%.
3. Final maturity 15 May 2012.  Single bullet payment of principal on that date.
   
4. Islamic Structure:  Ijara (rent transaction).  Maan AlSanea as Chairman of Saad leases  (the Head Lease) certain land (ex buildings) in Saudi Arabia to the Issuer (a special purpose Bahraini company)  who in turn sub leases it back to Saad.  The net proceeds of the Sukuk issue (keep the word "net" in the back of your mind as it will come up again) are paid to Saad as the advance lease rental for the Head Lease.  A single payment up front.  This gets him his "loan" if we were using non Shari'ah financing. The payments under the Sub Lease are the origin of the debt service for the Sukuk.
   
5. Legal Structure:  Limited recourse certificates (Trust Assets only) with a Saad purchase obligation.  Under the Sub Lease Agreement, the certificates are redeemed at face value plus any unpaid Periodic Distribution Amounts.  See the OC Section 9 "Termination Sum" on page 38.  Such purchase can take place either at maturity (scheduled dissolution) or prior thereto in certain cases (unscheduled dissolution after the occurrence of dissolution events and a vote to terminate by holders of at least 25% of the sukuk amount).  In effect this is a form of guarantee just like the structure in TID Global Sukuk 1, though we won't call it that.
6. Governing Law:  English Law for the Head Lease, the Sub Lease, Certificate Purchase Agreement (agreement with banks who placed the deal), Service Agreement  (Saad to maintain properties including any major maintenance) and the Costs Undertaking (Saad to pay the various service providers, e.g., Ohad, Citicorp).  All these documents are part of the Trust Assets.  The Corporate Services Agreement (Ohad and the Issuer for Ohad's services) under Bahrain Law.   And finally Saudi Law for the Promissory Note and Note Issuance Agreement and each Payable Rental Promissory Note (for the next rental payment due under the Sub Lease).
   

Let's turn to the detail.

(1) The Trust Assets

As per the OC page 19 "Recourse to the Issuer is limited to the Trust Assets and the proceeds of the  Trust Assets are the sole source of payments on the Certificates. Upon the occurrence of a Sub-Lease  Termination Event which constitutes a Dissolution Event, the only remedy available to Certificateholders will be to require the Sub-Lessor (or the Delegate acting on its behalf) to invoke its rights against the Sub-Lessee to pay the Termination Sum due pursuant to the rights granted in favour  of the Sub-Lessor under the Sub-Lease Agreement."

So what are the Trust Assets?

Title to land parcels in Saudi?  No.  As per the OC page 26, the land parcels are recorded in the name of Mr. AlSanea.   And there they shall apparently stay.

As per the OC page 17  "The ‘‘Trust Assets’’ consist of all of the Issuer’s rights, interest and benefit, present and future, in, to and under the Head Lease Agreement, the Sub-Lease Agreement, the Promissory Note, each Payable Rental Promissory Note, each of the other Transaction Documents, all monies standing to the credit of the Transaction Account, and all proceeds of the foregoing." 

The investors' security then is in the strength of these contracts. 

(2) The Purchase Obligation

Under the Sub Lease, the Issuer may call upon Saad to redeem the certificates prior to maturity if there is a Dissolution Event and at least 25% of Sukuk holders vote to terminate.  OC Section 9.2 page 38.

Dissolution Events (in a non Shari'ah compliant financing "Events of Default") are detailed in OC Section 12 page 39.   These contain the normal non payment (7 day grace). as well as several others . This Section does not contain any general covenants on Saad nor any cross default language.   However,  Section 12 (c) contains reference to Sub Lease Termination Events also triggering a Dissolution Event.  Flipping to Section 3.5 pages 68-71 we find the usual event of default matters covered under Sub Lease Termination Events.

(3) Promissory Notes

To support the purchase obligation there is a note for US$650 million.  Note that is for the gross proceeds of the issue not the net proceeds.  It will become clear why I keep hitting this point later.

At the beginning of each rental period, Saad will execute an additional promissory note for the Payable Rental Amount which is the funding for the Periodic Distribution Amount (in a non Shari'ah compliant transaction that would be called interest).

This is a "neat" drafting approach.  In the event that Saad doesn't pay, instead of  hauling a stack of complicated documents subject to English Law into a Saudi Court, the intent appears to be to have a straightforward and simple document that clearly evidences Saad's obligation to pay.  Of course, the borrower would very likely try to get all the documents into court to prolong the case and seek whatever advantage he could. 

(4) Restructuring Issues

First, some background points from the OC.

(a) Page 25 - "The calculation of the Payable Rental Amounts is not directly linked to the value of the Land Parcels, and as a result should the calculation of the Payable Rental Amounts be challenged by the Sub-Lessee there is a risk that the Saudi courts may apply the principles of equity."  Recall that the rental payment is being reverse engineered.   We know where we want to get.  The investors want a return of Libor plus 0.85% per annum paid to them.  The borrower wants US$650 million.   This issue arises strictly because of the "Islamic" nature of the transaction.  There can be no interest, but the investors want a certain return.  The Promissory Notes are designed to overcome this issue in a Saudi Court by reducing the "case" to one of an unpaid debt acknowledged by Saad for a sum certain.

(b) Page 28-29 - There is a good description of enforcement of obligations in Saudi Arabia.  This is key because as the OC's Risk Section points out, most of Saad's assets are in Saudi Arabia.  The key sentence in this section is "The courts and judicial committees of the Kingdom of Saudi Arabia have the discretion to deny the enforcement of any contractual or other obligations, if, in their discretion, the enforcement thereof would be contrary to the principles of Islamic law."  An issue that faces every creditor whether he extends under Shari'ah compliant or non Shari'ah compliant structures.

(c) Page 30 -  Another key sentence:  "The concept of trust as deemed in common law jurisdictions does not exist in Saudi Arabian law."

(d) Page 45 Use of Proceeds - The net proceeds are estimated to be US$645,750,000 or US$4,250,000 less than the gross proceeds.  The difference is for the banks' placement fees as well as legal and other costs.

Second, as the Lease and Sub Lease are the heart of the security for the transaction, these would be a target for an attack.  Can a party overturn the Sub Lease contract on the basis of equity using an argument that the rental is not fair given the value of the land? If Saad is insolvent, can a creditor argue that the rental payments are a lesser obligation than that creditor's debt and that the creditor should be paid first.  Here again the Promissory Notes are a defense that the rental payment is just as valid a debt as the creditor's loan.

This is also where the difference between gross and net proceeds finally comes in.  The Promissory Note is for US$650 million.  But the amount Saad received was US$4.25 million less.  In Saudi Courts borrowers have been known to produce an accounting of all cash flows in an effort to reduce the amount they owe the lender.  The bank gave me a $100 loan and over the years I paid them back $100 (the borrower would list all payments to the bank irrespective of whether they were principal or interest).  Since the Shari'ah doesn't recognize interest, the Court could assume that all cash flows were principal.   Once a banker from a neighboring country told me that a borrower had pulled this ploy and the court ordered his bank to refund the overpayment!  That is, the bank wound up owing money to a non paying borrower.  If  Saudi courts still might  take this stance, then Saad could charge that he only received US$645.75 million not US$650 million -  and therefore there was something wrong with the Note and the transaction.  I think if the gross proceeds were desposited to Saad account and he paid the US$4.25 million in fees, there would be a stronger case than if  he only received the net.  This is not an issue particular to this transaction, even a conventional non-Shari'ah bond could run aground on this shoal.

(6) Other Interesting Points from the OC 

(a) OC page 14 Ownership of the Issuer.  AlGosaibi Investment Holding EC  Bahrain ("AGIH")  owns 99%.  Those of you who have been following the legal battle between AlGosaibi and Mr. AlSanea know that AlGosaibi has accused him of undertaking transactions in AlGosaibi companies without their knowledge.  It would be very interesting to know who at AGIH authorized this transaction.  Without that information, we can't draw any conclusions.

(b) OC page 22-23 Shari'ah Opinion.  The last paragraph gives an insight into the practical approach taken:  "The Shari’ah Board also took into consideration (i) the legal constraints under which this product is being developed; (ii) the need to facilitate and bring ease to the Islamic financial institutions and others who are determined to raise financing according to Shari’ah principles; and (iii) the prevailing conditions and a¡airs of the Ummah and the need to remove them from the shackles of riba. And Allah Knows Best."

For those interested there is a description of the Saad Group  as well as some now dated financials at the end of the OC. 

If there are any trained lawyers out there, I'd love to hear your thoughts on Golden Belt as well as on my previous post on TID Global Sukuk 1.  All without attribution and as well pro bono.

Golden Belt Sukuk 1 (Saad Group) Vote on Dissolution

Following the payment failure on 16 November 2009 and the earlier event of dissolution notified investors last August, the Delegate on the Sukuk has approached investors again asking them whether they wish to vote to dissolve the Trust and thereby collapse the Sukuk triggering Saad's purchase obligation. 

25% of investors have to vote for this to be effective.

So far 7.4% have. 

Notice posted on BSE here.

Nakheel Asks NasdaqDubai to Suspend Trading in Its Bonds

Apparently in a move to prevent price deterioration  and further negative sentiment towards Dubai World.

Islamic Financing & Restructuring Part II - TID Global Sukuk 1

A second installment in my series on Islamic Financing and Restructuring. 

 But first just a note that I am not a lawyer and the following is not legal advice.

Tonight I want to look at The Investment Dar's "TID Global Sukuk 1" issued in September 2006.

Before we set off, let's make sure we have the right gear in our "kit":

1. AAOIFI February 2008 Sukuk Principles  - You'll recall the issuance of this document was credited with causing turmoil in the market.  Here's Norton Rose's take.
2. TID Global Sukuk 1 Offering Memorandum  ("OM")
   
3. TID Global Sukuk 1 Musharaka Agreement   ("MA")
   

Some short details on the transaction:

1. US$150 million issue
2. Five-year final maturity with Periodic Distribution Profit computed at Libor plus 1.25% for the first three years and then Libor +1.75% for the last two with payments each 20 March and September.
3. Principal repayment at the final maturity date  (Musharaka End Date).  A "bullet" structure.
4. Islamic structure - Musharaka (Profit Sharing Agreement).  TID to contribute value in kind in form of Trust Assets  8,532 cars (as per the MA) plus property in Kuwait.  As a result, TID will hold 51.22% of the Musharaka.
5. Legal structure - limited recourse certificates - recourse is to the Trust Assets.  Additional protection is given by a Purchase Undertaking by TID.  Re the Purchase Undertaking OM Section 8 (Pages 66-67) set forth an Early Redemption Date (voluntary redemption).  OM Section 9 (Pages 67-68) set forth redemption under a Dissolution of the Trust.  You might consider this a guarantee but don't let AAOIFI hear you say that.
   

 Let's turn to the detail.

(1) The Trust Assets

As per the OM page 7 "Proceeds of the Trust Assets are the sole source of payments on the Certificates".

Let's take a close look at them given their importance.

As per the MA Section 2.5 (d) "It [TID] shall hold and maintain such registered title as agent for the Musharaka and shall not do or omit to be done any act, matter or thing which will, or might reasonably be expected to, result in either of the Partners [TID and the Sukuk holders] breaching any of its obligations under any Transaction Document."  AA:  In other words, the Trust Assets remain legally registered in the name of TID.  The issue here is similar to that discussed in my earlier post about The International Banking Corporation and its trust arrangements with its parent, Ahmad Hamad AlGosaibi and Brothers.  One needs to be sure that such arrangements are "bullet proof" so that one's trust assets don't wind up in the legal estate of the agent.

The critical issue for investors then is the strength of the trust agreement and its enforceability under Kuwait law.  Why Kuwait?  Because that's where these assets are located.  The trust indenture itself is drawn under English law as are the other Transaction Documents.   Since the Sukuk certificates are subject to English law, there is some logic in having a key document like the Trust Agreement also subject to English law.  However, marching into a Kuwaiti court with an English law agreement does pose some problems.  Kuwait does not have reciprocal agreements with England to honor each other's court judgements.  And any local judge - not just a Kuwaiti -  may wish to review the case.

(2) The Purchase Obligation

As per the OM Sections 8.1 and 8.2 (Page 66), investors have a "put option".  Nor more than 180 days and no less than 120 days prior to the Early Redemption Date (the sixth Periodic Distribution Date, i.e. 20 September 2009), the investors can require the Trustee (TID) to buy all or a portion of their certificates. and the Trustee is legally obliged to buy them.  

The Purchase Obligation is also triggered by a Dissolution Event (an "event of default" in typical non-Shari'ah finance speak).

The Purchase Undertaking is included to give investors recourse to TID so that they have a claim on its creditworthiness.  Clearly, the benefit of this arrangement depends on the ability and willingness of the Trustee to make such a purchase.  Assuming it works, TID is in effect an obligor on the certificates. 

And note, if TID is an obligor (as in a guarantee) but does not pay, that guarantee obligation should be pari passu (equal in status) to funded debt - at least in most jurisdictions.

The critical issue then is how a court treats the Purchase Undertaking.  Is it the equivalent of a guarantee?  If so, it then becomes an obligation equivalent to a loan made to the Trustee.   TID gives a representation to this effect in the OM on Page 4.  If the Purchase Undertaking is merely a commercial contract, could a court void it?  I don't know enough about Kuwaiti law to provide a definitive answer.  Would a Kuwait court take an English law determination?

(3) Periodic Distribution Amounts

Under a Musharaka, the partners participate pro-rata in profits and losses.  Since this is really a borrowing, the transaction has to be structured so that the Sukuk investors get their interest payment only.

Let's step through the document.

First, there is the obligatory comment in the OM (Page 3):  "Each Musharaka Partner, pursuant to the Musharaka Agreement, shall be entitled to share in the profits of the Muskahara and bear losses of the Musharaka ratably in accordance with the proportion that such Musharaka Partners' Units in the Musharaka bear to the aggregate of the Units then held by both Musharaka Partners".  AA:  The Shari'ah principle is upheld.

Second, on the same page:  "The Management Agent [TID] shall be entitled to a management incentive fee computed as provided below.  AA:  Nothing obnoxious to the Shari'ah in compensating the Managment Agent for doing a good job. 

Third, on the same page:  "The Management Agent is entitled to certain fee ("Incentive Fee") when, in respect of any Accounting Period (as defined herein), the Musharaka Accounts (as defined herein) show a Net Cash Profit payable to the Issuer greater than the Periodic Distribution Profit Amount [Libor plus the margin]".   AA: In other words, any profit over the Periodic Distribution Profit Amount (let's call that interest for the moment) is the Incentive Fee to the Management Agent.   That's some incentive.  But it achieves the goal.  This is a borrowing and the lender is entitled to his interest.  Exercise left for the student:  Are Shari'ah principles pristine at this juncture?   

(4) Accounting Treatment

TID's last annual audited statement was issued for Fiscal 2007.  This Sukuk and one issued previously are shown as liabilities in the balance sheet, equivalent to borrowings.  Note 18 describes the Sukuk transactions in more detail. 

Section 18.2  of that Note states:  "Islamic Sukuk are secured by assignment of finance receivables amounting to KD 18,251,420 as of 31.December 2007 (KD 30,495,918 as of 31 December 2006)."   AA: This structure was approved prior to the AAOIFI February 2008 statement of principles.  While the balance sheet treatment looks uncomfortably close to a loan, one could argue that since TID is the majority owner of the Musharaka, under accounting principles it must consolidate the entire entity.

(5) Restructuring Issues

(a) Strength of the Trust Arrangement

The Sukuk and non Sukuk holder are going to be motivated by their assessment of the value of the assets in the Trust.  If there is real value there, the non Sukuk holder will attack and the Sukuk holder will uphold the Trust Agreement.  If not, the Sukuk holder might try to argue that there was no Trust  so that he can access more assets as a general creditor.  In such a case the non Sukuk holder would argue for the Trust. 

Another issue has to do with Sukuk holders changing the Trustee.  If the Trustee is in difficulty, getting the Trust Assets registered in another Kuwaiti entity's name - one not in a debt restructuring - would be ideal.  Without the text of the Declaration of Trust, it's not possible to determine  what can be done.    It would be a matter of law as one would expect the English law firms involved in drafting the Transaction Documents would try to incorporate this principle.   The potential "rub" would be Kuwaiti law and practice.

What's also important here is the precise claim the investors have over the Trust Assets.  Is it merely the proceeds they generate?  Or do the investors have the right to the assets themselves?

(b) Management Agreement

What are the circumstances under which the Sukuk investors can replace the Managment Agent?  If the Agent is unable to fulfill his duties, the underlying property might suffer dimunition in value.  Those obligated under the car or property receivables might have a legal right to hold payment.  Or might choose to take advantage of diminished oversight to try to avoid their own obligations.  Again one would expect this to be addressed in the Management Agreement  And like the Trustee issue above, Kuwaiti law and practice would be the practical issues.  There is a disconcerting statement on Page 3 in the OM in the Management Agreement section "... the Management Agent shall be irrevocably appointed as manager of the Musharaka."

(c) Purchase Undertaking

Is this the equivalent of a guarantee?  Or a voidable contract?  Again a logical target for a non Sukuk holder creditor to attack.  This would be similar to the attempt made by the non Shari'ah BIB creditors described in my first post on this topic.

(d) Public Policy

As a final word, it's important to recognize that public policy is highly likely to influence decisions - not merely the letter of the law.  Countries in the area are unlikely to set precedents which undermine "Islamic banking".

The Investment Dar Kuwait - Standstill Agreement - 12 November Key Date - Creditor Response Uncertain

 

Today is a key date for TID and its advisor, Credit Suisse.

12 November is the deadline already extended once from 15 October for a response from creditors to a proposed standstill agreement.  A standstill would involve creditors voluntarily halting legal action against TID in return from some reciprocal actions and commitments from TID. 

Signs are not encouraging.  Failure to get creditors to agree to the Standstill would complicate matters but would not necessarily be "fatal".  The problem is the situation is complicated enough already.

While it's long past the end of the day in Kuwait, the lack of an announcement is not necessarily confirmation that creditors have not agreed.  TID is likely to have creditors in other jurisdictions and votes may still be coming in.  And if history is any guide, there will be ambiguous answers or contingencies placed on "yes" votes.  So some "hanging chads" to be resolved.

However, since votes like this don't take place on a single day, it's probably safe to assume that there wasn't a landslide of yes votes.   Otherwise, TID would have announced victory already. 

If asked to, I'd guess that the standstill is not likely to be accepted.  And if it's accepted, it will be by less than the number necessary to ensure protection from legal actions by dissident banks.

As you'll recall that in an earlier post, I noted the reported reluctance by certain participants in wakala transactions with TID to sign the standstill, preferring instead to rely on the "trust nature" of their transactions to secure repayment outside any debt restructuring.  And some speculation on the rumored resignation of an Adeem and Investment Dar Bank Bahrain director and connections with the TID restructuring.

TID's restructuring has been complicated by the fact that unlike Global Investment House ("GIH"), it has not issued any financial statements since its 30 September 2008 interim report.   Bankers don't like uncertainty.

As well unlike GIH, the Central Bank of Kuwait has appointed a temporary monitor at TID apparently at the request of creditors to oversee the completion of financials and the restructuring process  Perhaps a sign of the level of uncertainty of the creditor group.

A bit of background regarding the negotiations with creditors regarding some KD 1 billion (US$3.5 billion) in outstanding debt via announcements:

1. December 2008:  discussions with Commercial Bank of Kuwait to lead refinancing.  These do not succeed.
   
2. 25 January 2009:  announcement of engagement of Credit Suisse as a financial advisor.
3. 12 February 2009:  announcement that Credit Suisse will assist in developing a financial restructuring plan.
4. 1 April 2009:  KSE suspends trading in TID.
   
5. 12 May 2009:  TID defaults on US$100 million Sukuk
   
6. 28 May 2009:  announcement of formation of Creditors "Steering Committee" and upcoming meeting with creditors
7. 10 June 2009:  progress announcement.  (AA:  Note creditors have hired Morgan Stanley as their advisor).
   
8. 7 September 2009:  CBK appoints monitor at TID. (AA: The language used reflects the apparent concern of creditors.  There is of course always a break down in relations between banks and debtors when they advise they have difficulty paying or might have difficulty.  In effect the creditors have asked the CBK to look over the shoulder of TID's existing management.  A theme we'll see repeated with the Chief Restructuring Officer).
   
9. 26 September 2009:  announcement that "Creditors Co-Ordinating Committee" and TID had agreed a standstill agreement which was being submitted to all creditors for ratification with a deadline of 15 October. (AA:  Note the change from a "Steering Committee" to a "Co-Ordinating Committee".  That sounds like the members of the committee decided they  want to de-emphasize responsibility.  So they've taken their hands off the steering wheel and are now co-ordinating not leading).
   
10. 4 October 2009:  announcement of appointment of Chief Restructuring Officer, fulfilling a TID commitment under the proposed Standstill Agreement.  (AA: The creditors request for the appointment of a CRO is another indication of creditors' concerns.  It is not a vote of confidence in favor of existing management.)
    
11. 12 October 2009:  announcement of the extension of the deadline until 12 November.  "The intention is that the revised timeline will give a greater opportunity for TID’s banks and investors to actively participate in the standstill process. As such; the new date by when TID’s banks and investors can accede to the Standstill Agreement is 12 November."  (AA:  In other words not enough creditors signed up by 12 October and it was clear they wouldn't by 15 October. So the deadline was extended.  But their language sounds more eloquent than mine).

Failure to achieve the standstill need not be fatal.  But TID and CS will have to move quickly to create some forward momentum that will keep creditors engaged in discussions rather than court rooms.  A task as difficult as the proverbial herding of cats.

I'll be following this and update as more news becomes available.

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.

IFC Lists US$100 Million Sukuk on Nasdaq Dubai and Bahrain Stock Exchange

On 4 November 2009,  the International Finance Corporation, the private sector lending and investing arm of the World Bank Group, registered a US$100 million Sukuk ("Islamic Bond issue") on Nasdaq Dubai and the Bahrain Stock Exchange.

Those watching the financial news have seen this story develop from earlier announcement (October) to today when the deal was done.  Here's the press release from Nasdaq Dubai.

Deal details: 

1. Issuer:  Hilal Sukuk Company Cayman Islands, a special purpose vehicle created for this transaction.  
2. Obligor:  International Finance Corporation ("IFC")
   
3. Annual Profit Rate (Coupon):  3.037 percent per annum payable semi-annually (May and November). 
4. Final Maturity:   May 2014.

Deal "firsts":

1. First Sukuk issued by IFC.  
2. First Sukuk issued by a non GCC financial corporation for term funding.
   
3. First IFC listing in Dubai and Bahrain Stock Exchange.  
4. First use of Nasdaq Dubai's central securities depository (electronic certficate form).
   

The prospectus for the transaction is here for those interested in more detail.  And as well the fatwa as to Shariah compliance.

There is a convenient transaction diagram in Section 1 which is a good introduction to those not familiar with the structure.

The key issue with a structure like this is the nature of the certificate holders' rights in the Trust Assets (the assets whose cash flow is the sole source of repayment of the Sukuk).

Often there is confusion on this topic.

Is the right to the assets themselves? 

Or the right to the cashflow from the assets?

If the transaction is truly collateralized by the assets, the certificate holders may upon a default take possession of the assets and sell them to a third party.

A few sections from the prospectus appear to settle this question.

1. Page 11 Risk Factors Limited Recourse:  "Furthermore, under no circumstances shall any Certificateholder or the Trustee or the Delegate, as the case may be, have any right to cause the sale or other disposition of any of the Trust Assets except pursuant to the Purchase Undertaking and the sole right of the Trustee and the Certificateholders against IFC shall be to enforce the obligation of IFC to pay the Exercise Price under the Purchase Undertaking."
2. Page 15 Transfer of the Investment Assets:  "Nevertheless, the Certificateholders will not have any rights of enforcement as against the Investment Assets and their rights are limited to enforcement against IFC of its obligation to purchase the Trustee’s rights, title and interest in and to the Investment Assets pursuant to the terms of the Purchase Undertaking. Accordingly, any such restriction on the ability of IFC to make a "true sale" of the rights, title and interest in and to the Investment Assets to the Trustee is likely to be of limited consequence to the rights of the Certificateholders."

Should investors be worried?

The World Bank Group carries the highest investment grade rating.  It is owned by the countries of the world.

If there is a future problem with the creditworthiness of the World Bank, it will be reflective of extremely serious global problems.  In that case collection of this bond will be among the least of investors' worries.