Wednesday 15 September 2010

Who Audits the Auditors?


A great deal of reliance is placed on auditors by Boards, regulators and the providers of debt and equity capital.   But how can these parties know the quality of the auditors' work?  Particularly, those not inside the firms being audited?

Understanding What Auditors Do and What They Don't

The first step is understanding precisely what is the role of the auditor.  A "clean" audit opinion does not mean that there was no fraud in the company.  Nor is it a guarantee that the financials are 100% correct.  If you think about it, to get to that level of certainty, the auditor would have to be present at every business discussion and follow each transaction at the company from "cradle to grave".

What the auditors' work should mean ("should" because it doesn't always) is that the auditor has determined that there is a proper system in place that is functioning reasonably.  That includes determining that  proper accounting principles are applied on a consistent basis, that the assumptions and estimates which affect preparation of the financials are reasonable and that a check of assets and transactions (on a sample basis) doesn't raise any red flags.  And finally that the results of operations (income, assets etc) are reported fairly in sufficient detail.

Several factors influence the performance and results of an audit:
  1. Interpretation of accounting standards and principles:  strict, moderate or lax
  2. Level of skill, experience, knowledge of the partners and staff
  3. Management of the audit process, e.g., audit plan design, management of staff and workflow, quality of the review process
  4. Ability and willingness to challenge management's assumptions and estimates
  5. Ability and willingness to stand-up to pressure from the client or outside parties
  6. Ethics
The second is understanding that the international firms are structured as partnerships, generally at the country level.  So Firm XYZG in the UK is not exactly Firm XYZG in Bahrain.  For one thing each has its own dedicated staff with their own level of skills, knowledge and experience.  What that means is that there can be differences between one office and another of the same firm.  

Auditing the Auditors

So, how can an outsider audit the auditors?

Three ways:
  1. Use the work of regulators and others who review auditing firms' work.
  2. Review the end product (the financial report) for quality.  While management is ultimately responsible for the content of financials, the auditors have a role to play as well.  Is the report clear?  Or is the true nature of transactions difficult or impossible to figure out?  Does the auditor seem to be condoning presentation at the edge or beyond in terms of accounting for transactions?  Do you see a repeated pattern of "easy audits"?
  3. Prepare a list of auditors for distressed firms.   Then identify those companies where the problems were outright fraud, improper valuation of assets, aggressive booking of profits.  You're looking for  major occurrences and a repeating pattern. 
Let's turn to these examples one by one.

Using Regulatory Reports

Unfortunately, such regulatory or other review reports aren't available for every country.  To a large extent that limits the utility of this method.    But where they are available one may gain some insights.  While firms are separately incorporated national partnerships, there is some level of quality control, sharing of expertise among offices as well as tone setting from the top.

It's important to know that public reports of this nature are written in diplomatic language.  So it's important to understand the "code" used.  The concept is similar (but not identical) to that in the IMF Public Information Notices.   It's also very important to understand the basis for the reports conclusions.  In some cases the sample of audits reviewed is small in terms of the total number of audits done.  And may not have been selected using statistical sampling techniques.   In such cases one has to be careful not to draw a conclusion about just how widespread a failing is.

Reviewing the specific issues for a firm can give an idea of that firm's overall approach and perhaps pinpoint particular areas of concern.  One can usually classify the shortcomings as due to (a) lax interpretations of accounting principles, (b) staff inadequacies, (c) work process failures (design, implementation, monitoring and review of the audit), etc. 

This exercise can provide another level of insight.


Besides information on a specific firm, these reports may also disclose common problems.   If the reports on almost or all of the firms repeat the same themes, this can indicate both the relative frequency and severity of a problem.  So, for example. if all firms are being criticized for  audit failures on revenue recognition,  that's a much different situation than if only one firm is. 


On this topic today the UK's Financial Reporting Council, Professional Oversight Board released its  annual public reports on the audit work four major international accounting firms in the UK.  There's a very important word in that last sentence:  "public".  We can infer from this that there were private reports.  No doubt much more direct and to the point.

One firm has been singled out in the press.  But if you look at the individual reports you'll see shortcomings in such central areas as:
  1. Obtaining audit confirmations for assets (one would think in the post Parmalat world this wouldn't be occurring)
  2. Failure to attend the physical count and inspection of inventory - a very key step in understanding the financials of a manufacturing or retailing company.  If inventory is overstated so are profits.  
  3. Technical issues such as going concern qualifications
  4. Failure to complete partner performance/competence reviews
But note that the sample of audits reviewed was not chosen according to statistical sampling techniques.

What's potentially disturbing here is that these sort of things are being discovered in the UK.  One might assume that with the existence of the FRC POB, a legal system that makes it easy for lawsuits, the firms would be on their best behavior.  If this is the case, and it may well not be, what then is the standard in other less regulated more opaque markets like the GCC?

Reviewing the Financials Yourself

The second method, reviewing the financials yourself, is admittedly tricky.  You've got to have a bit of knowledge about accounting standards and presentation.

Here by way of example are some things that caught my eye.  And which two different observers might draw different conclusions.
  1. The 2009 report of an investment bank in Bahrain.  Late in 2009, in what some might see as a vindication of its proven business model, it announced the successful issuance of a US$100 million convertible murabaha.  It's only when one reads further into Note 16 that one learns that the murabaha was issued at a discount, though you won't see that word used in the financials.  Nor was it in the press release.  It's only at the end of Note 16 we learn that proceeds were only US$80 million.  Technically, is the information there? Yes.  But it must be teased out of the Note.   Like that table you bought from Ikea, some assembly is required.  Is this really in the spirit of  شفافية ?  Isn't this material information important to the readers of the financials, particularly shareholders? Shouldn't it be disclosed in plain unambiguous language?  Apparently, management and the bank's auditors thought otherwise.
  2. The 2009 annual report of a conventional investment bank in Bahrain, who some might describe as the grande dame of the industry.  During the year, it issued some US$500 million in preferred equity which is duly reflected in its books as of the end of its fiscal year.  But a look at Note 6  (Cash and Banks) shows that some US$381 million of that amount is as "cash in transit".  What this means is that the funds were received after the statement date.  They were not in the bank on the statement date.  Reflecting the full US$500 million as paid in equity seems a bit premature.  Perhaps this post balance sheet event is more properly reflected in a "Subsequent Event" Note.   Note 7  (Receivables) discloses that another US$110.5 million of the US$500 million was also not yet received.  So paid in equity has increased by US$500 million but only 1.7% of the amount was received by the statement day.  As in the case above, management and the auditors agreed on this presentation.   
  3. The 2006 annual report of the same investment bank.  A change in IAS #28 led to a US$354 million charge to retained earnings which dropped from US$528 million to US$170 million.  Previously, the bank had valued some of its investments in associates at "fair value" using only comparable transactions using an exemption for assets held for sale in the "near term".   The bank noted that "near term" was not precisely defined in the Standard.  It reasoned  that since private equity and similar investments are held for three to seven years, that period  must be what was meant by "near term".  Like the cash in transit  treatment above this seems a rather conveniently elastic determination.  The firm's auditors apparently had no real problem with this approach because they countenanced it for years.   But there's more.  With that exemption no longer applying, the assets became Fair Value Through Profit and Loss with the methods for determining fair value now also including comparable market values (not just actual transactions).  The result of this additional method?  A US$359 million charge (68% of 2005 retained earnings).  Whether this was properly classified as a prior period adjustment (direct to equity by passing the income statement)  statement) is a matter of debate.  But the size of the required adjustment does suggest that tests for impairment may also have benefited from generous assumptions.   You'll recall that when the restatement occurred (June 2006) macro economic conditions were not particularly depressed.  And that over the next two years (a relative boom particularly in the markets where the investments were concentrated) there was no subsequent write up of these assets, lending further credence to the adjustment being more of an impairment.
Involvement in Distressed Situations
  1. This is fairly straightforward.  The initial list can be compiled from the well known names in distress.  
  2. One then looks for cases where there was particularly egregious behavior.  And then sees if the same firm's name is turning up repeatedly. 
  3. Two very important points. 
  4. First, firms get into financial distress without there being any defects in audit or any unethical behavior on the part of management.  Bad things do happen to good people.   
  5. Second, everyone makes mistakes.  It's when one makes a lot of them that the red flag should go up.
  6. Over the past few years, we've seen some spectacular falls from grace.  While some of these were due to (a) poor management or (b) the global economic crisis (lower case "g", please), in others there was apparent manipulation of financials.
  7. In some of these cases, there have been allegations that loan portfolios were fictions of the imagination, that outside parties controlled the entities overriding what is described as a compliant/supine management, that internal documents, loan files,  minutes of board meetings were forged, etc.  If these allegations are true, there was massive sustained fraud.  Financial institutions may have been run as criminal enterprises.
  8. In other cases fair values turned out to be vanish with astonishing rapidity.  Often in  companies that engaged in a high volume of obviously dubious transactions with related parties - buying and selling stock in one another, playing musical chairs with assets.  On a scale to suggest that this behavior was the usual mode of conducting business.
  9. In some other cases, companies abused positions of trust and expropriated client and investor funds for their own use, stuffing those unfortunate parties with the losses or using assets of uncertain quality to extinguish amount certain liabilities.  Yet, the audit reports solemnly aver "We are not aware of any violations of local laws".  Though perhaps to be fair in some countries local law may not prevent such behavior.  It may instead be a sanctioned national sport as some of my "Southern" GCC friends claim is the case in one "Northern" country.
All of the above are of course indirect and not conclusive proof.  

But like the mosaic theory of research analysis (in which a bright analyst takes lots of little bits of information about a company to develop a powerful insight into its value), one can potentially do the same here.  And a sense of the quality of financials and audits can be a powerful (though not sole) input to an investment decision.

In the process one also has to apply appropriate weights to behavior.  So, for example, one might be more forgiving of  some shortcomings than others.  It's a bit easier to "understand"  an auditor  letting some window dressing pass than countenancing related party schemes to pump up investment values.  Though it's probably a good idea to be a bit more wary of an auditor who repeatedly demonstrates a "flexible" or "accommodating" approach than one that does not.  Each crossing of a "line" makes the next easier.

Tuesday 14 September 2010

Union of Kuwaiti Investment Companies Studies the Constitutionality of New Capital Markets Law

AlQabas reports that the Union of Kuwaiti Investment Companies has been studying the new Capital Markets Authority Law as part of their self-proclaimed selfless desire to participate in all aspects of the economy and decisions relating thereto.  

As a result of these efforts, they've discovered some shortcomings it seems and have rather patriotically pointed these out to the authorities.   Further careful study has uncovered some articles which are clearly unconstitutional and,  as well, probably run counter to the original intent of the Founders.  By what I suppose might be described as sheer coincidence, the offending articles relate to penalties applicable to Kuwaiti investment companies.

Appropriate action will be no doubt be taken. 

Monday 13 September 2010

Mercer Global Quality of Living Survey: GCC


I thought I was late with my "news" about Unicorn.  Well, today AlQabas beat me with a story about Mercer's study released last May.

A few interesting points from that article.

First, the ranking of GCC cities (world ranking in parentheses out of 222 cities surveyed):
  1. Dubai (75)
  2. Abu Dhabi (83)
  3. Muscat (100)
  4. Doha (110)
  5. Manama (111)
  6. Kuwait (122)
  7. Riyadh (158)
  8. Jeddah (159)
Looking at the world rankings:

  1. Vienna  (A shout out to The Real Nick).
  2. Zurich
  3. Geneve
  4. Vancouver
  5. Auckland
Baghdad was dead last at 222.

Dubai World: Aurelius Capital Management, The Single Recalcitrant Creditor?


According to the Financial Times quoting informed sources close to DW, Aurelius Capital Management with a $5 million stake bought in the secondary market is the only creditor not yet to have signed on to the rescheduling.  

The company is billed as a US company.  It's unclear if there's a relation to Aurelius Capital Management in Vienna.   Perhaps this is a US-based fund managed by ACM Vienna?  There is an office for Aurelius Capital Management LP and Aurelius Capital Partners LP at 535 Madison Avenue in Midtown Manhattan.

With this level of acceptance and ACM's small ticket, it seems they can be easily brushed aside by recourse to the DIFC Special Court.  Once the Court ratifies the restructuring, I think that ACM would be effectively crammed down not just in the UAE.  

Perhaps, ACM is hoping that it's so small a fish, that rather than incur the fuss, DW will pay it to go away.

It all depends on how DW wants to respond.  Since Dubai Inc has other debts to reschedule, it may make sense to make an example of a recalcitrant creditor. Particularly, when the stakes are low.   If the Company wants to play hard ball, it can string  ACM out in court actions in other jurisdictions, forcing them to incur legal expenses.  Holding payments in escrow until they sign the rescheduling. 

Insights into the GCC Markets from Markaz’s “Golden Portfolio” Report


In April 2008, Markaz issued its first report on the "Golden Portfolio" – the various stocks held by GCC government owned enterprises ("GOEs"). On 7 September it updated its analysis with data as of 5 July 2010.

The report tracks the holdings of 51 GCC GOEs in GCC stock markets.

The following two charts summarize the macro snapshot (original chart on page 2 of September 2010 report).

First, the number of companies in which investments are held.



COUNTRY
NUMBER

OF GOEs
NUMBER OF

COMPANIES HELD
TOTAL NUMBER

OF COMPANIES


PERCENT
Saudi Arabia104714033.6%
UAE102911026.4%
Qatar8184540.0%
Kuwait104219421.6%
Bahrain9204445.5%
Oman142312718.1%
TOTAL5117966027.1%

Second, the value held expressed in US$ billions.



COUNTRY
VALUE OF GOE
INVESTMENTS
TOTAL VALUE

OF MARKET
PERCENT
Saudi Arabia$109.7$314.635%
UAE$ 28.3$ 97.229%
Qatar$ 26.0$ 97.727%
Kuwait$ 11.7$ 90.913%
Bahrain$ 3.5$ 16.421%
Oman$ 2.7$ 16.716%
TOTAL$182.0$633.529%

This data gives an idea of the relative government presence in local markets. It also shows the relative sizes of markets.

But if you drill deeper into the information on the country tables, what you learn is that: 
  1. In Saudi Arabia, 5 companies held by GOEs account for 38% of total market cap. One company SABIC over 21%. 
  2. In the UAE, 5 companies held by GOEs for roughly 42% of market cap. One company, Etisalat, almost 23%. 
  3. In Qatar, 7 companies held by GOEs for 47% of market cap. One company, Industries Qatar, for 15%. Another Qatar National Bank for another 15%. 
  4. In Kuwait, 8 companies for almost 44%. (If you're wondering, the group does not include NBK which is a market heavy weight in its own right). With Zain at 19%. 
  5. In Oman, 5 companies for 35%. One, Omantel, for 14%. 
  6. In Bahrain, 4 companies for a whopping 69% of the market. One, Batelco, for just short of 20%.
By contrast Exxon Mobil (the largest single stock) represents roughly 2.6% of the NYSE's US$11.7 trillion in July 2010 market value. HSBC just short of 7% of the LSE's US$2.7 trillion of value.

"So what?" you might ask.
  1. Modern portfolio theory ("MPT"): Where a handful of companies dominate the market, market risk may be swamped by specific risk. What sense does it make to use the tools of MPT, e.g., CAPM, betas, etc in this context? 
  2. Conflict of Interest: But there's more. Where the government has significant holdings in companies, even if this shareholding is less than a majority, it may exercise effective control. In such situations, companies may be managed with national strategic goals more important than maximizing shareholder wealth. 
  3. Liquidity: Government strategic holdings reduce free float. The consequence is reduced trading which limits price discovery, increased share volatility (small transaction "tickets" have a disproportionate effect on price) and limited liquidity (the ability to exit one's position).
The implications are pretty clear but I think often not really thought through by market participants. And so probably not fully reflected in prices.

Sunday 12 September 2010

Off to a Great Start

Perhaps the only time that really counts.

With the passing of the fourth game, the mandatory ritual silence may now end.

Off to a great start.  And to a great finish!

Saturday 11 September 2010

Dubai World: The Impact of the Fixed Interest Rate on Secondary Debt Prices

FOR SALE 
 
Great Price.  One Owner Only! 
Carefully Underwritten and Maintained

Asa Fitch over at The National has a report on secondary loan sales of DW debt.  As per his report only US$25 million has been sold so far by an unnamed Asian bank at US$0.55 of par.

Traders are quoted as saying there is a disconnect between the bid and offer prices with sellers looking for modest discounts and buyers thinking more in the range of 30 to 60% discounts.  That's an extremely wide range - which indicates the lack of real demand.  Also it may be reflective of differing discounts for the five-year and eight-year paper.

For a potential buyer there are two key risk issues with a purchase:
  1. Repayment Risk - Will DW settle its debt in full?  So there is a premium added to the "risk free" yield to compensate for this risk.
  2. Interest Rate Risk -  DW's debt is at a fixed not floating interest rate.  The price of financial instruments with fixed interest rates moves inversely to the current market level of interest rates.   If you think about that it makes perfect sense.  If the market if offering to sell you a new bond with a fixed 5% coupon, why would you pay the same amount for an equivalent credit risk bond with a fixed 2% coupon and the same repayment profile? You'd be willing to buy the 2% bond only if its price were less than par.  Sufficiently less so that you earned 5% on  the bond. The extra bit of yeild coming from capital appreciation.  This price risk exposure is measured by duration and convexity. Duration estimates the price change using a linear approximation of the price change function (equation).  Since the actual function is not linear, a second approximation, convexity, (technically the second derivative) is used to correct the first. Bond sensitivity to interest rates can work both ways.  If market interest rate levels decline, then one's bond is worth more.  That is, reversing the example above, one has the 5% coupon bond in the 2% market coupon environment.  As noted above in the original example, if market interest rates increase, one's bond is worth less.  Since DW's bonds are at below market rates and since market rates are at historic lows, there is little upside potential.  Any buyer will be focused on pricing the downside risk into it's bid.  Compounding the pricing will be the credit risk element.  Just to complete the discussion, floating rate instruments are less much sensitive.  Their duration is generally equal to the length of the repricing period not a function of maturity.  With, for example, a quarterly interest payment reset one can ignore interest rate risk.
These two factors affect the discount.  The bigger the required yield on the instrument the bigger the discount.

Since I haven't seen much discussion of interest rate risk, and since I think it's an important factor affecting the secondary pricing of DW debt, I'm going to focus on it in this post as you may have guessed from my "succinct" discussion of this topic immediately above.  

This is a structural issue.  As the restructuring was crafted, lenders had two options to reflect the economic value of the debt.  
  1. Haircut the debt and get a market or near market rate on the debt. 
  2. Maintain the fiction that the debt was worth par and take a below market interest rate.
Why did they choose the structure they did?

Some potential explanatory factors:
  1. The importance of cashflow to DW.   DW is cash strapped.  A higher interest rate will impact them more now than reduced principal repayments which in traditional restructuring style are going to be backended.  DW's overriding goal is to delay as long as possible the sale of assets, hoping that an economic recovery will allow them to realise more value.  Or that  a refinance will become possible.  Particularly important because a lot of these were purchased at the top of the market with more than modest levels of leverage. 
  2. The wise lenders in the steering group who have the remarkable accomplishment of being responsible for 60% of DW's debt (Another great moment in banking!) are probably not going to be selling because the pain would be too great.  It's much easier to absorb say an US$11 million loss on one's US$25 million stake than say a US$2+ billion loss.  So they have no burning incentive to  create a more seller friendly structure.  They're holding at cost not marking to market.  Assuming DW performs under the restructuring, their "haircut" will be the IAS#39 mandated one time present value difference using the new interest rate versus the older higher one.
  3. Forgiving principal sets all sorts of dangerous precedents and raises all sorts of dangerous ideas in the minds of borrowers.  
  4. Also since interest rates can't go negative, an interest rate reduction has an absolute bound in terms of the haircut.  
  5. Additionally, many folks don't understand the concept of present value so an interest rate reduction is not considered as serious as a principal reduction.  You might be surprised (and maybe some of you dismayed) to learn that in many institutions a principal reduction requires a more stringent approval than an interest rate reduction - even when the present value impact is the same.   With the financial press and the average investor the awareness appears to be even lower.
 As usual,  let's begin with the assumptions:
  1. A market-demanded discount of 50% of par.   Roughly in the midpoint of the mentioned discount rates.
  2. An average 5 year life for the 8 year DW restructured loans.  Since we don't know what the principal repayment schedule is, we have to assume an average life.  I think five years is a good guess. DW's repayments probably mirror the pattern typical for restructurings:  low payments in the first years with the largest in the latter years.  If equal amortization would result in a bit over 4 years average life, then 5 years should be on the safe side. Use of 5 years then sets what I think is a reasonable upper bound to the YTM.  In any case hopefully enough for a directional analysis.  Hint:  I will gladly receive a copy of the  restructuring term sheet if anyone wants to send it to me.  Use the Contact Form to make the initial contact to agree transmission details.
  3. A 2% (fixed) coupon.
  4. Repayment in full on schedule assumed.
Here are the numerical results.

We can bound the yield to maturity on the 8 year tenor loan between two  points.

Yield to Maturity ("YTM")
  1. Assuming a straight bond with a bullet repayment of principal at the end of Year #8, the YTM is roughly 12%.  While interest payment frequency affects the YTM, the difference is minor.  For our directional analysis, I'm therefore going to ignore it.  12% represents the minimum YTM because the restructured loans provide for principal repayments during the life of the loan not just at the end.
  2. Using a 5 year average life, the rough YTM is 17%.
Modified Duration
  1. For the straight 8 year bond, duration is very roughly 7 times.
  2. For the straight 5 year bond, duration is very roughly 4.5 times. Recall that as above we're guesstimating that the average life of the loan as 5 years.
  3. What that means is that if  interest rates increase 1% with no change in default risk (credit rating of DW) and no change in credit spreads (the margin demanded for a specific credit grade), then the DW debt will lose roughly 4.5% of its market value. I've chosen to ignore convexity here because it's not likely to be a significant decrease of the duration impact for  the range of likely market interest rate levels.  Since over the next five to eight years, interest rates are more likely to go up than further down, this is a real risk.  A modest 2% hike in interest rates and there is a 9% loss - which will more than outweigh the coupon earnings.
  4. Of course, for an investor who intends to hold the bond to maturity, the price loss will be a mark-to-market event and not necessarily a cash flow loss.  Unless of course the investor sells the bond.  However, a fund or a trader will be marking to market and thus performance will be affected.    With a direct impact on such personally important things  for a fund as fees and reputation for the next fund sale. Or for a trader his bonus and perceived trading skills. You can probably easily imagine how these might increase reluctance to increase one's bid, particularly when demand is minuscule in relation to supply.
Other Factors Affecting Demand
  1. Secondary Play:  There is no secondary play here.  Often in distress situations, buyers of debt may be motivated by the chance to acquire a company cheaply (buy the debt wipe out the existing shareholders) or other factors.   Emirates Airlines or Emirates NBD are not on offer.   The restructuring is "done and dusted" so there's no negotiating leverage over deal terms.  And one would have to make quite an investment to acquire a blocking vote on the chance there would be a future covenant hiccup that one could take advantage of.    One of our regular commentators, Laocowboy2 mentioned a time-honored sovereign debt settlement mechanism - using the debt as the currency for investing in a new project in the country.  Often with the debt being exchanged at par (not its purchase price) and sometimes at a favorable FX rate which effectively lower the cost of the investment.  Many an savvy investor in Latin American tourism reaped a bonanza return using this framework.  Others who invested in more brick and mortar enterprises less so.  Hint:  An investor's return in such transactions depends more on the creative use of imaginative transfer pricing than one's ability to run a business, though the latter is important.  In any case,  I suspect it is unlikely that Dubai will offer such a program.  The sovereign debt "hole" here is not that deep. Nor the distress that acute at present.
  2. Credit Rating Upgrade:  While the "hole" is not that deep, there is still a hole.  Assuming good performance, at some point DW will be upgraded.  However, this is unlikely to happen in the near term.  By the time significant debt is repaid, it may be so close to final maturity that the impact on YTM may be relatively modest. As well, the structural fact that the debt is at a below market fixed rate is going to work against any significant increase in the price.   
  3. Credit Spread Compression:  Usually this occurs in times of irrational exuberance.  Judging by the state of the world economy, a near term return to such giddy days is perhaps not a bet a savvy investor would make today.  And again the very low fixed rate is a negative.
  4. Prepayment:  It's unlikely that DW is going to prepay the loan in the near term. If it did,  the YTM could dramatically improve. With a rate this low there is an incentive to ride to maturity. Presumably, the desire to "repay" the restructuring and remove a living blot from its escutcheon would be a motive to refinance (when that was possible).  More importantly, it could alleviate cashflow demands, including the requirement to dismantle its expensively acquired empire of  "core" investments.  The unknown is when banker and investor ADD will kick in and permit a refinance.  A good guess is probably more than 3 years out, particularly as the upcoming US$30 billion of new maturities over the next 2 years will remind the apparently congenitally forgetful and heedless of the "hole".

Friday 10 September 2010

It's a Happy Eid Indeed

Copyright Kristoferb


A special celebration at Suq Al Mal today.

Our coffee and tea shop is now open again during the day.

The location in the picture above a very very happy memory though sadly gone today like the "bust" of the founder.

Dubai World: 99% of Creditors Agree Rescheduling


According to Asa Fitch at The National DW has issued a statement that roughly 99% of creditors have agreed the terms of the restructuring.

An outcome never much in doubt once the steering committee representing 60% of the amount of the debt agreed the terms.  The remaining banks knew that it would take just a few of their number to reach the "magic" special DIFC Court threshold for a potential cramdown.  So why not sign up and get the early bird bonuses?  Also the rescheduling represents the better alternative for recovering the maximum amount of money.

An accomplishment for DW.  But now comes the more difficult bit.  Meeting the terms of repayments.  And in order to do so, probably parting with some of the "Vision's Dreams" at a loss.

عيد مبارك

Wednesday 8 September 2010

Dubai Holding: Some Creditors Selling Debt

Asa Fitch over at The National reports that some creditors are looking to exit their exposure to Dubai Holding - DHCOG and DIC - through secondary sales at a hoped for modest discount.

This makes eminent sense in view of the many indirect costs associated with carrying distressed debt.  Costs of additional internal reporting and monitoring for credit purposes as well as for accounting purposes (both book keeping and disclosure).  

On top of all of this, if a creditor feels there is the possibility of an impairment, the decision to close the file  now, recognize the loss and move on may be highly appealing, particularly if there is no long term relationship.  Or if such a relationship is not perceived as being sufficiently profitable in the future.

Clearly, this strategy does not work with banks holding sizable shares.  Unloading a $5 million or US$10 million "bit" is a lot less painful than $50 million or US$100 million.

Dubai: Athens on the Creek?

Photograph by Tbc  Released to Public Domain

Martin Dokoupil at Reuters has a rather negative report on Dubai's financial condition quoting a Bank of America Merrill Lynch report that 
  1. Dubai state owned companies are "sitting" on US$100 billion of debt of which US$30 billion comes due through 2012
  2. Dubai's debt is 170% of GDP compared the article notes to Greece's 103%.
That last statistic sounds quite alarming.  But before you plunk down that deposit for an off plan villa at Palm Athena, recall that much of the US$100 billion was debt incurred by corporations not the sovereign itself.  In many cases entities with real businesses.  Emirates Airlines.  Emirates NBD.  Dubai Ports.   In several cases businesses that are incorporated outside of the Emirate.  Or whose main theaters of business activity are outside of the Emirate.

That doesn't mean that everything is just fine.  But rather as always one needs to look behind the headline or headline ratio to the details.

Kabul Bank, Mohammed Karzai, Sherkhan Farnood and Palm Jumeirah

Photograph Ivanlo  Released to the Public Domain 

How often do you hear about companies that advertise services that they really don't offer?  Where managements talk the talk but don't walk the walk?

Well, that's not the case at Kabul Bank where management takes seriously the slogan "The Easiest Way to Earn Millions" as we learn from Bradley Hope over at The National.

And what could be easier than real estate investments in Dubai, particularly in the prestigious Palm Jumeirah development.

One chap made a quick AED3 million, though he can't remember what he did with it.

And what can you say about a Chairman who's so solicitous of his bank's investments that he registers them in his and his wife's name?  No doubt in order to keep a close personal eye on them?  Sadly now, the former Chairman due to some onerous new banking regulations in Afghanistan. 

16 or so villas on Palm J and two plots of land in Business Bay reportedly worth some US$150 million.

As per KB's 31 December 2008 financials (the latest posted on its website), that amount being twice the Bank's shareholders' equity and 21% of total assets (assuming of course that the properties are reflected in the balance sheet). 

Tuesday 7 September 2010

CitiGroup and Its Magical US$50 Billion in Deferred Tax Assets


While many in the Developed West are liable to ascribe magical powers to those from the East, the Hindu Fakir, a guru at an Ashram, a bank in Bahrain, there is magic aplenty - particularly of the accounting sort- all over the world.

Today we look at one of the USA's major banks with US$50 billion worth of  DTAs (roughly one-third its capital).  Under accounting standards, Citi has to earn some US$99 billion in taxable income over the next 20 years to fully utilize the DTAs.

Like me I'm sure you're thinking surely there must be an "Islamic" equivalent.  Perhaps a Deferred Zakat Asset.  I'll be watching my favorite financial institutions in Bahrain and Kuwait to see if this shows up in their financials.

In response to a comment from Chapter 11, I'd note that of Citi's US$50 billion in tax credits, approximately US$31.5 billion are disallowed from computation of regulatory capital.  See Note #4 on page 36 of its 2Q10 10-Q.

Dubai Debt Maturities Through 2012

 Eiger Nordwand
Copyright Kurt Ritschard 
 
Reuters has posted a list of debt maturities (bonds and loans) for Dubai through 2012 by issuer.

Euromoney - A Forest of Paper


One of our regular commentators noted that Euromoney mails his firm multiple copies of its brochures, supplying the above photograph.  

He commented that he's planning to acquire several more PO Boxes and then go into the paper pulping business.

As befits his country though,  I trust he'll make sure that at least 60% of assets are in "investments".

New CEO at Unicorn Investment Bank Bahrain (Delayed News)


I'm catching up on some old news.  

In case you missed it on 2 August, Unicorn appointed Mr. Ikbal Daredia as Interim CEO of the Bank with immediate effect replacing the former MD and CEO, Mr. Majid Al Refai.   Mr. Al Refai remains a member of the Board of Directors.

Mr. Daredia is the Global Head of the Bank’s Capital Markets, Institutional Banking and Treasury units. 

While no reason was given for the abrupt change, rumor (and note that word) is that the Board had differences over "strategy" with Mr. Al Refai - similar to those he had with the Arcapita Board earlier.  Mr. Al Refai is known in part for his keen interest in developing Islamic banking business in Asia.  The Board reportedly wanted to concentrate on Saudi Arabia.  As with Arcapita, he was one of the drivers of the foundation of Unicorn.

Those who read Unicorn's 1H10 financials will also note a loss of US$160 million for the first six months of the year due to provisions of US$97 million and fair value negative adjustments of US$51 million.   This resulted in an approximate 40% decrease in shareholders' equity to US$253 million.  In 2009 the Bank had a modest net income of US$2.2 million.

Dubai World: Offering “الطيور المبكرة” an Extra 20 BP on Interest Rate


According to AlKhaleej newspaper (Dubai), informed sources at Dubai World tell it that DW is offering   “الطيور المبكرة” ("early birds") an extra 20 basis points on interest if they accept the Company's rescheduling plan this Thursday 9 September.  This is in addition to other incentives offered early acceptors - which presumably includes the signing "bonuses" mentioned earlier.

The 9th is the first day for creditor responses but is not the last - though the newspaper's source didn't provide details except to say the final date is in the coming weeks.  Earlier DW had given 1 October as the "final" date to determine the fate of the plan - which would put the last date for acceptance by bankers at least 5 or so days earlier.  That latter bit is my estimate.

The article also repeats the Company's earlier comments about how the longer tenors will enable it to obtain more from asset sales along with the remark (threat) that in the case the banks fail to agree and resort to the courts they will likely receive nothing.  Finally, the agreement of the steering committee representing 60% of DW's exposure is noted.  Already the earliest of the early birds.

It's likely that the Company will achieve the necessary level of approval to secure an effective cram down of creditors using the special DIFC court.  

And what appears to be the long running "soap opera" of agreeing a rescheduling will come to an end, though there will be at least 8 more seasons of implementation.  Not quite a 54 years' run, but still respectable particularly in today's ADD world.

Dubai Holding Commercial Operations Group - Delays Payment Again Until 30 November


As per an announcement on Nasdaq Dubai, DHCOG is delaying payment on its US$555 million revolving credit facility until 30 November 2010.

In July it announced a two month delay in order to finalize legal documentation.   Perhaps, the drafting is being done by hand?

You'll recall that last January, DHCOG excoriated S&P for downgrading it, claiming in effect that the rating agency didn't know what it was doing.  This may indicate who was right in that debate.

You can use the tags "Dubai Holding" and "DHCOG" to access earlier posts.

Gulf Bank to De-Emphasize Investments and Focus on Core Banking Business


Issa Abdul Salaam at Al Qabas quotes informed sources that Gulf Bank is exiting several funds and reducing its share in others during the rest of the year.

GB reportedly withdrew from one fund it had invested in the "past months" with a view to realizing profits in 3Q and 4Q this year and that it intends to exit from several foreign funds.

This represents a change in strategy from that approved by the previous board.  The new board's strategy calls for the bank to focus on its core (banking) business.

Three comments:
  1. Sticking to one's core competence is a sensible strategy.
  2. Many a change in strategy is motivated more by the need for cash than  long range planning.  The number of lines of business that suddenly become "non core"  are in direct proportion to the cashflow deficit.  Gulf Bank certainly has some serious challenges in its loan portfolio.
  3. When picking the "core" business to focus on, it's good to pick one that one has a future.  Whenever I read PR from some firm announcing that it  has made a strategic decision to focus on its core business, I wonder why it wasn't in the first place.  I also recall two business school cases.  In the first,  Pan American Airlines, the company divested itself of Intercontinental Hotels to focus on its airline franchise.  By contrast, in the second, Greyhound/Dial Corp, the dogs were (largely) sold.  One positive thing in this case, the core commercial banking business is a protected one in Kuwait.  And there's probably more of a long range future in commercial banking in Kuwait, if one can get credit underwriting right.

Monday 6 September 2010

Global Investment House Hiring - Opportunity of a Lifetime


From one of our readers.

Hello there...

Love the blog, and thought you would find the following email rather amusing, someone I know received an email from Global Investment House, asking them if they'd be interested in joining? I've heard from others that they're madly hiring too, bet creditors are happy with that from a cashflow perspective...

Note, this person has ZERO financial experience, and had not shared their details with any recruiters for over 2 years. It is a blatant cold call!

The email is copied below (names removed)


Dear XXXX,

Good day and greetings.

We had come across your contact in our database, and here at Global Investment House we are looking to hire Kuwaiti professionals. If you are interested to have new opportunity please send me your update profile so we can take it further.


Looking forward to hear from you.



Best Regards,

XXXXXXX
Senior Officer - Recruitment
Human Resources & General Administration

E-mail:
Tel:
Fax:
P. O. Box:
Website:XXXX
(965) 22951
(965) 22951
28807 Safat, 13149 Kuwait
www.globalinv.net
This is what we in the developed West would call more evidence of the "War for Talent".

Damas Shareholders Meeting 30 September: Ernst and Young to Be Replaced by Deloitte Touche


Damas announced that it would hold its AGM/EGM on 30 September.

Among the agenda points are:
  1. a change in auditors from Ernst & Young to Deloitte and Touche
  2. formal election of the Board who were appointed in the wake of the resignation of the old Board as per the DFSA order.

Sunday 5 September 2010

Abyaar Real Estate to Sign Debt Agreement After Eid

Al Watan reports that Abyaar is expected to sign a debt settlement agreement with a major firm after the Eid Holiday. 

The article notes that the company is focused on meeting its obligations as well as completing its real estate projects.  Noting that despite the difficulties in 2009, the Company was able to settle 20% of its liabilities.  While Al Watan doesn't mention it, I'd note that the paydown of the liabilities occurred in close proximity to the Company's successful share issue of some KD52 or so million in September 2009.  That of course was no mean feat given the state of markets.  And Abyaar also increased its capital in 2008 if I'm not mistaken.

The article also notes that Abyaar has just about completed a 40 storey tower in Dubai.  Also that the prudent provisions it has taken against its real estate portfolio will enhance earnings going forward, i.e., the carrying base of assets has been lowered so profit will be higher.  This is  of course just the temporal shifting of profits (or losses) from one accounting period to another and doesn't represent an overall gain in profit for the Company.

ARE started off as a JV between Aayan Leasing and Investment and the AlRashdan Group.   After listing, they each hold about 17% or so of the Company.  There aren't any other disclosed major shareholders.

ARE is listed on the KSE (Symbol 432) and trades at KD26 fils per share a substantial discount from its KD100 fils par value.

Noor Investment to Reschedule KD187 Million

Al Watan reports that Noor Investment Company is ready to sign a KD187 million restructuring with KFH, the lead bank.  

The rescheduling:
  1. Converts short term to medium term debt
  2. Carries an interest rate of 3.5% p.a. down from 5.5% - a savings of roughly KD4 million.  (I make it more like KD3.50 million the first year assuming that payments the first year are modest).
  3. Will be repaid from cash profits and not from asset sales
  4. Will commence with the first repayment in early 2011
As per Noor's 30 March 2010 financials (the latest posted on their or the KSE website), total bank debt was some KD184.5 million - with interest at 5.5%, the amount would be KD187 at 30 June.  Note that total bank debt appears in two places:  KD181 million shown in Note 11 and KD3.5 in Note 7.   All of the bank debt was due within one year.

Noor is owned 50.8% by National Industries Group.

Previous posts can be accessed using the tag "Noor Investment Company".

Public Prosecutor Stays Gulf Bank Case Against Derivatives Client

Citing parties close to the case, Al Qabas reports (or at least I think so) that the Public Prosecutor has stayed Gulf Bank's case against its client responsible for the derivatives debacle in 2008 (when GB lost some KD359.5 mm leading to the surgical removal of its board and elements of senior management along with the KIA taking a significant stake to top up the needed capital restoration).

I say I think so because I'm not quite sure that my translation of " النيابة العامة حفظت القضية المرفوعة من قبل بنك الخليج "  is correct.  Sadly, AA didn't graduate from KU's Faculty of Law.

Anyone out there who can confirm or correct my translation, please post.

Thursday 2 September 2010

Threat to Capitalism Warning Notice: Expansion of Shareholder Rights

If you weren't scared by my earlier post, you w'll be by this one!

They say that courage is like a potato chip.  Try one and you're likely to be back for more.

After reading my earlier warning on the appearance of yet another manifest danger to the free market system, one of our readers has called my attention to an even greater danger.  And one frankly I had been avoiding mentioning.  But fortified with yesterday's "first chip" of courage, here I am today confronting another manifest imagined danger.

How much fear can one human bear?  I suppose with courage more than one initially thought.  If you're feeling brave, read on.

I know that many of you out there will be saying what could be a greater danger than more disclosure of CEO pay packages?  Socialists on motorcycles?  Disclosure of senior officers' expense reports?  You had how many "massages" in a single night at the Pen in Manila?  Just how many scotches do you have to drink to run up a $750 bar tab in five hours?  By the way what were you doing in a bar for five hours on a business trip?

No this time the danger is an expansion of shareholder rights.  And again we have the FT to thank for making us all aware of the stealth assaults on our way of life, though I would note  more in sadness  than malice that they did also give a forum to those who support the measure.   Fringe individuals and groups like two former SEC Chairmen, Calpers, self-appointed corporate governance experts.  So we may have to mark the FT down as a waverer in the fight to preserve our way of life. 
The proposed SEC rule on "proxy access" would allow shareholders to nominate up to a quarter of a company's board members. It would allow shareholders to nominate directors if they own 1 per cent to 5 per cent of stock, depending on the company's size, and amend a federal measure that allows management to exclude shareholder proposals that nominate directors.
Sounds simple.  And even good.  Who could argue with an expansion of democracy?  Of shareholders' rights?   
The rule under discussion is "probably the most flawed and unworkable proposal" the SEC has issued on proxy access, the US Chamber of Commerce, the business lobby group, wrote in its letter. Tom Quaadman, its executive director for capital markets, said yesterday that the group was keeping all of its options open, including a lawsuit against the SEC.

Wachtell, Lipton, a big Wall Street law firm, said the proposal would have "negative consequences" for US companies and competitiveness.
When a distinguished firm like Wachtell Lipton or the US Chamber of Commerce weigh in, you know you should listen seriously.  No doubt they're remembering just how well the boards of Citigroup, Lehman, Bear Stearns, Enron, and others - selected, I would remind you, without shareholder interference -  enhanced "competitiveness" to know that the system works just fine as it is.

TAQA Responds: No Merit to Peter Barker Homek Lawsuit

TAQA issued a press release on the Abu Dhabi Exchange this morning:
  1. No merit to Mr. Barker-Homek's lawsuit.
  2. The Company will respond through legal channels at the appropriate time.
  3. No impact on financial statements expected.
Earlier post here.

Kuwait Stock Exchange - Mushrif Pays Its Listing Fees Now There are Six Suspended Firms


The KSE has updated its list of companies suspended for failure to pay their 2010-2011 listing fees.  Mushrif Trading and Contracting has apparently paid.   So now this august group is six.  Earlier post here with the original list.  Mushrif was #5.

[10:13:37]  ِ.إيقاف شركات عن التداول لعدم تسديد رسوم الاشتراك السنوي ‏
يعلن سوق الكويت للأوراق المالية بأنه تم إيقاف تداول الشركات
التالية لعدم تسديد رسوم الاشتراك السنوي لعام 2010- 2011 ‏
اعتباراً من 1-09-2010:- ‏
ِ1- المجموعة الدولية للاستثمار ‏(المجموعة د)(موقوفة) ‏
ِ2- الشركة الخليجية الدولية للاستثمار ‏(غلف انفست)(موقوفة) ‏
ِ3- شركة لؤلؤة الكويت العقارية ‏(لؤلؤة)(موقوفة) ‏
ِ4- شركة الصفاة العالمية القابضة ‏(صفاة عالمي) (موقوفة) ‏
ِ5- شركة الابراج القابضة ‏(الابراج)(موقوفة) ‏
ِ6- شركة الشبكة القابضة ‏(الشبكة)(موقوفة) ‏
علما بان اخر موعد للسداد هو 31-08-2010 .‏

Wednesday 1 September 2010

Bahraini Regulatory Quiz: When Do Bahraini Banks Have to Publish Their 30 June Basel II Pillar 3 Disclosures?

As if there weren't enough excitement here at Suq Al Mal with compelling analyses of zakat payments, magical provisions, we're going to have a contest to liven things up a bit more.

My understanding was that locally incorporated banks in the Kingdom of Bahrain are required to publish their Basel II Pillar 3 disclosures concurrent with their 30 June financials.

But one firm noted for its unwavering verbal commitment to disclosure and transparency has yet to do so.  That obviously means that my understanding is wrong.

Hence, this competition.  

The first one to post the chapter and verse from the CBB's Rulebook will receive the grand prize --  a slightly worn "proven business model" formerly the property of a self-proclaimed world class "Islamic" investment bank.  Early responders may be eligible for a bonus prize - a half baked business plan for a US$4 billion energy city/financial and day care center.

Multiple entries are permitted.