Saudi Investment Banking Fee Riches – Just How “Rich”?

Happy Banker Counts His Legendary Saudi Fees

March 16 Bloomberg reported that Saudi Fee Riches Will Keep Citicorp and Credit Suisse Waiting.  Bloomberg didn’t say how long but the article implies it could be a bit of a wait.

AA thinks it will be even longer before banks get “rich” off Saudi or MENA fees.  (Editor’s Note:  With this post SAM has adopted the Spicer Style Book convention on the use of quotation marks.) 

"Rich” is a relative term.  A chap or chapette with US$10,000 equivalent in Pakistan is doing quite well.  That same amount in Luxembourg not so well.   AA is assuming talk of “riches” is in relation to the latter, though ...

The 2015 net income figures cited by Bloomberg in the article for net profits at HSBC KSA and  JPMorgan KSA (respectively US$75 million and US$10 million) indicate just how far there is to go.   For these banks this is "hobby" not mainframe LOB income.   

A few quotes from the Bloomberg article to set the stage.

Saudi Arabia and its ambitious reform plans are the focus of all the hype in Middle Eastern financial circles these days, but it’s still in the United Arab Emirates where banks are earning most of their money.

Investment banking fees paid to lenders in the U.A.E. were 45 percent higher than in the kingdom last year, according to New York-based research firm Freeman & Co. Saudi Arabia has trailed the U.A.E. for fees earned from merger and acquisitions, equity capital market and financing deals since 2011, and is off to a slower start this year, according to the data.

Global banks are investing in Saudi Arabia in preparation for an expected fee bonanza.

Sounds fantastic.  45% higher.  Fee bonanza, albeit “expected”.

There is no sweeter song to banks and bankers than of outsized fee revenue which carries the happy implication of the bonuses such flows imply.  Think on average near to 50%--at least in happier days—shared with self-professed hard working and “savvy” bankers.

But let’s take a closer look.

First at the quantum of fees as per Bloomberg.

Banks earned $237 million in investment banking fees in the U.A.E. last year, compared with $164 million in Saudi Arabia, the Freeman data shows. Lenders secured $154 million from financing deals in the Emirates, compared with $121 million in Saudi Arabia, even after the kingdom raised $17.5 billion in the largest-ever emerging-market debt sale. M&A fees in the U.A.E. were $70 million, almost triple the $24 million earned in Saudi Arabia.

Just how big are these numbers in the global context?

Charitably speaking, rounding errors.

Thomson Reuters (TR) estimates that global investment banking fees in 2016 were approximately US$85 billion.   The fee rich geographical areas are USA and Europe (primarily Western Europe). As per TR’s report roughly US$45 billion of the US$85 billion related to US deals.

On that basis, parsing UAE and KSA fee levels either individually or in total is like analyzing the relative positions of Sunderland and Middlesbrough.  Which is the better team?  Which of the two  will take home silver next season? 

If that US$85 billion total hasn’t already well and truly taken the luster off talk of KSA IB fee “riches”, or for that matter UAE or MENA IB fee riches, let's drill down a bit further..

The charts below are compiled from Thomson Reuters individual LOB reports on estimated full-year 2016 global investment banking fees for just three IB revenue streams so they don’t total to US$85 billion mentioned.  Just three to provide a bit more granular detail on where MENA fits in the global fee picture.

2016 Estimated Investment Banking Fees
Billions of US Dollars
M&A		$30
Debt Capital Markets		$24
Global Syndicated Loans		$16
Total		$70

MENA Share of Estimated Global Fees
M&A		0.083%
Debt Capital Markets		0.517%
Global Syndicated Loans		0.500%

Note: 0.083% is 0.00083 in decimal terms.  

MENA fees at their highest don’t reach 1% of total global estimated fees in any of the categories above.    

Side note:  You can sign up for free copies of TR’s reports (which are quarterly) if you have a corporate email or so AA has been told.  Disclosure:  I didn’t hear this from a Fox News commentator, but the information is almost certainly as, if not more, credible, if you can believe that.

Seems to AA that not too many banks or bankers are going to get rich off this level of MENA fees. 

These MENA M&A fees are less than the fees for some single deals in the USA or Europe.  Profit-oriented banks and bonus-hungry bankers are likely to focus elsewhere, particularly where the same or similar templates can be applied to a greater flow of transactions.

Typical AA Irrelevant Aside:  Once some years ago in one of our weekly deal review meetings with some of the highest life forms in the firm present ethereally electronically as befits their exalted existence, one of my colleagues began touting a deal with $6 million in revenue.  A rather distraught team leader jumped in to minimize embarrassment by noting the deal was significant for “potential market development”.  An unfortunate turn of phrase.  The “big” man or others of nearly the same rarefied stature would periodically ask how PMD was coming along when they wanted to tweak a tail.  PMD thereafter became a sort of tag line in the group to justify “certain” behaviors.  There was the case of a rather large beverage expense incurred with several colleagues that AA successfully explained as “PMD brainstorming”.   

What could change to propel MENA into relevant fee territory?

Fees are the product of volume and pricing.  (Math pun intended).

US and Europe have volume.  MENA doesn’t have the volumes.  Even with KSA’s economic plans sustained volumes at the US/Europe level are unlikely.

But there’s another problem.  Low fee levels, particularly in KSA, as Bloomberg notes.

Banks and advisers working on Saudi Arabia’s $6 billion National Commercial Bank IPO, the world’s second-largest IPO in 2014 after Alibaba Group Holding Ltd., received about $6.7 million in fees, or about 0.1 percent of the offering’s value. By comparison, Credit Suisse and Morgan Stanley took about 1.2 percent of proceeds on the Alibaba sale.

"The Aramco IPO is likely to have fees hugely squeezed," said Emad Mostaque, chief investment officer of emerging market hedge fund Capricorn Fund Managers.

One might argue that MENA fees are depressed now because current clients are predominantly public sector entities that generally pay lower fees.

Indeed.

What are the prospects for a local private sector Alibaba (other than the one pictured above) and the sort of private sector deals we see in the USA or Europe?

Off in the distant future if at all.

After the successful National Commercial Bank IPO, KSA state entities retained some 60% of the bank.  The planned Aramco IPO targets placing a whopping 5% of existing shares, leaving 95% in government hands.  In neither case are private sector fees likely to apply to follow-on deals.  And if the initial performance holds (NCB was wildly oversubscribed and Aramco is likely to be as well), market demand will bolster client demand for lower fees. 

That doesn’t mean that foreign banks will shun Saudi or other MENA deals.

Fees aren’t the sole criterion for participating in a deal. 

Sometimes “maintaining relationships” or “creating” them is a compelling motive.  The mantra goes: Do a cut-price deal, gain admission to the client’s magic circle of favored banks, be repaid many times with  subsequent richly priced deals.  But often the subsequent “rich” deal is a mirage.  If the client is used to “cut rate” prices, future transactions are likely to be just as “fee skinny” as the entrée deal. 

Or if the deal is strategically important to the country, your reward will be a fast track to a banking license in the country where you can earn above average profits from private sector clients. That’s the theory, though this also often doesn’t work out in practice.

Banks have other motives, e.g., doing deals to enhance league table position to bolster their image and marketing.  That’s why you’ll see more than the necessary number of banks on very large or very prestigious deals often working for a song.  But without sustained substantial fee revenue such efforts come to naught. 

Also sadly, as history shows, despite self-proclaimed “smarts”, IBs are prone to fads, fashions, and, yes, hype.  See Lehman, Bear, Citi, et al.  Or dotcoms,mortgages, whales, etc.  If the music is playing, there is a strong compulsion to get up and dance.

Important Disclosure re Abu Arqala's Position at Suq al Mal

Divinely and Wifely Guided

Sadly, neither God nor my wife insisted that I take my current position at Suq al Mal.  It seems that not all are called.

On a positive note, I rather like what I do here.

Indian Banks: Sadly Things are Looking More “Subdued”

It's Not Cricket!

Bloomberg reported 3 March that “India Needs `Bad Bank' to Clean Up Soured Debt, Rating Firms Say”

Things are looking mighty “subdued” as careful observers might say.

Some quotes from Bloomberg followed by (AA) comments.

Bloomberg

Stressed assets -- made up of bad loans, restructured debt and advances to companies that can’t meet servicing requirements -- have risen to about 16.6 percent of total loans in India, the highest level among major economies, data compiled by the nation’s Finance Ministry show.

AA is puzzled.  I would think that “advances to companies that can’t meet servicing requirements” would qualify as “bad” loans.  And that restructured debt that was performing, i.e., meeting servicing requirements would not be bad debt.  On the other hand if restructurings were “cosmetic” in nature, then they are indeed bad loans.  If loans aren’t performing, they’re “bad” loans.  If loans are restructured at lower rates perhaps even below market rates but are performing, shouldn’t banks bear this cost? 

Bloomberg

Ratings companies including Fitch Ratings Ltd have come out in favor of setting up a state-backed “bad bank” to tackle India’s ballooning stressed assets problem, a move resisted by Raghuram Rajan, the former governor of the Reserve Bank of India.

Seems to AA if banks’ “bad” loans are ballooning, the country probably already has more than one “bad” bank, particularly when one factors in the comments in the article about “hiding” bad loans, failing to take tough decisions.   

Bloomberg

The RBI completed its audit of the nation’s 50 lenders last year, forcing them to lay bare previously hidden non-performing loans.

That sounds like rather “bad” behavior to AA.

Bloomberg

Banks had been reluctant to offer discounts to offload bad loans even where they are clearly worth much less than their book value because such sales “invite the attention of anti-corruption agencies making bank officials reluctant to sign off on them,” Fitch analysts including Guha wrote in a Feb. 23 note.

AA wonders if the anti-corruption agencies should look earlier in the loan cycle, e.g., at initial underwriting and subsequent “hiding” stages?  Also are bankers looking for the “bad” bank to make “bad” pricing decisions and buy the duff loans at prices higher than their fair value?  Thus, bailing out the banks’ previous bad behavior?  Perhaps this explains former Governor Rajan’s reluctance.

Bloomberg

Bankers selling bad loans to a national bad bank won’t be questioned, as this institution will be empowered by the government to take tough decisions,” said Rajesh Mokashi, managing director at CARE Ratings Ltd. in an interview. A bad bank will also bring to an end to fear of “witch-hunting” of lenders, if any, by anti-graft agencies, he said.

Is this an admission by bankers that they are restricted from taking “tough” decisions?  Or that they are incapable or unwilling to take “tough” decisions?  If either, then a sale to a bad bank does nothing to change this “bad” behavior and is likely to lead to a repeat of bad loan creation by these same banks that can’t or won’t take “tough” decisions.

Bloomberg

With more than $180 billion in stressed assets, the government and regulators have to evaluate all avenues including a bad bank to drive better recovery rates,” said Nikhil Shah, managing director at Alvarez and Marsal, a firm that specializes in turnarounds.

AA wonders how selling duff assets to an asset manager--or “bad” bank, if you prefer--improves recovery rates.  Does this mean that banks are unwilling to take hard decisions or aren’t allowed to?  If so, what guarantee is there that the “bad” bank will?   If the fundamental problem is a slow moving erratic legal process, will the fact that the plaintiff is now a “bad” bank really speed up the legal process?  Or is the idea to buy the duff loans from the banks above market, thus improving their “recovery” rates and stick the “bad” bank with the losses?

All in all not a very pretty picture.  Subdued indeed.

But every situation has both positive and negative possibilities.  As this post about comments from the head of a distinguished bank in a  neighboring country shows, attitude can play a key role

Practical Application of Extreme Vetting to Secure the Homeland

Case in "Point"

As you no doubt recall Candidate Trump called for "extreme, extreme vetting" of immigrants to secure the Homeland.  While this call was focused on immigrants from certain Muslim majority countries, it would seem logical to expect that similar vetting would be applied to those in senior positions in the incoming Administration.  Like staffers with top secret security clearances allowing them access to intelligence reports, meetings of the National Security Council, etc.

greatagain.gov website  18 November 2016

“I am pleased that Lieutenant General Michael Flynn will be by my side as we work to defeat radical Islamic terrorism, navigate geopolitical challenges and keep Americans safe at home and abroad,” said President-elect Trump. “General Flynn is one of the country’s foremost experts on military and intelligence matters and he will be an invaluable asset to me and my administration.”

Washington Post  14 February 2017

Michael Flynn, the national security adviser to President Trump, resigned late Monday over revelations about his potentially illegal contacts with the Russian ambassador to the United States, and his misleading statements about the matter to senior Trump administration officials.

Business Insider   10 March 2017

President Donald Trump was not aware that his former national security adviser, Michael Flynn, was being paid to lobby for Turkish interests in the months leading up the US election, White House press secretary Sean Spicer said Thursday.

But Rep. Elijah Cummings, Ranking Member of the House Committee on Oversight and Government Reform, sent Pence a letter on November 18 requesting more information about the potential conflicts of interest posed by Flynn's lobbying work.
Cummings sent the letter four days after both the Daily Caller and Politico reported that Flynn's consulting firm, Flynn Intel Group, Inc., had been hired to lobby for Turkish interests.

rightscoop website 18 November. 

But Flynn was compensated by the Flynn Intel Group, where he serves as a principal and which has registered as a lobbying firm for a Dutch company owned by a Turkish businessman with close ties to Turkey’s President Recep Tayyip Erdogan. The relationship is more than professional, apparently. Flynn has called for the extradition to Turkey of the cleric Fethullah Gülen, whom he called a “shady Islamic mullah” who lives in exile in the Poconos and on whom Erdogan has blamed a failed July coup attempt (among a host of other sins).

Like The Daily Caller, RS is considered a "conservative" forum.  So both right and left and those in between called this back in November.

Right out in the open. 

Yet, the WH missed it  That's "extreme vetting" with both a capital "E" and "V"!

Help Find Urgently Needed But Apparently Missing US Congressman

Have You Seen This Congressman?

Pictured above is Representative Darryl Issa, (R) California 49th District, Senior Member of the House Foreign Affairs Committee, dogged investigator on national security. 

Apparently missing.

He's urgently needed to conduct at least one and perhaps three investigations on matters of national security. 

GFH 2016 Results: Settlement Assets

It Depends ...

This is the third in a series of three posts on GFHFG’s 2016 earnings.

Today’s post looks at GFH’s US$ 464 million out-of-court settlement.

What precisely did GFH get?

Well for one thing, not a dime or even one fils of cash.  

Instead GFH got illiquid hard-to-value assets, primarily real-estate.  

GFH’s 2015 financials state that “The fair values were determined by independent external professional firms using a combination of market and income approaches, as appropriate for each asset”.  Determining fair value of illiquid assets like these is no easy matter (euphemism of the post).  Different assumptions would lead to different “fair values”. 

Time will tell whether GFH gets more or less than the current carrying value.

For details let’s turn to note 19 in GFHFG’s 2016 financials which contains key information.

If you look at the auditor’s opinion, you’ll see that GFH’s auditor used a “matter of emphasis” comment to call attention to this note.  Presumably they felt it was critical information for readers of the financials. So exploration of the note is worthwhile for just that reason alone.  But we’ve got another purpose:  determining what was received and what the impact and implications of that receipt are.

The following table is based on note 19.

Litigation Settlement - USD Millions
Development Property		$118
Investment Property		$192
Unlisted Equity Securities		$9
Investment in Associates		$28
Other		$117
Total		$464

Let’s take a closer look.

Development Properties—US$ 118 million. As per GFH’s financials (page 21), “Development properties are properties held for sale or development and sale in the ordinary course of business. Development properties are measured at the lower of cost and net realisable value.”   As per note 8, the properties are in UAE, Bahrain, and North Africa.   There appears to be no cashflow from these assets until they are sold.  Note that in 2016 GFH sold DP with cost of US$ 43 million and declared a profit of US$ 46 million.  Of which some US$38 million remains uncollected as of 31 Dec 2016 (note 11). 

Investment Properties—US$ 192 million (net of financing).  As per GFH’s financials (page 21), “Investment property comprise land plots and buildings. Investment property is property held to earn rental income or for capital appreciation or both but not for sale in the ordinary course of business, use in the supply of services or for administrative purposes. Investment property is measured initially at cost, including directly attributable expenses. Subsequent to initial recognition, investment property is carried at cost less accumulated depreciation and accumulated impairment allowances (if any). Land is not depreciated.”  I didn’t see a disclosure of the amount of revenue from IP.  Any revenue associated with the IP acquired via the settlement would accrue only from October.

Unlisted Equity Securities—This amount is so small as to not be worthy of attention.

Investment in Associates—The US$ 28 million in value is ascribed to 20% interest in Global Banking Corporation Bahrain and 33.33% of  Ensha Development Company Bahrain.  Another small irrelevant amount, except those who follow the financial sector in Bahrain might question the ascription of value to GBC and wonder what this means for valuation of the larger amounts in the “windfall”.   

GBC’s 2015 audited annual report repeats the going concern qualification in the 2014 report (note 2.1). The auditors state that GBC’s Board decided in May 2014 not to undertake any new business and dramatically reduced staff from 31 to 10, including key management and risk control positions.  As in 2014, 2015 note 6.1 discloses that there is material uncertainty about the full recovery of one of GBC’s investee companies.  GBC reported losses in fiscal 2014, 2015, and for the first nine months of 2016.  

Since GFH does not show separate values for GBC and EDC, it’s not possible to determine the value ascribed to GBC.  AA would not expect GBC to have much, if any, value from continuing operations.  Even though GBC reduced staff to 10 and has no interest expense (GBC is essentially funded by equity and non-interest bearing accruals), it still cannot generate a profit. 

So any value ascribed must be liquidation value.  Taking values in 3Q16 financials for investment properties (real estate assets) and bank deposits at face value, 20% of GBC would roughly equal US$ 14 million, though liquidation values—particularly for real estate-- can often be much less than carrying values.   What would happen to values in liquidation is anyone’s guess.  I couldn’t find anything on Ensha either but both are relatively small amounts in the grand total.

Other Assets—US$117 (net).  This includes three assets related to Al Areen, including the Lost Paradise of Dilmun Water Park, and the British School of Bahrain.  Note 19 provides additional information on the determination of the value.  Some US$55 million of the US$212 million gross value of assets roughly 26% is “goodwill”.   

My impression is that the LOPD is not a major cash generator but would welcome readers’ comments.  There was an article back in 2010 or 2011 in the GDN with expectations for 180,000 patrons for the year.  There doesn’t seem to be any news reports more recent.  Nor could I find any financials or financial data.  Not surprising because it’s not a listed company. 

Looking at the summary financials for all of the US$ 117 million in other assets, it’s a bit troubling to see so little cash and cash equivalents on hand given the US$ 32 million in deferred revenue (payments made by customers for services to be provided).  This money has apparently been spent but the services not provided yet and expenses likely need to be paid, e.g., teachers' salaries. 

Some closing observations.  

The settlement did not include the payment of any cash to GFH.   There’s nothing like cash to settle an obligation.  Clear value is received.  Cash can be easily employed for acquisitions, funding development of one's existing lines of business, etc.

So what explains the absence of cash?

When one take assets in lieu of cash, one takes a residual risk that asset values may go down as well as a chance for upside appreciation.

There are two reasons for taking assets in a settlement. 

1. The payer doesn’t have sufficient cash and assets are the best the payee can do.  
2. Or the payee knows the assets are dramatically undervalued presenting an opportunity for an additional gain. 

AA suspects the first is the explanation.  The inclusion of GBC, Ensha, and the equity securities--all minor amounts--indicate that value was short and had to be topped up with some minor assets.  And in the case of GBC a troubled asset whose value is most likely based on a liquidation scenario.     

If the assets were dramatically undervalued, the payers would have sold some of them and thus been able to give less in value to GFH minimizing the decline in their own net worth.

These assets do not appear to generate substantial cash flow or profit, though there is insufficient information in the 2016 financials currently issued.  Perhaps the Pillar 3 disclosures for 2016 which are likely to be included in the “glossy” annual report will shed more light.

In light of this analysis of the “windfall”, what are we to make of GFH’s pronouncements about its performance, the success of its 2014 strategy, and prospects for the future?

When I read GFH executive management comments, I also see assertions that somehow receipt of illiquid hard-to-value assets somehow has dramatically improved GFH’s fortune, positioning GFH to “accelerate” its strategy. 

But how? 

GFH isn’t sitting on a cool half a billion in cash which it could use to fund acquisitions or to expand its lines of business.   The windfall doesn’t seem to generate stable cashflows that might fund such expenditures albeit at a lower level.   Nor are lenders likely to find these assets suitable collateral against which to advance loans in significant amounts.  Realization (sale) of these assets is likely to require time.

In addition GFH’s underlying business hasn’t been transformed as 2016’s results show.  And that’s even if one discounts the full amount of the impairment allowances taken.  To top it off the strategic talk sounds strangely similar to the pre-2014 strategy.