Dana Gas Restructuring: Not So Current (Assets) Trade Receivables -- UPDATED

Not Snow Not Sugar

They say that "even Homer nods".  If a comparison is to be made with Homer and AA, it's more likely Homer Simpson not Homer. 

In my haste to release this post, I failed to include one very key detail.  

The KRG trade receivables are payable to Pearl Petroleum Limited not DG.  The use of the word "share" in DG's financials Note 17 and 28 is crystal clear. 

What does that mean?

• DG's is unable to sell the TR because it does not have title. There could be restrictions imposed by PPL's contract with the KRG on transfer of title or assignment of proceeds by PPL to a third party, here DG.  As noted elsewhere, certain unspecified actions by PPL require 100% shareholder agreement.  It is not clear if this is one of those decisions.  If it is, then another shareholder--perhaps from among the three 10% shareholders--OMV, MOL, and RWEST--might frustrate a transfer.
• As PPL is the payee/owner of the TR, any payments from the KRG go to PPL.  As such, there is the theoretical possibility that such proceeds could be trapped at PPL.  Presumably, PPL has been structured to avoid third party debt with shareholders providing any needed debt financing.  But there ae other liabilities that could interfere with the transfer of funds from PPL to DG.  For example, claims of environmental damages by the KRG, other contractual liabilities, or other third party damage, etc. 
• As I read Note 28, the aggregate KRG TR owned by PPL are some USD 2.04 billion.  What that suggests is that if the KRG pays $100 to PPL, DG's share is $35.  Meaning in effect that for DG to collect the entire USD 713 million, the KRG will have to pay PPL USD 2.04 billion.  That certainly seems to lower the probability of a prompt payment and perhaps even payment. 
• And to state the obvious, sukuk holders' do not have direct access to PPL's assets including the TR, but have access through DG's equity stake in PPL.  Not  a particularly comfortable place to be in. 

One other note and that's Note 28.  PPL is charging the KRG interest.  Contrary to an earlier erroneous statement by AA, DG is accruing interest to income but is not increasing the balance of TR.  Rather it is deducting this amount from Provisions on its balance sheet.  

DG’s ability to repay its creditors depends on the company’s ability to generate cash.  

In this post we'll look at Trade Receivables.  These are accrued amounts owed by customers that have yet to be paid, that is, converted from receivables into cash. 

DG is having a problem (first euphemism of the post) converting TR to cash.  If you bill your customers and they don't pay promptly or don't pay at all, you have a problem. 

Dana Gas Trade Receivables - USD Millions
	1Q2017	2016	2015	2014	2013	2012	2011
Total Receivables	999	982	950	992	795	599	475
KRG	712	713	727	746	515	365	247
Egypt	283	265	221	233	274	234	228
% Total Equity	36%	35%	33%	37%	31%	25%	21%
% Retained Earnings	163%	163%	137%	172%	165%	172%	216%

  Source:  DG Annual Reports.

1. DG income is dependent on two customers – the Kurdish Regional Government (“KRG”) in Iraq and Egypt.  As AA learned in business school, a successful business needs a good product and a diverse and credit worthy base of customers who actually pay.  In baseball a 50% average (for a hitter) would be outstanding.  In business, however, it isn’t good enough!
2. Recently Zora UAE has begun generating revenue but only about 5% of the total.
3. Total receivables have more than doubled since FYE 2011 largely concentrated in KRG “paper".

Dana Gas Trade Receivables - Past Due Analysis
	Total Amount	Current	Past Due Not Impaired
Year	USD Millions		<120 Days	>120 Days
1Q2017	999	7%	5%	88%
2016	982	5%	14%	81%
2015	950	8%	8%	85%
2014	992	11%	19%	70%
2013	795	16%	18%	67%
2012	599	17%	17%	66%
2011	475	23%	33%	45%

DG Annual Reports Note on Trade Receivables.

1. Over the period FYE 2011 through 1Q2107, the proportion of past due receivables has almost doubled, while the amount of current receivables has declined dramatically.
2. While DG’s presentation is technically “true”, that information does not convey the extent of the past dues. 
3. Yes, some 88% of TR are past due by more than 120 days.  But that's akin to the difference between saying “I hit Jimmy” and “I hit Jimmy and killed him”.  Both are technically true statements about the same event.  Yet, the first is misleading.  (Second euphemism of the post.)
4. Reading DG’s financials one might think that because TR are classified as “Current Assets”, the outward limit would be one accounting cycle or 1 year.  So no TR would be past due more than 365 days. That’s clearly not the case.  
5. From Slide 11 in DG’s 1Q2017 Investor Presentation, it’s clear that a good portion of TR date from 2014 and earlier.   
6. Side Note: DG charged the KRG past due interest at 9% according to its no doubt “Shari’ah” interpretation of its contract beginning in 2013.  In 2016 following an arbitration award, some USD 121 million in accrued interest for 2015 and 2016 was reversed, being the difference between the accrued amount and the Arbitration approved rate of Libor plus 2%.  If you use the amounts of billing and collections shown in the slide, you will have an unexplained difference (even when including the 2015 and 2016 interest reversals) which likely is the effect of other interest transactions.   There's only a minimum problem of USD 4 million constant difference on the Egyptian TR.
7. As per Slide 11, KRG collections over the period 2015 through 1Q2017 were USD 175 million and billings were some USD 246 million.  Note  
8. For the purpose of this analysis, we’ll apply collections on a LIFO basis (against current billings) and FIFO (against the oldest billings).  Billings are actually applied as per contract terms, which are unknown, but this exercise will give us a range of possible outcomes. 
9. If the USD 175 is applied on a LIFO basis, then some USD 700 million plus is more than 2 years past due.
10. If the USD is applied on a FIFO basis, then some USD 500 million is more than 2 years past due. 
11. Either way that’s a dismal picture.  
12. As the table immediately above indicates, at FYE 2014 there were substantial past due amounts from prior years.  Given the KRG’s share of TR, there are likely to be substantial amounts of KRG receivables past due for many years.  AA is guessing 5 or more years.  Some clear present value implications.  
13. Collections from Egypt over the same period were some USD 217 million and billings USD 267 million.  Note Egypt TR at FYE 2014 were USD 233 million.  
14. On a FIFO basis, Egypt receivables would be more current with substantial amounts close to 2 years past due. 
15. On a LIFO basis, the past due tenor would lengthen out to more years. 

The presentation of past due receivables in DG’s financials raises some interesting questions for the Company and its auditors. 

1. As per DG’s financials, TR are generally contractually due between 30 to 60 days.  At what “time” point does a receivable that is past due cease to be a current asset?  AA would think that receivables past due over 1 year would no longer be “current” assets to say nothing of those overdue for multiple years. 
2. If receivables are overdue an inordinate amount of time, when does an allowance become necessary?

Let’s turn to DG’s 2016 Annual Report for their “case”. 

1. Accounting Policies Note 2 Page 58 "Loans and Receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They are included in current assets, except for maturities greater than 12 months after the end of the reporting period. These are classified as non-current assets. The Group’s loans and receivables comprise ‘trade and other receivables’."  
2. Accounting Policies Note 2 Page 59 "Trade and Other Receivables Accounts receivable are stated at original invoice amount less a provision for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off when there is no possibility of recovery."  
3. Financial Risk Management Note 32 Page 81 "(i) Trade Receivables The trade receivables arise from its operations in UAE, Egypt and Kurdistan Region of Iraq. The requirement for impairment is analysed at each reporting date on an individual basis for major customers. As majority of the Group’s trade receivable are from Government related entities no impairment was necessitated at this point." 

AA’s observations: 

1. Despite stated maturity, the Trade Receivables haves whiskers on them like the old undisposed of items in your refrigerator (see picture above) that start stirring around when the door closes and the light goes out.  Including them (the TR) in current assets on the basis of dishonored contractual maturities does not seem appropriate. (Third euphemism of the post).  Any more than referring to the feral food inhabiting the dark corners of your refrigerator as “fresh”.  At the very minimum, the “time” buckets in the aging should convey more accurately the extent of past dues, e.g., past due 1 year, 2 to 3 years, 4 to five years, and over five years. 
2. DG’s non-impairment argument based on obligors being "government related" is laughable.  Assuming DG are correct, then there is no need for provisions or worry about Puerto Rico. It’s not only government-related, it’s government.  No one seriously thinks that PR is a solid credit.  
3. But there's more. No one should be mistaking the KRG or Egypt for investment grade or even BB borrowers.  Both Iraq and Egypt are rated B (non-investment grade).  There is a world of credit quality difference between say Switzerland and Iraq. 
4. When a B credit does not pay for a prolonged period, provisions are not just a good idea.  They’re required. Even if the obligor is a government related. 
5. What makes the argument even more absurd is it application to the KRG.  Not only is the KRG a sub-sovereign, but at some point in the (near) future, Baghdad is likely to reinforce that sub-sovereign status with vigor, perhaps with the help of two neighboring countries.  Then DG may face an argument similar to the one it is making about the Sukuk: that the existing contract with the KRG is illegal and unenforceable and thus the debt is void.  

AA can understands why the DG has adopted its stance on the TR: self preservation.    

But AA does not understand their external auditors’ position, though I will give them credit for noting in their 2016 FYI audit report page 41: "Considering the uncertainty around recoverability of trade receivables from KRG, we have included an emphasis of this matter in this audit report."   

AA will be taking a look at DG's ability to generate cashflow in a coming post.  

Perhaps this post and that one will suggest reasons why DG have thought it “wise” to adopt their “clever boots” maneuver on the Sukuk.

Dana Gas Restructuring: Friendly Fire - Sharjah and the UAE

DG has placed the courts of Sharjah in a difficult place.  But the uncomfortable situation won’t stop there. Creditors are almost certain to appeal any Sharjah ruling in favor of DG in UAE Federal courts. 

The Sharjah courts are in a proverbial “pickle”.  The Sharjah ruler is Honorary Chairman of DG.  His son sits on the Board.  DG is also a “home-town” company.    

Do they rule with these considerations in mind?  Or do they rule in view of the impact on the UAE, “Islamic” finance?  Or do they rule in DG’s favor and kick the can to the Federal level?

Hard to tell.  Perhaps, though, there’s an indication:  the 25 December date for the hearing on the injunction granted earlier this month. 

AA would think that a highly visible case involving a USD 700 million restructuring and touching on the fundamental validity of “Islamic” finance would warrant a higher priority waiting six months. 

Perhaps, Sharjah Courts are occupied with even larger and more significant cases.  Who would have thought?  Not AA.

If local courts including the Federal Courts uphold DG’s assertion, the reputation of these courts and the UAE’s system of law will suffer, though as an Emirati banker once said to AA.  “By creating the DIFC and the DFSA the Government of Dubai have expressed their opinion on the state of our onshore laws and courts.” 

An assessment shared as well by other parties, I might note.  I'd end by noting that DG is not the only UAE entity to have issued Murabaha based Sukuk

Dana Gas Restructuring: Collateral Damage - "Islamic" Finance

By asserting that changing Shari’ah interpretations can void a borrower’s existing legal obligation to pay principal and “profit” as well as adhere to covenants, DG’s strategy strikes directly at the heart of “Islamic” finance by creating fundamental uncertainty about the legal validity of “Islamic” transactions. 

Simply put, the result of a DG victory is that “Islamic” legal documentation couldnot  be relied on.

Who is affected? 

Here are three potential key affected parties along with some idea of potential injuries. 

• Existing investors whose Sukuk become subject to fundamental uncertainty.  If the market in general were to mark down these transactions due to the uncertainty, investors (including financial institutions that hold Sukuk as investments) could suddenly lose substantial amounts.  For those investors unlucky enough to be holding the Sukuk of DG or a copycat obligor, value loss could be more substantial as debts and interest are repudiated. 
• Existing and potential borrowers who prefer or depend on this form of financing could well find it much more expensive (higher required profit rates, additional collateral, etc.), assuming that finance were available at all.   In some cases skittish investors may decide to exercise rights to accelerate repayment rather than forebear to avoid being caught by a surprise alleged re-interpretation of Shari’ah.  
• Shari’ah experts, commercial and investment banks, legal firms, and other entities who structure and place “Islamic” finance transactions could well see a significant drop in business.

All of the above have a strong motive to oppose DG’s maneuver as well as individuals and entities with primarily religious and not economic reasons for promoting “Islamic” finance. 

At least three parties have already spoken out.

• Shari’ah law experts have begun to challenge DG’s position.  Sheikh Yusuf Talal DeLorenzo (USA) and Mohamad Akram Laldin (Malaysia) as per Reuters both not based in the GCC.  For those who don’t know, there is no central Shari’ah authority.  There is no Rome or Pope in Islam. 
• In a 22 June press release Fitch Ratings have in effect stated that they do not accept DG’s interpretation/assertion: “We believe our current assumption that sharia compliance typically does not have credit implications for Fitch-rated sukuk remains appropriate”.  More importantly Fitch have noted the results if DG’s position is legally upheld: “For this reason, if non-compliance had credit implications and such implications cannot be quantified under our criteria for rating sukuk, instruments may not be rateable”.  If instruments are not rateable, the impact is twofold: (1) higher pricing and (2) less demand.  
• On 27 June Moody’s issued a statement (because this is paywalled, I’m using a press report) which quoted it as follows:  “Although Dana Gas is a small issuer in the UAE market, the credit implications of a court decision in its favour would test Sukuk regulatory and legal frameworks beyond Dana Gas as an issuer or the UAE as a jurisdiction.”  And “The implications [of “illegality” voiding responsibility to repay] include concerns about the legality of existing Sukuk and the effect on their issuers, the role and authority of Shari'ah boards, the responsibilities of the lead arrangers’ due diligence on the issuances, our approach to analysing Sukuk structures, and the liquidity of Sukuk markets.

AA suspects that many more third parties will join the chorus.  

Dana Gas Restructuring: Certificate Holders in a Difficult Position

A Clearly Painful Position But Nothing Like the DG Creditors

Sukuk holders are in a weak economic position even though the documents as written give them relatively strong rights.  They are also now into year 10 of their planned 5 year adventure with DG and the obligor would like another 5 years!  But there is little to suggest that another 5 years will be sufficient to repay the debt.

Obligations are repaid by cash not covenants.  DG’s cashflow is uncertain. Creditors may well strike a deal and impose their terms on DG.  But unless there is a sea change in attitude or aptitude of Egypt and the KRG, creditors face a long and uncertain path to full recovery of their funds.  They also find themselves in "bed" with an obligor whose integrity may be questionable.

The simple fact is DG’s cash flow is insufficient to repay the debt as scheduled this October. Creditor huffing and puffing no matter how extensive is not going to change that fact.  The debt needs to be rescheduled.

But how can realistic terms be set?  Given the KRG’s and Egypt’s inability/reluctance to pay and no apparent way to force them to, it is difficult to develop reasonable cashflow forecast scenarios.  How does one design a restructuring when 95% of the obligor’s cashflow is uncertain? 

But sadly there’s more.

Back in 2007, the original Sukuk holders cleverly “signed up” for what was a limited recourse type project, funding it through a bond instead of a loan.  Horses for courses:  a loan probably would have been more appropriate because in general bonds are covenant light. Or in other words:  don't saddle up a cow if you're going "jumping".

The original “security” (such as it was/is truly “security”) consisted of equity (dead last in the legal priority of payments) in companies undertaking what was a new venture for DG.  The Sukuk holders accepted a structure which limited their repayment to the proceeds from these assets (the Trust Assets).  If the “Trust Assets” are insufficient to repay the Sukuk, the creditors have no claim against DG or its other assets.  Contrast that with the security package for the Zora project (described in my last post). Not an identical transaction but instructive for how risks can be better managed. 

They also agreed to a bullet repayment structure.  With a bullet instrument of any size one is generally relying on a refinancing for repayment. If there’s no market for a refinancing from other creditors/investors, then unless collateral is sufficient and legally accessible, the “bullet” is pointed at the heads of the creditors who must reschedule – either directly or via a disguised rescheduling, i.e., a bond exchange.   

With the (first) earlier restructuring, the Sukuk holders improved their position by adding USD 300 million of Egyptian receivables to the “security” package. If we assume a scenario in which the Sukuk holders get ownership of the collateral, what’s likely to happen?  If Egypt isn’t clearing up past due receivables by paying DG, what would be their motive for scrambling to make the creditors whole?  They have an ongoing commercial relationship with DG who generate cash for them.  A relationship with creditors would be a one-sided outflow of precious hard currency.

Similarly, if the Sukuk holders manage to access the KRG receivables by realizing the collateral, i.e., acquiring shares in the operating companies in the KRG, the situation is likely to be the same as with Egypt. And here the relationship between the KRG and DG has been strained by claims and counterclaims. 

One might expect these two obligors to delay even more and perhaps inspired by DG find or invent reasons to challenge the original amounts of the receivables or to reduce them based on asserted failures to provide ongoing contractual services. 

At that point what is DG’s incentive to assist the creditors collect the receivables if it has been shorn of its two "crown" jewels?

Unintentional Investment Advice from the Chairwoman of the Federal Reserve

A Case of Goldilocks' Fever?

Earlier this week the Chairwoman of the US Federal Reserve System spoke at The British Academy President's lecture.

She was asked about the possibility of a new financial crisis, according to Reuters.

"Would I say there will never, ever be another financial crisis?" Yellen said at a question-and-answer event in London.

"You know probably that would be going too far but I do think we're much safer and I hope that it will not be in our lifetimes and I don't believe it will be," she said.

It's either a case of inadvertent investment advice or perhaps an indirect disclosure of health problems.

More likely the former. 

So it's an appropriate time to adjust your investment criteria to the side of more caution, if you haven't already given the new Administration in Washington..

Dana Gas Restructuring: Own Goal for Dana Gas

GOAL!!!!  (Sadly Own)

Without the Number Can't Tell If He's Management or an Advisor

DG’s maneuver—declaring the debt invalid, seeking court injunctions to restrict creditors’ rights, and apparently preferring UAE creditors with the Zora prepayment—is likely to have several effects. 

First, at the very least it will poison the initial phases of the restructuring negotiations. 

AA doesn’t understand why DG took this path. 

Unless completely somnolent, creditors were likely aware that they were not going to be repaid in full, though they were/are probably hoping for a significant “slice” of DG’s almost USD 300 million in cash to reduce outstandings. 

DG has a clearly compelling case that its ability to repay is restricted because its two main customers (95% of DG’s business) can’t or won’t honor their obligations in a timely fashion.  That allows DG to focus creditor anger away from itself to its customers.  

The creditors have limited opportunities to go on their own.  Additional security (more of those “current” receivables from the KRG and Egypt), a higher profit rate, tenor adjustments/principal amortization, etc. could probably secure a deal albeit with hard bargaining.    

Instead DG has in effect “declared war” on the Sukuk holders. 

Second, but that’s not all.  DG’s apparently half-baked strategy has caused it an even larger problem by creating more enemies who are likely allies for the creditors. 

Third parties whose interests are directly threatened by DG’s move are likely to oppose DG, providing ammunition to creditors in the courts.  Other third parties are likely to take positions that support the creditors, even if only indirectly. 

Instead of fighting battles with one adversary, DG has apparently though it wise to take on the “world”.

It’s hard to understand what DG are thinking, if indeed they are. 

A strategy like this is one that an obligor in a desperate situation adopts.  A very weak financial position, problems with ethics or legality that are about to emerge,  or an irrational set of creditors. 

If that's not the case, then the strategy is the result of some "clever boots" removing his shoes at the wrong moment during the decision process.

AA is not privy to insider information.

Third, but whatever the cause, it’s hard to see this turning out well for DG. It could "win" a pyrrhic victory or wind up on the pyre as the vanquished. 

• If DG’s Abu Yusuf legal arguments prevail, finding additional or new creditors is likely to be difficult.  Those few with an interest in providing future debt capital will probably seek to impose higher profit rates and enhanced protective terms – legal structure, collateral, etc.  That assumes that any such creditors will believe that legal structuring can create adequate defenses against an obligor who has clearly demonstrated disdain for contractual agreements.  
• If DG’s legal strategy collapses, creditors could well impose draconian terms on the company, e.g., a higher margin, additional collateral, shorter tenors, and a  requirement for a mandatory "sinking fund" or cashflow sweep. (More on this in a post to follow). Bond holders typically don't have the stomach or attention span to undertake these   In the worst case DG could wind up being managed for cashflow.  As I noted in my post about Global Investment House Kuwait, a creditor bent on principal recovery in an uncertain cashflow situation has little to no consideration for future growth of the firm. When creditors feel that an obligor cannot be trusted, that propensity is exacerbated. 

Dana Gas Restructuring: Almost Certain Winners

Well Almost Every Time

As promised earlier, some thoughts on potential winners and losers from Dana Gas’s “clever boots” maneuver.  Given AA's positive nature, let’s start this series of posts with the most likely winners. 

As with any restructuring, the most likely winners are the financial and legal advisors engaged by the obligor and the creditors as well as other firms that may be called upon to provide services, e.g.,  accounting firms, subject matter experts (here Shari'ah law and "Islamic" financial structuring), etc.  

Assuming payment of fees (particularly those owed by the obligor) there is a financial win for both sets of advisors.

But reputational risks remain until the restructuring is complete. And sometimes even after.

Did a financial advisor give bad advice that harmed its client and did news of that harm become public?  Sometimes an advisor makes a bone-headed demand. The other party’s advisor recognizes the mistake, prudently keeps silent itself and advises its client to do so. Its client reaps the benefit. 

Did a law firm miss a critical detail and a legal case went awry?  Did its pen make an unintentional slip in document drafting that resulted in unintended benefit to the other side?  Or did it miss an intentional attempt by the other party’s legal advisor to “redo” the termsheet through clever drafting?  As one of AA’s legal eagle friends notes when you’re on the benefit end you need to have a poker face.  When you’re on the receiving end of mischief intentional or otherwise, you need to have a sharp mind and loud voice. 

• DG’s advisors are Houlihan Lokey (financial) and Squire Patton Boggs (legal) as per the Company’s 5 June 2017 press release. 
• Creditors have reportedly engaged Moelis (financial) and Weil, Gotshal & Manges (legal) as per Reuters.  

At present, advisor reputational risks are focused on the advisors being tagged whether rightly or wrongly with DG’s high risk and poorly thought out strategy.   More on that point to follow.      

Dana Gas: Why Did They Do It?

It's More Than Just Hot Air

I promised in my first post to write again on the winners and losers from Dana Gas’s maneuver.  A post from Arkad has temporarily derailed that plan.

What I’d like to offer today is some hopefully intelligent speculation on DG’s motive for declaring the outstanding certificates as “illegal under Shari’ah and thus unenforceable” and obtaining court injunctions against payment, particularly because these two steps are almost certainly going to poison the relationship with creditors which is critical in a restructuring.

Dana’s 13 June 2017 press release offers two potential explanations: 

• An outflowing of piety perhaps triggered by prayerful meditation during the holy month of Ramadan.  “As a result, a restructuring of the current Sukuk is necessary to ensure that it conforms to the relevant laws for the benefit of all stakeholders.”
• A desire to avoid repeat alleged damage to the company because “During the 2012 restructuring, representatives of Holders unnecessarily declared a Technical Default while negotiations were still ongoing, causing lasting harm.” 

The press seems to share AA’s view that piety is not the motive and has seized upon the second: prevention of a Technical Default. 

AA thinks there’s more to the story.    

Simply put this is a maneuver to stop the creditors from exercising their rights under the security agreement to gain time and increase DG’s negotiating leverage in the restructuring.  

According to Reuters, last Sunday Dana advised that it has obtained an injunction from the High Court of Justice Commercial Division in British Virgin Islands (BVI) and a restraining order from the High Court of Justice in England blocking creditors from taking “hostile” action in addition to the Sharjah Court injunction. 

Why were these steps taken and why are they significant?

• The BVI is “home” to DG’s affiliates who conduct business in Iraq in territory of the so-called Kurdistan Regional Government and in Egypt and whose shares are “security” for the Sukuk.  USD 300 million of Egyptian receivables owed to Dana Egypt also part of the security package.   A BVI injunction complicates an already difficult road for creditors to realize the collateral whose enforcement (but only the first step) is subject to the jurisdiction of the BVI. 
• The laws of England and Wales apply to key transaction documents as I pointed out in my earlier post in particular those documents under which certificate holders would quite justifiably call a default.  

Another sign that protecting assets is a key concern are the steps Dana Gas has taken to minimize its exposure to potential actions by other creditors acting under cross default clauses.  This limits potential collateral (secondary) damage (pun intended).  It also lessens Sukuk holders’ negotiating leverage by reducing/eliminating this threat.

The step also prefers UAE creditors.  A step not likely to be received well by Sukuk holders. 

Let’s let DG make this case by using quotes from the Directors’ Report in its 1Q2017 interim unaudited financials.  As customary, red boldface to distinguish AA’s “distinguished” comments. Black boldface to highlight particularly relevant statements by DG. 

“Subsequent to quarter end, in early May, the Company prepaid the Zora outstanding loan amounting to USD 60 million (AED 220 million) plus applicable interests/costs.”    DG’s 1Q2107 financials were signed 11 May by the auditors which means that the prepayment took place before that date.  AA would hope that creditors would ask if that was before or after the 3 May announcement that the Sukuk was going to be rescheduled. 

But it gets even better.

After announcing the prepayment, in the very next sentence DG states: 

“On 3 May 2017 the Company announced that, due to continued challenges it faces around cash collections and the resulting need to focus on short to medium term cash preservation, it will commence restructuring discussions with the holders of both its Sukuk dated 8 May 2013.”

According to DG’s 1Q2017 interim report note 11, as per contractual terms, USD 33 million of the Zora facility was not due for repayment until 2018.  Zora is located in the UAE and the lending syndicate is composed of UAE banks.      

As a side note, interest due on the Sukuk next month would be approximately USD 14 million.  Apparently, the USD 14 million are worth more than the USD 33 million prepayment to local banks –roughly 2.4x as valuable – when it comes to cash “preservation”.    

Zora was secured by a very robust security package as is typical project finance structure.  Lots of tripwires and potential pain for DG. 

“Project Security covers, commercial mortgage over mortgage-able Zora gas field project assets (onshore & offshore), assignment of rights under Gas Sales Purchase Agreements, assignment of all Dana Gas Exploration FZE bank accounts, assignment of Zora Project Insurance proceeds, Project performance Guarantees from Contractors & Irrevocable Letter of Credits from Sharjah Petroleum Council. Dana Gas PJSC has pledged the shares of Dana Gas Explorations FZE in favour of security agent. Dana Gas PJSC is also a Guarantor for the entire tenure of the term facility”

As noted elsewhere in the note there was also a cash sweep mechanism. 

Prepayment neatly resolves the issue of cross default for an income earning project in the UAE albeit small “beer” earnings compared to its Iraqi and Egyptian operations. 

Dana also repaid roughly 84% of the FYE 2016 USD 12.5 million outstanding murabaha facility from Mashrekbank Egypt again as per note 11 1Q2017 financials.  This facility was cash collateralized. 

UAE banks’ exposure to Dana is eliminated or reduced.  Dana has clearly “preferred” UAE creditors over the Sukuk holders, though one might argue that these are relatively small amounts when compared to the approximate USD 700 million outstanding on the Sukuk and removing these makes the restructuring less complicated. 

Some USD 25 million of debt remains for two sale/lease back transactions for DG Egypt (DGE):  (a) a building in Egypt and (b) spare parts/equipment acquired some years ago that have yet to be used as per note 25 c.  Perhaps DGE would welcome returning the latter to the lessor. 

In following posts I’ll pick up the promised discussion of winners and losers, well mostly losers, from DG’s "clever boots" maneuver. 

Dana Gas Sukuk: The Providential Detection

Violation of Shariah Caught Just in Time

You’ve probably been reading articles-such as this, or this or this-- on Dana Gas’s 13 June announcement that its existing U.S.$425,040,000 Exchangeable Certificates and U.S.$425,040,000 Ordinary Certificates due October 2017 (together the “Sukuk”) are no longer Shari’ah compliant and therefore “illegal” under U.A.E. law, requiring their restructuring. 

As a consequence, the company announced it will not make the July “profit” payment or the October principal repayment.  This discovery appears to have been made during Ramadan.  Perhaps (but not likely) as a result of the company’s prayerful reflections during the holy month grounded in its fastidious adherence to both Shari’ah and UAE law.  

That this providential “detection” was made one month before payments are required under the allegedly “illegal” agreement is no doubt one of those “remarkable coincidences” that occur from time to time in the finance.

Apparently further compelled by its probity and piety, the company sought and obtained an injunction from the Sharjah courts that prohibits payment.  The courts will hear arguments on the case 25 December, that is roughly two months after the October principal due date.

Just coincidentally this will allow the company to conduct restructuring discussions with the certificate holders which Dana Gas asked for on 3 May 2017 before it seems it became aware of the “violation” of Shari’ah.  Then its only stated concern focused on more mundane cashflow related problems. 

Note that it gave its “solemn” word to proceed not only in a “practical” and “sensible” manner but to “balance the interests of all stakeholders”.  This probably does not apply.

“Dana Gas PJSC (the "Company"), the Middle East's largest regional independent natural gas company today announces that, due to continued challenges it faces around cash collections and resulting need to focus on short to medium term cash preservation, it will commence restructuring discussions with holders of its Sukuk dated 8^th May 2013.  The Company will be addressing the way forward on the Sukuk, which has a maturity date of 31^st October 2017 in a practical manner that balances the interests of all stakeholders. The remaining profit payments will be addressed sensibly as part of the solution.”

As near as AA can tell, the detection occurred sometime after that date and 13 June.  It wasn’t mentioned in the June 5 2017 press release announcing the appointment of Houlihan Lokey as financial advisors and Squire Patton Boggs as legal advisors.

AA sincerely hopes that neither of these firms advocated this transparent bit of Abu Yusuf-efry.  “Abu Yusuf” Yacub Ibn Ibrahim Ibn Habib Ibn Saad Al-Ansari for those who don’t immediately recognize the reference.

In a 13 June 2017 press release Dana broke the news about Shari’ah non-compliance.  AA comments in red boldface.  We’ll step through the press release one paragraph at a time.

“The Company has scheduled a call with the Committee for later today during which the Company will cover the following points and set out an initial proposal for restructuring the existing Sukuk based on these broad principles and terms: Due to the evolution and continual development of Islamic financial instruments and their interpretation, the Company has recently received legal advice that the Sukuk in its present form is not Shari'a compliant and is therefore unlawful under UAE law. As a result, a restructuring of the current Sukuk is necessary to ensure that it conforms to the relevant laws for the benefit of all stakeholders.

• As a legal matter and AA claims no expertise in UAE law, it would seem that if Dana’s assertion is true (which AA doubts) the sukuk then would become a non-Shariah bond and that the legal concept of equity would require that Dana honor the debt as per the existing contractual terms.  There is no doubt that Dana borrowed the money (or more precisely restructured an earlier borrowing), agreed to the terms, and agreed not to challenge the legality of any of the transaction documents (more on that below).  Assuming Dana’s legal arguments are valid, one might expect Shari’ah scholars to “grandfather” this transaction which has a scant five months to run but forbid future such transactions.  But الله أعلم    
• Dana’s assertion raises or should raise concerns among certificateholders that Dana will cite future such “continual development” and declare the replacement sukuk no longer “halal” to justify its non-payment in 2021.  See more on that below. 
• Unlike The Investment Dar in its attempt to deny BLOM repayment, Dana has not alleged that the transaction was contrary to Shariah from inception, but has become so with the “evolution” of “interpretation” of Islamic financial instruments.  A neat way of not casting aspersions on the work of Dar al Shariah or Shaikh Hussain Hamed  Hassan  head of DAS Shariah Advisory Board.  AA hopes though that it will meet with the same stern rejection that TID did.   

"The Company therefore proposes to exchange the Sukuk with a new enforceable, Shari'a compliant instrument, which would have a tenor of four years, confer rights to profit distributions at less than half of the current profit rates and without a conversion feature.  Such new profit payments will comprise a cash and PIK element. " 

• Dana does not appear to have provided details on why the existing sukuk is “illegal”. 
• According to Reuters,  “a source with direct knowledge of the situation said the firm planned to argue the sukuk were not sharia-compliant because their repurchase price was fixed, the coupon was the result of interest-based not profit-based calculations, and the coupon paid out regardless of Dana's financial performance.”
• The terms outlined above by Dana seem to mirror those of the existing transaction, albeit less generous than the existing sukuk as well as eliminating the conversion feature  
• Given this is a second restructuring, credit risk has increased justifying a higher not a lower margin or profit share, absent of course of application of 2.280. 
• But put that aside. 
• If eating a ham sandwich is not halal, what makes eating one-half of the sandwich halal?  Or in other words, if the problem is a fixed rate, then how does a lower fixed rate solve the problem? 
• If profit-sharing payments must be based on profit, don’t PIK (payment in kind) payments imply the company has not really realized profit?  And if so, will “evolving” legal advice in 2021 result not only in refusal to repay principal but also “invalidate” all the PIK payments.

"The new instrument would represent a fundamental improvement to the current situation for Holders as it would be enforceable and would provide repayment to Holders over time."

• Since the courts have not ruled on this matter, this statement is an opinion by a party (Dana) which the less charitable of you out there might believe is not completely disinterested in this matter. 
• Sharjah and the UAE still recognize conventional non-Islamic finance.   Thus, the local courts may rule that while the transaction is no longer “Islamic”, it is a debt Dana owes according to the contract signed by the parties.  

"As the Company's receivables and future damages payments may be unpredictable, Dana Gas proposes to make prepayments under the new Sukuk either in whole, or in part at par, prior to its maturity without any penalty thus providing a path for early pay-down for the Holders." 

• AA would advise the certificateholders to demand a cash sweep to make such payments mandatory and not rely on the company's good faith  of which there is scant evidence so far.  

"The next two Distributions scheduled for 31 July 2017 and 31 October 2017 cannot be paid now that the existing Sukuk is deemed unlawful but will be accounted for as part of the new Sukuk instrument."

• As the courts have not ruled and given the very real possibility of conflicting opinions on Shariah as there is no single central authority, this is a mere assertion not a legal determination. 
• Certificateholders should treat it with the derision it so richly deserves. 

"During the 2012 restructuring, representatives of the Holders unnecessarily declared a Technical Default while negotiations were still ongoing, causing lasting harm.  The Company now assures all parties that no Dissolution Event nor Technical Default has taken place, nor indeed can take place due to the unlawful nature of the Sukuk.  While the Company is keen to reach a consensual agreement with the Holders, Dana Gas has a duty to protect the assets of the Company for the benefit of all stakeholders and will take action to fulfill this duty.”

• Another assertion. 
• There is a very strong case for a default that’s default with a capital “D” not a “technical” default under transaction documents which are governed by English not local law which offer creditors a presumably easier path than the courts of Sharjah to call default.  And as outlined below default need not be called for a prospective (now) or actual (July) failure to pay.
• The Offering Memorandum  page 108 outlines  events of default.  Here are a quick three.   (a) “Non-payment”: either the Obligor or the Mudarib fails to pay any amount payable pursuant to any Transaction Document to which it is a party and/or either the Obligor or the Mudarib fails to pay any amount payable or deliver any shares pursuant to any Transaction Document to which it is a party within three days of the due date for payment or delivery thereof; or  (c) “Repudiation”: either the Obligor or the Mudarib repudiates or challenges the valid, legal, binding and enforceable nature of any or any part of a Transaction Document to which it is a party or does or causes to be done any act or thing evidencing an intention to repudiate or challenge the valid, legal, binding and enforceable nature of any Transaction Document to which it is a party; or (d) “Illegality”: at any time it is or will become unlawful for either the Obligor or the Mudarib to perform or comply with any or all of its obligations under the Transaction Documents to which it is a party, or any of the obligations of either the Obligor or the Mudarib under the Transaction Documents are not, or cease to be legal, valid, binding and enforceable;
• Dana has advised that it will not pay and has obtained a court injunction to engineer a legal obstacle to its payment.  The default under (a) will occur at the latest next month.    
• In refusing to pay and seeking the court injunction, it has repudiated the transaction documents (c) as of at least 13 June.  
• If on the other hand, its assertion that the transaction is illegal, then (d) is operative. By obtaining the injunction and applying for one in the BVI, the company is directly complicit in making its compliance with its obligations illegal.  It isn’t the Sharjah or UAE courts or a Shariah board which has initiated a legal action.  It is the company itself.
• Bond indentures generally have a lower threshold than syndicated loans for an instructing group – 25% is a typical number and that is reflected in the offering circular at least in respect of some transaction documents.  Thus, a relatively small number of certificateholders can call default.

In following post(s) I’ll take a look at the "winners" and "losers" of Dana’s “maneuver”.  The former will require much less comment than the latter, if any.

Global FX Code of Ethics: If You Have to State the Obvious, You Obviously Have a Real Problem

Annual Manifestation of the Free Market God at the AEA

Regular readers of this blog will have noticed that AA has little faith in the myth of the “self-regulating free market”.  Just last week  AA’s scant faith was confirmed yet again.

On 25 May the central bank-led Foreign Exchange Working Group (FXWG) in partnership with the private sector Market Participants Group (MPG) released a global code of conduct for the wholesale foreign exchange (FX) market.

The first principle of six in the Code is Ethics.  

This section of the Code calls on market participants to inter alia “strive for the highest ethical standards”, “the highest professional standards”, as well as “identify and address conflicts of interest”.

But let's let the Code "speak" for itself with AA using boldface to highlight key ideas

“Market Participants should:

• Act honestly in dealings with Clients and other Market Participants;
• Act fairly, dealing with Clients and other Market Participants in a consistent and appropriately transparent manner; and
• Act with integrity, particularly in avoiding and confronting questionable practices and behaviours.”

What this means in fewer words is that market participants should be honest and capable.

Two observations:

First, with reference to the “highest ethical standards” AA is at a loss to understand how being honest is an exemplar of “highest ethical standards”.  Are there ethical standards that allow one to be dishonest or act unfairly?  AA holds that being honest and acting fairly is like being pregnant.  One either is or is not.

Second, the six principles are not listed in alphabetical order.  Does the fact that ethics is placed first reflect an assessment by the FXWG and MPG (though perhaps the latter’s assessment is not as strong as the former’s) that there is a particular problem with ethics or more precisely a lack of ethics? If one has to make a point about what is self-evident, that seems to be an indication implication that practice is lacking.    

Does the need for promulgation of ethical standards refute the dogma of the self-regulating market?  If the market regulates itself, then such problems would be transitory and quickly remedied   

AA's parents and then AA himself spent a not inconsiderable sum on education, a good portion of which funded AA’s direct and indirect studies of economic dogma. 

It is an article of the Free Market faith that market forces driven by intense free market competition, act to indirectly compel ethical behavior among market participants.  Those who are unethical and act unfairly are displaced because customers flock to virtuous participants who act fairly and with high ethical standards.  This occurs even though the latter's salutary behaviour is motivated solely by the pursuit of profit not of virtue.  

That's the theory but this press release seems to confirm not the practice.