“Boring” IMF Report Contains Interesting Information on Dubai

The typical reaction to a report issued by one of the multilateral agencies is a polite "yawn" as one consigns it to the bin. That is a mistake that both investors and lenders make because these reports often contain important information. Information the IMF gains through its special access to the sources.  And which often is better than that given creditors or rating agencies.

What can be learned from these reports? 

1. Insights into fundamental factors or conditions that can help one look beyond the current hype – whether it's irrational exuberance or unjustified pessimism. From these agencies' autopsies of earlier financial problems, one can develop an insight into the factors that were associated with problems in other countries. Not universal laws. Nor magic equations that infallibly predict the future. But reasonably good early warning indicators that help one identify situations that lead to potential problems or are themselves symptoms of such problems.  One can also develop some ideas about the likely exit path if a problem hits. What happened in other countries? How severe and how long were those problems? And some "back of the envelope" comparative metrics one can use to make directional (but not exact) predictions of the path and severity of a  similar problem in another country.  Or at least set bounds on the severity estimate and likely paths.  This information is not only useful when the crisis hits, but when one is considering whether to make the initial investment.  Or if one has made the initial investment (or loan) when might be a good time to get out. - hopefully before the crisis occurs.   For example of this sort of information see the comparative analysis of real estate crises in four countries on Page 23 which might give some insight into the potential impact on UAE banks.
2. Then robust data on that country with which to apply these insights - or at least as robust as the country is able or willing to disclose.  One can use that data to see if those same conditions that caused problems in other countries are developing in this country. To what extent? Or, if the crisis has hit, what are the new vulnerabilities and exit path? 
3. Finally, other information - facts and judgments. For example, this report contains  an estimate of the amount of debt of Dubai Inc and the Government of Dubai.  The maturity profile. And, as I've noted in earlier posts, sometimes in the diplomatic language of the reports, one can discern the multilateral agency's assessment of problems and it sconcerns.  In some cases pointing out problems.  In other cases pointing out trends that will lead to fundamental changes from past. behavior  As an example of the latter look at the discussion the labor market in structural issues below.

Here's the link to the IMF "Staff Report for the 2009 Article IV Consultation" with the UAE so you can not only follow the analysis below, but also read and "wring" out additional bits of information.  This post long as it is does not discuss every insight or bit of information in the Report.

Pages 38 to 49 contain a special section on the Dubai World Debt Situation. 

Let's take a look at these first as they are likely to be of the most immediate interest to most readers.  But don't skip the section after that which discusses the main body of the Report.  It has some interesting information.  

Now to the topic of keen interest - the Dubai World Restructuring.

1. Page 39 Paragraph 6 "Dubai Inc. dominates the economy of Dubai (Annex Box 1). Dubai Inc. is a network of commercial companies and investment arms owned directly or related closely to the Ruler of Dubai, his family, or the Government of Dubai (GD). At its simplest, Dubai Inc. consists of three holding companies, Dubai Holding (owned by the Ruler), Dubai World, and the Investment Corporation of Dubai (both owned by the GD). A few other companies are owned jointly. Each holding is present in Dubai's growth engines and this overlap has fostered competition as well as duplication. Each holding has choice assets with solid earnings, as well as start-ups requiring large amounts of capital upfront, particularly in property.3Dubai's private companies are mostly owned by old merchant families. The private sector is fairly small and dependent on Dubai Inc.'s business." What this suggests is that the collapse of the Dubai development model (leveraged real estate development) and the sharp decline in many (but not all) foreign assets are going to have a serious effects on Dubai until there is a turnaround in Dubai Inc's fortunes.  Probably not a near term event.
2. That's reinforced by Paragraph #8 on Page 40 "DW's real estate interests are concentrated in Nakheel Properties, Limitless World, and Istithmar World. Nakheel's focus is Dubai; Limitless World, a more recent company, has comparatively more overseas real estate ventures; and Istithmar World is an investment arm with several overseas property-related interests. Although consolidated financials of Dubai World are not public, Nakheel and Limitless likely constitute about half of Dubai World's assets, the rest being held mainly by DP World, JAFZ, and Istithmar. Nakheel's remaining interests in overseas properties were transferred to Istithmar in September 2008." Assuming the statement that troubled real estate assets are roughly 50% of Dubai Inc's holdings, there is going to be a substantial ongoing drag on the Emirate.  Cashflow from existing projects is likely to be negative - diminished cash from operations eroded by heavy financing  charges.  And limited opportunities to sell the assets.   As  new projects are likely to remain stalled.  Since property and construction have represented 25% of economic activity, a slowdown in new projects will be another stress on Dubai.  Even assuming a relatively quick agreement with creditors on a restructuring, these problems are going to weigh on Dubai. Talk of any sort of a rebound in 2012 seems very premature. 
3. On Page 41, you'll find a handy chart showing the companies belonging to each of the three holding companies: Dubai Holding, Dubai World, and ICD. And the following pages contain some additional information on the various entities in each of the three.
4. On Page 45 there is a breakdown of DW debt between local and foreign banks. "Information on debt within the DW standstill perimeter has become clearer than on debt of DW's consolidated or Dubai Inc.'s debt. At this time, and after the payment of the Nakheel 09, the standstill perimeter is about $22 billion (in local and foreign currencies), of which $12 billion is in the form of syndicated loans, $7.5 billion corresponds to bilateral loans and $2.5 billion to bonds. The share held by national banks is 45 percent of the total ($10 billion), of which 2/3 is to Dubai-based banks (6 percent of their book) and 1/3 to Abu Dhabi banks (3 percent of their book). The national banks also hold 80 percent of the Nakheel 10 and 11 sukuk bonds. The debt subject to negotiation is owed by Nakheel, Limitless, and by DW at the holding company level (DW Holding, DW Group Finance), the largest component being at the holding company level. The extent and form of the needed debt restructuring will become clearer as the negotiations between DW and its creditors progress."  This quantifies the UAE bank exposure and raises some questions about market access.  Was this exposure built up in the last few years as foreign creditors reduced appetite for DW debt? Were local banks "stuffees" on deals the market wouldn't absorb?
5. Page 49 has IMF estimates of the Emirate of Dubai's Debt with a breakout of Dubai Inc's debt.  And then a further allocation within the constituent parts of the Dubai Inc . The headline number which you've probably read elsewhere is some US$109.3 billion for the Emirate.   That is 130% of the Emirate's GDP - not a comforting ratio.  But the IMF estimate does NOT reflect all liabilities.  There are amounts due to contractors for work already performed.  Advance payments taken from customers for real estate purchases.  So the total amount of Dubai's liablities is likely to be much more.  The debt burden measured in US$ or in terms of percentage of GDP is therefore much more.  All of which implies a severe economic burden to unwind the position - to pay down the debt.  To de-leverage.   In an article today, The National estimates another US$ 60 billion.  Whether that's the right number or not isn't clear.  Unfortunately, the financial statements of DW, DH and ICD  are not available.  Otherwise one could use these to round out the liability estimate.   So with the caveat that US$109.3 billion may be significantly understated, let's drill down to see what additional ew can learn.  First a look at the overall composition of debt among the various Dubai Inc entities and the Government of Dubai.  A boom built on a "credit card".
   

Entity	Total Debt (US$ Billions)	Percentage
Dubai World Entities To Be Restructured	US$ 14.35	13.1%
Other Dubai World (DW Ports, etc)	US$ 11.69	10.7%
Dubai Holding	US$ 14.79	13.5%
ICD	US$ 20.40	18.7%
Other Dubai Inc	US$ 24.35	22.3%
Dubai Inc Total	US$ 85.59	78.3%
Government of Dubai	US$ 23.70	21.7%
Total All Govt Related Dubai Debt	US109.29	100.0%

Now an estimated maturity profile (amounts in US$ billions) to outline cashflow demands on Dubai.  For the DW entities to be restructured, their problem is a near term two-year window of "bunched" maturities.  This occurs at a time when there are much heavier cashflow demands on other Dubai Inc entities. It doesn't seem that there are resources that could be taken from other entities in the Group to tide over Nakheel, Limitless and Istithmar.  And with these sort of amounts, a clear need for refinancing.  The Emirate remains dependent on banks and investors - probably foreigners as the Central Bank of the UAE tamps down on credit from local banks.  At best higher margins.  At worst limited access which in itself might tip other entities into restructurings.  A difficult situation to navigate.

Entity	2010	2011	2012	2013	2014	Beyond
DW To Be Restructured	US$ 5.2	US$ 4.6	US$ 1.9	US$ 1.1	US$ 0.3	US$ 1.3
Other DW	US$ 0.2	US$ 2.0	US$ 5.7	US$ 0.5	US$ 0.0	US$ 3.2
Dubai Holding	US$ 3.5	US$ 3.2	US$ 0.8	US$ 0.5	US$ 2.1	US$ 4.6
ICD	US$ 2.0	US$ 5.8	US$ 5.7	US$ 3.0	US$ 0.1	US$ 3.8
Other Dubai Inc	US$ 4.7	US$ 8.8	US$ 4.9	US$ 1.8	US$ 0.6	US$ 3.6
Total Dubai Inc	US$15.5	US$24.4	US$19.0	US$ 6.9	US$ 3.2	US$16.5
Govt of Dubai	US$ 0.0	US$ 0.0	US$ 0.0	US$ 1.8	US$21.9	US$ 0.0
Total Dubai Govt Related	US$15.5	US$24.4	US$19.0	US$ 8.6	US$25.1	US$16.5

Note: Amounts do not add exactly due to rounding.

Now to the rest of the report.

1. Page 4: "With foreign investor confidence shaken and international capital markets less accessible, Abu Dhabi's policy of selective support to Dubai will play an important role in limiting contagion to the U.A.E. economy and the banking system." The key takeaway here in case anyone out there missed it is that Abu Dhabi is not writing a blank check to bail out its neighbor. And that reason for that is clear. In fact there are 109 billion reasons. 
2. Page 6: "The crisis unfolded with differential impact on Abu Dhabi and Dubai. It highlighted three key issues: (i) the contrast between growth based on hydrocarbon resources and that based on nonhydrocarbon diversification funded by maturity-mismatched leverage; (ii) the spillover effects and financial support structures in the federation; and (iii) the volatility of markets in response to a lack of information disclosure and transparency. In particular, the debt announcement undermined the widely held market perception of implicit government support, including from Abu Dhabi."  
3. Page 11 contains a series of charts that provide in graphic terms (sorry for the pun) an indication of the nature of the problem and some potential early warning indicators. First is the dramatic increase in foreign borrowing from BIS banks. The second is a chart showing the explosion in local borrowings beginning in 2004 where the growth curve moved from roughly a 6 degree angle to over 60 degrees. As noted in Paragraph #38 on Page 20 some US$ 100 billion of credit above the trend line was extended. Third is a dramatic rise in short term borrowings. Anyone familiar with the Asian Crisis of 1997 would recognize this pattern.  It's very similar to what happened in Thailand.  If that lesson had been assimilated, perhaps Dubai would not have crashed.  Or at least those who paid attention would have avoided the collapse.
4. Paragraph #21 on Page 13 brings home the point that while the IMF is projecting 0.5 percent growth for the UAE in 2010, that growth is going to be very uneven. Abu Dhabi's growth will be propelled by a significant public works program.  Dubai is going to stagnate.  Footnote 2 on Page 7 gives an indication of the growth differentials. If these 2009 statistics are any guide to the future, Dubai will experience negative growth again in 2010. Very roughly  8% or so negative assuming Abu Dhabi repeats 2009's 6% growth and using a very crude 60/40 split.
5. Page 14 contains a box with a detailed discussion of the  mechanics of the Dubai special insolvency regime for Dubai World. It also raises two questions as to whether its decisions will be recognized outside the Emirates (I'm guessing they will unless they seem to be overly slanted towards the borrower) and whether the special tribunal will enforce foreign judgments against DW entities. If the intent is that the tribunal is applying "global standards", then it should enforce foreign judgments - again presuming they are reasonable.  If one wants to play in the Premier League, one has to follow the rules.
6. Page 16 some quotes on the Dubai model of development. "Even though Dubai has achieved an impressive degree of diversification and has become a major trading and services regional hub, recent events call into question the sustainability of enhancing growth through large-scaled and highly leveraged property development. The Dubai authorities recognized that the recent events require a reassessment of Dubai's real estate sector to ensure the economic and financial viability of the emirate's corporate sector. As a result, over the medium term real growth was likely to be slower but more sustainable than in the period preceding the crisis. The authorities were of the view that Dubai had a top quality infrastructure, and that its hospitality, trade and logistics engines should continue to benefit from Asia's pull. Although the scope of the restructuring was still being defined, the focus would be on refinancing the property sector."  The question is what replaces the old model.  The implications for growth seem to be clear.  Less growth. Normal commercial activities are not going to deliver the growth that a speculative property boom did.   Less growth also has a negative implication for debt service abilities.  For the rise of asset values.
7. Page 18 a confirmation that the Dubai crisis has strengthened Abu Dhabi's hand. "The authorities emphasized that the crisis had encouraged greater cooperation between the federal and emirates levels of government and between the emirates themselves. Going forward, Abu Dhabi would continue to support Dubai in its efforts to achieve a viable position. However, the Abu Dhabi authorities emphasized that Abu Dhabi was not legally liable for DW debt and that any decision to extend support would be made on a case-by-case basis. In this regard, they stressed that they did not want to create moral hazard by supporting potentially nonviable corporations, but would provide support if necessary to limit contagion to the .A.E. economy and banking system." Greater co-operation will mean more centralization. Abu Dhabi will benefit from that. And "moral hazard" probably also encompasses the hazard to Abu Dhabi's check book given the size of Dubai's obligations. 
8. Page 20 gives some idea of the credit growth that lead to the crisis. " The U.A.E. financial system entered the global crisis exposed to a highly leveraged economy. The system is bank-based and focused on the domestic economy. Commercial banks expanded credit very aggressively during 2004–08, generating about $100 billion of credit above the underlying trend growth. Credit growth was the fastest among emerging markets by a good margin, and the capital base was disproportionately low for such growth (figure 4). During this period, banks by and large did not retain sufficient profits to maintain capital buffers, despite their exposure to an economy with significant leverage. Nevertheless, banks remained highly rated throughout 2004–08, in part reflecting perceived support from governments and in some cases government ownership. In addition, banks' liabilities (deposits and interbank loans) have been under 3-year blanket federal government guarantees since September 2008."  Hence the Central Bank of UAE initiatives to force banks to retain capital by limited cash dividends for 2009 and imposing tighter provision requirements.
9. Pages 23 to 25 present stress tests of the banking system for various haircuts. Paragraph 41 on Page 23: "However, the DW debt situation has increased the need for additional capital as these contingencies have become more likely to materialize. The uncertainty created by the prospective debt restructuring implies that banks may need material capital buffers above the regulatory minimum to maintain adequate ratings for dealing with market counterparties. To illustrate, assuming that banks need at least a 14 percent CAR, the additional capital needs would be about $6 billion or 2.7 percent of GDP. 5he possibility of a principal haircut on the DW debt subject to the standstill cannot be ruled out, an outcome which would have a significant effect on banks' provisioning. As an illustration, staff estimates that the capital top up could reach 3.4 percent of GDP for a 25 percent haircut and 4.3 percent of GDP for a 50 percent haircut of DW debt subject to the standstill."  Something every equity investor in UAE banks should be considering in terms of anticipated performance. As well as something for foreign counterparty banks to consider in terms of the amounts, types, and tenors of credit they extend.  While the UAE has demonstrated a very strong intent to support its banking system, a careful creditor always looks at the underlying strength of the obligor. 
10. Page 24 provides an assessment of the quality and capacity of the Central Bank of the UAE as a regulator. "While the extra capital need appears manageable, the exercise underscores the importance of contingency planning, supported by intensified supervision. The global financial crisis is testing the CBU as a regulator, as it did with many other regulators. The DW standstill has increased the potential for surprises and, consequently, the need for a more pro-active supervisory approach and effective enforcement. The CBU could for example use more systematically its power to block dividend distributions in the interest of building larger capital buffers. There may also be a need to re-assess how exemptions to large exposure limits are granted in the case of GREs. Finally, CBU inspections follow a traditional model of rolling examinations of individual institutions, whereas the current situation suggests the need for simultaneous cross-firm examinations of specific risks such as sectoral concentration, name-lending, or deteriorating funding standards. In the latter case, the CBU's limited resources, including for off-site analysis, hinders such an approach." A clear criticism of a failure to control banks' exposure to groups like DW.  The Central Bank of the UAE has taken the IMF's advice.  It has limitied2009 cash dividends.  Paragraph 45 on Page 25 details other measures it is implementing: a 1.25% general reserve on risk weighted assets and the new 90 day non accrual rule. 
11. Pages 26 and 27 discuss three structural issues. Labor markets and the need for uptiering skills. As this unfolds, it's likely that labor will be imported from different countries than it is now.  This is going to have some strong implications for those countries, e.g., a decline in worker remittances, loss of safety valve for unemployment, etc.  The need for long term financing and the lack of adequate local financing sources. Until markets for term financing can be developed, a dependence on foreign financing will remain - probably with the same short tenor preference on the part of foreign banks and investors which was in part responsible for the current crisis.  Inadequacy of data that limits the government's ability to monitor the economy and formulate policy. This issue is also related to debt management since each Emirate has been responsible for its own finances.  Without co-ordination (ideally central direction) there is a potential for problems.

Those 67 "boring" pages were packed with a lot of information and, as well, hopefully some lessons useful for future investment decisions - both at the underwriting as well as the monitoring stages.  And there's still more to "mine" from the report.

Dubai World - Debt Tribunal Opens But No Claims Lodged Yet

The National reports that the special tribunal has received about 100 inquiries on the process for filing claims though no claims have been filed yet.

The article also notes that if DW files a notice of an intent to restructure the Court can grant it a 120 stay of legal action to develop such a plan and present it to creditors.

Whether or not the company can restructure as is hoped depends on its economic position.  If that is weak and there is no external support, then it's hard to see how it can continue except under a disguised wind down.

I'd guess that this is precautionary move on the part of creditors.  They are preparing for a breakdown in the debt restructuring or some other need to prove their claims.

Earlier one of the reasons given for the delay on the DW side in presenting concrete proposals to its creditors was that it needed to "sort out the mess in its accounting".  If that is indeed the case, then it is perhaps just as likely that not all liabilities were recorded properly.  Back in the early 80's when oil prices collapsed many Saudi and foreign contractors found out that those "change orders" which their clients had needed done on a rush basis were not documented properly.  Whether it was a matter of proper procedures or a way to ride the trade and get discounts, the Saudi authorities slowed payments down dramatically.  Some improperly documented changes were disallowed.  A creditor (particularly one whose obligation is not a clear cut loan or bond) might be wise now to make sure its debt were acknowledged by the obligor.  And if not to prepare to litigate.

Saudi Capital Markets Authority - Three Fines Levied

The CMA announced it had levied three fines today:

1. SAR50,000 on AlRajhi Bank for delay in notifying the CMA of the resignation of  the GM of the Finance Group and GM of the Commercial Group.  Link to AlRajhi's English page at Tadawul.
2. SAR50,000 on Shams (Sun) Tourism Enterprise Company for failure to advise the CMA of the firing of the CEO by the Board.  The Board took its decision on 22 December 2009 but didn't notify the CMA until 27 December 2009.  Link to TEC's English page at Tadawul.
3. SAR50,000 on Sabb Takaful for failure to advise the CMA of several (unspecified) changes in senior management during the period 13 January 2008 through 13 October 2009 until 21 December 2009.  Link to Sabb's English language page at the Tadawul.

These are admittedly small amounts.  What I think is the story here is that the CMA is monitoring and penalizing companies for the sort of infractions that would have been overlooked in the past.

You can switch from the English language company pages to the definitive Arabic language ones by using the button at the top of the upper left page next to the "Home" button.  Also note that generally the announcement on fines are not translated into English at either the Tadawul site or over at the CMA's website. 

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Speedy recovery Aaron.

عيد المولد النبوي الشريف

Happy National Day and Liberation Day

Copyright   Steve & Jem Copley   Creative Commons Attribution-Share Alike 2.0 Generic license

Happy National and Liberation Days

Arabtec Stops Work on Nakheel Project Due to Non Payment

This article from The National is not encouraging.  AlFurjan is one of Nakheel's largest projects (housing).

If Nakheel is unable to conduct its business, it's not going to generate a cash flow.  It's also going to have a knock-on effect on other firms.  Not good news for bankers. Especially since a promise was made to use the Abu Dhabi $10 billion contribution to pay suppliers and contractors.

Interesting Blog: The Race for Iran

The Race for Iran from Flynt and Hillary Leverett.

Some "outside the box" thinking on the issue.   Often the best sort of thinking.

Whether or not you agree I think you'll find your mind stretched.

Where Is The World Economy Going?

Interesting post at Wall Street WTF on Bernake and his likely actions.

And another by Martin Wolf at the Financial Times.

And a piece by William White, former Chief Economist at the BIS.

I think this issue "boils down" to some fundamental questions:

1. Do we have the right diagnosis for the disease?
2. Do our economic doctors have an effective course of treatment?
3. Has the right treatment been prescribed?

The Psychogenesis of Restructurings

Copyright M0tty  GNU Free Documentation License

Make yourself comfortable on "Dr." Arqala's metaphorical couch as we delve into the darker recesses of the "psyche" of finance – those connected with restructurings.

We'll conduct our forensic study by tracing the various stages in the restructuring process with tongue firmly in cheek. A planned subsequent post, "Great Moments in Restructurings" will provide some concrete examples from case studies.

Restructurings are usually thrust on the participants. Sometimes this occurs in a rather violent fashion with an unexpected failure to make a payment. Whatever the triggering event, restructurings heighten a wide range of latent pathologies, both traditional as well as those associated with behavioral finance.

Stage 1: "Houston, We Have A Problem"

When confronted with a serious problem (before the payment failure), the borrower's first reaction is to ignore it. "It's just a temporary setback." "When the market recovers, so will we." If I pretend it isn't there, it won't be.

But when the problem refuses to go away and the date of the payment inexorably approaches, the obligor develops an almost religious faith in miracles. "We'll sell our newly formed subsidiary in Waziristan." Or maybe just 40%. "We're going to IPO our not yet created affiliate in Marjah (Afghanistan)." "Our lenders will gladly refinance their loans to allow enough time for our assets to regain their value."

Sometimes borrowers recognize the problem themselves. But usually they don't. Many hire an advisor in the belief that a new loan or a quick refinancing will solve the problem. AA's particular favorite is a bond exchange. In such cases the advisor's first task becomes convincing the obligor that the problem is really serious – two aspirin and a band-aid won't do the trick. At this point the advisor is well advised to refrain from pointing out that in large measure the problem is self-made. That can be dealt with later. And then presented as a remarkable contribution made by the client to finance theory. Through his pioneering efforts the world has discovered heretofore unknown financial principles such as the danger of too much leverage or the risk of financing long term or illiquid assets with short term money. Or that markets and asset prices sometimes go down. Who could have imagined?

Stage 2: "From Hero To Zero"

A great relationship with one's creditors is contingent on there being no problems. The old saw about commercial bankers sums this up quite nicely: "A commercial banker is someone who gladly lends you an umbrella on a sunny day. And then at the first sign of rain demands it back immediately."

The natural tendency for the borrower is to presume that his lenders will understand. "Why they told me that I'm a strategic customer". "I have a personal relationship with their (insert as appropriate) Chairman, Deputy Chairman, Global Head of Syndications, etc. and they won't treat me the way they did (insert name of another company in difficulty)"

Creditors don't react well to the unfortunate news that payments cannot be made on time, particularly if the "news" is delivered by the non payment itself. It's not just a matter of disappointment. A solemn promise has been broken. What could be more sacred than the vows in a financial contract? What sort of person would break them? "How could you do this to me? I trusted you" is not only the lament of the betrayed spouse but the disappointed banker.

Often such events lead to equally startling revelations about the character of one's client. He is suddenly unmasked as incompetent, a habitual liar, and perhaps even a crook. Particularly if the customer has previously told his bankers that there wasn't a big problem. Or that one or more miraculous events would occur. Financial takfir is often pronounced. Or, if not spoken, at least thought.

You can imagine the shock of the borrower at his great fall. And the psychological damage it causes. "How could they turn on me? It wasn't my fault." Betrayal it seems is a two-way street – at least in the borrower's mind.

Stage 3: "And Where The Offense Is, Let The Great Axe Fall"

Such an outrage must have consequences – dire consequences. A virgin or one or more members of senior management must be thrown into the volcano to appease now angry lenders. Since management is the more likely of the two to be handy, a member of management is tossed in.

In some cases professions of contrition and suitably fast talk may secure some reprieve and avoid a sacrifice.

In some lesser emotionally developed markets, the lenders insist that the obligor feel acute pain, even if it is evidently but a pale reflection of their own profound distress. Sometimes the crudest financial revenge is sought – "to obliterate, to punish and to discourage others". Not necessarily at the outset. Perhaps later when the restructuring is being crafted. Hell hath no fury like a scorned banker.

Sometimes the borrower unilaterally takes such an action to show it is serious about the restructuring. A pre-emptive sacrifice to dispose of a senior manager whose credibility with the bankers may be such that he is more a liability than an asset in the negotiations.

Stage 4: "Send In The Clowns"

Negotiations begin.

If the creditor group is large enough, a "Steering Committee" or "Creditors' Committee" is formed to facilitate the process.

By and large the same great minds – both among the lenders and the borrower - that made the original loan are involved in its restructuring. Who better to straighten out the mess than those who created it in the first place? After all, they've already demonstrated their competence in matters financial.

The process begins with a mutual show of lack of trust. The bankers for the unmasked miscreant who days before was their "best customer". The borrower shocked to find that all the prior assurances of relationship were empty words. Blame needs to be assigned. Feelings must be vented.

Then comes the hard part of agreeing the way forward. The borrower wants nothing simpler than to continue his previous path – the sound business strategy and vision that got him into his predicament not through his own fault but due to the manifest errors of others. The bankers want their money and want it now. Business empires have to be dismantled. Plans for the future all have to be shelved to achieve this end.

Generally the borrower's unrealistic ambitions and delusions can be made to surrender to the creditors'.

The problem often is that often the most difficult negotiations take place among the creditors themselves. A process described as trying to herd cats.

During negotiations, the borrower is often told something can't be done because the syndicate won't accept it. "We understand your request, but not all the banks will accept it." A rather convenient excuse to deflect criticism from the Steering Committee for imposing harsh conditions on the borrower or ignoring its requests. As with many commercial negotiations the bankers' "kalaam" on this topic isn't always "sharif". But what duty of honesty does one owe to someone who doesn't honor solemn bond regarding his debts?

Creditors who evidenced scant understanding of banking during underwriting now step forward boldly to advocate a variety of really silly and/or trivial things. No longer quieted by the prospect of joining a "great deal" as they were at the underwriting, they give free rein to their imaginations and lack of knowledge to develop "great ideas". The task of the Steering Committee is to try and bat down the silliest or least useful of these. But to get a deal done sometimes compromises are made. In other cases there is no will. Ultimately it is the borrower who suffers. And what better person to suffer in such a case than the "faithless one"?

Great amounts of time and money are spent in the process. It is here that one can observe "Abu Arqala's Law of the Conservation of Due Diligence" in action. If creditors by and large failed to do a reasonable level of due diligence at the underwriting stage, they will more than make up for it now. With overcompensation directly proportional to the extent of their earlier failure. Legal issues are parsed with Talmudic zeal. Legal and accounting fees pile one upon another.

As usual, the only guaranteed winners from every restructuring are the legal and accounting firms. They get richly compensated no matter what happens. And collect their fees before the first principal repayment is made. The advisors in the Lehman restructuring have already been paid over US$642 million for 16 months' work. And their labors have not yet ceased!

Stage 5: "This Is A Court Of Law, Young Man, Not A Court Of Justice"

A major factor affecting the course of the negotiations is local law and the state of the judicial system. Laws and legal systems that favor the borrower can lead to prolonged negotiations. In some cases the borrower is almost immune from creditor efforts to liquidate it. A strategy of delay to wear down the creditors can work well here. Where the law gives creditors the upper hand, the process can be quicker. If it's too quick, it can turn into a lynching. A general rule of thumb is that the longer it takes to conclude the restructuring the more value that is lost (or more aptly squandered) in the firm and in the ultimate recovery of the lenders' funds.

As well, if the legal system is deficient or can be gamed, the party able to take advantages of these defects has a strong advantage. This applies not only to creditors versus borrower but within the creditor group itself as discussed in Stage 8 below.

Stage 6: "Do You Want to Know A Secret?"

Just like people, companies, all companies, have secrets they would like to keep. Behavior they're not especially proud of and would rather not have come to light. Or be the subject of open discussion. The due diligence process generally exposes these embarrassments. In a restructuring one's kimono is not just open. It's taken off.

These can be "simple" things like that expensive redecoration of the executive floor or more "complicated" things like uses of corporate resources for private projects. Or that "performing" asset that really isn't performing so well. In one view being provided intensive care and nurtured to recovery. In another view, a failure disguised. The lapses in procedures. The special deal for a friend.

Though they have their own similar behavior, banks naturally react with horror and often feigned indignation to the moral shortcomings of their borrowers. I once was involved in a creditors' group which contained a very outraged banker who complained unceasingly about the borrower's moral and business failings. As we all were, that chap was billing that borrower for his attendance at meetings – travel, lodging, meals. His expenses also included rather frequent in room "massages" at his hotel. Apparently, he had a very sore "back". And to ensure his ability to function properly at the meetings during the day required at least one and sometimes two "massages" a night. He was also apparently quite generous in providing beverages for the masseuse.

The more outrageous "sins" are of course terminated. In some cases, tolerated as the "price" of a restructuring. Restructurings are often not the step to financial soundness but moral as well. At least for the borrower.

Stage 7: "Let's Make A Deal"

At some point, often mutual exhaustion, the parties decide it's better to strike a deal than continue negotiating in circles. Sometimes one side can take advantage of the other's greater predisposition to exhaustion to secure an advantage on this or that point. This is where the nature of the legal system can play a major role.

In any case, once the moment arrives, the borrower and the Steering Committee become serious and hammer out a draft termsheet - a document that contains the basic terms of the rescheduling but is not the formal loan agreement. One that does not include all the details. Often the termsheet is agreed with what appears to be unnatural speed, particularly when the time taken to reach this point is considered.

Since the termsheet is the result of a process of "give and take" by the two sides, one might think it was the product of careful analysis of reality and agreement on reasonable projections for the future forged in the furnace of debate. One would be disappointed. Repayment schedules are more often based on what is acceptable to the banks rather than what is required. One simple example: a borrower might need seven years to repay. Banks will insist on five years. To avoid a problem in the early years, payments will begin at modest levels with the problematical amounts shifted to the latter years in large unrealistic payments. Why? Because it is easier to sell such terms to credit committees. "It's a five year deal, honest." And one doesn't really want to harm one's career by advocating the longer (required) tenor. The hope, as I've posted before, is that if any problem occurs it will be on someone else's watch not one's own. And thus by good business logic, the fault of that person.

But this is only a small step forward. The terms must be agreed by all the creditors.

Stage 8: Herding Cats

As the title implies a difficult process. Primarily because individual banks now hold more power than they did at the inception of the loan. Then, if they raised too many issues, they would be dropped and another "wise" lender would take their place. Deadlines for decisions were cast in stone. A failure to respond could cost one's place in the deal. Now there are no such constraints. The lender is already in the deal. Its vote is critically important.  

At this point, an institution may require more time to come to a decision.  Analytic skills which atrophied due to lack of use in the underwriting stage may need a bit more time to regain their full vigor. Decision making which proceeded with alacrity at underwriting may now need to proceed at a more thoughtful measured pace – much more thoughtful and measured. 

What suddenly gives an individual bank such power?

Legal matters which often give a single bank a right of veto.

The first of these has to do with the legal regime in the country of the borrower. Some jurisdictions have mechanisms that allow a specified majority of creditors - but less than 100% - to approve a restructuring. Under this regime, dissenters are forced to go along with the majority vote. They are "crammed down". The old loan contract is superseded by the new one. And thus all creditors lose their right to sue to enforce the old loan contract. If other jurisdictions recognize the validity and integrity of this procedure, they will also deny dissenters the right to bring suit in their jurisdictions.

On the other hand, other jurisdictions, for example the GCC states, require 100% creditor approval to abrogate the old contract. So despite the fact that The Investment Dar has a "deal" in Kuwait, its dissenting creditors still have the right to sue under their old loan agreements for payment and potentially overturn the deal. That's why the strong preference of lenders is to secure the requisite number of votes to preclude such actions.

The second of these has to do with approval on facilities that have more than one bank as lender. Syndicated loans require that 100% of the creditors must agree to any material change in the terms of the financing for it to be binding. These would include final maturity, the amount and pattern of principal repayments, the interest rate, or other material deal terms. One bank can therefore hold up the approval of a syndicated facility even if it only has a very small portion. And, just to be clear, cram downs don't apply at this level unless specifically provided for in the original loan documentation. I've never seen a loan agreement that allows this.

As you might expect, where a single creditor or a relatively small number of creditors can make a problem by delaying a deal, they may exercise this power in the hopes of causing enough trouble so that someone buys them out. Larger creditors with much more at stake who can't let the deal fail. Or the borrower or a "friend" of the borrower. The "friend" because loan agreement covenants prohibit preferential payments (like buyouts) - those not made to all of the syndicate members.

One example of the potential power of the dissenting creditor – though in a (different) pre default context - is the Nakheel Bond where QVT put together a group sufficient in size (usually bond indentures have a low 25% threshold for acceleration) that Nakheel could not strike a deal for a payment standstill or rollover because the QVT group would call default – triggering cross default on other Nakheel obligations. Here the power stopped a default from happening and secured on time payment of 100% of the amounts due.

As well, there can be other impediments to approval. A resolute creditor can revive its previously dismissed "bright" ideas. Where the Steering Committee is powerful and chooses to exercise its power, it may threaten retribution to recalcitrant banks. "Play nice or we'll cancel your lines." Where it is not or chooses not to, less than optimal creditor ideas are included in the restructuring.

Stage 9: The Devil Is In The Details

Once the termsheet is finally approved the creditors' lawyers begin their drafting of the rescheduling agreement. The creditors insist their counsel do this to ensure their control over the process.

This is not only a time for legal wordsmithing but an opportunity for a clever lawyer to try and recast the deal in the termsheet. Or sometimes for a sloppy lawyer to undo aspects of the deal.

In some cases concepts in termsheets are expanded beyond the original understanding of the parties – particularly the borrower's. The idea is that at this point as the train is moving forward to the station, the borrower will be reluctant to get off.

Sometimes what are thought to be brilliant ploys to impose new terms on the borrower turn out in retrospect to have been unintended favors – sometimes quite significant economically. Like the angry creditor who unintentionally gutted a cashflow sweep mechanism – significantly reducing the borrower's mandatory prepayments.

Documentation must be satisfactory to all parties. Once again a determined or slow responding lender can affect the time to complete the restructuring because it isn't legal until all the "bits of paper" are signed. Before signing them, a lender must find them acceptable. The borrower also has a chance here to object.

Another step in the process is the borrower complying with whatever "conditions precedent" it has agreed (or been forced to agree) as part of the deal with the lenders. In the Global Investment House restructuring, certain assets were to be transferred to two special purpose vehicles. No doubt, arranging those transfers was a condition precedent to the restructuring becoming effective. Until GIH did this, its restructuring deal wasn't complete.

Stage 10: "You're Only Using One Side Of The Toilet Paper?"

Lenders want to ensure that the borrower's funds are directed to repayment of their loans on a priority basis. As you'd expect this is a critical issue for creditors. To achieve it they impose a variety of restrictions. Major cashflow items like cash dividends or significant new capital expenditures are controlled by explicit limits or prohibited outright.  Other expenses are scrutinized for ways to conserve cash. These restrictions along with financial undertakings and ratio maintenance are made covenants in the restructuring agreement. Violation of these gives a stated percentage of lenders (usually more than 50%) the right to call a "default" and accelerate the maturity of the (restructured) loan. Most of these controls make eminent sense.

But often minor expenses which have no real economic bearing on ultimate repayment are targeted. The borrower must be made to live a more frugal almost monastic lifestyle. More often than not the economic benefit to lenders is less than 1% of the amount of the obligation. Like the chap in one loan restructuring who wondered why certain members of management needed subscriptions to both the Financial Times and The Wall Street Journal. One rather wry and highly numerate fellow creditor thanked him noting that the impact of this simple action would ensure payment of the loan in 50,000 years. Whether the motive is "to obliterate, to punish and to discourage others" or simple stupidity is not always clear.

Elaborate and costly mechanisms are established to ensure that expenses are controlled.  Frequently, an  accounting firm is engaged to review expenses, charging as is their practice not only an engagement fee but by the hour billing. As you'd expect, it's relatively easy to control a few big items. Not much time or money need to be spent checking if dividends were or were not paid. Or a new building started.

But reviewing a myriad of small expenditures is highly labor intensive. Particularly if a limit is breached. Then offending expenditures have to be identified with elaborate analysis of the justification or lack thereof for each. And a suitably detailed explanatory write-up prepared and provided to the creditors. Not infrequently, the cost of the control becomes more than the face amount of many of these items. To say nothing of management's time diverted from running the business as it must justify each and every overage to avoid running afoul of some covenant in the restructuring agreement.

Unlike funds spent by the borrower, these expenses are always considered perfectly reasonable. As are, the expenses of lending banks: such items as first class airfare, fine hotels, and gourmet meals to attend meetings– all no doubt highly relevant to the restructuring process.

It's hard to find an economic reason for such behavior. A dollar spent however it is spent is in the final analysis a dollar spent.

Postscript

With luck the borrower makes the necessary repayments to the banks and retires the obligation.

Both emerge from the process suitably chastened for previous unwise behavior – though usually only temporarily.

Idiocy Knows No Borders: القذافي يدعو الى "الجهاد" ضد سويسرا

All one has to do is see his name to know where to file the Brother Leader's comments.

BBC report here.

Global Investment House v National Bank of Umm Al Qaiwain US$250 Million Deposit

You'll remember the long standing saga and legal case of the US$250 million deposit that GIH placed with NBQ re a potential investment by GIH in the shares of NBQ.

So what's happened since the last time we looked?

Well here's an extract from NBQ's recently released 2009 audited financials.

"Other liabilities include AED 918.25 million (equivalent of USD 250 million) received from Global Investment House - Kuwait (GIH) as advance payment on the proposed issue of bond to be converted in to 330 million shares of AED 1 each at a premium of AED 6.15 per share totaling AED 2.359 billion, entered through a Memorandum of Understanding (MOU) dated July 16, 2008. This amount is included in  other liabilities without any interest attached towards it.

During December 2008, the Bank has received a letter from GIH for the cancellation of the above transaction and for refunding the advance of AED 918.25 million. On legal advice, the Bank has taken the view that GIH request is not valid and that the MOU is a binding sale purchase agreement. Accordingly, the Bank proceeded for completion of the transaction by seeking the balance due from GIH.

GIH had filed a lawsuit during 2009 in the First Instance Court of Dubai which was rejected due to arbitration clause in the MOU. The Court of Appeal has set aside the arbitration clause in the MOU stating reasons that authorised signatory from GIH who signed the MOU was not explicitly empowered by GIH to arbitrate and thus to sign an arbitration clause which was included in the MOU.

Based on the appeal filed by GIH, the Court of Appeal has decided to return the lawsuit to Court of First Instance and to judge the case based on its merits."

Idiocy Knows No Borders: Modern Day Paul Revere Warns The "Muslims Are Coming"

In times of danger, brave patriots stand watch over our great land.  Frank Gaffney is no exception.  Through his careful exegesis of the recently redesigned logo for the USA's Missile Defense Agency, he's discovered a rather nefarious plot by President Obama.

What could be code-breaking evidence of the latter explanation is to be found in the newly-disclosed redesign of the Missile Defense Agency logo (above).  As Logan helpfully shows, the new MDA shield appears ominously to reflect a morphing of the Islamic crescent and star with the Obama campaign logo.

If you're stout of heart (and that is perhaps the true test of your patriotism), here is Logan's blog which explains in rather graphic detail just how this abominable logo was created.

If you're not afraid after reading his post, you should consider this.  It's a well known fact that the US Congress generally does not meet on Fridays.  Fridays as we all know are the Muslim holy day.   Just a mere coincidence.  Or "chilling" cause of the recent uncharacteristic snowstorms in our nation's capital?

I'd like to thank David Roberts at the Gulf Blog for bringing this shocking revelation my way.   They say there's a special relationship between the USA and the UK and this proves it yet again.  Were it not for his  blog, I might have missed this item and perhaps my last chance to eat pizza with Italian sausage.

I'll be making an emergency trip to his local pizza parlor this weekend (deep dish, of course).