Strong Evidence No Discount for Gulf Holdings on Villamar Sukuk Repayment to GFH

AA Solves Another Case by Applying Non-Euclidean Geometry

As you’ll recall, in 2018 GFH purchased the Villamar Sukuk—on which Gulf Holding KSC Kuwait is obligor--from AlRajhi at a discount of some USD 77.8 million from its face value (roughly USD 203 million).

In its FY2018 financials GFH declared a gain of this amount.

In looking closely at GFH’s financials, I thought there were two possible structures for the “settlement”:

1. Option 1: GFH reduced the debt amount, GH to pay USD 125 million
2. Option 2: No reduction in debt amount, GH to pay full USD 203 million.

Based on that June analysis, I assessed that Option 2 was the more likely settlement mechanism. You can read the June blogpost here for the detailed argument for that view.

But as often is the case, GFH’s financials didn’t provide all the information necessary to make a conclusive determination.

An apparent dead end. But not really.

Additional “Evidence”

Gulf Holdings publishes financials.

If GFH offered it a discount on repayment, that should show up in GH’s 2018 annual report.

If it doesn’t, then there is further indication that Option 2 is the settlement mechanism.

As it has done in the past, GH included its financials in the shareholder package for its FY 2018 Annual General Meeting.

According to those financials:

1. The principal amount of the sukuk is unchanged.
2. As per Note 25, there has been no material change since the date of the financials (31 December 2018) and the date of the external auditors’ report (23 April 2019).

If discussions were ongoing for a reduction, then these should be mentioned in the “subsequent events” note. 

That increases my confidence that the sukuk is being “settled” under Option 2: GH to pay full value.

However, it is possible that GFH and GH did not begin negotiations until after 23 April. But again I consider this unlikely.

There was another open question from my June analysis regarding the potential need for a provision. The Sukuk was non-performing and AlRajhi sold it at a 38% discount. That would seem to be a strong indication that the Sukuk was impaired.

So how could GFH be confident enough persuade itself and its auditors to (a) book the entire USD 77.8 million gain in 2018 and (b) treat the Sukuk as unimpaired.

AA overlooked the fact that the sukuk is secured by Villamar Project assets.

GFH is the “natural”--perhaps the only—realistic buyer for these assets. Arguably it is also the potential buyer best placed to extract full value from the assets.

In any sale GFH and GH (controlled by GFH) would enter into “arms length” negotiations to set the price.

Now some out there might be thinking: “But, AA, this gives GFH the opportunity to potentially manipulate the sale price to its advantage to ensure it ‘collects’ 100% of the Sukuk thus justifying the USD 77.8 million ‘debt settlement gain’. It would be able to bury any shortfall in the value of assets acquired where that amount will be hard to detect”.

To those doubters I say that AA is highly confident that GFH will acquit itself in this transaction applying the same standards of ethics for which it is well known.

Regarding a potential sale of GH assets, according to the GH’s 2018 AGM package, shareholders were to be asked to approve the recommendation of the Board of Directors for a strategic sale of Residential South Real Estate Development Company SPC (RSREDC) and the owner of the Villamar project for a total value of US $ 52,466,853 US $ 47,466,853 / cash (US $ 5,000,000) and authorize the Chairman or his designee to take all necessary actions to complete the sale and transfer of ownership.

As I translate the Arabic AGM notice, the sale price appears to have two tranches: a cash tranche of USD 5 million with the remainder non-cash. Perhaps in partial settlement of the Sukuk?

You can check my translation by using the link above to find the AGM Agenda Point 6 on page 5.  If I've missed something, please set me straight.

I haven’t yet found any press release or other announcement about a sale.

But one appears to have taken place.

If I’ve read the information at www.sijilat.bh correctly, ownership in RSREDC (CR 59128-1) was amended in November 2019 from Gulf Holdings Kuwait to GFH Asset Company Cayman Islands.

Anyone out there with info, please post a comment.

Tesla Phenomenal 4Q 2019 Earnings - Built on Government Handouts

Sadly Tomorrow Never Comes

Tesla announced 4Q19 net income of USD 105 million.

Accompanying the announcement, Elon Musk said:

A lot of retail investors have deeper and more accurate insights than many of the big institutional investors

He went on to predict great things for Tesla’s future. A claim he’s made before.

In that respect Tesla is like Brazil - its bright future always remains in the future. Or the bar portrayed above.

Some 9 years after its IPO, Tesla still has to turn an annual profit. 

Excitement over the 4Q19 announcement should be tempered by realisation that Tesla has not yet had a significant profit from its basic lines of business.

An important point for investors to consider unless harvesting government handouts is the key business of Tesla. 

In 4Q19 Tesla’s revenues included some USD 133 million from sale of regulatory credits. So Tesla’s basic businesses earned a negative USD 28 million in the Quarter. 

That "performance" is not as good as 3Q19 where the reported net income of USD 143 million included regulatory credits of only USD 134 million. In that Quarter Tesla’s basic businesses earned a whopping USD 9 million.  And you thought Saudi investment banking fees were huge.

For 2019 reported net income was a loss of USD 862. Total regulatory credit sales were USD 596 million.

So the net income from basic businesses was a USD 1,450 million loss. 

With performance like that AA can’t understand why the stock has hit USD 1,000 per share.

Bahrain Middle East Bank - Fatally Wounded Barring an Unlikely Miracle

Bring Out Your Dead.  And Your Near Dead Too.

Since last July ever so often I would check to see if there was anything new on The Curious Case of Bahrain Middle East Bank.

After some months, fatigue set in. I missed BMB’s release of its “missing” 2018 financials.

Belatedly I’m catching up.

Late November BMB released its 3Q18 unaudited financials and its FY 2018 audited financials. BMB’s auditors did not issue an opinion.

Why?

Two factors: massive losses and apparent fraud.

Losses

Through 3Q18 net losses were some USD 193 million, reduced slightly to USD 189 million for the full year.

At FYE2018 Total Liabilities exceeded Total Assets by some USD 113 million due to provisions on USD 195 million in non-performing related party exposures.

A rather dismal picture summarized in the following (all figures as of FYE 2018):

1. USD 189 million loss represents 95% of Total Assets.
2. Negative equity of USD 113 million.
3. CAR is a negative 142.9%.
   

Apparent Fraud

So was this the result of a few bad commercial decisions? Investing in WeWork, taking a flier on Softbank?

No.

According to Ernst and Young, during 2018 the new Board discovered that certain exposures were to or for the benefit of a related party and not to independent third parties.

As of FY 2018 that USD 190 million in exposure was composed of direct loans, interbank placements, and securities.

While the latter two amounts were with independent third parties, there were side agreements that secured benefits from them to the related party. No further details. Perhaps as collateral?

There is an additional USD 4.6 million in accrued interest not included in the amounts above, bringing the total to USD 195 million.

Related Party Exposure

What do we know about the related party exposure?

From Director’s Report in the English version of the FY2018 AR, we know that the related party is related to a major shareholder not a member of management.

There are only two major shareholders AN Investment (ANI) (owned by the Turkish “Three Amigos”) and Al Fawares Kuwait.

I believe the related party is AN Investment (80.77%) not ALF (14.48%).

1. Recall that the ALF directors appear to have been warned—presumably by the CBB--and were able to resign before the CBB “fired” the Board. Unlikely if ALF is the culprit.
2. In the Directors’ Report in the 2018FY AR, the parties under investigation are listed as the former Vice Chairman (Mr. Solak), CEOs and CFOs. No investigation of the Chairman (which ALF held) is mentioned.
3. It would seem unlikely that ANI as the predominant shareholder would allow ALF to engage in self-dealing at a level that would risk ANI’s entire investment.
4. The related exposures are all in Turkey. I don’t believe ALF has any ventures in Turkey.

Who is the related party?

The terms “TFC” or “TFC Group” are used to refer to the related party in the Directors’ Report cited above.

I assume “TFC” is an abbreviation for “trade finance counterparties” which was the term used in BMB's press release in 2018 regarding the CBB prohibitions on the bank.

Why?

Not only does the CBB have restrictions on related party transactions but also has a limit on the maximum amount of risk that can be taken on a single entity or group. 

BMB’s exposure to "TFC" is well above that limit.

One might be able to make a case that a single entity or group wasn’t a related party, but it would be pretty hard to disguise exposure of this amount to a single party. The exposure would have to be divided among several ostensibly “independent” entities with each entity’s exposure below the single party limit.

From the “Minutes” of BMB’s 2018 AGM held 6 January 2020, we learn that:

1. The entire exposure is in Turkey.
2. There are multiple exposures to various trade transactions. Not to a single obligor.
3. BMB is working “alongside a consortium” of other creditors to recover the amount, hoping to secure a pledge of collateral. But that no restructuring agreements have yet been signed. And it is too early to determine ultimate recovery.

BMB FY2018 AGM and EGM

The first two AGM meetings proposed for 23 December and 30 December 2019 did not reach a the required quorum of shareholders attending and so did not take place.

Under Bahraini law, there is no minimum quorum required for a third AGM.

That’s good because the 6 January 2020 AGM was attended by just 0.04% of shareholders. You read that correctly. Not even 1%.

Clearly, ANI facing potential legal exposure wasn’t interested in attending. Nor was ALF or the ultimate beneficial owner of the ALF shares as it would no doubt face questions on how it “missed” the fraud.

Thanks to the question of Shareholder Khalil al Mirza (162,000 shares) we learned more about the related party exposure (as outlined above). With 162,000 shares he appears to represent almost all of the shares attending at the AGM save for holders of very small amounts.

There was one other significant-but not unexpected-bit of “news”.

Typically at AGMs, the shareholders vote to discharge the Board Members from liability for their actions during the fiscal year in question.

BMB’s Agenda Item #7 specifically referred to the discharge of the current directors. Shareholder Mohammed Abdul Rahman (1 share) asked if the prior directors were being discharged and was advised that none of the previous directors (this would include ALF’s two directors) were being discharged.

The EGM was not held because of lack of a quorum at all three meetings proposed: 23 December, 30 December, and 6 January.

The key item for the EGM was to take a decision on what to do in light of the losses which trigger compulsory remedial action under Bahrain’s Commercial Companies Law and the bank’s Articles of Association. 

With losses this large as a percent of equity, there are only two options for BMB: raise capital or wind-up the bank.

BMB Prospects- Little to None

The Bank is wounded very likely fatally.

This is now the second scandal resulting from fraud that clouds the Bank’s name. And BMB’s reputation never quite recovered from the commercially related losses in 1999 and the subsequent multi-year restructuring that followed.

Hard for me to imagine any serious equity investor interest.

There is no obvious institution that might be compelled to step up. For example, an existing shareholder. 

Rather an entirely new investor will have to be enticed to commit capital.

Other than the banking license, there don’t seem to be any positive enticements at the Bank.

BMB doesn’t currently have a viable line of business, a significant market position or a valuable customer base. 

Its reputation is less than sterling.

A new investor will have to make a significant capital contribution.

First to meet the CBB’s minimum shareholders’ equity requirement. That will involve at a minimum some USD 213 million to restore equity to CBB’s minimum of USD 100 million for a wholesale bank.

Second, cash will also be required to fund the creation of a new LOB.

While BMB may recover of all or a good portion of the related party exposure, on a best case basis that is likely to be a multi-year exercise.

It may well be that the Bank's auditors and the CBB may accept a write-back of some of the loss after a restructuring is signed, thus, lessening the required capital contribution.

But that will not alleviate the need for cash now to invest in its business.

Customers and financial institutions are likely to have little interest in dealing with the Bank. Lack of FI support will limit BMB’s ability to use leverage to increase its assets and ideally ROE, conduct trading activities etc.

Speaking of banks, recall that there is a single “regional” financial institution (SRFI) that BMB owes some USD 127 million for interbank deposits taken. The SRFI is in line to bear the brunt of any shortfall in recovery.

It seems pretty clear that this SRFI has been “legally” trapped in BMB.

That leads to the suspicion that it is not an FI that most financial investors would want to do business with.

The size of the amount owed by the Bank to the SRFI also presents a problem.

Paying it off either in full or in stages would require a significant commitment of cash. That would reduce funds for investment in BMB’s LOBs.

A potential new investor is likely to consider all of this more unwelcome “hair” on an already hirsute BMB.Or the final straw on the camel's back.

At this point barring a miracle, BMB’s fate appears sealed.