Mashreqbank v The International Banking Corporation

This post reviews documents submitted in the case brought by Mashreqbank against TIBC in the Supreme Court of New York State (Case Index #601616/2009). This case has been stayed following TIBC's filing of a petition under Chapter 15 (Ancillary and Other Cross-Border Cases) of Title 11 (Bankruptcy) of the USC. Chapter 15 provides for USA recognition of insolvency or reorganization legal proceedings in other countries.  When that recognition is given then all legal proceedings in the USA are stopped pending the outcome of the foreign case.

As a foreword, there's no substitute for reading the original documents. So I recommend that you go to the NY Supreme Court website. Use the above Case Index Number to search for the case records. Note there are two cases with this Case Index Number. One in Nassau County and one in New York County. The latter is the TIBC case. Click on this one. On the next page look for the button for e-filed documents. It appears in the lower right hand. This earlier post has some instructions on how to navigate the NYSC website.

Here's a summary:

1. On 5 May Mashreq and TIBC entered into a split value FX deal. On 5 May Mashreq was to pay US$75 million to TIBC's account at HSBC NY. On 11 May TIBC would pay Mashreq SAR282.150 million to Mashreq's account with the National Commercial Bank Saudi Arabia. 
2. You will notice this is the exact same FX rate (3.762) that Mashreq applied in its transaction with AHAB. 
3. Mashreq made its payment. TIBC did not. 
4. On 11 May (from the documents in Exhibit B (Document 4-2), TIBC tried to transfer its remaining balance at Mashreq NY US$6.15 million to its account at Bank of America New York City. Mashreq canceled the transfer and offset that amount against the US$75 million. 
5. Thus, its claim is now US$68.85 million.
   

Looking at the other exhibits, specifically F and G (Documents 4-6 and 4-7), account information supplied respectively by HSBC New York and BofA New York on TIBC's accounts with them, we see that:

1. The US$75million received from Mashreq on 5 May 2009 was transferred to TIBC's account at BofA on 6 May. 
2. After various debits and credits during the month, at the end of the month TIBC had some US$57 million in its automatic investment account at BofA. An auto investment account is an account linked to the main clearing account. Each day after all transactions have been processed, the bank automatically debits the clearing account (above some agreed minimum balance to be retained and in agreed multiples) and transfers the funds to an interest bearing overnight deposit account. Each morning the funds are returned to the clearing account so that the bank can use them for its payments. 
3. At the end of May, TIBC had an approximate US$2.35 million credit balance at HSBC New York. This resulted from a credit of US$8.97 million on 20 May which partially covered a persistent overdraft of US$6.62 million in the account. Mashreq tried to seize the entire amount of the credit but HSBC had offset it against the OD. The parties agreed to recognize the Court ordered freeze on the US$2.35 million credit balance in Mashreq's favor and deal with the US$6.62 million later.  That is, whether HSBC had a right of offset against the OD on its books.
4. What precisely happened with these funds after the NY Supreme Court recognized the Bahrain legal proceedings under Chapter 15 is not clear to me.  Are the funds still in New York? Are they frozen in favor of Mashreq? Or frozen in favor of all creditors of TIBC?
   

Exhibit A (Document 4-1) provides a list of FX transactions undertaken between Mashreq and TIBC from January 2009 through 5 May 2009. 

1. There are 21. 
2. Only one was not a split value transaction. 
3. The countervalue (Saudi Riyal) amounts are not shown in this list so it's not possible to determine what the interest rates were on the loans that Mashreq was granting TIBC through this mechanism.

 
 

Saudi Arabia: Value of AlSanea Group Debt Surges 67% to 200%

Beatrice and Benedict Discuss the Value Surge

1 February Thompson Reuters reported that following recent reported efforts by the KSA Government to “step up its efforts” to resolve the Ahmad Hamad Al Gosaibi/Maan al Sanea USD 22 billion or so debt dispute: 

“In a sign that some creditors are now more optimistic there will be a positive outcome to the debt dispute, Saad Group’s debt has been trading up at 3 to 5 cents on the dollar in recent weeks, compared to 1 to 3 cents previously, bankers say.”

In percentage terms that's quite a movement.  Not so much in absolute amounts.

AA would guess that these now more optimistic creditors are the same ones who made the original loans to AlAwal and TIBC.  Or would have if they had had the chance. 

For some of those earlier “great moments” in banking you can refer to the posts right here on SAM, e.g., AlAhli Bank Kuwait letters of credit, Mashreq Bank’s split value FX deals, and many more.  Here. Or here.  Name lending combined with what some might rightly consider unsound banking practices.  Talk about compounding errors!

Those less charitable than AA might also make a comment about the extent of the “step up” by the KSA Government of its efforts.  After all, it’s only been a scant 8 years 10 months. 

No surprise that when there’s good news, there’s always some naysayer like AA who refuses to acknowledge it or see the upside potential.  Saudi investment banking fee riches is yet another example. 

“But some investors remain skeptical. A hedge fund trader who had been considering buying Saudi debt described the attempts by Saad’s advisers to resolve the issue with creditors as a “dog and pony show” and said “very little” work had been done to reach a settlement since November." 

Note that the anonymous hedge fund trader quoted above would be purchasing the paper at a deep discount.  Unlike the original lenders who have been well and truly skinned, he could still make a profit even if final settlement were at a 8% recovery level.  Yet, he still doesn’t find it attractive. 

Why is that?

As AHAB/AlSanea and REDEC have well demonstrated, generally KSA prefers (in the technical legal sense of a preference) domestic over foreign lenders. SAMA take good care of their banks. Foreign banks not so much. 

If that weren’t enough, the Saudi courts and legal system generate “uncertain” outcomes (euphemism of this post).  Hapless foreign creditors are more likely to get “shaken down” than to get a “fair shake”.  Or is that shaykh?  To be fair KSA is not alone in the region.  One need  look no further than Dana Gas in the UAE.

Deutsche Bank v The International Banking Corporation

This post reviews documents submitted in the action commenced by Deutsche Bank against The International Banking Corporation in the Supreme Court of New York (Case Index # 601471/2009). This case has been stayed following TIBC's filing of a petition under Chapter 15 of Title 11. Chapter 15 provides for USA recognition of insolvency or reorganization legal proceedings in other countries.  When that recognition is given then all legal proceedings in the USA are stopped pending the outcome of the foreign case.

As before I recommend that you review the documents yourselves. You can do this by going to the NY Supreme Court website and using the above Case Index Number to search. As you progress from page to page, look for the button for e-filed documents. This earlier post has some instructions on how to navigate the NYSC website.

While this case has been stayed, it does provide a bit of additional information, though this is more just on the existence of the debt.

Here are DB's allegations:

1. On 6 April 2009, DB and TIBC entered into two equal forward US$/Sterling foreign exchange transactions.  DB was obligated to pay TIBC US$59,762,440 and TIBC to pay DB Sterling 40,000,000 value 8 May 2009. 
2. These were not "split" value date transactions. Both parties were to settle on the same day. So there is nothing unusual. These appear to be "garden variety" forwards. 
3. DB delivered on its side of the transaction by paying the funds to TIBC's account at HSBC New York. 
4. TIBC did not pay the Sterling DB.
   

DB is claiming a total of US$74,232,440. 

1. This is equal to the US$ side of the defaulted FX forward plus termination fees estimated at US$14,470,000. 
2. There isn't a detailed explanation as to how this latter amount was calculated. I presume it refers to DB's cost of closing out other forward FX transactions with TIBC and represents the difference between the contractual rate with TIBC and the market rate at closeout. 
3. Clearly, since TIBC has defaulted on the two 8 May settlements, DB has no desire to make additional payments since it believes (and probably rightly so) that TIBC would not honor its side of these transactions. 
4. The dealing relationship between the two banks is documented by an ISDA Master Agreement which gives either party the right to terminate any outstanding deals if the other to the agreement fails to perform. The Master Agreement also provides that the defaulting party must pay the "break" or "replacement" costs of outstanding deals which the other party cancels as a result of the default as well as any legal costs related to enforcement of the MA.
   

There's not a lot more to note here.

Gulf Finance House - Capital Reorganization and Raising - A Look "Behind the Curtain"

"Pay No Attention to the Man Behind the Curtain"

GFH published the agenda for its shareholders' general meeting on the capital reorganization/raising to be held 31 October.  So far only in Arabic on the DFM and on the KSE (copy below so you can follow along).  Strangely not yet on the BSE.

As the picture above suggests, by looking behind curtain we can get a real understanding of what's going on.

In brief the key points are:

1. The capital reorganization and US$500 murabaha are being structured to make them as attractive as possible to new investors.  That means that existing shareholders are being substantially diluted through a variety of clever means - which might not be apparent to most readers of the agenda for the shareholders' meeting. 
2. A share swap transaction between Mr. Janahi and GFH which seems designed to strengthen GFH's creditworthiness as well as provide some much needed "relief" on the CAR both in terms of risk weighted assets and potentially equity.

First, let's look at what's immediately visible:  the agenda for the shareholders meeting.   Shareholders are being asked to:

1. Approve a share swap between GFH and its Chairman/Executive CEO, Mr. Esam Janahi.  In return for his 104,923,734 shares in Khaleeji Commercial Bank ("KHCB"), GFH will give him 100% of its shares in AlAreen Company for Leisure and Tourism (whose main asset is the Lost Paradise of Dilmun Water Park in Bahrain) plus US$3 million.  The latter either in cash or Treasury Shares of GFH. 
2. Reduce the number of GFH's issued shares from 1,896,332,565 to 474,083,141 in a reverse 4:1 share split.
3. Reduce the paid in capital from US$625,789,746.45 to US$142,224,942.375.  A difference of US$483,564,804.075. 
4. Reduce the par value of shares to US$0.3075 from US$1.32.
5. Approve the issuance of up to US$500 million in a privately placed convertible murabaha through a special purpose company set up by the bank or established at its request.  (That is, the SPV will lend to GFH.  It will obtain its funding from various investors.)
6. The profit rate ("interest rate") on the murabaha to be the "market rate" according to the rate and formula established by the Board of Directors shortly before issuance.  Such profit rate to be payable in cash or additional GFH shares.
7. The conversion price to be between US$0.31 and US$0.40 per share - with the rate of discount not less than 20% to 40% of the market price of the shares - but not below the nominal share price.  The conversion price to be set by the Board shortly before issuance.
8. A tenor of 3.5 years.
9. Conversion at investors' option with right of Board to offer an early conversion "incentive" according to conditions the Board will set.  Note that means that the murabaha does not count as equity for either regulatory (CAR) or accounting purposes until it is converted.  For the latter, only the embedded equity option is counted as equity under IFRS.
10. Waiver of pre-emptive right of shareholders to new equity.
11. Authorization for Board or whoever it appoints to take necessary legal steps to implement and for Chairman or whoever he appoints to sign the necessary legal documents.
12. Conversion of GFH's share register to electronic form according to the rules of the Central Bank of Bahrain and the BSE.

Now a look behind the curtain via some hopefully informed analysis:

A.  Share Swap - KHCB for GFH

1. GFH gets several benefits from this transaction.
2. Immediate strengthening of GFH's creditstanding.  KHCB is a better asset than the Water Park, which is why the West LB syndicate asked for the former.  Probably better earnings and better future.  The Water Park like the Riffa Golf Course, no doubt, looked like a very "wise" idea on paper.  In the real world, it's probably not.
3. Regulatory relief on the CAR - a matter of great importance to GFH who sit right on the edge.  The first way this comes is by moving this "puppy" (the water park, which is risk weighted in the GFH's CAR calculation) to someone else's kennel (balance sheet).  In return GFH gets KHCB, increasing ts holding from 36.99% to 46.99%.  Currently, GFH partially consolidates  KHBC, and, thus,  it doesn't have to worry for CAR purposes about fluctuations in KHCB's share price - which has dropped by roughly 50% since last year this time.  Since KHCB's CAR is roughly 31% as at 30 June 2010, the impact on GFH's Risk Weighted Assets and thus its CAR should be positive.
4. As you'll notice, the US$3 million owed to Mr. Janahi can be paid in cash or GFH shares.  So there's a potential boost to equity if the latter can be used to settle this amount.  Treasury Shares are deducted from Shareholders' Equity at their cost. What this means is that if GFH gets more than zero in proceeds from the sale or conversion of Treasury Shares, the amount of its Shareholders' Equity will go up by the amount of the proceeds received.  This happened in 2Q10 where GFH sold US$29.1 million (original cost) of Treasury Shares for US$7.6 million and recognized a US$7.6 million consequent increase in Shareholders' Equity.  While admittedly a small card in the scheme of things, this could be just the thing that helps GFH keeps its head about the 12% threshold in a close situation.   As I suspect the 2Q10 Treasury Share sale was.
5. And, to round things out, a footnote on KHCB.  Without qualifying my opinion about the  credit benefit of acquiring KHCB, I call your attention to Note 3.4 in KHCB's Basel II Pillar 3 Disclosures as of 30 June 2010, which shows that some 24% of its Islamic Financing Assets are past due.  According to that information, some 42% of the past dues (BD47,385 - which is the total amount of the past due loans not just the past due installments which  are BD10,487) are up to 30 days late.  Proceeding cumulatively, 51% up to 60 days, and 72% up to 90 days.  According to KHCB's risk classification system, some 59% of the past dues are rated Credit Grades 1-6.  Personally, I would have thought a past due loan  would automatically go on the "watch list" (Credit Grades 7-8) but then I don't have the details of KHCB's loan portfolio including collateral.  In any  case those concerned with KHCB should keep an eye on this area to see if there is deterioration or improvement in the future.

B.  Capital Reorganization

1. Under the Bahraini Commercial Companies Law of 2001, GFH is obliged to take action now that accumulated losses are 75% or more of paid in capital. Approved methods for rectifying this situation are:  (a) reducing paid in capital by an amount sufficient to offset the losses and/or using other equity reserves (share premium, statutory or voluntary reserves), (b) raising additional capital and (c) a combination of (a) and (b).  Generally, financial institutions use Method (c).  In some cases a bank might get away with merely offsetting the losses against existing capital - assuming its pre-reorganization CAR were robust.  GFH's is not so it must do both.
2. As you'll notice, GFH is not using its reserves.  Why? Very simply put:  the path it has chosen is designed to make the murabaha more attractive to investors.  Under GFH's plan, they will get more of the total shareholding of the Bank for each dollar they contribute.  
3. 1H10 financials  provide the details of the components of GFH's capital.   If GFH were to use its US$206 million share premium and US$85 million statutory reserve  (total US$291 million), it would only have to "use" US$192 million of paid-in-capital.  Thus, leaving original shareholders holding US$433 million in common equity instead of US$142 million. 
4. To take control, the new money would have to put in US$433 million plus $1.  Under GFH's reorganization plan it only needs to put in US$142 million plus $1. 
5. Similarly, if the new investors put in the full US$500 million, under GFH's plan they get 78% of the total equity.  If the reserves were used as outlined above, they would only get 54%.
6. Clearly, there is a conflict here.  Existing shareholders want to be diluted as little as possible.  New shareholders want the most value for their new dollar.  Sadly for the existing shareholders, including the even "wiser" ones who invested in late 2009, their money is already spent.  The new and presumably much wiser investors need to be persuaded to part with their money.  GFH has set  the reorganization and the terms of the murabaha to make it as easy as possible to get the money that it desperately needs.

C.  US$500 Million Murabaha

1. Use of an SPV as the lender can be quite a useful device in shielding the identity of the new lenders/shareholders, particularly if the SPV is not incorporated in Bahrain.  It will depend on how much transparency the CBB wants to demand here and how far it can push this Bank which has an important and powerful friend in Bahrain.
2. One would expect the market rate for unsecured GFH debt to be rather hefty.  And the value ascribed to the option on GFH shares much less so.  The Board will price "at market" - which will mean in effect what investors demand. 
3. The approval also provides for a discount from market price of between 20% to 40%.   This is where the reverse split comes to play.  There is nothing in the Bahrain CCL that requires this as part of the capital reorganization.  I suspect GFH is hoping that  the reverse split will work a bit of magic on their market price.  Over the past two weeks, GFH has traded at KD0.033 (roughly US$0.11) per share.  A 4:1 reverse split should bring the price to say US$0.44 per share - allowing the Board to discount the conversion price to say just a whisker over par to make the transaction even more attractive. 
4. "But wait there's more" as they say on the late night TV ads for the ShamWOW!  The Board is allowed to offer an incentive (terms unspecified in the approval) for an early exercise.  That allows an even greater discount to attract new investors.  So, if the conversion price is set at a whisker over par, can the Board issue shares below par through this device? 
5. You ask about the hapless existing shareholders?  Well, GFH already has their money and needs more.  So they are out of luck.

KSE announcement below.

[12:17:53]  ِ.اجتماع الجمعية العمومية العادية و غير العادية لبيت التمويل الخليجي
يعلن سوق الكويت للأوراق الماليه بأن بيت التمويل الخليجي أفاده بأنه
سوف يتم عقد جمعية عمومية عادية و غير عادية للبنك في الساعه 9 من
صباح يوم الاحد الموافق 31-10-2010 في فندق منتجع و قصر العرين
وقد طلب البنك ايقاف التداول على اسهمه في السوق اعتبارا من اليوم
الاحد الموافق 17-10-2010 وحتى اشعار اخر حيث حصل على موافقة ‏
مصرف البحرين المركزي على ذلك .‏
هذا وسوف يتم خلال الجمعية العمومية مناقشة ما يلي
أولا : جدول اعمال الجمعية العامة العادية
ِ1- المصادقة على محضر الاجتماع السابق .‏
ِ2- المصادقه على معاملة استبدال الاسهم بين بيت التمويل الخليجي و رئيس
مجلس ادارته السيد /عصام جناحي و التى سيتم بموجبها تحويل حصته في المصرف
الخليجي التجاري ش.م.ب بالكامل (104.923.734 سهم ) الى بيت التمويل الخليجي
مقابل الحصول على حصه البنك في شركة العرين للترفيه و السياحه ش.غ.خ و ‏
البالغه 100% (جنة دلمون المفقودة) بالاضافه الى مبلغ 3 ملايين دولار تدفع
اما نقدا و / او بواسطة اسهم خزانه بيت التمويل الخليجي .‏
ِ3- الموافقة على تغيير سجل مساهمي البنك من سجل عادي الى الكتروني ‏
وفقا لاحكام مصرف البحرين المركزي و سوق البحرين للأوراق الماليه .‏
ثانيا : جدول اعمال الجمعيه العامه الغير عاديه ‏
ِ1- المصادقه على محضر الاجتماع السابق .‏
ِ2- التباحث في والمصادقه على دمج الاسهم الصادرة لبيت التمويل الخليجي ‏
بمعدل 4:1 لينتج عن ذلك تخفيض عدد الاسهم الصادرة من 1.896.332.565 سهم
الى 474.083.141 سهم .‏
ِ3- التباحث في والمصادقه على تخفيض راس المال المدفوع من 625,789,746.45 ‏
دولار امريكي الى 142,224,942.375 دولار امريكي بسبب الخسائر المتراكمه ‏
ِ(سيقدم المدقق الخارجي السادة كي بي ام جي بيانا مستقلا يتعلق بتاييدهم لهذا
التخفيض ) .‏
ِ4- التباحث في والمصادقه على خفض القيمة الاسمية الجديدة للاسهم والتي ‏
ستبلغ 1.32 دولار امريكي بعد الدمج و تخفيض راس المال المدفوع المشار اليه
في البندين 2 و 3 من بنود جدول الاعمال الى 0.3075 دولار امريكي .‏
ِ5- التباحث والمصادقه على قيام بيت التمويل الخليجي من خلال اية شركة
غرض خاص يؤسسها البنك او تؤسس بناء على طلبه لاقتراض ما يصل ‏
الى 500,000,000 دولار امريكي من خلال مرابحة تمويليه قابلة للتحويل
الى اسهم بناء على البنود و الشروط التاليه :‏
ِ- معدل ارباح يحدد وفقا لسعرالسوق ووفقا للمعدل والصيغه المحددة من قبل مجلس
الادارة قبل وقت قصير من تاريخ السحب . يمكن دفع  هذا الربح نقدا او في صورة
اسهم عينية في بيت التمويل الخليجي .‏
ِ- سعر تحويل يتراوح من (0.31 دولار امريكي الى 0.40 دولار امريكي) ‏
ِ(بمعدل خصم لا يقل عن 20% الى 40% من القيمة السوقيه في اعقاب
الدمج بحيث لا تقل عن القيمة الاسمية للسهم) فيما سيتم تحديد السعر النهائي ‏
من قبل مجلس الادارة قبل فترة قصيره من تاريخ السحب .‏
ِ- مدة تصل الى ثلاثة سنوات و نصف .‏
ِ- غير مضمونه و لكن قابله للتحويل بمحض خيار المستثمر الى اسهم في بيت
التمويل الخليجي قبل انتهاء المدة ووفقا للشروط التى يحددها مجلس الادارة.‏
ِ- حافز التحويل المبكر لتشجيع المستثمرين على التحويل الى اسهم قبل
نهاية المدة وفقا للشروط التى يحددها مجلس الادارة .‏
ِ6- منح التنازل عن حق الاولوية الخاص بمساهمي بيت التمويل الخليجي ‏
فيما يتعلق باصدار اسهم عادية جديده سيتم اصدارها عند تحويل تمويل المرابحه
وفقا لبنود الفقرة 5 من جدول الاعمال .‏
ِ7- تخويل مجلس الادارة و/او من ينوب عنه للقيام بجميع الاجرءات الرسمية ‏
المطلوبه و الصحيحه لتفعيل تمويل المرابحه بما في ذلك دون حصر تحديد و/او
تعديل شروط المرابحه والمستندات الاخرى ذات العلاقه .‏
ِ8- تخويل رئيس مجلس الادارة او من ينوب عنه بالتوقيع على تعديل عقد
التأسيس و النظام الاساسي نيابة عن المساهمين امام كاتب العدل فيما يتعلق ‏
بالتغييرات في راس المال لتعكس ما تقدم .‏
علما بأنه في حالة عدم اكتمال النصاب القانوني لهذه الجمعية سيكون الاجتماع ‏
الثاني يوم الاحد الموافق7-11-2010 في نفس الزمان والمكان وفي هذه الحاله ‏
ستسري احكام الماده 57 من النظام الاساسي للبنك. وفي حالة عدم اكتمال النصاب
القانوني في الاجتماع الثاني ، سيتم عقد اجتماع ثالث يوم الاحد الموافق ‏
ِ14-نوفمبر-2010 في نفس المكان و ذلك بسريان احكام المادة 57 من النظام
الاساسي للبنك . ‏

Gulf Bank: How "Improved" Are Their Financials?

One of our newest readers  raised two interesting questions via our contact page:  

1. He's heard rumors that GB is engaged in restructuring of several large exposures and wondered if I had any insights.
2. Indirectly he asked about the seeming improvement in GB's financials.

Gulf Bank Loan Restructuring

I have no special insight into what's going on at GB.   Perhaps some of our regular readers/commenters - Laocowboy2, The Rageful Cynic, Advocatus, or anyone else out there - may.  If so, please post a comment.

In the interim some speculation. 

Banks restructure loans for a variety of reasons:

1. To agree a repayment schedule with a distressed borrower that provides a reasonable probability of repayment.  The rationale here is to avoid legal proceedings unless absolutely necessary as these generally result in "wastage" of the debtor's estate, particularly in those jurisdictions where creditors' rights are weak.
2. As a pre-emptive strike to keep a loan from falling into the NPL category. 
3. To surgically remove NPLs from the distressed column and transfer them to "restructured" and eventually "performing" loans.  This lowers the total of NPLs and improves the provisions/NPLs ratio.  At FYE09, GB's Specific Provisions covered 43% of NPLs versus 63% a year earlier.  Between FYE08 and FYE09, GB's NPLs increased 138% from KD482.5 million to KD1,148.6 million.  2009 Annual Report here.

The last two can be largely cosmetic - to "manage" problems or at least the appearance of problems.  

Certainly, GB has a sufficient stock of NPLs that it should be busily restructuring away for the substantive first reason mentioned above.  Whether it is engaged in any cosmetic restructuring is not known.

Gulf Bank's Financials - Improved or Not?

Many have noted that for 1H10, GB reported  KD2.1 million in net income versus a loss of KD7.5 million for 1H09.   That certainly looks like an improvement.  But is it?

Two factors were responsible for this apparent improvement:  an increase in the net interest margin of KD11.2 million and an increase of KD22.7 million increase in Operating Income (excluding interest).  Let's take a look at each of them to see where the improvement arises - and if it is due to improvement in the business or to other factors.

The improvement in the net interest margin can I think be explained by three factors.  

1. First, interest expense in 1H09 driven by the aftermath of GB declaring a KD359.5 million loss for FY2008.  If you look at FY2009, GB had total interest expense of some KD119.4 million for the year.  From the comparatives in the 1H10 report, we see that interest expense for the 1H09 was KD72.1 million - 60.4% of the full year total.   Once GB had successfully recapitalized itself, its cost of funds declined in 3Q and 4Q09.  So is the improvement here an improvement in market sentiment due to the raising of KD376 million in new equity? And not a fundamental improvement in the underlying business.
2. Second, pricing increases.  There was an interview with Michel Accad in which he mentioned that GB had repriced (upwards) its facilities.  For some reason, GB no longer breaks out interest income by LOB which would allow an approximation of the gross yield on its loan portfolio.  It stopped with its FYE2009 Annual Report.  Wonder why the change?  With this info we could attempt to quantify the impact of any pricing change between 1H09 and 1H10. to see if indeed  margins had improved.  Using that method for 1H09, we get a gross annualized yield of about 5.6%.  Using this method through 3Q09, the yield is about 5.4%.   If we use the same split between Commercial Banking and Treasury interest as in 2009 (83% as of 1H09 or 84%  for the first nine months of the year 2009) for 1H10,  the 1H10 yield on the loan portfolio is actually lower:  4.9% (1H09 interest split) or 5.0% (Full 3Q09 split).  But that may be an incorrect assumption.  Note to Regulator:  More transparency rather than less is highly desirable.  Note to GB:  Unless you've got something you'd like to hide disclosing this information would be very helpful. Final Note:  This analysis is not conclusive.  The missing step is to see what happened at other Kuwaiti banks'  gross yields to get an idea about the macro environment.
3. Third, as GB continues to aggressively provision for loans (some KD108.5 million so far this year) it reduces its funding cost.  One would expect that the NPLs were already on non accrual so that the provisioning would affect interest expense primarily. One might say that provisioning is inversely related to problems.  On that score, there really doesn't seem to be a fundamental improvement in  the business.

The improvement in Operating Income (excluding Net Interest Margin) is largely explained by "Realised Gains on Disposal of Available for Sale Investments" of KD22 million roughly KD18.2 million over 1H09's earnings for the same category.  A decrease in "Impairment Losses on AFS Investments" of 3.8 million accounts for the rest.

Some observations.

1. Without the AFS asset sale (not a core constituent of GB's commercial banking franchise but a Treasury activity), GB would have recorded an Income Statement loss of KD20 million for 1H10 as compared to the KD7.5 million loss it recorded for the comparable period in 2009.
2. But there's more.  Since GB had already recognized KD20 million of profit on these assets in its fair value reserve (Statement of Comprehensive Income), its Comprehensive Income  for 1H10 was  a KD18.5 million loss versus a KD11.4 million gain for 1H09.  Looking at the Balance Sheet, you'll notice that Shareholders Equity declined KD21 million between FYE09 and 1H10.   And that's the bottom line on financial health - growing equity.  If you're wondering, the extra bit (KD2,5 million) is movement in GB's Treasury Share Reserve.

On a segmental basis, GB's commercial banking division did not make a profit in 2008, 2009, or 1H10.  And I'd note that GB was unable to allocate KD246 million of its 2008 "expenses" to either segment.  Perhaps, they properly belonged as "management overhead"?  

So at this point taking all these factors into consideration, I'd suggest a pause before speaking about "improved" financials.  

There's still a way to go.  To determine when real progress has been made keep your eye focused on:

1. Comprehensive income, looking for a positive number and an increase in Shareholders' Equity from "income" from one period to the next.
2. NPLs and provisions, looking for both to decline.  For provision coverage ratios to increase.
3. Meaningfully positive results in GB's core commercial banking franchise.  As Michel Accad said in part in the 2009 Annual Report in discussing GB's strategy:  "We have redefined our Vision; we seek to dominate the local retail and commercial banking space ..." If commercial banking/retail banking is the key, then GB will be healthy when those businesses are healthy.  Today they're not.

AlGosaibi v Maan AlSanea - Fortis Bank versus ADIB - The Letter of Credit

See important additional information here on Bunge's role in transaction and ADIB's knowledge of the nature of the transaction.

As promised a look at the Letter of Credit ("L/C") issued by Awal Bank which Abu Dhabi Islamic Bank ("ADIB") advised and confirmed to Fortis Bank Netherlands.

The text of the L/C issued by ADIB through Fortis is Exhibit #2 to Document #24, the Declaration of Nuhaid Saliba dated 31 August 2009. Note Exhibit #1 is the text that Awal proposed to ADIB.  That of course is not the instrument on which Fortis relied and through which ADIB conveyed its irrevocable undertaking.  Exhibit #2 is the key document as ADIB is its author.

And just to be complete, as you'll recall, ADIB is asserting fraud as the basis for voiding its obligation but not fraudulent documents or fraudulent shipment or non shipment.  Most jurisdictions have held that if the documents comply with the terms of the L/C then the bank is obligated to pay.  The "fraud" defense is applicable only in very limited circumstances.  

These and other documents can be found at the NY Supreme Court Website http://iapps.courts.state.ny.us/webcivil/FCASMain  under Case # 601948/2009, 

Let's step through the details of the L/C.

1. Issue Date: 16 June 2008.
2. Expiry Date:  14 July 2008
3. Applicable Rules:  UCPURR = Uniform Customs and Practice for Documentary Credits (#600 of 2007) and Uniform Rules for Bank-to-Bank Reimbursement under Documentary Credits (#725 of 2007).  The former sets forth the rules for the handling of L/Cs.  The latter the rules for banks to reimburse or pay one another   These are pretty much the standard governing principles for commercial letters of credit (aka "documentary credits").
4. Issuing Bank:  Awal Bank BSC Bahrain
5. Applicant - AlGosaibi Trading Services Hamilton Bermuda
6. Beneficiary - Bunge SA Switzerland
7. Currency/Amount:  US$39.999,996.52
8. Payment:  360 Days after acceptance of documents.
9. Port Loading:  Any port in Brazil.
10. Final Destination: Any port in Taiwan and/or Spain.
11. Latest Date of Shipment:  30 June 2008.
12. Goods Description:  (a) 52,686.31 MTS of Brazilian soybeans, packing in bulk at US$564.90 Per MT CFR Taiwan (b) 30,000.00 MTS of Brazilian maize SLM packing in bulk at US$341.25 per MT CFR Spain.  (Note: CFR = Cost and Freight)
13. Documents Required:  (a) One copy of commercial invoice.  (b) One photocopy of the bill of lading. (c) One copy of beneficiary's certificate stating that the copies of shipping documents provided are true and correct copies of the originals.  That the original bills of lading relating to the shipment should be sent to the Notify Party stated in the B/Ls or to the agent at destination and that the goods described should be discharged at the port state in the B/Ls.

Additional Conditions:

1. Third party documents except drafts and invoices acceptable.
2. Documents showing one or more third party (ies) as shipper and/or exporter are acceptable.
3. Fax or photocopy of documents are acceptable.  Documents issued before LC issuance (including B/L) are acceptable.
4. Documents acceptable inspite of any and all discrepancies with exception that invoice value drawn may not exceed the maximum letter of credit value and the letter of credit may not be expired.
5. Typing mistakes do not constitute a discrepancies.
6. Late presentation of documents is accepted on the condition that documents are presented within LC validity.
7. Bill of lading presenting a greater quantity/amount than shown on invoice is acceptable.
8. Documents shall be acceptable as presented.
9. Abu Dhabi Islamic Bank Abu Dhabi UAE is authorise to confirm this L/C and advise it to Fortis Bank Rotterdam.
10. Fortis Bank Rotterdam is authorised to confirm this L/C at the request and for the account of the beneficiary.  The confirmation of the first advising bank, that is Abu Dhabi Islamic Bank, Abu Dhabi UAE covers the obligation of the issuing bank, that is Awal Bank BSC, Manama and the confirmation of the Fortis Bank (Nederland) NV Rotterdam only covers the obligations of the first advising bank, Abu Dhabi Islamic Bank, Abu Dhabi UAE.
11. Charges:  ADIB's confirmation charge (a cool US$500,000) for Awal.  Fortis' charge (not specified here) for Bunge.

Now to the tafsir.

First, as is pretty clear from the text of the L/C this is not a typical documentary letter of credit.  It is closer to a standby letter of credit - which you can think of as a guarantee of payment.

1. At no time do any of the banks involved have an original bill of lading in their possession.  An original bill of lading is generally required by a shipping company to release goods it has shipped.    Having the B/L provides a measure of collateral security, if the applicant does not pay.  Now in a transaction in which the bank is giving its obligation to pay the beneficiary in the future (in this case 360 days after it accepts the documents) having the B/L only provides collateral comfort for a short period while it is at risk for the applicant or issuing bank's failure to pay.
2. In Additional Conditions #4, the issuing bank has explicitly waived all and any discrepancies in the documents except for the amount drawn under the credit and presentation within the L/C validity.  That means any other condition.  Hardly the stance that a party concerned with the underlying commercial transaction would take.  The power to refuse payment for discrepancies (in the documents) provides a way to enforce the terms of the contract on the seller. Giving this right up doesn't make a lot of commercial sense.
3. In Additional Conditions #7, B/Ls showing a larger quantity are acceptable.  Under UCP 600, for bulk commodities, a variation of +/- 5% is allowed (Article 30 (b)) unless prohibited.  5% of the amount shipped would be roughly US$2 million.  Would all of you out there who think that Bunge is going to ship another US$2 million worth of crops but not get paid for them, please raise your hands?  Didn't think I'd see any.  Of course there is no harm in this clause as it benefits the applicant.   But what is the commercial reason this would be included?  
4. A couple other conditions are worthy of mention.  As noted above, Additional Condition #1  allows third parties on the shipping documents.  Meaning the shipper need not be Bunge and the party receiving the goods need not be AlGosaibi.   Additional Condition #3 allows documents to be dated prior to the L/C issuance. Faxes of documents are acceptable.  Coupled with the earlier waiver of  all discrepancies except for payment amount and presentation within L/C validity, all this looks like setting up the conditions for document shopping.  That is, making it very very easy to find conforming documents from another trade transaction not involving the parties named in the L/C.  All one needs is access to documents and a photocopier.

Second, is there a commercial reason for such a structure?  Possibly but how likely?

1. The above conditions would be useful if both parties were engaged in rapid turnover trading.  Bunge strikes a deal with ATS at price X but finds another seller willing to sell at less than X.  Being able to substitute sellers/shippers allows Bunge to make an additional profit by buying the goods from this other party and delivering to ATS.  This condition allows ATS to sell the goods  to a third party, Buyer B, before it has taken possession by switching the delivery party.
2. But waiving the right to refuse to pay for any discrepancies could be problematical if ATS has on sold the goods as described to new Buyer B.   One would think Buyer B would have stipulated certain quantity and type of goods and reserve the right to refuse payments if these and other conditions that it required were not met.  Now perhaps Buyer B has waived these.  But what are the chances?  The goods are the commercial heart of the transaction.
3. On that score it might be more typical to see an inspection certificate (of the goods) particularly since a third party shipper might not be as reliable as Bunge. 
4. Now it's not unheard of that cargoes already at sea are sold (remember that documents issued prior to the L/C issuance date are acceptable).  But at that point, one should know the exact quantity of the goods and the identity of the parties.  And this could be incorporated into the L/C.  Now, I suppose the transaction could be taking place so quickly that speed was of the essence - a split second response required.  However, the documents submitted in the case indicate that ADIB cogitated for a while (though perhaps not long enough) before agreeing to the transaction.  And then it appears the transaction amount was increased after it had given an approval for a lower amount.  And so it had an opportunity like Proud Edward "tae think again".  Though to be fair, ADIB seems like Proud Edward to have thought again after "24 June" and not before.
5. Generally, transactions of this sort would be secured (from the intermediary buyer's perspective -- here ATS) by use of a transferable letter of credit (opened by the final buyer Buyer B in favor of ATS).  Or through a "back to back" L/C which is a particular favorite among many MENA banks though it is technically less sound from a protection perspective, including for the issuing/confirming banks of the second or "back to back" L/C.

Third, so what could be another reason for this structure?   To provide Awal and/or ATS financing.  But this requires a few bits more in the structure.

1. This L/C provides for a payment to Bunge 360 days from documentary acceptance.  At this point there has been no movement of funds.  Now it's not uncommon in such situations for the seller (Bunge in this case) to ask the confirming bank (Fortis) to make an immediate payment.  The bank would "buy" (discount) the acceptance for an amount less than its face value.  You can think of the difference as interest.  This could get the money to Bunge, though strictly speaking that's not necessary to get funding to ATS/Awal.  
2. If you reflect on the typical "Islamic" "trade" financing described above, you'll see that the ADIB L/C is the equivalent of the purchase of the goods on deferred payment basis.
3. Getting the funds to Awal/ATS requires the other half of the "Islamic" "trade" financing structure: the offsetting transaction the sale of the goods for spot settlement.  Such as sale could be either back to Bunge.  Or to a third party.  This may be a reason why ADIB's lawyers are pushing for further disclosure by Fortis to see if they are involved in this critical leg.
4. Just to close the Bunge circle.  The usual "Islamic" "trade" finance transaction keeps the deal "all in the family" so it's not inconceivable that they might have been involved.  If Bunge were involved, one would presume that it discounted the Fortis payment to use as the purchase price back from ATS/Awal - of course with a suitable commission for its trouble.   Note:  This is hypothetical.  I have no knowledge of Bunge being involved in the second leg. This discussion provides an illustration of how the transaction may have been structured.  Not that it was so structured.
5. Presumably, ATS did not hang on to the commodities with the intent of selling a year later.  Equally, it's unlikely that ATS has a "factory" in which to process the goods.  So the likely disposition of the goods is a sale.  If the goods were sold on a spot basis, then ATS/Awal have a one year loan due when the Fortis acceptance "matures" - irrespective whether Fortis has or has not discounted that obligation.
6. It's well known out there that commodity companies and brokers (including the one named in the TIBC  BNPP / ADIB legal dispute) specialize in providing "trade documents" for "Islamic" "trade" transactions that are really disguised financings.  Because Shari'ah Boards have become a bit more alert, many of these parties have established special purpose subsidiaries with completely different names so the buyers and sellers appear to be unrelated parties.   And have made presentations to  banks who wish to engage in "Islamic" "trade" transactions (or loans if you'd prefer) on how they  can help.
7. How does this work?  The financing bank arranges to acquire goods from Company A (Let's call it Dewey Night Company).  It then sells them to the Buyer (borrower if you will) on a deferred payment basis (the tenor of the loan) at original cost plus a mark-up.  At the same time it offers to sell the goods spot for the Buyer (borrower) to another company (Let's call that one "Eagle" Trading Company).  Usually the Murabaha contract (for this is a Murabaha trade transaction not a loan!) specifies that the spot sale cannot be for less than the original cost. The helpful commodity firm or broker provides all the required documents for the two sales   The mark-up miraculously just happens to equate to the interest on the loan.  Proving that in some forms of "Islam" miracles are indeed common. The commodity company makes a fee for its role - just as the innkeeper makes a profit for renting you a room for a night.  Documents are available for the Shari'ah Board to review if it wants.  These on their face document a trade transaction.  It seems everyone is happy.  و الله اعلم
8. And if you'd like to place a deposit with a bank, you can do the reverse transaction.

Fourth, how does this transaction differ from a typical "Islamic" "trade" transaction?

1. The ultimate financing bank in the transaction is ADIB.  While it is true that it does not advance funds, it is ultimately on the hook if Awal does not pay.  Under its confirmation it is obligated to pay Fortis if Fortis claims within the validity of the L/C and complies with the miniscule conditions provided.
2. For this transaction it only requires half of the set of documents.  A bit less financial engineering.
3. More importantly what is in effect a guarantee or a standby L/C is treated as a commercial L/C with a lower capital charge under Basel II.  Thus, ADIB's risk adjusted ROE/ROA is higher.  And more importantly, its CAR is higher.

Fifth, how credible is ADIB's sudden charge that something was wrong with the transaction?  That there was potential for fraud.

1. First, to accept ADIB's contention, one has to begin by assuming that ADIB has a very limited understanding of letters of credit and UCP600.  Or that the L/C Department personnel assigned to this transaction were incompetent.
2. Second, one also has to assume that ADIB is rather new to structured transactions.  However, since AA has seen ADIB's "Islamic" "trade" documentation of various flavors, at least for AA accepting that is more than a "bit of a stretch".
3. Third, the documents submitted by lawyers in this case indicate what would appear to be scrutiny of the transaction by ADIB's credit department.  If this transaction "slipped by" and wasn't recognized as a "structured" transaction - a payment guarantee and not a trade transaction - then one has to draw some rather unfortunate conclusions about credit analysis and risk management at that bank.
4. Rather what seems to have happened is that ADIB decided for about 500,000 good reasons (the US$ equivalent of the confirmation commission it received from Awal) to go forward with a structured transaction.   One that had some CAR advantages.  
5. Now that Awal has hit the wall, in what sadly seems to be a tradition of some "Islamic" banks (paging TID in re BLOM)  it's looking for a legal way out. (Paging Abu Yusuf).  At least in this case, it doesn't appear they're resorting to spurious arguments regarding the Shari'ah.
6. Finally most of what is labeled "Islamic" "trade" finance  is structured with manufactured transactions   All the parties (save perhaps for the Shari'ah Boards) know that these transactions are structured.   That they are really money on money loans, dressed up in thaubs and ghutras to disguise the reality.  For ADIB to suddenly claim ignorance of this is well beyond the plausible. 

A bit later I'll post some more comments on this case.  In the interim, you can look at the NY Supreme Court website.  Documents #78 and #79 contain letters by the two sides recapping the main points of their arguments.

Board of Saudi Zain Proposes Capital Reorganization for Shareholder Vote

Saudi Zain announced on the Tadawwul (Saudi Stock Exchange) today 21 August a plan for a capital reorganisation to be put to a vote at an extraordinary general meeting of shareholders for their ratification subject to the Company obtaining the prior approval of the Saudi Capital Markets Authority, the Ministry of Commerce and Industry and any other concerned body for the plan.

The reorg will take place in two steps:

1. In the first capital will be decreased.  While it's not stated, this is clearly to eliminated accumulated losses.
2. In the second a partial restoration of capital.

Here are the details. 

Capital Reduction 

1. Reduce paid in capital from SAR14,000,000,000 to SAR7,328,843,885.  This covers the accumulated losses of SAR6,671,561,150 as of 2Q10.  2Q10 financials:  Arabic version here and English version here.
2. There will be a reverse split with shareholders getting 1 share for approximately each 2.096 shares they currently own.  As a result, 667,156,115 shares will be canceled.
3. Not stated, but the balance represented by these shares SAR6,671,561,150 will be transferred to Accumulated Losses zeroing it out.

Capital Increase

1. Increase capital by SAR4,383,487,180 to to SAR11,711,926,030.
2. 438,348,718 new shares are to be issued.  There is no discussion of the offer price.  SZ's nominal (par) value is SAR10 per share.  If the shares are offered for a higher price (at a premium) then SZ will raise more than the SAR4.4 billion.  My guess is that there will be a strong incentive to issue the shares at par given the Company's financial condition and a desire to obtain as close to 100% take-up as possible.
3. In addition to the normal pro-rata allocation among shareholders, founding shareholders will be able to convert all or part of the debt they've extended the Company.  That amounts to SAR2,914,000,000.  Of that amount Zain Kuwait holds SAR1,859,397,000 (63.8%).  Zain Kuwait holds 25% of SZ's stock and 50% of the Founding Shareholders' portion.  The Saudi General Organisation for Retirement and the Public hold the remainder.
4. Kuwait Zain's response to the new share offer will give a clear indication of Zain's ability and willingness to continue as a shareholder.  There is perhaps an indication of their attitude in that the SAR2.2 billion 6 month supplier credit SZ obtained in June 2010 was guaranteed by one of the Founding Shareholders, presumably Zain Kuwait.

In a bit I'll post on Saudi Zain and the indications of a turnaround.

Dana Gas: Creditors Negotiating With Themselves?

The Chicago Way But Not Milton Friedman's Way

As reported by Bloomberg, DG’s tragically unfortunate creditors made DG an offer to restructure the approximate USD 700 million of outstanding sukuk with the following terms:

1. An upfront repayment of USD 300 million (par value) in principal.
2. A maturity extension of three years. 
3. Maintenance of the existing interest rates:  7% on the exchangeable sukuk and 9% on the ordinary sukuk. 
4. A request for a dual listing of DG shares on the London Stock Exchange. 
5. Maintenance of the existing conversion price at AED 0.75 for the exchangeable sukuk. 
6. Payment of interest amounts due last July and this October. 

DG rejected the offer and is said to be pursuing a litigation-based strategy. Bloomberg cited an unnamed party not authorized to speak on DG’s behalf.  The FT was more categorical that the company had rejected the offer.  FT article here. 

Some comments. 

AA wonders about the creditors’ negotiating strategy.  In Middle Eastern carpet stores, the seller’s initial price is a long way from the price at which he sells.  The prospective buyer needs to have a similar negotiating strategy.  Once the buyer begins negotiations and gives his first price, it's hard to go lower. 

But DG’s creditors face a more complicated situation that buying a rug from a reputable merchant.  DG has adopted an extreme position.  Its current “offer” to the creditors is (a) you owe us money or (b) in worst case we owe you no more than USD 60 million.   

That’s what Herb Cohen would describe as a “Soviet” negotiating strategy.   The appropriate response is not to make a typical counteroffer and then split the difference because the Soviet tactic moves the frame of reference way off market terms.  

Often the counterparty (the party not adopting the Soviet style tactic) proceeds as though it’s in a “normal” negotiation, replies with a counteroffer to the extreme offer, and winds up in effect negotiating with itself to its detriment. 

DG’s creditors need to be very careful not to embark on that path. 

They’ve made an offer (their first price in rug shop terms) from which they will most likely negotiate less favorable (to themselves) terms.  So what does that mean?  A five year tenor?  A USD 100 million principal payment?  An interest rate of 3%?  All of the above. 

A Jimmy Malone (pictured above) strategy seems to be more appropriate given DG’s negotiating strategy and its less than sterling behaviour.  When you’re negotiating with someone you don’t trust, the typical rules of negotiation go out the door.  There’s no “win-win” when the other party is trying to cheat you.  

One other bit of unsolicited advice for creditors: a single word “amortization”. 

No doubt some clever mind has stated that with a three year instead of a five year tenor the average life of the sukuk has been drastically reduced – 5 to 3 years.  But –a rather large but—a bullet is a bullet.  Payment is promised in one lump sum in the future. Creditors would be better off with recurring principal payments (amortization).  Money in the hand now is much more valuable than a promise of money in the future, particularly when the integrity/ethics of the party making the promise to pay are doubtful. 

AA was particularly intrigued by the creditors’ request for a dual listing on the LSE. 

Listing this mutt on the LSE is not going to turn it into a purebred. Or magically create investor demand.  The dumb money is already present.  

Is this an attempt to try and force better corporate governance on DG or somehow bind them closer to English law?   Corporate governance is fundamentally a people issue.  Listing on the LSE doesn’t by itself change that.   Unless DG reincorporates, it is a Sharjah company with all the drawbacks of UAE law. 

Is this an attempt to scare shareholders that the creditors intend to convert the sukuk and take some or all of this “gem” of an investment from their hands, thus, prompting shareholders to put pressure on DG’s board to be more accommodative?  Not bloody likely, the shareholders are a disparate group.  From ADX trading statistics, they appear to be primarily retail investors who no doubt are right now calculating how they will spend their share of the USD 1 billion they imagine will soon be in DG’s hands. The major shareholder is a related party no doubt on board with DG’s “clever socks” strategy. 

To AA’s surprise Goldmine and Blackrock are apparently holders of DG paper.  Unless they bought their stakes at a deep discount and have a reasonable prospect of turning a profit with a fractional return of nominal principal, they should not be DG investors. 

Side note: If they purchased their stakes at a discount, then “whole” dollar creditors should understand there is a fundamental conflict between their own full price interests and  creditors whose entry price is much less. 

In defense of Goldmine and Blackrock, you might be inclined to remind AA about the role of risky securities in a well-diversified portfolio. 

AA is well-schooled in how such a portfolio can tolerate some risky securities.  DG paper certainly falls into that category.  The promised return is tempting, particularly in the current low rate environment.  But there are some risks that one shouldn’t take.  Or if one mistakenly takes them, one should exit.  Despite widespread belief to the contrary, finance theory doesn’t magically protect one from unwise investment decisions. 

Some of the "red" flags on this paper.

1. This company defaulted five years ago. 
2. Since then, its performance (ROE and ROA) and cash generation are dismal -- clear signs of likely future inability to repay. 
3. The sukuk is structured as a bullet which is not appropriate for an issuer like DG nor one that operates in squirrely markets (that’s a technical finance term). 
4. If that weren’t enough, DG is based in a country whose fine legal system motivated the government of one of its constituent emirates to set up an offshore regime, including offshore laws and an offshore court system.  It doesn’t take a law degree to figure out that legal protections for creditors are uncertain (you knew I’d slip a euphemism in somewhere) in DG’s home “court”. 
5. Exacerbating that factor, the deal is highly structured with cross-jurisdictional legal issues abounding.  The fundamental (“Islamic”) structure is not well tested in courts.  Courts in more “certain” legal jurisdictions are unfamiliar with Shari’ah and likely to defer to local courts, undermining to some extent the benefits cross-jurisdictional legal structuring was designed to confer. 

Just one or two of these factors should disqualify this paper. But all of these? One can surely find other high yield securities with less risk baggage.   

One further point for those who read the FT article cited above.  To get more insight into the KRG settlement take a look at my earlier post. And don't miss the posts in reply.  Despite a comment in the FT article about the settlement removing DG’s “ability to pay” defense, cash is not about to rain down on DG.    

Burgan Bank 2Q10 Financials: A Closer Look

Let's take a closer look at Burgan's 2Q10 financials.  Press release here.

Income Statement

Net interest income for 1H10 at KD50 million was in line with 1H09's 48.6 million – no doubt some of the increase resulting from the consolidation of Tunis International Bank ("TIB") and Bank of Baghdad ("BoB") which BB acquired from United Gulf Bank, a related party (common KIPCO ownership). Earlier post on the asset sale here.

A similar case with Fees and Commissions: KD16.5 million in 1H10 versus KD15.9 million in 1H09.

Other Income (FX, Investment Income, Share in Associates Results, Dividends and Other) was KD17.1 million versus KD14.6 the half year earlier. As Burgan states in Note 5 referring to the acquisition of banks from UGB, "The business combination was achieved in stages. The Bank re-measured its previously held equity interest in BoB and TIB at the acquisition-date fair value and recognized a resulting gain of KD10,909 thousand , net of acquisition related expenses of KD43 thousand in the interim condensed income statement as part of "Net investment income" (note 10)."  Proving I guess, if one needed any proof, of just how wise and profitable these acquisitions were and are!

Operating Profit before provisions was KD53.8 million versus KD55.9 in 1H09.

Provisions were KD51.1 million versus KD27.8 million in 2009. 

As per Note 13, Provision for Impairment of Loans and Advances is split among BB's three LOBs as follows: 

1. Banking KD53.4 million charge 
2. Treasury and Investment Banking KD6.8 million "recovery" and 
3. International KD4.6 million charge.
   

As per BB's press release, with its specific provisions plus KD33 million of unallocated general provision, its Non Performing Loans are covered at 58%. 

Let's go back to FYE 2009 financials. At that point as per Note 5: 

1. Non Performing Loans totaled KD236.7 million.
2. KD5 million of which are "pre 1990 invasion" loans fully provided for. 
3. Specific Provisions were KD98.4 million.
4. General Provisions 80.8 million.
   

Since then it has added KD51.1 million in Specific Provisions. The language of the press release is not clear. It states that "In addition KD33 million in unallocated precautionary general provisions is available in the bank's books which resulted in a 58% provision coverage ratio". 

Either this means that only KD33 million of the KD80.8 million in General Provisions have been allocated to cover NPLs. Or that during 1H10, BB transferred some KD47.8 million in General Provisions to Specific Provisions. 

Because Burgan's regulator doesn't think this sort of information is useful it has not mandated that it be disclosed. Nor has it required the movement in the Provisions Account to be disclosed (write offs, FX movements, recoveries, etc). Apparently the KIPCO Group's legendary Shafafiyah Program doesn't call for this disclosure. Or perhaps Burgan may not deviate from the Central Bank's mandated form. Whatever the case, the lack of information affects the precision of the calculation below.

If we assume that only KD33 million of General Provisions are being counted for the 58% ratio, then Burgan's non performing loans are roughly KD314.7 million =(KD98.4 +KD51.1 +KD33)/.58. If on the other hand, Burgan made the KD47.8 million transfer from General to Specific, then NPLs are KD397.1 million. = (KD98.4 +KD47.8 +KD51.1 +KD33)/.58.

Those equate respectively to 13.3% and 16.6% of the gross Loans and Advances Portfolio (L&A as stated on the balance sheet plus the Provisions). One can assume that the 1H10 capital increase was motivated primarily by a need to shore up the Bank's defenses against troubled credits. And so these sort of levels make sense.

Balance Sheet

I didn't see any significant changes on the face of the balance sheet.

Looking at Note 3, Burgan has redirected some of its Cash and Banks from current accounts to time accounts (due within 30 days). At 1H09, the ratio of current deposits to total Cash and Banks was roughly 40%, falling to 35% at FYE09, and 19.7% at 1H10. No doubt motivated by Burgan'sTreasury's desire to wring a few more bps into interest income.

From Note 14, we see that KD168.8 million of Burgan's liquidity  (=Cash and Banks)  -- roughly 32.5% -- is placed with related parties. Sadly, it seems that United Gulf Bank has not bothered to publish the notes to either its 1Q10 or 2Q10 interim financials on its website. Without related party disclosures, it's not possible to say how much of UGB's US$401.9 million in interbanks taken at 1H10 were from related parties like Burgan. However, we do have data for FYE09 when US$333.2 (72.7%) of UGB's US$458.3 million in Due to Banks was from "Associates" (in which category Burgan should fall, though it may not be responsible for all of UGB's related party deposits. It is a big Family after all!). At FYE09 (Note 18), Burgan has KD172 million with Other Related Parties (US$602 million).

Finally from Note 13, we see that Burgan allocates its assets: KD1.1 billion to Banking KD1.4 billion to Treasury and Investment Banking and KD1.0 billion to International.

Cashflow

Operating Profit before Changes in Operating Assets and Liabilities is pretty much the same: KD46.8 million in 1H10 versus KD54.9 million the comparable period in 2009. 

Change in Operating Assets and Liabilities are a net source of funds of KD207 million in 2010 versus a rough balance in 2009 – a source of KD0.8 million. 

A substantial portion of the funds were used to acquire new subsidiaries – some KD92.7 million – which as Note 5 discloses were those involving UGB. 

During 1H10, Burgan paid down some KD72.8 million in Other Borrowed Funds, including KD48.1 million in a subordinated debt from a related party after obtaining "the approval from the regulatory authorities". (Note 14). The Bank also raised KD100.8 million in capital during the period.

After considering all the various items in cashflow, Burgan's cash decline is KD83.3  million (almost spot on equal to the payment to UGB for the acquisitions and the repayment of the related party subordinated loan).

Since AA is not only a strong believer in but also a strong supporter of Family Values, I am positive this is just a coincidence.