IFC/World Bank Group "Doing Business in the Arab World 2010"

Today the IFC/World Bank Group officially released its annual report on regulations in the Arab World  "Doing Business in the Arab World -2010".  Those watching the GCC press have been aware of the report for a couple of days as it was discussed in several of the UAE papers under headlines calling for reforms of UAE insolvency law.  Here's one link.

This report is part of a larger project undertaken by the World Bank Group to measure regulations affecting the 10 stages in the life of a company - from birth (registration) to death (closure) in 183 countries.   The goal is not only descriptive.  It is as well prescriptive - to encourage reform.

Like many such efforts, it reduces very complex matters to a single number for ease of comparison.  The report ranks countries not only at a macro level (overall ease of doing business) but  at various sub levels (the ten regulations, e.g. starting a business, dealing with construction permits, etc).

Because the ease of doing business is not directly observable or measurable like the amount of rainfall during a year or average daily temperature, one measures it indirectly by using proxy variables.  The WBG has chosen 10 regulatory issues mentioned above.  These are also measured for ease of accomplishment.  That leads to the choice of a second level of proxies.  One then has to specify the relationship and relative weights of the proxy variables (write the equation).  Once the equation is specified, one needs data.

This is a difficult process.  How does one choose the proxies - both at the first and the second levels?  How does one determine the equation and the relative weights of the proxies?  How does one ensure that data across 183 countries is consistent - both in terms of definition and standards for reporting?  For example, if the measure is days to get a license  for a new business, how does the local MOIC  track dates?  From the date of a properly completed application?  But what if there are numerous rejections of an application as incomplete?  Are  those days counted?  Does the clock start ticking from the date the applicant drops off the completed application?  Or the date the MOIC enters it into its records?  What is the quality of the record keeping?  I posted a comment to a blog about Yemen LNG with articles raising doubts about the GDP calculation for the USA and Japan, two countries whose statistical accuracy might be assumed above reproach.

All in all a daunting task.  Because it is difficult does not mean it should not be done.  Because it involves interpretation (there is no single right answer) does not mean it should not be attempted.

Efforts like this are to be applauded and encouraged. That being said, the issues involved should not be overlooked.  The results should be recognized for what they are:  interpretations not facts.

And that gets to perhaps the central issue here:  the report is designed as prescriptive.   A country can reform by using the WB specified equation.  But what if it is mis-specified either with the wrong proxies or the wrong weights?  Reform will be mis-directed. 

There is another issue.  I am a bit uneasy about  the  individual numerical rankings.  Singapore is rated #1 for ease of doing business.  Hong Kong #3.  As a businessman, would I really notice a perceptible difference between the two in the running of my business?  If I could, would it really matter?

I think that such studies should be directional rather than locational.

Instead of individual rankings, determined with apparent Cartesian precision,  countries should be grouped into bands chosen where there is a very perceptible break in "ease".  The difference between Hong Kong and Singapore may be too minor to notice.  That between Singapore and Yemen is probably not. 

Anyways to the report, first the overall rankings for the GCC states for ease of doing business:

(Note:  The report rates 183 countries).

1. Saudi Arabia  (#13 in World Rating) 
2. Bahrain           (#20)
3. UAE               (#33)
   
4. Qatar              (#39)
   
5. Kuwait           (#61)
   
6. Oman              (#65)

Drilling a little bit further into the report, here are the rankings for investor protection with world ratings again in parentheses:

1. Saudi Arabia   (# 16)
2. Kuwait            (# 27)
3. Bahrain           (# 57)
4. Oman /Qatar   (# 93)
5. UAE                (#119)

Had I been asked to come up with ratings based on personal experience, I would have a different order.  For the record, the rating is determined by equal weights of the following three index proxies: disclosure, director liability, ease of shareholder suits.

Rankings for contract enforcement:

(The report includes details on the average time to settlement and the average cost of enforcement - lawyer's fees, etc. - measured as a percentage of the claim.)

1. Qatar               (# 95) 
2. Oman               (#106)
3. Kuwait             (#113)
4. Bahrain            (#117)
5. UAE                 (#134)
6. Saudi Arabia    (#140)

This ranking is based on three equally weighted variables: number of legal steps, average number of days to a settlement and the cost of enforcement as a percentage of claim.  It seems to me that outcome of the case would be a very important measure. Legal procedures might be very simple (a few steps), get completed quickly (say 60 days), and cost relatively little as a percentage of the claim.  But,  if  the result is unjust,  how is the contract enforced?   That gets back to my comment about the difficulty of measuring abstract qualities.  How does one measure a just decision?  Clearly, the plaintiff and defendant are likely to have quite opposed views.

As one of my lawyer friends says the clearest commentary on the state of GCC legal systems is that both the DIFC and QFC use as a major selling point the fact that  their centers have their own imported law and judges separate from the local on-shore legal system.  That is hardly a ringing endorsement for local justice.  And it is coming from a governmental or quasi-governmental authority in the country!

One might well criticize local courts.  I know that I could easily recite a list of complaints and anecdotes.

That being said, I would not want to bring a lawsuit in Texas.  Texaco could testify more eloquently  (perhaps 10 billion times more!) than I could about the legal system in that state.  Or a bank  I know that tried to foreclose on an office building loan, only to have the judge dismiss their case on the grounds that under Texas law a lender may not take a debtor's primary residence.  Seems the borrower moved a bed into the building  the night before the trial and claimed it as his home!  

Headlines Say UAE Central Bank to Tighten Regulations - But the Real Story is Personal Loan Losses Loom

Under current CBUAE regulations a sub-standard loan is defined as one on which debt service is 180 days or more late.  This regulation dates to 1988.  Other countries in the Gulf have a 90 day time frame.  The latter is pretty much the international standard.

The National in Abu Dhabi is reporting that the CBUAE intends to tighten its requirement and bring UAE regulation in line with the 90 day standard. 

This report sounds rather ominous.

The immediate thought is that if these new rules are adopted, the amount of non performing loans will balloon.

But is that the case?

The article states that most UAE banks are using the more standard 90 day time frame.  A quick check of several banks' financial statements shows that to be the case.

What I think is more important in this article is some information about personal loans  that is tucked away in the middle of the article:  the estimate of a  potential 10% non performing rate.

One might quibble about the implication that credit bureaus (and quibble I will in a bit) are largely responsible for bad loans, but the ticking time bomb that personal loans represents is unmistakable.

Some signs of distress:

1. A group of Kuwaiti MPs is pushing for the government to buy Kuwaiti financial institutions' personal loan portfolios (Kuwaiti citizens' loans only) to relieve distress of the average Kuwaiti.  Estimates of the cost of doing this range from KD 2.2 billion to  KD 6.5 billion depending on which loans are included.  The appeals are usually accompanied by statements that the cost of living is higher than citizens' income and so borrowing is the  only way they have been able to make ends meet.  This AlQabas interview with Nasser AbdhulMuhsin AlMarri, Deputy Chairman and Managing Director of Noor Investment Kuwait, is one example.  See the first question.
   
2. Living beyond one's means through the use of debt is not uncommon.  In one country I'm familiar with, a lot of the locals I know at the junior level have debt service ratios over 70% of their monthly income - meaning that to make the minimum required payment each month, they should pay the lenders 70% of their salaries.
3. As I've noted in an earlier posting, the Central Bank of Bahrain issued a regulation to set a maximum that banks could lend consumers at 50% of gross monthly income because it was concerned citizens were getting in over their heads.
4. Cars in the Dubai airport parking lot. 
   

Some signs of lending practices that might make a sub-prime lender blush (though I'm told these folks are made of pretty stern stuff);

1. A local I knew was in over his head with credit cards.  With some help he negotiated revised payment terms and a lower interest rate.  Once this was done, one of the banks where he had been max-ed out and which had frozen his credit card wrote him a letter thanking him for clearing up his debt.  And now since he was a customer in good standing, they were not only re-instating his credit card but increasing the limit.  Yes, while his rescheduled debt sat in their work-out group's portfolio.  By the way this bank has won several awards in the GCC for banking excellence of one sort or another.  Marketing seems a natural category, though I think the awards were for something else.
   
2. I received a couple of SMS's from that very bank promising me that if I transferred my outstanding credit card balances from another bank to their fine institution not only would they happily accept my balances, they' also give me a credit line equal to 110% of those balances.  That way I could "afford" to spend a bit more.  Since my phone was registered in a company not a personal name, it seems fairly clear that this bank was happily blanketing the market with mass SMS mailings.  
3. One of my local friends advised me that rotation of creditors was a common strategy. Max-out at Bank A.  Go to Bank B to get a larger line.  Max-out at B. Go to Bank C.  Eventually one winds up back at Bank A and notes one's sterling credit.  Not only did I pay in you (Bank A) and Bank B in full, but look Bank C gives me  this  big a line.  I've got to be a really great credit.  To get me to move to your esteemed bank,  you'll just need to give me a bigger line.
   
4. I've seen outdoor billboards from one Shari'ah compliant lender offering to lend me and everyone else who passes by 95%  of the price of a new home.  Not much margin for error there if the price of one's new house drops just a bit.   To be fair, they no longer offer this level of financing.
5. There were ads from another retail bank offering to make a loan for a vacation with five year repayment terms. 

So now to the quibble.

Yes, a functioning credit bureau (with access to all borrower data) will make my job as a banker easier.

But, how much help do I need?  Do I need to be as smart as Gail Trimble to figure out:

1. Credit cards aren't used to purchase houses.  Or cars.  If they are, that's probably not a sign of good creditworthiness.  By and large they are being used for consumables.  If a prospective borrower already has a very high ratio of existing debt to income, that's also probably a sign that he or she is living beyond his or her means.
2. If this new customer is such wonderful business, how come my competitor is letting him slip away?  If the price of luring this customer to my bank is the simple act of increasing his/her credit line, whey doesn't his existing bank do this?  Am we really that much smarter than they are?  Really?  If this is such a great idea,  then why don't we do this with our existing customers?  After all, we do it with new customers about whom we have even less data.

By the way a tip of the hat to the folks at Emcredit  the Emirates credit bureau.

MECRA Regional Credit Bureau: Bahain, Oman, UAE and Pakistan

A significant development in improving the institutional architecture for banking in the region.

This will give banks a clearer picture of the exposure of their existing and potential customers.

Gulf Women's $40 Billion in Wealth - News or Marketing Campaign?

The local (GCC) press is abuzz with the story that women in the Gulf control US$40 billion in wealth.  Here and here.

And elsewhere, but you can Google that yourself.

However, since this was first reported in 2007, I guess we can draw the conclusion that the original 2007 article's statement that they have a conservative investment strategy of holding money market assets has been proven correct.  If they had invested in the market, they'd hold considerably less today.

Interesting how these news articles seem to be less about women's wealth than about the capacity of an investment firm to help them with it.

Global Forum VI For Fighting Corruption and Safeguarding Integrity - Doha Qatar

Doha is hosting the "Sixth Global Forum for Fighting Corruption and Safeguarding Integrity".

Fairly distinguished attendees and speakers.  A worthwhile and highly relevant topic.

Some press articles here and here.

And more background here.  It appears that speeches will be published at this site later.  QNA has already published one or two.

Yemen LNG US$2.8 Billion Financing in Yemen - How'd They Ever Pull That Off?

When you read my earlier post about the first LNG shipment from Yemen, did you wonder how the project was able to raise its financing?

Yemen LNG posed some difficult financing challenges:

1. Size:  US$ 5 billion dollars with a high percentage of foreign costs which can't be financed in local currency.   So quite sizable foreign currency loans are required.  Raising a loan 1% this amount would be a challenge.
   
2. Tenor:  A project like this requires long tenors.  To compound matters bankers aren't keen to even make short term loans in the country. 
   
3. Yemen:  Lots of problems - economic, political, social.  A weak country = a weak sovereign credit.  Not exactly a prime target for bankers.
   

Standard and Poor's, Moody's and Fitch do not bother to issue a credit rating for Yemen.  There really isn't any demand.   Other ratings agencies do.  But the ratings are not good.   Capital Intelligence assigns Yemen a "B" and the Economist Intelligence Unit "CCC".   Unlike the academic world, a  credit rating of "B" is not a passing grade.  Except perhaps in the sense that bankers usually  "pass" on the opportunities to extend credit to borrowers with that grade.

Putting aside the project finance structuring issues (upon which I'm sure you can imagine I could wax, if not eloquently, at least profusely), there are two answers to how the deal got done - both of which gladden the heart of flinty-eyed bankers:

1. Equity - To provide a cushion to lenders: project cashflow pays lenders first before it pays shareholders.   The more equity the less risky the project.   If you were a lender, which of two identical US$1 billion projects (except for equity) would you prefer to lend  to?  The one with  $500 million in equity?  Or the one with  $100 million?  But there's more to equity.  It's not just the quantum of equity provided up front but also the credit quality of the shareholders that comforts lenders.  Having parties with both a significant monetary interest in the project (something to protect) and the capacity ("deep pockets") to lend a helping hand if the project hits a rough spot is very good.   Securing this kind of quality shareholder is a common goal in project finance everywhere.  In Yemen it was, no doubt, even more important.  Both  to the commercial lenders and the export credit agencies ("ECAs") involved in the transaction.
   
2. Guarantees - There's nothing that makes a banker's life easier than someone else taking the difficult bits of risk.  In this case 100%.   Especially if the guarantors are major sovereigns  acting through their ECAs or a major MNC like Total. 

Yemen LNG reports that the project has 40% equity (US$2 billion) and 60% debt (roughly US$3 billion).

Let's look at the equity first.

Shareholders are:

1. Total France - 39.6% (International oil and gas major, active in the ME since 1924 and Yemen since 1987.  Other LNG projects in the GCC - Qatargas, Dolphin).
2. Hunt Oil USA - 17.2% (Founded by HL Hunt.  Ray Hunt supposedly is on a first name basis with the President of Yemen.  Active in the country since 1981.  Hunt Oil, that is, not Ali).
3. Korea "Inc" - 21.5%   (SK at 9.6%, Korea Gas at 6.0% and Hyundai at 5.9%)
4. Yemen Gas Company - 16.7%. (Yemeni Government company).
   
5. GASSP (Yemen) - 5% - Yemen's General Authority for Social Security and Pensions.

More details on these entities here.

The majority foreign ownership involving oil companies like Total and Hunt would give lenders  and ECAs comfort.  Why?  They have demonstrated technical competence with similar projects from discovery through successful commercial operation as well as marketing of the offtake -the project product, LNG.  If something goes wrong (and bankers should always worry about that), these shareholders should be able to fix the problem if indeed the problem can be fixed.

Kogas is a major buyer of LNG.  Having it as a shareholder, gives it incentive to continue to buy from the project.  If suddenly it needs less LNG, instead of canceling its contract with Yemen LNG, it could cancel its contract with another seller (unless of course it's a shareholder there as well).   In the case of a problem with another offtaker, Kogas might step up to buy more to protect its equity in this project.  (As an aside, the offtakers are:  Kogas at 31%. of planned project production.  Total 31%.  And Suez 38%.  Twenty year contracts with highly credit worthy parties -- another comfort to those holding project risk).

The other two Korean parties were involved in the construction.  By buying equity they have reinvested part of their profit into the company.  If the project fails, they lose all or part of their profit margin - an incentive for them to help to make the project work if it has problems.

The Yemen government agencies mean the government has a direct stake in the project's success.  It's not just in their country.  They're owners.

Turning to the project debt, US$2.8 billion was raised.

1. US$1.3 billion in senior limited recourse project finance facilities extended by a group of international banks but bearing comprehensive risk cover (both political and commercial). This  cover is being provided by the official export promotion programs of France (Coface for US$648 million), Japan (Nexi for US$80 million), Korea (KEXIM for US$160 million).  The lead banks involved are Bank of Tokyo Mitsubishi, BNP Paribas, Citigroup, ING, Royal Bank of Scotland, Societe Generale, Lloyds TSB, and SMBC (Japan).  They make  and administer loans to the project.  In the event of project non payment, they can call upon the ECAs to repay their loans.
   
2. US$240 million direct loan to the project from KEXIM (the Korean Government ECA).
3. US$120 million direct loan to Yemen LNG from JBIC (the Japanese ECA).
4. US$1.1 billion commercial facility guaranteed by Total France. Same banks as in #1 above.  I'll comment a bit later about an interesting feature of this guarantee.
   

It's clear that Total did the heavy lifting necessary to make the project a success:  contributing the majority of the equity and guaranteeing the US$1.1 billion loan.  

Most reviews of this transaction - at least the ones I have seen - don't  discuss the fact that Total has counterguarantees in its favor for roughly 32% of its US$1.1 billion guarantee from other equity partners in the deal.  One alternative would be for all the parties to give guarantees to the lenders:  Total for 68% of the amount and the other shareholders for 32%.

But that would pose some problems.  First, some of the shareholders are not acceptable to lenders for any amount or tenor.  That would mean a loan for less than US$1.1 billion (and remember the project needs US$1.1 billion not less).  Second, Total's credit rating is easily higher than the other shareholders.  It can get the best terms - the best interest rate and the longest tenor.

By giving its guarantee for 100% of the loan, Total substitutes its credit for its partners.   In effect Total is intermediating credit risk .  It accepts the relatively weaker credit risk of its partners (the 32% counterguarantee) so the lenders don't have to. If Total's guarantee is called by the lenders, it is obligated to pay whether or not the other shareholders honor their counterguarantee to it.

And one final comment.  The Yemen LNG financing won several awards in 2008 for "Deal of the Year".  Since bankers like to give themselves awards (and who doesn't),  there are a large variety of contests and awards, though as of yet I don't believe Donald Trump is hosting any of them.  Besides that bankers also devote their creative talents to designing titles for participants in a deal.  Having a fancy title and a good position on the deal "tombstone" (on the left at the top of the list of the banks is preferred in case you're wondering) is very important.  Some of the most intense discussions in a deal are not with the borrower or issuer but among the banks.  On one deal we contented one bank with the title "Technical Modeling Bank".

Trackback to previous related post.

Yemen LNG Makes First Shipment

A bit of good news for this beleaguered country - which is desperately in need of hard currency earnings, not to mention water, peace, progress .....

Most estimates are that over its 20 year or so life the Yemen LNG project will generate US$20 billion for Yemen.  The Yemeni Government's own "conservative projections" estimate US$30 to US$50 billion.

Much needed because oil exports, Yemen's current major source of FX revenues (roughly 90%),  are rapidly running out.  Estimates are for 10 years more production, though the Yemeni Government disputes these figures.

Anyways a few random data points to illustrate the importance of Yemen LNG to the country:

1. In 2003 Yemen exported 450,000 barrels of oil per day.  In January 2009 the total was down to 280,000 bpd.
2. During the first six months of 2009, FX earnings from oil exports were down 75% from the same period in 2008.  Most of that is due to the decline in oil prices, but a worrying 25% drop in volumes exported was also a major cause.
   

So Yemen LNG's first shipment is good news for Yemen.  A substitute for dwindling oil exports.

For those interested in more on Yemen LNG, here's a link to their website.

The project has been "kicking around" since the 1990's.  As one might expect, putting a deal of this magnitude together in Yemen is not an easy task.  The shareholders' group has been a bit of a revolving door - ExxonMobil withdrew after the 1994 civil war.  Enron sniffed around a bit but declined. At one point Hunt Oil (an old Yemeni hand) was rumored to be contemplating withdrawing from the project.  Competition from Qatargas and Dolphin in which Total (the major shareholder in Yemen LNG) has interests also were obstacles.

For those interested in a bit more information on Yemen, two suggestions:

1. Christopher Boucek's "Yemen Avoiding a Downward Spiral" at Carnegie.
2. The IMF's Public Information Notice ("PIN") on  Article IV Consultations with Yemen released this March.
   

Boucek's piece is an overall analysis of all factors - political, economic, and social.   It is also written to promote a particular policy response so factor into your evaluation how that goal may affect his diagnosis and conclusions.

The IMF PIN is focused on economics only.

Some background on the Article IV process and PINs.

Each country that has joined the IMF  (there are 186 or so) undertakes certain obligations with respect to the conduct of its affairs.  A key part of those are reflected in Article IV.   Each year the IMF "consults" with countries about their obligations focusing on Article IV. Member countries have the right to decide how much detail is released to the public about the results of those consultations.

Two other things are relevant to Article IV consultations.

1. Diplomatic Speak:  The position of the IMF is couched in diplomatic language.  Criticisms come in the form of "encouragements" or "strong encouragements".  Issues are described in similar gentle language.  Instead of stating that a member country's economic statistics are deficient, the PIN will speak about improving the timeliness and accuracy of statistics. 
2. Mathhab:  The IMF holds more or less to a certain economic philosophy.  It's important to understand this when reading both their diagnosis and prescriptions. 
   

A second post will follow to hopefully shed some light on the intriguing story of how US$2.8 billion in long term financing was raised for a project finance in a country in Yemen's situation.

The "Two Powers" Continue Their Check Flap

The check flap is now a legal battle royale (in more than one way!).

There's also an account in AlQabas of debate earlier this Summer in the Majlis AlUmma on the Executive Branch's proposed 2009/2010 budget along with an extract of key comments by MPs - which gives some background flavor on the nature of the dispute and the various issues.   For those who don't read Arabic, the headline discusses secret payments and preferences in land (presumably the latter refers to allocation of lands).

An Updated Tale of One Market: Dubai

A bit of an update to my earlier post "A Tale of Two Markets" as well as to the "GCC Business Confidence Survey".

1. Japanese contractors owed billions by Dubai firms.  The fact that the usually polite Japanese are going public means that they have been stiffed for quite a while and are really hurting.  You'll also note that this appeared in an Abu Dhabi paper not a Dubai one.
2. Nakheel offering purchasers in The Palm Jebel Ali the option to move to other developments.  The project is delayed no doubt to conserve cash.  See #1 above.
3. Dubai debt levels as percentage of GDP versus other GCC States.  Perhaps, an explanation for #2 and #3.  On an aggregate basis, Dubai Inc (both sovereign and publicly owned companies) has something in excess of US$80 billion in debt with US$50 billion coming due over the next three years.

There is also a bit of flash news on a Moody's estimate of US$25 billion in bad debt in Dubai. 

When and if  I get access to more details, I will update this post.

All of the above may explain the depressed business sentiment in the UAE. 

Ahmad Hamad AlGosaibi and Brothers / Saad Restructurings

A very interesting news article at The National newspaper in Abu Dhabi on work being done by investigative accountants at Grant Thorton who have been appointed liquidator for Saad Investment Company Ltd. ("SICL") Cayman Islands.

It's important to note up front that this is a newspaper's account of the contents of Grant Thorton's report and not the report itself.  And equally the Grant Thorton report is a report not a judicial finding. So at this point, this is speculation.

Some "technical" comments on the article.

1. Awal Bank is owned 100% by Maan AlSanea.  48% through SICL.  47% directly in his name.  And 5% by Saad Trading Contracting and Financial Services.
2. The name of the AlGosaibi-owned bank in Bahrain is The International Banking Corporation.
3. Assets that are unlikely to be realized are not a "cash pile".   From the article it sounds like the cash may be in Swiss banks.   And the "pile" in the Caymans or at least owned by entities in the Caymans.
   
4. The Saudi Arabian Monetary Agency ("SAMA") froze Mr. AlSanea's accounts in the Kingdom earlier this year.  If the account that received the $60 million is known to be his and the funds  are still in it, the $60 million may be recoverable by creditors. 
   
5. A Cayman Islands court has frozen his assets in that country.  
6. To the extent that entities in either Saudi or the Caymans have effective control of assets registered in their names but located in other reputable jurisdictions those assets are also frozen.

If indeed records are missing and there is a complex web of intercompany transactions, cross financings and cross guarantees, it is going to take quite a long time to sort all this out. The fact that there is inter linkage between Saad Group and AlGosaibi is going to exponentially complicate the resolution of each of these cases.

Bankers don't like uncertainty.  Bankers also don't like to take losses.  A very tricky situation.

The Gulf Blog - Relative Competitiveness in the GCC

David Roberts over at The Gulf Blog has an interesting piece on GCC competitiveness looking at the ease of doing business in the Gulf as well as perceptions of corruption.

While his blog is well established and widely known and certainly doesn't need a plug from these pages, if you missed that article for whatever reason it's well worth a read.

Restructurings & Islamic Financing - Part 1

No, this post isn't a reflection on Surah Al-Baqarah Ayah 280, though perhaps that would make an appropriate topic for a future post.

Rather it's about some of the wrangling that has occurred about the legal nature and thus the legal status of "Islamic" deposits and loans versus those of conventional banks to borrowers in corporate distress.

As you might expect, in such situations legal status matters quite a great deal as it affects the payment of obligations.  At these critical times, creditors are looking to maximize the recovery of their obligations.  Borrowers are looking to avoid being needlessly harmed.  At that point the law can be a convenient tool to protect one's interests (and principal too!).  This is also usually the first time the parties to the transaction have really seriously focused on legal issues.

Because of the teachings of the Islam (prohibition against interest as well as other matters,) Islamic financings have different structures and thus different legal documentation than non-Shari'ah financings.  Many of these structures are of recent invention and application.

By contrast, even in the Muslim world, non-Shari'ah financing instruments have been used for a long time.  Therefore, they have been tested in a variety of court cases from simple breach of contract to corporate distress situations - reorganization, administration, and liquidation.   The  law is fairly well defined and ample precedent exists in common law countries.  Where the civil code prevails, the code has been amended, as necessary, in the light of experience.

By contrast Islamic financings have not yet been rigorously tested, particularly in the furnace of corporate distress and bankruptcy.  This is changing.  Two recent defaults on Sukuks (The Investment Dar and Sa'ad Group) will be the test cases (sorry for the pun) on this instrument.   Other defaults (Bahrain International Bank in 2002, The Investment Dar in 2009, etc) have tested and will test other Islamic financing structures.  But this process has only begun.  The robustness of Islamic financing structures will only be established after several rounds of such testing.

This post (the first of a planned series on this topic) will deal with short term financing.

To focus the discussion on what I hope are key details, I'll look only at financial institution distress.

When an Islamic financial institution wants to lend funds to another financial institution, it does not place a deposit as say Deutsche Bank might with HSBC at least not in the outward form.  But both place a sum of money for the same tenor and earn the same interest rate.

Two structures are commonly used:

1. Wakala
   
2. Murabaha
   

To place the discussion in context, let's first review a conventional non-Shari'ah deposit.  The depositor places funds with the bank and is paid an agreed  interest rate.  The bank takes the depositor's money and funds a loan, an investment, etc.   The bank's obligation to repay the deposit is completely separate from the performance of the asset (loan, investment, etc.)  If the bank makes a duff loan, it still owes the depositor his money back.

Islamic deposits take a completely different legal form.

Under a Wakala (fiduciary) contract, the bank acts as the client's agent (Wakil) in selecting an investment to be made with the funds.  The client is the principal (Muwakkil) in the investment transaction.  Therefore, repayment of the client's funds is conditional upon the performance of the asset.  If the investment turns out to have been bad, the client  loses his money, unless the Wakil  has been negligent.

This form of Islamic deposit appears equivalent to a non Shari'ah trust account.  Based on that legal interpretation, it would not be part of the assets of the bank.   In the event the bank went into liquidation,  those assets would not be part of the bank's estate in bankruptcy.

By contrast  the assets funded by a conventional deposit would be part of the bank's estate.  And  the proceeds from those assets would  be shared among all creditors according to their legally established priority for repayment.

Under a Murabaha (cost plus financing) arrangement, the bank (the Purchaser) and its client  (the Seller) agree to trade goods - usually commodities.  The bank acts a purchasing agent for the client, buying commodities (often non precious metals) from one party and arranging a forward sale of these commodities to another party on behalf of the client with payment to be made on a deferred basis.

If you relate this structure to a conventional deposit, the time between the spot purchase and the deferred payment is the tenor of the deposit.  The difference between the cost of the purchase of the commodities (the deposit) and the deferred sales price (cost plus profit) is the profit margin.  In conventional banking this would be called the interest.

Now let's take these two concepts into the world of corporate distress.

First, Murabaha transactions.

When Bahrain International Bank ("BIB") encountered problems in 2002, its creditors' initial assessment (which by the way turned out to be too pessimistic, I am told) was that  they would recover  only 15% of the face value of their obligations.

As one might expect,  this concentrated a lot of minds that previously had apparently been highly unfocused on credit and legal issues.  Some clever non-Shari'ah creditors came up with  a way to get their claims preferred over the Islamic creditors.  If successful in this endeavor, they would enhance their recovery to 25% to 30%.

How could they do this?

Most legal jurisdictions have a special bankruptcy regime for banks which gives depositors and lenders priority over certain other creditors.  Some of the conventional banks argued that the Murabaha transactions were sales and purchase contracts not deposits.  And, thus, their own deposits should be paid first with any money left over (the expectation was there would be none) used to settle these non deposit "commercial transactions".  As you can see from the structure and legal contract described above, there is some merit to this argument.

For their part, the Islamic banks vigorously defended their transactions as deposits.  To do otherwise would be to take a loss.

The Central Bank of Bahrain refused to entertain the non-Shari'ah creditors' argument.  The Murabaha transactions were treated as deposits.  Whether this was solely a legal decision or whether public policy considerations (preserving Bahrain as an Islamic banking center) played a role is not clear.  Given the language in the Murabaha contracts, one could well imagine the basis for  a contrary decision.

Now, let's look at Wakala transactions, where the shoe is on the other creditor's foot.

Currently, The Investment Dar Kuwait ("TID"), an Islamic investment firm, is in the midst of a  very difficult KD 1 billion (US$3.5 billion) restructuring. Some Islamic banks and other creditors which have placed funds with TID on a Wakala basis are arguing that these are really fiduciary transactions.  Therefore, they are not part  of TID's assets.  As such, they should not  be shared with creditors of TID.   Rather they   should be returned immediately to the Islamic banks.  An article in the 11 October issue of AlQabas includes language which suggests that this interpretation is supported by the Central Bank of Kuwait ("CBK") 

As an aside, AlQabas is a newspaper.  It is not the CBK.  Nor is it a court of competent jurisdiction.  Time and proper authority will determine the status of these transactions.

Given that often the most bitter fights in a restructuring are among creditors themselves rather than between creditors and the borrower, the BIB and TID stories suggest potential areas of dispute between Islamic and non-Shari'ah creditors.  And depending on the particular structures used apparently ammunition for each side to get its claims preferred.

Corporate Governance in the GCC - The BASIC Score

What's the current state of corporate governance in the GCC?

Is the trend in the right direction?

How are companies being encouraged to do more than the minimum?

Harking back to my earlier post today about the key role played by research and professional institutions in market development, I'd like to answer the above questions by reporting on the efforts of three local institutions to analyze and further corporate governance in the GCC:

1. The National Investor Abu Dhabi, a privately owned investment and merchant bank
   
2. Hawkamah, an institute devoted to corporate governance
3. Mudara, an institute focused on developing the professionalism of board members

Rather than use more electrons to describe them, I'll let them speak for themselves.  This link  provides a short "bio" of each of them as well as contact details.

 

They have devised an analytical process to analyze the liquidity (trading), volatility, and transparency of some 607 companies listed on the GCC stock exchanges.  Regional companies' performance against 43 data points are benchmarked against eight international companies to anchor results to best international practice.  Final summary results are expressed in a single number - the Behavioral Assessment Score for Investors and Corporations ("BASIC").    The effort began in 2008 with BASIC 1 and has now been expanded in 2009 with BASIC 2. 

BASIC is a tool that investors can use to make more informed decisions.  It is also a guide to rated corporations on how they might improve their score.  It is also (or should be) a highly useful device for regulators, stock exchanges and auditing firms.

Access to the BASIC report is via this link.

Some of the key findings:

1. There has been improvement in the average BASIC score since 2008.  The trend is favorable.
   
2. Despite their size, Bahrain and Oman tend to dominate in the aggregate averages as well as the top ten rated companies (each has 3 listed).  
3. Given greater regulatory requirements on the financial sector, as a general matter companies from this sector tend to score well.
   
4. Kuwait has the weakest overall score at 2.95 compared to the GCC average of 3.87 and as well has the dubious distinction of being the home of 7 of the bottom ten rated companies.
5. Rankings are:  Oman (5.05), Bahrain (4.62), Abu Dhabi (4.38), Qatar (4.36), Dubai (4.16), Saudi Arabia (3.06),  and Kuwait (2.95).  For those not familiar with the GCC, trading volumes on the Kuwaiti and Saudi stock exchanges are high relative to the rest of the GCC. 
   

As with any analytical tool, one might want to tweak this or that aspect, but what is more important is the work that these three institutions are doing and the salutary impact it apparently has and will have on the GCC.

The Role of Institutions in Market Development

Institutions play a critical role in the development of financial markets.

It's easy to see the importance of those who establish the regulatory and operational architecture of the system:

1. Legislators who establish the laws
2. Regulators who translate those laws into specific regulations and procedures and then enforce them
3. Accounting Standards Setters - IASB, FASB and particularly relevant to the GCC because of its specialist focus on Shari'ah compliant financial institutions  AAOIFI
   
4. For listed securities, exchanges who establish listing and trading rules and provide a forum in which buyers and sellers can conduct transactions
5. Various professional groups that establish conventions for dealing
6. Brokers and custodians
   
7. The Reuters and Bloombergs out there who provide the instruments through which market information is made available and often the mechanism for conducting trades

But there is another group with a key role, those who provide information to investors to help them make more informed investment decisions and those who take actions to set or encourage the development of industry practice and standards:

1. Research firms - not only for company research but also research on sectors, individual countries and macro trends as well as investment strategies
   
2. Rating agencies - Fitch, Moody's, Standard and Poors and those with a particular GCC focus: Capital Intelligence,  Islamic International Rating Agency
   
3. Professional Development Associations - CFA Institute, ISDA,  Hawkamah, Mudara  and others.
   

 The work these groups do can have a profound effect on not only the behavior of individual companies but overall market conduct as well.

A Tale of Two Markets: Saudi Arabia and the UAE

"It was the best of times.  It was the worst of times."

Those who read my previous post (6 November) of the Oliver Wyman/Zogby International poll and saw the stark disparity between business sentiment in the UAE and the Kingdom of Saudi Arabia may be inclined to apply Dickens' description of England and France quoted above to these two GCC states.

What is a key factor which affects and as well reflects business sentiment?  And which might be responsible for the views of Saudi and UAE businessmen?

Liquidity in the market - the availability of lendable /spendable funds: 

1. So one's customers can buy whatever one is selling.  
2. So one can borrow to support one's own ongoing business activities (working capital) as well make any needed long term investments in plant, equipment and property.  And perhaps an acquisition or two.  And of course to refinance existing debt as it matures.
   

The nice folks at Markaz up in Kuwait kindly provide a highly useful tool for exploration of this topic and even "nicer" they do so for free: Their "Daily GCC Fixed Income Report."

Let's take a look at the 4 November 2009 issue.

Look at the "Interbank Rate Section":

1. The first thing to focus on is the dramatic decline in interest rates from 31 Dec 2008.- save for Oman.  This decrease reflects increased liquidity.  That's a good thing, though too much liquidity can be a bad thing.
   
2. Next notice that Libor (the London US Dollar rate) is much much lower than the rates in any of the GCC states.  That gives a relative indication of difference at the macro level in liquidity between the Gulf and Europe. 
   
3. Then notice that the UAE ("AEIBOR") has the second highest rates in the GCC - an indication that liquidity is relatively strained.  Only Oman is tighter.
   

Notes:  

All the rates shown are for local currencies.  Libor is the US Dollar.. Euribor is the Euro.

These rates reflect the interest rate one bank would charge another creditworthy bank to place a deposit with it.

Loans to corporations or less creditworthy banks would have a margin added to this "base" rate.

 

Another interesting bit of  information in the report is the table of  5 Year Credit Default Swap Rates.  These reflect the cost of buying "insurance" on a 5 Year Bond.   The lower the price the better.

Here the takeaway is that Dubai's CDS rate is well above  that of other GCC States and even above Turkey and Lebanon.   Using these rates, one can construct a relative market price based "sovereign risk rating" matrix.  Saudi the "best" credit and Dubai the "weakest" in the GCC.  But note that prices can also be affected by  other factors than just the obligor's credit.  For example, the volume of bonds outstanding and number of "market makers" willing to write  insurance are important factors.

  

Turning back to AEIBOR, it's possible to perform a more detailed in-country liquidity analysis. 

Before we do that, a bit of "tafsir" on AEIBOR or as the Central Bank of the UAE calls it "EIBOR". The rate is determined (in banker-speak "fixed")  by getting quotes from 12 banks in the Emirates.    The two highest and lowest quotes are excluded.   An arithmetic average of the remaining quotes is then computed.  That result is the EIBOR "fixing".

As we ranked liquidity at a country level above by looking at rates, we can do the same with individual banks.    Unfortunately, I couldn't find the CBUAE's report for 4 November on their website.  So let's work with the CBUAE's  current report.   Select "Today's Eibor Rates" for the fixing report.

At first glance, one can draw some quick impressionistic conclusions about relative liquidity.  Those banks with higher prices are less liquid than those with lower prices.

But one big caveat to our study of individual banks.

This is but a single data point.   The rates from a single day.

To really understand the liquidity situation of banks one would have to look over a longer period to see if there was a persistent pattern.

Why?

Bank interest rates reflect not only liquidity but management of their interest rate "books".  Most banks do not match fund assets with liabilities.  An example of match funding would be to take a six month deposit to fund a six month loan made by the bank.  Rather banks deliberately create interest rate mismatches by taking, for example, a one month deposit to fund a six month loan.  At the end of the one month when the deposit was due, the bank would then take another deposit.  The tenor it would take would depend on its existing interest rate gap book and its gapping strategy.  The result is (in banker-speak) interest rate "gaps".  If you take a look at the notes to your favorite bank's financials, you'll see an interest rate risk table which will show the gaps that bank has taken.

The Central Bank of Bahrain has fairly extensive disclosure requirements so let's use Bank of Bahrain and Kuwait's 2008 financials.  Note 28 provides a maturity (but not a repricing gap analysis).   That will be good enough to illustrate the point. Bear in mind that the typical 5 year loan  resets interest every 3 or 6 months.  And the interest rate reset is what drives the interest rate gap.  But close enough for both government work and this blog's purpose.   

The bank's treasurer uses the interest rate on deposits as the tool to achieve the desired gap position. With deposits, he can adjust his bank's bid rate (the rate which the bank will pay another bank or a customer for a deposit placed with it) and his bank's offer rate (the rate at which the bank will place a deposit with another bank) to attract or discourage transactions.

GCC Business Confidence Survey

An interesting survey of business sentiment by Oliver Wyman/Zogby International.
Note:  The survey was conducted with C-Level business executives in Saudi, UAE, and Qatar.

There are a variety of interesting findings:

1. The opening of Iran seen as extremely positive (a bit of a surprise) especially given the recent surge of media comment on the regional Iranian threat.
   
2. Conflict with Iran as the biggest negative (no surprise there)
   
3. Sentiment against maintenance of the US Dollar as the major world currency as well as realistic expectations for that happening (or in this case not happening)
   
4. Despite the UAE being seen as the most business friendly, Saudi businessmen are actually more positive about business prospects in their country and the economic stimulus policies of their government.  UAE business views are decidedly and grimly downbeat.
   
5. The comment about consolidation of regional companies into global leaders is in my view applicable to a rather slim segment.  (Page 5)
   

Dysfunction in Kuwaiti Government

Technically, I don't suppose this strictly fits the definition of news.

It's certainly not something new or novel. 

It's actually more like an ongoing soap opera.

The "Two Powers" are ratcheting up their struggle.

The most recent flap over a KD200,000 check issued by the Prime Minister.

Stories in English here with the Prime Minister's reaction in Arabic huna.  The latter headline reads "I Will Sue You".

Parliament is also getting ready for one of its periodic interpellation sessions.

With sights set on five ministers this time.  The PM, Defense Minister, Finance Minister, Works Minister, and the Interior Minister.

If the Executive Branch wishes to avoid the grilling.  the two time honored methods are resignation by individual ministers or dissolution of the Majlis AlUmma.

Taxes Inevitable in Bahrain?

Given the uproar that accompanied the imposition of a 1% training levy tax on Bahrainis and 3% tax on expatriates (with a maximum of BD40 per month), I'm guessing that Dr. Essam Fakhro's (Chairman of the Bahrain Chamber of Commerce and Industry) popularity is in for a dip after his speech to the Australian Business Group at the Ritz.

Other signs of taxes - though it appears only on business/investment - are also on the horizon.  Bahrain currently has a corporate income tax only on oil companies.  More details on Bahrain's tax regime here.

Paging Dr. Hazem Beblawi.

For more on the rentier state.

And of course the classic.

IFC Lists US$100 Million Sukuk on Nasdaq Dubai and Bahrain Stock Exchange

On 4 November 2009,  the International Finance Corporation, the private sector lending and investing arm of the World Bank Group, registered a US$100 million Sukuk ("Islamic Bond issue") on Nasdaq Dubai and the Bahrain Stock Exchange.

Those watching the financial news have seen this story develop from earlier announcement (October) to today when the deal was done.  Here's the press release from Nasdaq Dubai.

Deal details: 

1. Issuer:  Hilal Sukuk Company Cayman Islands, a special purpose vehicle created for this transaction.  
2. Obligor:  International Finance Corporation ("IFC")
   
3. Annual Profit Rate (Coupon):  3.037 percent per annum payable semi-annually (May and November). 
4. Final Maturity:   May 2014.

Deal "firsts":

1. First Sukuk issued by IFC.  
2. First Sukuk issued by a non GCC financial corporation for term funding.
   
3. First IFC listing in Dubai and Bahrain Stock Exchange.  
4. First use of Nasdaq Dubai's central securities depository (electronic certficate form).
   

The prospectus for the transaction is here for those interested in more detail.  And as well the fatwa as to Shariah compliance.

There is a convenient transaction diagram in Section 1 which is a good introduction to those not familiar with the structure.

The key issue with a structure like this is the nature of the certificate holders' rights in the Trust Assets (the assets whose cash flow is the sole source of repayment of the Sukuk).

Often there is confusion on this topic.

Is the right to the assets themselves? 

Or the right to the cashflow from the assets?

If the transaction is truly collateralized by the assets, the certificate holders may upon a default take possession of the assets and sell them to a third party.

A few sections from the prospectus appear to settle this question.

1. Page 11 Risk Factors Limited Recourse:  "Furthermore, under no circumstances shall any Certificateholder or the Trustee or the Delegate, as the case may be, have any right to cause the sale or other disposition of any of the Trust Assets except pursuant to the Purchase Undertaking and the sole right of the Trustee and the Certificateholders against IFC shall be to enforce the obligation of IFC to pay the Exercise Price under the Purchase Undertaking."
2. Page 15 Transfer of the Investment Assets:  "Nevertheless, the Certificateholders will not have any rights of enforcement as against the Investment Assets and their rights are limited to enforcement against IFC of its obligation to purchase the Trustee’s rights, title and interest in and to the Investment Assets pursuant to the terms of the Purchase Undertaking. Accordingly, any such restriction on the ability of IFC to make a "true sale" of the rights, title and interest in and to the Investment Assets to the Trustee is likely to be of limited consequence to the rights of the Certificateholders."

Should investors be worried?

The World Bank Group carries the highest investment grade rating.  It is owned by the countries of the world.

If there is a future problem with the creditworthiness of the World Bank, it will be reflective of extremely serious global problems.  In that case collection of this bond will be among the least of investors' worries.

Kuwaiti Ministry of Commerce and Industry to Crack Down on Related Party Transactions?

A week ago, AlQabas reported that the Kuwaiti MOCI had discovered "gross offenses" by local companies in related party transactions and as a result was going to implement some greatly enhanced requirements effective 2010.  Link to the article in Arabic here.

Two areas where offenses occurred were singled out for particular note:

1. Board compensation (one suspects the problem is not with too little)
2. Withdrawal of capital under the pretext of transactions with affiliates and subsidiaries.

The MOIC will reportedly tighten requirements as follows:

1. Auditors will have to submit an original signed copy of the company's financials  to the MOIC to attest that the auditor has indeed audited and agrees with the numbers presented therein.  The auditor must also disclose the extent of  its reliance on documents attested to it by the company. 
   
2. If after a review of the financials and other information it has on the company, the MOIC feels an auditor's work is deficient, it can transfer the case to the professional disciplinary board for a hearing.
3. If it is determined that there are serious deficiencies, the case will be referred to the public prosecutor for criminal prosecution.
   

In conducting its review and investigations of company financials, the MOIC promises to ensure strict confidentially of a company's "business confidential information".

It is an old saying that a rising tide lifts all boats.

Equally when the tide goes out the conditions of the hulls of the ships in the harbor become evident.  The GCC is not a flood tide right now.  And, no, the Mishref Plant does definitely not count here.

This is probably as good as any time to comment on AlQabas, the source of this information.

Critical evaluation of sources is (pardon the duplication) critical in conducting careful inquiry.  All of us are biased - consciously or unconsciously.  Knowing where those biases are and what they are helps evaluate the account.  If the isnad is strong, the matn has a higher probability of being sound.

Within the standard Kuwaiti political framework of the "Two Powers",  AlQabas is definitely in the parliamentary camp.  Closer to Saadun than AlSabah.  The name of the newspaper itself ("The Firebrand") is a pretty good indication that it has a different  orientation than the more "establishment" AlWatan (the largest paper in the country).

Central Bank of Bahrain Real Estate Exposure Limits Lifted

Reuters reports that the CBB had lifted its previously issued restriction on Bahraini financial institutions" exposure to the real estate sector.

If you read the story carefully, you'll note that the "lifting" occurred 3 or so months ago.

What makes the story worthy of comment now?

From this blog's perspective, there are two takeaways:

1. The quality of the CBB as a regulator.
2. The fundamental problem a regulator faces.

On the first , as indicated by this speech by the Governor of the CBB, H.E. Rashid al Maraj,  the CBB was aware of the risks of over exposure to this sector and  has been following this issue actively since 2005.  I can confirm  from direct knowledge that this is case.

As a general rule, the CBB is one of the better central banks in the Gulf in terms of its prudential supervision, including the identification of risks and trends.  It has a highly organized and disciplined regulatory regime comprised of regular review and quarterly updating of its regulations as well as a robust consultancy process. 

As an example of its ability to look forward, the CBB issued a regulation in 2005 (if I'm not mistaken) on consumer lending designed to prevent consumers from getting over their heads in debt. The updated regulation is included in Section CM-8.1 of the larger Credit Risk Management Module.

The CBB also took a leading role in the creation of the first central credit reporting bureau in the country (again in 2005) enabling banks to determine an individual customers' outstanding credit facilities and obligations with other financial institutions.

The second point is that regulations have to be implemented in the real world.  Often what is a  sound idea would, if implemented, lead to greater problems than not implementing it.

A glance at the financial statements of major Islamic banks in Bahrain (both conventional banks like Kuwait Finance House Bahrain and Bahrain Islamic Bank or investment banks like Gulf Finance House and others) shows the magnitude of the "facts'" that the CBB faces with implementing this regulation.   Causing banks to reduce exposures within the limit would lead to the forced sale of assets in an already distressed market.  Forcing prices down and thus directly impacting collateral values on other loans. 

The extent of the "problem" is not only a matter of credit exposure to the property and construction sector but as well equity investments in real estate or in firms with a direct exposure to that sector, e.g., construction materials, property management, etc. 

In short the CBB faces the classic regulator's dilemma:  how does one safely let the air out of an asset bubble?  One which one has been trying to contain for several years.

Rumors of Resignation of Vice Chairman of Adeem Investment Company Kuwait - Link to The Investment Dar Restructuring Saga?

There is an unconfirmed rumor that Mustafa Ibrahim AlSalih, Vice Chairman / Managing Director of Adeem Investment Company Kuwait and a Board Member of Investment Dar Bank Bahrain  ("IDBB"), an "Islamic" investment bank, has resigned due to differences over strategy.

The Investment Dar Company Kuwait, also an "Islamic" investment bank,  ("TID") is the major shareholder in IDBB.   TID and Adeem have partnered in some investments including the purchase of Austin Martin.

The rumor is that Mustafa objected to certain actions TID proposed to take at Investment Dar Bahrain.  Since major shareholders generally get their way, a director opposed to the majority's wish might resign if he felt strongly enough. 

One article also unconfirmed and therefore a rumor suggests a possible reason he might have felt the need to resign.  Another from a TID press release may also indicate possible areas of conflict between TID and IDBB. See the third paragraph.

What's less clear is why he would resign from Adeem as well.  Perhaps Adeem is supporting TID's proposal at IDBB?  Or it may be something else.

What makes this story worthy of note is that TID is the midst of the very difficult debt restructuring of  KD1 billion (US$3.5 billion) of its own liabilities.

That suggests a post on TID would be timely.  And, perhaps, one on Global Kuwait, another major Kuwaiti investment firm in the midst of a debt restructuring.

Given the TID link,  more news is likely to come on this story.

Stay tuned.

And, finally, while it should be clear from the above, it's important to note that I am merely commenting on rumors rather than vouching for their accuracy.

Saudi Drivers in Bahrain

I'm considering this post related to the GCC Financial Sector because Bahrain is a financial center.

I'm allowed to do that because this is my blog.

Anyways, a good shopkeeper should have something unique - a bit of flashy merchandise - to catch the eye of potential customers to get them into his shop.

So here goes.

Gulf News in Dubai recently ran a report quoting an official at the Saudi Embassy in Bahrain that on average 20 Saudi nationals are cited each day by Bahraini police for traffic law violations.  The article goes on to imply that traffic law enforcement in the Kingdom of Bahrain is very strict. Link here.

But, as someone who has driven in Bahrain, two things in the article just don't square with my own experience:

1. 20 a day seems awfully low based on what I've seen driving around in Bahrain.   On more than one occasion I've seen a car with Saudi license plates commit 4 or 5 traffic violations within the space of just five minutes.  And, no, it wasn't the weekend.
   
2. It would also be helpful if the article stated when strict traffic law enforcement started as that would be a significant milestone worthy of recording and celebrating.

As one who has been boxed in by double and sometimes triple parkers of a certain nationality, I must confess though that the term "incorrect parking" belatedly lightens the predicament.

Painful But Manageable Stress in the Saudi Banking System

All eleven Saudi banks have  now issued financials for 3Q09 so it's possible to get an insight into  the state of the banking market.

For the first nine months of 2009, Saudi banks' provisions were SAR 5.78 billion (US$1.54 billion) versus SAR 1.51 billion (US$403 million) in the comparable period in 2008.

Most of the provisions are believed to be related to exposure to  two Saudi borrowers:  Ahmad Hamad AlGosaibi Brothers ("AHAB") and the Saad Group.   Estimates are that Saudi banks hold approximately US$5 billion out of the aggregate US$22 billion to these two groups.

A closer look at individual banks may give some idea where the problems are.

On that topic, it's important to note that SAMA (the central bank) does not set mandatory provisioning guidelines.  Individual banks make their own determination.  Banks may  therefore have different provisioning percentages for the same credit.     

Two banks accounted for 54% of the provisions:

1. National Commercial Bank ("NCB"), the largest in the country, with SAR 1.876 billion 
   
2. AlRajhi Bank ("ARB"), the third largest, with SAR 1.237 billion.  

NCB's provisions were 9x those in 2008.  ARB's a more modest 1.9x. 

Among the other majors:

1. Samba,  the old Citibank joint venture and the second largest,with SAR 377 million - just shy of 3x. 
   
2. Riyad Bank, the fourth largest, SAR 434 million - 3.7x 2008.

Two banks had larger percentage increases than NCB:

1. Banque Saudi Fransi, the sixth largest, at 15x with SAR 224 million and 
2. Saudi Hollandi (the eighth largest) at 10.7X  with SAR 415 million.

Both reflect rather rapid buildups and are due either to provisioning for Saad and AHAB (more likely) or severe deterioration in other borrowers.

No one expects Saudi bank failures.

Even with the dramatic rise in provisions, NCB's profit was only down 28% from 2008.

The banks are relatively well capitalized.

The Saudi Arabian Monetary Agency has a tradition of engineering bank rescues when needed.

But the increase in provisions says something about the pain being felt.

More details for those who read Arabic from AlRiyadh newspaper. 

(Exchange rate:  SAR 3.75 = US$1.00)

Critical Sand Shortage in the Gulf

It may sound strange: a GCC state that needs to import sand.   A bit like carrying coals to Newcastle.

But that's the case with Bahrain.  Without imports of sand and gravel, its construction and real estate sectors would be seriously hurt. Costs would escalate.

What's perhaps even more strange:  a GCC country banning the export of sand and gravel because of concerns over a potential shortage.

Earlier this month Saudi Arabia announced that at the end of November it would cease exports of all sand and gravel.  It appears the Rub Al-Khali (Empty Quarter) may indeed be empty.

Two remarkable events.  And two contradictory accounts.

The first in English from Bahrain's Gulf Daily News is the more upbeat of the two.  From this the problem is manageable, though if it so modest, it's not clear why government support is needed.

From across the King Fahd causeway on which the sand comes (at least until the end of November), a much different story in Arabic from AlWatan.    Prices of sand up 30% since the announcement of the impending ban as Saudi and Bahraini merchants prudently hoard stockpiles in anticipation of further price increases in December.  As well, an account of a dramatic price increase from BD1.5 per m3 to BD4.5 over some unspecified time.  And a picture of "sand pirates" busy scooping up the precious commodity near Dammam.

There was a similar sand crisis in 2003 - also triggered by a Saudi ban.  Subsequent consultations between the two governments led to the apparent discovery of additional Saudi sand.

One hopes that similar exploration will be successful this year,  not only for the industry but also for the banks that finance it.

Arab and GCC Banks: Financial Position and Capacity

Earlier this week at the Kuwait Financial Forum, H.E. Hamood Bin Sangour  Al-Zadjali Executive President of the Oman Central Bank advocated bank mergers as a way of strengthening the GCC financial sector.  As a first step, he called for active GCC central bank promotion of domestic bank mergers to be followed by regional cross-border mergers and expansion. 

A very worthy goal.

The GCC has too many banks.

As a result, limited financial capital and human talent are dispersed preventing the development of the scale and muscle necessary for local banks to truly compete on the global stage and to fully  serve regional markets.

Perhaps, that last comment about limited capital seems strange.  After all, the GCC states are major oil exporters.  It seems intuitive that their banks would be major players in the world.

Let's drill down into the details to see that this is not the case.

Each year The Banker prepares a list and analysis of the "Top 1,000 World Banks".  Note that this is based on financials from the close of the previous financial year: the 2009 list is based on 2008 fiscal year end financials.

The 2009 Top 100 Arab Banks had Tier 1 Capital of US$138 billion, roughly 3.2% of the total Tier 1 Capital for  the Top 1,000 banks. The GCC Banks' share was US$110 billion or 2.6% of the Top 1,000. 

To put this into an even starker perspective, the Tier 1 Capital of just JPMorgan Chase was $136 billion - roughly equal to all of the Top 100 Arab Banks.  The market capitalization of  ICBC (PRC)  US$248 billion.

Looking at assets, the Top 100 Arab Banks had total assets of US$1.3 trillion and the GCC Banks' share of that amount was just short of US$1 trillion.

By contrast one bank, Wells Fargo (ranked #18 in assets among the Top 1,000) had US$1.3 trillion in assets.  Dexia Bank Belgium (#25 in the list) had total assets equivalent to all the GCC banks in the Top 100 Arab Banks.

What's even more striking is the Emirates Bank-NBD (UAE), the largest of the Top 100 Arab Banks,  had total assets of US$76.9 billion - roughly 57% of JP Morgan's Tier 1 Capital!  When compared to US banks, Emirates Bank-NBD would be slightly larger than Country Wide (the 16th largest US bank) and slightly larger than JP Morgan's Delaware Bank (the issuer of JPMC's credit cards).

National Commercial Bank (Saudi Arabia) had the largest Tier 1 capital among the Top 100 Arab Banks at US$6.68 billion.

For those interested in pursuing this topic further, additional information on The Banker's 2009 List is here and on the Top 100 Arab Banks here.  You'll find links to detailed charts on the Top 100 Arab Banks at end of the second link.

First Asset Backed Securitization in Lebanon

Not strictly the GCC, but this is my blog and I have strong affection for Lebanon.

BEMO Securitization SAL announced the closing of Rymco Drive 1 for Rasamny Younis Motor Company ("RYMCO"),  Lebanon's authorized GMC, Nissan and Infiniti dealer.

This deal is a first for two reasons:

• It's the first auto receivable asset backed security ("ABS") in the country.  
• And the first term securitization under Law 705 of 2005.

The total transaction is for US$13.1 million, divided into two tranches:

• A senior tranche, Tranche A, at 77.5% of the transaction - roughly $10.5 million - with an average life of 3.7 years.
• A subordinated tranche, Tranche B, at 22.5% - roughly US$3.0 million-  to be retained by RYMCO which provides an effective first loss credit enhancement for Tranche A holders.

During the coming three year period, additional auto receivables may be incorporated into the structure resulting in US$40 million in aggregate funding for RYMCO.

The deal also includes some other protective features:  a funded cash reserve and an "excess" interest capture.

Congrats to BESC for a landmark deal.

And, as always, a pleasure to see the distinguished banking name, Obegi, in the press!

The One Billion Dirham "Camel"

"Tie your camel first, then trust in God."

SRA

(Jami'y al-Tirmidhi)

Given the anniversary, a belated postmortem of the AED 1.5 billion convertible bond deal beween Dubai Banking Group ("DBG") and Shuaa Capital ("SC") and DBG's resulting AED 1.016 billion (US$277 million) loss - slightly more than the cost of the average camel.

On 31 October 2007, DBG and SC sign an agreement for a one-year convertible bond.  The bond has a quarterly 6% coupon and is convertible into 250 million SC shares.  The stated conversion price is AED 6.000 per share.  However, since as part of the deal DBG advanced SC another AED 176 million (so SC could terminate its stock option program), the effective strike price per share is AED 6.704 - approximately SC's market price at signing.

Fast forward to the maturity date one year later.  SC shares are trading at AED 2.71.

Not surprisingly, DBG has no interest in converting.  To do so would result in an immediate loss of AED 998.50 (US$272 million) - roughly 60% of the initial investment.

However, SC issues a conversion notice, advising DBG that the bond has been converted to shares.

What?  How could that happen?

Clause 6 in the Note Certificate allows both parties - SC and DBG - the right to force conversion.

DBG refuses, threatens litigation to force repayment.  The parties embark on a very public drawn out dispute.

On 25 June 2009 they announce a settlement:  the bond will be converted into 515 million SC shares.  The resulting strike price is billed at AED 2.91 per share - though when the extra AED 176 million is factored in, the strike price is actually AED 3.25 per share.  At this point SC's shares are trading at AED 1.28.

Using market value, DBG has just paid AED 1.676 billion for AED 659 million in shares - a loss of AED 1.017 billion (US$277 million) - 60% of its initial investment.   One heck of a "control" premium.  DBG's one consolation is that it owns a lot more of SC than it would have under the original conversion terms.  Somehow I'm suspecting that may be cold comfort.

Of course, markets move.  Anyone with a stock portfolio in October 2007 has seen some wide and painful movements.

But the whole point of a convertible bond is the structure is designed to give downside protection.   To combine the "safety" of a bond with an option to capture  potential price appreciation.   One only converts if the stock price is favorable.  If not, one cashes in the bond.

But for this to work,  one can't give the issuer of the bond the right to convert because as shown by the above example, the issuer has an incentive to convert when the market price of its stock is below the strike price. 

I'm at a loss to explain this transaction from any banking or finance principle I know.

If anyone out there can, please post.

To rephrase the hadith quote above:  "First, tie down you deal terms firmly, then trust in God".

For those interested in more background, additional documents and information can be found here as part of shareholder information for SC's March 2009 EGM.

'Amm Yusuf (Yusuf Abdul Aziz Al Wazzan)

إنا لله وإنا إليه راجعون

Amm Yusuf as he is known in Kuwait passed away last week.

A short note to acknowledge his passing and to express condolences to his family.

From his father's small shop in the suq, he rose to become a major businessman. Instrumental in founding many Kuwaiti companies, including financial firms and banks, he was also a member of both the "city council" as well as the national assembly. Active in charity work and a sportsman.

Click here for a link to a short bio in AlQabas.

Ahlan wa Sahlan

Some introductory words as I launch this blog.

What do I intend Suq Al Mal to be?

A market place of ideas and discussion on the financial sector in the GCC.

While I can only offer virtual shay and qahwa to those who vist my dukkan, I hope that will not stop you from  entering.

And as with any true suq, expect to barter. Respond to my offer with your own bid.

The first price is usually not the best nor the last, though I will assert that no other merchant has as fine an inventory as mine nor works with such modest margin of profit.

One small housekeeping matter while I sort out the HTML code.:  the above picture is subject to copyright by  MOseQar under the terms described at Wiki Commons.