Kuwait Stock Exchange Warns AlAbraj Holding on Trading Suspension If Financials Not Provided by 31 January

The Kuwait Stock Exchange issued a public warning today to AlAbraj that if it did not produce its fiscal year statements (AlAbraj's fiscal year ends 31 October), it would be suspended from trading.

The Company is involved in a legal case with Boubyan Bank over its non payment of KD45.2 million of debt. This is an indication of significant financial issues at the company which are no doubt responsible - at least in part - for the delay in release of its financials.

Here's the text (Arabic only) of the KSE announcement.

[14:27:1]  ِ.تذكير (ابراج) الالتزام بقرار لجنة السوق رقم(16)‏
يعلن سوق الكويت للأوراق المالية واستنادا الى قرار لجنة السوق رقم (16)‏
لسنة 1987، والذي يلزم كافة الشركات والصناديق المدرجة بتقديم البيانات
المالية السنوية في موعد أقصاه ثلاثة أشهر من تاريخ انتهاء السنة المالية،
فانه وفقا للقرار المذكور على كل شركة مدرجة في السوق الالتزام ‏
بتقديم بياناتها خلال المدة المذكورة اعلاه ، وحيث ان شركة الابراج القابضة ‏
ِ(ابراج) تنتهي السنة المالية بتاريخ 31-10-2009 واستنادا للمهلة المذكورة ‏
اعلاه فإن اخر يوم للاعلان عن هذه البيانات المالية هو يوم الاحد ‏
الموافق 31-01-2010 .‏
وبنائا علية فإن ادارة السوق سوف تقوم بوقف التعامل في اسهم هذه الشركة في ‏
حال عدم تقديمها البيانات المالية السنوية في الموعد المحدد .‏

0-0

On to Sunday and Man U.

Sensible Advice: Islamic Finance Not Necessarily Safer Than Non Islamic

Philip Thorpe Chairman and Chief Executive of the Qatar Financial Center Regulatory Authority gave an interview to Reuters at Davos.

Some times the truest statements are the most elegantly simple.

Philip had two.

Here's the first.

It's a myth to assume Islamic finance products are safer than conventional products and underlying risks should be studied more carefully, Qatar's top regulator said on Wednesday.

I guess that here at Suq Al Mal that's the equivalent of preaching to the choir.  Thinking Islamic products are safer than conventional ones is on a par with thinking that if my borrower's name is Muhammad he's more likely to pay me back than if his name is Ganesh.

And as I commented before these structures have not been rigorously tested in courts and because of their need to incorporate asset backed elements into their structures may pose some significant legal challenges.

Here's the second:

The role of regulators is to identify risks and in some instances to become a bit more interventionist," he said.

"If we saw a product that was unsafe for investors, we would not permit it to proceed. Regulation has never been about free markets. Regulation is not a consensual act. It's a political act...Recent events may have moved the bar up in terms of regulator tolerance."

It is so refreshing to see a regulator who doesn't feel he has to apologize for regulating markets. And understands that regulations and regulators are needed because the market is not perfect.

The Emirate Strikes Back: Emirates Bank NBD Drops S&P

"What is thy bidding, my master?"
"There is a great disturbance in the Ratings".
"I have felt it".
"We have a new enemy, the rating agency who downgraded DHCOG."

Here's the press release.  I trust the Death Star is ready.

The International Banking Corporation - Arrest of CEO

Rupert Bumfrey had a post today that AlBilad Newspaper in Bahrain reported that the former CEO of The International Banking Corporation had been arrested after being charged with fraudulent transactions in excess of US$ 2 billion.

That really caught my eye so I decided to take a look at AlBilad's account, figuring it might have additional interesting details.  It does.  As well, it suggests some potential answers to the question as to why the recovery rate on TIBC debt is expected to be so low.

First, a look at the article and then the usual comments.

Here's a quick translation of AlBilad's article.

Nawaz Hamza, Head of Public Prosecution Department, ordered the detention of the (former) Chief Executive of TIBC for a period of six days or the payment of a bond of BD10,000 (US$26,500).  The charge is breach of trust and misappropriation of funds/embezzlement.

Reportedly, the accused chose prison and after a two day investigation, was charged with fraud  involving in excess of US$2 billion. 

Earlier the Prosecutor had determined that the signature of Sulyaman Ahmad AlGosaibi on numerous documents connected with loans and money transfers had been forged through computer imaging of Sulayman's signature.  Once scanned, the signature's appearance had been enhanced by using blue color to make it appear to be an original signature.  And presumably the discovery of forgery prompted the investigation of the CEO.

(An earlier AlBilad article here from 17 January has a bit more detail on the forsensic investigation that determined that Sulayman's signature had been forged on various agreements - presumably loan and similar agreements - as well as certificates of board decisions.  Interestingly, this article asserts that TIBC was under the administration of Mr. Al Sanea.  In fact it makes that statement twice.  It's unclear what the basis for this statement is,  that is, how Al Bilad knows this to be the case.  As you'll recall if you've been following this case,  this is AlGosaibi's complaint: that Mr. AlSanea not they are responsible for the financial distress in their companies).

The article notes that in a meeting  last year in August with regional, Arab and international creditors AlGosaibi had presented a number of documents which it asserted were forged and which established that there had been a widespread forgery of documents and certificates used to obtain loans, bank guarantees, and to make transfers of funds in the name of TIBC and AlGosaibi entities.  As the article notes, this was an attempt by AlGosaibi to prove its innocence from involvement in these transactions.  As well, it  requested creditors to submit documents for transactions with TIBC and the money exchange firm in Saudi so that it could reply on them - presumably whether they were genuine or forged.

Now to the analysis.

1. First a bit of context, TIBC's 31 December 2008 financials (the last issued) showed total assets of roughly US$3.8 billion.  So in excess of US$2 billion is quite a large sum even when considering that some of the transactions also involved AlGosaibi entities in Saudi Arabia, such as the money exchange firm.
   
2. The assertion of widespread fraud suggests some possible reasons for the very low anticipated recovery rates on TIBC.  On that topic, the Governor of the Central Bank of the UAE is on record as telling his banks to provision 100%.   Earlier I had analyzed TIBC's financials and was left scratching my head about the decline in asset values that would be required to cause the apparent loss.  I was focused on duff investments and loans resulting from poor business judgment not fraud. Two potential explanations surface from this assertion of fraud. First, that not all liabilities are recorded.  Thus, assets may be roughly close to the US$3.8 billion in TIBC's financials but real liabilities may be US$2 billion  or so more.   Second, if one is going to forge documents to secure funds, then one is probably not going to have  any scruples about forging documents for assets, though this involves a bit more than scanning one person's signature and changing its color. Just to be clear:  the article does not explicitly state that there are unrecorded liabilities or fraudulent assets.  But that seems a logical conclusion.
   
3. It's important to note that the former CEO has not been convicted. And all we have is a press report that he has been accused.  It's important to note that under Bahrain's Law #47 of 2002 ("Press Law") disclosure of the identity of those accused and press reports on trials are limited so this is at present an uncomfirmed press report.
   
4. It's hard to understand how BD10,000 in bail is adequate security in a case allegedly involving over US$2 billion.  But then again the courts of Bahrain move in the most mysterious of ways.  One can be fined BD1,000 for hitting someone with a fish.  And BD50 for sexual assault.  
   

International Investment Group Kuwait Cures Payment Default

If you've been following the story, you know that on 11 January, IIG Funding Limited was to make a Periodic Distribution Payment (equivalent to interest under a conventional bond) of US$3,353,062.50 on its US$ 200 Million Trust Certificates "Sukuk Al Mudarabah" due 2012.

It did not.

At the time IIG (which is the source of the payment) advised it intended to pay on the 19th.

The payment was received on 20 January.

Under the terms of the Certificates a  three day delay in payment is grounds for the dissolution of the Trust.  Once the three days passes, even if IIG makes the payment as it did in this case, the Certificateholders have the right to dissolve the murabaha transaction.  A dissolution  is the same thing as an acceleration of a conventional bond:  IIG would be legally obliged to repay the Certificates in full - some US$200 million in principal plus any Periodic Distribution Payment ("interest") due.  

However, just as with a conventional bond, the Certificateholders must vote to exercise their right to accelerate payment. 

My guess is that they will not.

Interesting Blog: The Boursa Exchange

Today's feature The Boursa Exchange, a blog on life in downtown Cairo. 

You might wonder why the plug here as it apparently has nothing to do with finance or the GCC.   Well, it has some very interesting posts.  And Cairo is one of the great cities in the world.  And this is my blog.  There is also a link, however tenuous to finance, the blog does take its name from the area where the Cairo Stock Exchange is located

As befits a country with Egypt's history, Cairo has a veritable treasure trove of buildings and neighborhoods - different periods, different styles ...

There's a neat book by Samir W Raafat "Cairo the Glory Years", which focuses on the modern European inspired architecture.  Sadly, it seems a lot of these gems are suffering from lack of proper attention. 

On the other hand, there are some new triumphs - the gisr "gamila" fouq 26th July Street in Zamalek.  And, of course, the Burg Al 'Ayb.  Or is that Burg Al 'Aar?  Shukran gazilan, Ustath Khalid!  

UAE Banking Statistics December 2009

The Central Bank of the UAE has published its "Banking Indicators" for December 2009.

As noted, the figures for 2009 are provisional and subject to revision.  Also the Total Private Funds (shareholders' equity) does not include current year earnings.

Once 2009 fiscal year audits are completed and approved, then it will be possible to perform an in-depth analysis of the UAE banking sector's performance.

In the interim, as a general comment, there were no significant changes or obvious signs of significant distress.

Total assets in the system are down some AED12.5 billion (US$3.4 billion) from November.  That is a fluctuation of less than 1%.  Year over year, total assets are up some AED62.9 billion (US$17.1 billion) an increase of 4.3% over 2008.

Looking at December 2009 figures, loans are down AED9.4 billion and personal loans up AED0.6 billion compared to November 2009.  When December 2009 figures are compared to December 2008  the increase is AED24 billion and AED3.8 billion respectively. The changes are respectively 1% and 0.3% from November 2009  and roughly 2% from December 2008.

The closely watched specific provisions number was AED32.6 billion in December roughly the same as November's AED32 billion, significantly above December 2008's AED19.7 billion.   General provisions for December 2009 were AED10.7 billion versus AED9.3 billion in November and AED5.3 billion in December 2008.  Here the percentage changes are more dramatic when December 2009's figures are compared to December 2008's:  65% for specific provisions and 102% for general provisions.

Another Own Goal for Team Dubai in the S&P/DHCOG Ratings Dispute

You've probably seen the press articles that Standard and Poor's lowered the rating on DHCOG from BB+ to B.  A weaker cash flow and lack of information are cited as the reasons along with some background on the Emirate and Dubai Inc.  These reports also note that S&P has withdrawn its rating.

What I want to focus on in this post is the proverbial "war of words" that they have launched.

Was this war necessary? Who stands to win? Who will be the most damaged?

As you might guess from the title, I have my own view. Team Dubai has roundly booted yet another one into its own net. And when it comes to scoring, it seems that just about everyone on the Team is capable.  To be clear here I am referring to DHCOG's reaction to the ratings downgrade and withdrawal by S&P.

Let's start by reviewing each's press release – where better to wage a war of words.

First, S&P. Their press releases, including rating actions, are password protected (though all you need is an email address and the willingness to give it to them to get access). If you can't or don't want to do that, Bloomberg has a more complete account than many of the reports in the press. 

S&P states that:

1. Materially weaker cash flow and a resulting negative impact on liquidity as well as lack of clarity on potential government support (that famous "implicit guarantee" rears its head again) is the basis for the ratings decline. 
2. Because of "inadequate timeliness of information and insufficient documentation (emphasis mine) to maintain their surveillance" they have decided to cease rating the company.  (You might ask why they didn't just withdraw quietly with no fuss and no downgrade.  It's common practice that a rating agency doesn't simply withdraw without either reaffirming or changing the rating.   This is especially the case if they have negative information and conclusions. Since this will be their last word, to do otherwise might leave the market with the wrong impression of their opinion. As to the fuss, it either came as a reaction to what I expect were rather sharp discussions between the two parties. The other less favorable interpretation is that there are significant shortcomings in the information that S&P cannot let pass without comment.). 
3. Three further important negatives. First, the rating trend is negative: more erosion in credit quality is expected. Second, the rating and the negative future view reflect their base case. In other words they are not basing their rating and view on the future on the "downside" case. Third, a broad criticism of "lack of market transparency, reliable market data, and the level of financial information" (Ouch).
   

Now over to DHCOG's press release.

Their view is clearly and starkly stated.

1. They dropped S&P as a rating agency due to S&P's "lack of understanding of DHCOG's business, its operations and relationship with the Government of Dubai." 
2. They have been "sharing adequate information frequently and in a transparent manner" with S&P. 
3. S&P has made "inaccurate statements coupled with factual errors that are misleading." 
4. Therefore, they "discredit and disagree with the content of the latest S&P report". 
5. They will continue to work closely with other rating agencies and directly with investors in full transparency".
   

Now let's look a bit deeper.

Not so long ago, November 2008 to be precise, DHCOG was rated investment grade with "A" or an "AA-".  A "B" rating is a bitter pill, though DHCOG has had prior tastes from earlier downgrades. At any time, a downgrade isn't welcome.  Given Dubai's current difficulties, the downgrade – dangerously close to CCC territory – was probably seen as a direct threat to the company, the parent, and the Emirate itself. Add on top of that a rather broad and sharp criticism of market transparency and reliability and DHCOG's strong reaction isn't surprising.  Another concern might as well be the potential adverse affect on the main shareholder's attitude to the management of the company. What I suspect is the proverbial straw on the camel's back is that S&P signaled that it was likely to further downgrade the company, probably into CCC territory.

Who dropped who?

A tricky question. 

Usually such disputes are settled in such a way that no excessive dust is raised.  The company tells the rating agency it isn't happy with the rating. The rating agency advises that it cannot change the rating. So they find a way to part – an amicable divorce. That wasn't the case here.  Both parties have kicked up quite a bit of dust and it seems more than a few rocks.

My guess would be the company made the decision to prevent further downgrades. S&P could have maintained coverage and just marked the company down further if it felt the information were inadequate or delivered too late unless of course it felt the situation was so bad that to continue would violate its integrity and potentially cause severe damage to its reputation. The question that can be posed to S&P is how does this lack of market transparency and reliability affect its ability to rate other companies. Is the situation so severe that it needs to withdraw from other rating engagements?

Just how serious is the dispute?

Both have levied fundamentally serious charges against one another that go to the heart of the other's competence. And a hint of criticism of integrity.

1. S&P contends that the company was not providing information on a timely basis and that when supplied the documentation was inadequate. 
2. DHCOG claims that S&P is unable to understand its business or its relationship with the Dubai Government – in effect the rating agency doesn't have the skills to perform its job. But more than that, compounding its deficient critical skill, S&P is making factually incorrect and misleading statements – a direct attack on its integrity.
   

Whose story is the market more likely to find credible?

In a dispute like this, outsiders are unable to conclusively determine whose story is true.  They don't have the facts so they rely on the reputation of the parties, their presumed motives, and their conduct in the dispute. Dubai is at a disadvantage on all three except perhaps in the region.

While the folks back home will probably quite naturally take DHCOG's side, the wider market will tend to believe the rating agency.

Why?

S&P enjoys a better market reputation than DHCOG. It is a "household name" and has built a perception in the market that it is a smart thorough institution.

The central reason though will be the perception that the company is motivated by defensive self interest. The downgrade affects the company's access to debt markets as well key deal terms, e.g., tenor, pricing, security and covenant packages.  It may also affect the price of the company's stock since shareholders are legally subordinate to all creditors. Faced with these potential outcomes, it's expected that the company will fight to prevent them from happening. Given the negative outlook, it's likely that S&P would have downgraded the company further. While DHCOG would prefer to avoid the "company" of single "B" rated companies, consorting with those in the "CCC" class has to be an even more distasteful prospect.  Also complicating DHCOG's sales story is the fact that many a company in this sort of situation has claimed that credit or stock analysts didn't understand their businesses or the real worth of the company. But, generally, history has vindicated the analysts.

On the other hand, the market finds it hard to believe the rating agency has a hidden agenda or gets great benefit from the downgrade. It is seen as doing its job in delivering the bad news.

So what does a smart company do in this situation?

The first is to realize that not much can be done.  The rating has been lowered.  No amount of protestation will cause the rating agency to change it. Trying to convince the market that you're right and the rating agency is wrong is difficult, if not impossible, for the reasons outlined above. And a variety of parties are locked into using the rate whether or not they believe it is correct.  Entities subject to Basel II. for their capital adequacy calculation.  Investment companies who are limited to investments of a certain credit grade.  Banks who translate external credit grades into internal models for underwriting decisions and pricing purposes, etc.

The second is to choose one's battles carefully. There is truth and there is the appearance of truth. The market does not have the facts. It will judge on appearance. Even assuming that the rating agency is dead wrong, the company has to think carefully if a bitter public dispute will help or harm it. One does not want to wind up in a worse position after the battle than before.

The third is to reply appropriately if one chooses to fight. What arguments are most likely to be plausible? As hurt and perhaps outraged as they were, the wiser thing for DHCOG to have said would be that S&P doesn't understand our business and hasn't given sufficient weight to certain factors. We disagree with the assumptions in their economic model. Their interpretation is therefore wrong. This is much better than saying that the rating agency has the facts wrong, that it lacks the requisite skills or that it is making inaccurate misleading statements. It will be very hard to convince the market that this is the case with a firm with S&P's reputation.  

Compounding DHCOG's position is that other rating agencies have been downgrading it. So in a sense DHCOG is not just fighting one agency, it is fighting the Big Three. An even larger credibility disadvantage. What the company can hope for is that there will be differences among the agencies and it can therefore discredit the lower rating. But, last December Moody's downgraded the company to "B1" – the same as S&P. Fitch's rating is "BB" – higher but by only one level. All three agencies have assigned negative future trends. This certainly takes the wind out of DHCOG's argument. Where there may be hope is that other agencies will not be so negative about the company's timeliness and quality of information and may not wield as broad a brush in criticizing the local market.  Perhaps, apparently small victories but important victories particularly in this climate.

Perhaps, in drafting its press release, DHCOG's target audience was the regional market, that in the UAE or one rather important shaykh in Dubai. And for this audience, their approach may have been the right one. But in terms of the wider market, the one that actually matters for financing, it is not. The press release is unprofessional. It sounds too emotional. It looks like it was drafted in a fit of pique. All that is missing is the sound of the foot stomping.

In the midst of a very challenging refinancing process Dubai Inc. can't seem to avoid scoring own goals.  This isn't the first.  And this isn't the only player (Dubai Inc entity) to do so.  Team Dubai needs to get a better hand on its play (public relations).  The task is difficult enough as it is without needlessly making it worse.   

Not only for the good of today but as well for the good of tomorrow.

Investment Dar - Forward Steps on Legal Agreements for Restructuring

AlQabas quotes sources on the Creditors Committee that Committee is moving forward with the legal documentation and the implementation of the restructuring despite the fact that the Central Bank has  not yet approved TID's financials.  (Those of you reading the Arabic text will notice that I have added the words "not yet" as the original wording didn't make sense.)

Two working meetings involving the Creditors Committee and its legal consultants will be held in preparation for a meeting at the end of February at which the wider group of creditors will be asked to give their final agreement to the legal documentation for the restructuring.  It's been agreed  in principle that the first meeting will be held on 8 February to agree the final draft of the legal model (documentation?) for the plan.  At this meeting two of the members of the Committee will be formally delegated to work with the legal consultants on finalizing certain technical details.  As per the article, it's been agreed that Lloyds Bank will be one of them.  A Kuwaiti institution will be chosen as the other. (Presumably,the choice of a Kuwaiti and an international firm is because implementing the plan involves steps in both Kuwaiti and "international" jurisdictions).  The article notes that the Committee's legal advisors intend to consult with these two firms and obtain their advice on numerous non legal technical points related to the transfer of the assets, the mechanisms for doing so, and the location of the entities that hold these assets).

A second meeting will be held on 18 February to put the final touches on the legal documentation. And then a wider creditors meeting will be held at the end of the month.

Based on my admittedly a tortured translation (either I'm off my game or AlQabas' reporter is), some comments:

1. Clearly, the creditors have a sense of urgency to get the deal done.  They are not waiting for CBK approval of the financials. This urgency is probably driven by two things.  First, having labored so long to get approval from a majority of creditors, the Committee wants to bind that approval through the signing of definitive documentation.  The longer this takes the more chance  that some creditors will withdraw their previous approval. Some approvals already may be contingent on agreement before the end of February or some other uncomfortably close other deadline.  Second, the creditors have evidenced a keen desire to get TID's assets under their firm control, e.g., the request that the CBK to appoint a monitor at TID during the negotiations, the repeated comments about disclosure, transparency and corporate governance, the requirement that the Company appoint a Chief Restructuring Officer, etc. 
2. What is hard to understand is the delay at the CBK.   Given the importance of TID's restructuring, it would seem that the CBK would be working hard  to finalize its review. 
3. With respect to the meeting schedule outlined above, I wonder if  the plan is to sign the definitive legal  documentation for the restructuring at the end of February.  If that is the case, then it would seem that following the 8 February meeting, the Committee would send creditors draft documentation for comments with the meeting on the 18th designed to address any points raised and allow time for the circulation of a revised draft.  Then signing could take place at the end of that month.  If not, then it would seem signing would occur sometime in March.
   
4. What will be very interesting will be how the restructuring deals with the non signing creditors.   And how those non signing creditors will react.  Will there be a late rush to join the restructuring?  Or will these creditors pursue TID for payment in court?  A right it seems they retain in the absence of a legally enforceable "cram down" in Kuwait.   If so, it would seem highly likely that one or more of them would challenge the asset transfers because after the assets are transferred and pledged to the signing creditors, there will be no assets of any significant value left in TID with which to settle their debts. 
5. So successful meetings in February may not be the last act in this long running saga. 
6. In any case, besides potential lawsuits, at a minimum, TID will probably have to fulfill the same KSE requirements as Global Investment House: obtain shareholder approval of the transfer and pledge of assets and then request KSE approval before making the transfers.  It's hard to see how the KSE could or would want to cut a different deal for TID.
   

A Man's A Man

St. Michael's Cemetery, Dumfries Scotland.

1-3

Now is as good a time as any to say "argh" I suppose.

But, on to Wednesday.  Red and White!

Saudi Mortgage Law on the Way?

So says the Gulf News quoting Bloomberg quoting HE Muhammad Al Jasser, Governor of SAMA.

It might come as a surprise to many out there but there is substantial unmet demand for housing in the Kingdom.

This law will facilitate the mobilization of real estate finance, particularly for residential housing.  It will also provide alternative investment opportunities for local financial institutions.  

In 2006 Unicorn Investment Bank in Bahrain teamed up Standard Bank and the IFC to launch the first ever securitization of housing receivables in the Kingdom.  Here's the IFC's write-up on the transaction. It was a modest sized deal of some US$18.5 million.  But followed by further deals by UIB in 2007 (US$600 million and US$1,000) for Dar Al Arkan.  Here is the portal page to UIB's press releases on these transactions, if you're interested.

Saudi Capital Markets Authority Levies Fine on CEO of Sadafco

The Saudi Capital Markets Authority announced it had fined the CEO of Sadafco SAR 50,000 for disclosure of "inside information" on the company's 1Q 2009 earnings.  If I'm not mistaken the CEO of Sadafco is a non Saudi.  No name was given in the announcement and so I'll refrain as well from providing a name.

Of late the CMA has been increasing the pace and rigor of its monitoring and enforcement actions.

Kuwait: Central Bank Governor Tells Investment Companies There Are Only Two Choices: Debt Restructuring or The Financial Stability Law

AlQabas reports  that the Governor of the Central Bank of Kuwait delivered a short and sharp message to Kuwaiti investment companies at his last meeting with them.

He is reported to have told them that they have only two choices in front of them.  Accordingly, they should abandon pleas for increases in liquidity, the lowering of interest rates, or the purchase of company assets.

Instead they have to choose from one of the two courses of action:

1. Agree a rescheduling with their lending banks.  Some investment companies have done this which proves it is not impossible. It's incumbent on other firms to begin this process.
2. Submit themselves to the Financial Stability Law mechanism.  He noted that to date there have been no cases so one cannot say what the results will be.  

He criticized companies for failing to confront and disclose their current situations.  A fact that he related to the size of their problems.

What's clear is that many of these companies are still in denial about the extent of their problems.  And that they are in the typical borrower's "delay and pray" mode.  If I don't formally recognize the problem, it doesn't exist.  Maybe a miracle will happen.  Asset values could reach their previous heights.  The government will launch a bail-out.  Sadly, this has happened enough times in Kuwait to make this a credible strategy.  A profound sense of citizen entitlement - even when unjustified - is one of the legacies of a "rentier" state.  And of course, local banks who funded these wise investments similarly are looking for a way out of the predicament.  So there are two sets of voices calling for a government "rescue".

Dubai World's Consolidated Assets More Than Twice Its Consolidated Debt: So What?

 

 

You've probably seen the press reports carrying the "good news" that Dubai World's assets (even after the market decline) exceed US$120 billion and could therefore easily "cover" its debt of US$57 billion.  Here's one sample.

The original article is here in Al Ittihad.

As you might expect, I've got some comments on the headline.  More on that later.  In the interim,  two words neatly sum up my reaction: "so what?"

But first to the real meat of the article: a discussion of the restructuring negotations.

Quoting an unnamed source, the article states that DW has been involved in intensive negotiations with its creditors and has achieved "tangible progress" during the past 25 days.  Creditors have reportedly shown "positive reactions" to the proposals submitted by DW.  The Company is concentrating its efforts on convincing creditors of the high probability of success because of two key factors.  Sadly, only one of them is mentioned in the article - the durability of its real estate and investments assets which have begun to demonstrate recovery of value recently.  The strategic nature of investments was noted.  That would I suppose make the financings that support them "strategic" as well as the repayments.  I am not certain, though, if the margin on such a loan would be strategic or just tactical.  One hopes that DW does not consider itself a "day trader".

The article then states that DW is focusing restructuring on its two "real estate" subsidiaries: Nakheel and Istithmar (?: I think Istithmar has wise investments in a variety of non real estate ventures).  Specifically mentioned as being excluded were Dubai World Ports, JAFZA, and Dubai Drydocks - all of which are recording "excellent operating results despite the world financial crisis which has affected world trade and transport."  Hopefully their bottom lines (net income) are doing equally well.

No mention of a formal request for a debt standstill.  No mention of any sort of draft proposals.  It still seems to me - despite this article - that progress is painfully slow.  And largely at the "touchy - feely" stage.  With nothing concrete to respond to, bankers are of course going to evidence all sorts of "positive reactions", especially if the coffee is good.  Or reactions that might be interpreted as positive because since they have nothing in hand concrete, they have not rejected anything.

Of course, such negotiations are not going to be conducted in the media.  It's going to be difficult enough herding the creditor cats.  But one would expect that some news beyond this rather superficial account would be in the press if really serious results had been achieved.  In that regard, it seems to me that securing the debt standstill is a key initiative.  This should be the easiest to achieve of all that will have to be done.  Once done, it is a visible milestone.  An accomplishment that gives a bit of psychological momentum to the process.  We've seen the opposite of this effect at The Investment Dar - where the standstill process has been a negative rather than a positive.

That being said, Mr. Birkett is an expert in this field so clearly I am missing something. I sure hope so.

Now to my comments.

It makes no sense to talk about the consolidated assets of Dubai World versus its consolidated debts unless those assets are going to be applied to the US$22 billion of debt to be restructured.  To do that Dubai World needs to take certain steps.  If it does not, then lenders to Nakheel or Istithmar have cold comfort from assets at Dubai World Ports or any of DW's other subsidiaries.

Why?  Two words (actually five):  "A will and a way"

The Will:  The article itself reconfirms what DW has said earlier.  It is restructuring these companies. The other companies and their assets are outside the restructuring.  Just as the fact that Shaykh Mohammed is the owner of DW does not mean that his personal assets are available to pay or support the restructured debts.  DW has evidenced no desire to make these assets available. 

The Way:  But, more importantly, is the way this would be accomplished.  In that regard it seems there may be some confusion about a very fundamental issue:  the difference between an economic entity and a legal entity.  Understanding this distinction is critical to understanding the "way".

Consolidated financials do not represent a legal entity, they represent an economic entity.  DW Group is not a legal entity.  The legal entities in the Group are the various subsidiaries (and their subsidiaries and so on) and the parent company - Dubai World Holding.  The Group is a combination of all these legal entities into an "economic" entity. From a legal standpoint it is a fiction.

Legal entities - not economic entities - own assets.  Legal entities - not economic entities  -enter into contracts, including those for debt. It is the wise lender indeed who understands precisely what assets  the potential borrower owns.  And then reacts appropriately to that understanding.

As a holding company, Dubai World legally owns shares in Dubai World Ports, Nakheel, etc.  It does not directly own the assets of these companies.   Those companies do.  And, if they are holding companies, this same pattern repeats itself.

At each subsidiary level there are a variety of legal relationships and requirements governing those assets.

First, in a liquidation, each and every creditor of that subsidiary gets paid back before the shareholder gets a single fil.

Second, any transfer, pledge or other disposal of an asset owned by that company (the subsidiary) is subject to the completion of legal steps as required by the local law in the jurisdiction where that company is incorporated and where the asset is legally domiciled.  This is both a matter of corporate law (which governs how corporations conduct their affairs) and of laws setting forth the legal requirements for a sale, pledge, etc.  For example, if a US company owns an asset in England, then both US and English law will govern what is needed to be done to dispose of or otherwise deal in that asset. In some cases assets may be subject to additional requirements, such as those imposed by financial exchanges (stock markets), etc.

Third, contracts can create new requirements beyond those mentioned above.  For example, any sensible lender puts covenants in its loan contract restricting the borrower's ability to pay dividends or to transfer, sell  or pledge its assets.   Loan agreements typically include financial ratios (debt to equity) etc. which the company must maintain.  To do so the company has to take or refrain from taking certain actions.  A properly structured set of ratios can impose all sorts of constraints on a company - constraints that if enumerated might require volumes. 

Some hopefully illustrative examples.

Let's look at the 2008 financial report of JPMorgan Chase.

Total consolidated assets (of the economic entity, the JPMC "Group") are an impressive US2.2 trillion. (page 131).  Total assets (of the legal entity JPMC, the holding company) are US$436 billion (page 225).  20%!  As you look at these assets, you notice "Investments in Subsidiaries" is a major category.   It is here that JPMC the Holding Company's ownership (through equity shares) in the separate legal entity JPMorgan Bank, NA is reflected. 

And, it's important to note, that at these subsidiaries, the same pattern may apply.  Think of DW's subsidiary, Istithmar.  It owns a variety of investments, Cirque de Soleil, Barneys, etc.  Each of which is a separate legal entity.  In fact, it probably owns these companies through one or more intermediate holding companies (for tax and other reasons).  When Istithmar's NY hotel got into trouble, lenders were not able to force Istithmar to pay (as it had apparently not given a guarantee for the hotel's debt).  Nor could they attach assets at the Cirque  - taking, say, the lead acrobat or his safety net.

How then does a lender get access to the assets?

An indirect way is to get the holding (parent) company to give its guarantee.   This establishes the holding company's obligation to pay the loan if its subsidiary does not.  However, it gives only an imperfect and indirect access to the assets.  The lender is an unsecured creditor of the holding company, which as indicated above has its main assets in shares of other companies.  If the holding company defaults, the lender can take possession of the holding company's shares in the subsidiaries.  However, as a shareholder, the lender still remains subordinate to all the creditors at those subsidiaries.   In effect the lender has merely "stepped into the shoes" of the shareholder.

A "better" way is to get the subsidiaries themselves to provide a guarantee.  In this case then the lender becomes a creditor at the subsidiary level and has the direct  lender's access to the subsidiary's assets along with all other creditors of that subsidiary.

There are a variety of issues involved in implementing these two previous steps.  The most important of which is establishing the legal basis for the giving of the holding company or the subsidiary's guarantee  so that it is legally binding on the subsidiary.  "Consideration" in English or "US" law terms.  Other issues would be the existence of any restrictions put on the subsidiary by its existing creditors to prevent just such actions - out of their own concern to maximize their share of the company's assets.

Orion Holdings Overseas - "Unauthorized" Trading and Corporate Governance "Shortcomings" Led to Collapse

A bit more information has come to light about the causes of the meltdown at OHO via an article in The National: at least US$20 million of unauthorized trades in gold and other commodities including oil.

That sounds familiar.

"It's hard to understand how this happened.  If OHO's main lines of activities were brokerage, fund management and technology, that is a great deal to lose in this period, even given the economic meltdown.  Was OHO taking proprietary positions that turned against it?  Was it trading in oil?  Or other commodities?  OHO was a member of the Dubai Mercantile Exchange."

However, a "mere" US$20 million in losses should not have caused the collapse of a company which  was valued at some US$263 million in February 2008.  The losses would have had to been more, a lot more.  Or it would have to be that the company had a lot of assets whose ultimate value proved to be much less than their carrying value. Or some combination of these and perhaps other factors.

That's not the only thing in the article that I'm having difficulty getting my head around.

1.  Shareholders' Blame Game - This seems to contradict the statement that "management was gambling with the firms' money".  Unless of course some shareholders felt that management was acting on the instructions or with the acquiescence of some of the other shareholders.  And were therefore asserting that that shareholder had a liability to make them whole.  Otherwise, it would seem the shareholders would have a very compelling shared interest to protect their dwindling investment by cleaning house of the culprits in management.  There is also the "testimony" from Shuaa that it was not involved in the management of the company.   Was no other shareholder?  Not even the largest? If so, what then is the basis for Shuaa's legal action against  the Chairman and Petra? 
   
2. Risk Management Report - The article seems to question whether the Board saw the report.  The Chairman says that he resigned in protest of the Board's failure to respond to the report.   It seems plausible that before resigning he would have raised the topic with the Board.   And then it would seem equally plausible that they would have asked to see the report if they had not.  One might also wonder if Sami Boujelben wouldn't have "rung up" the board members as part of the professional discharge of his duties.  Now, if at his resignation, the old Chairman did not agree to allow other parties to select his replacement, his resignation did not diminish his company's control over the number of seats on the Board and thus over OHO. It was then only a matter of changing a face.  Another set of questions regarding corporate governance and risk management focuses on the losses themselves.  Once they occurred, did the Board not receive and review financial reports?  Did the CEO or CFO brief the Board on the financials, including the losses?  If the Board wasn't getting periodic copies of and verbal reports on the financials, then there are some rather potentially difficult questions for the Board about how it implemented corporate governance.
   

What is presented raises more questions than it answers - at least for me.

The shareholders of OHO are primarily institutional investors.  They are not small unsophisticated retail investors hoping to turn a quick buck on their shares so they can buy a refrigerator (as one punter on the Dana Gas IPO told the press in Bahrain).  Thy had placed serious money on the table.  It was evaporating.  They did nothing? 

It seems there must be something more to the story.  Just as the US$20 million loss doesn't fully account for the financial distress the company now finds itself in, the corporate governance  related comments here don't seem to as well.

Another interesting bit from the article and that is the assessment that Shuaa over reached in its private equity investments and will be retrenching to focus on more core business of brokerage.

Finally, other investments as well as the general market trend are responsible as well for the decline in Shuaa's share price. It's not just OHO. When Shuaa issues its year end detailed audited financials, it will  hopefully be possible to quantify in part the relative contribution of each investment to the provisions and the loss.  No doubt,  the debacle involving the convertible and Dubai Group also played a role. 

"Mastermind" Attempts to Defraud UAE Central Bank

A thoroughly engaging story of an Asian "mastermind" who attempted to defraud the Central Bank of the UAE.

I remember watching Mastermind India on the TV.   Sid Basu.  The Hot Seat.  Your time starts now!   Even the losers were formidable.

Nothing like this story. 

I think the appropriate reference is "The Weakest Link".

Saudi Zain - Just What Did It Miss? Financial Covenants Not Payments

You've probably seen reports that Saudi Zain missed "commitments" under its US$2.6 billion  equivalent "Islamic" facility.  The natural assumption was that these were monetary commitments, e.g., principal or interest payments.

On Saturday, Saudi Zain's CEO, Saad AlBarak, told AlArabiyya that Saudi Zain missed certain EBITDA targets mandated by the facility.  Zain's lenders have waived the breach of the covenants in 2009 and required the company to provide a revised set of targets for 2010 for their approval.

EBITDA is bankerspeak shorthand for earnings before  (the payment) of interest, taxes, depreciation and amortization.  EBITDA is an attempt to capture the ongoing operating cashflow of a company.   Loans and other debts are settled with cash not net income which is accrual based and can often differ significantly from the firm's actual cashflow.  

Lenders include covenants like EBITDA targets as requirements in loan agreements for two reasons.

First, they provide a set of monitoring tools of the company's performance.  In this  case, the EBITDA targets help lenders to determine if the company is earning enough money to settle its obligations, including their loans.  

Second, since these are covenants, a failure to meet them by the company constitutes an event of default under the facility.  In that case banks have the right (but are not obliged to) to declare the borrower in default and accelerate the due date of the loan.  There are two reasons for using such covenants.  First, the covenants and the threat they might be used will focus the borrower's management on doing their utmost to make the company perform.  Second,  if the borrower does not meet the target, the banks have the right to accelerate the loan, if they want.  In such a case they can  require immediate repayment before value in the company is eroded.

It really does pay to be careful with press releases that contain disclosure that one has missed a covenant.  For some inexplicable reason the market gets excited about that sort of thing.  And when the wording lacks clarity the market imagines the worst.  It's also doubly important when one's auditor has included a matter of emphasis statement in his report as this should make any sentient creditor nervous. 

One might state that this sort of poor communication shouldn't happen.  As an old hand in the region, AA has gotten to the point of just hoping that it doesn't occur.

Mr. Obama's War

I read with alarm the news in the press that President Obama has declared war on bankers.   Apparently a sudden shift in his previously benign policy.  It seems that he now proposes imposing limits on the activities that banks may engage in as well as taxes on and other measures affecting bankers' compensation.  Joining in this coalition of the willing in at least  some of the theaters of operation are not only stalwart allies of the recent past but even some  of those previously feckless elderly Europeans.  Or at least so I am told.

The generally sober financial press that I read is beside itself with dire warnings.  It appears our very way of life may well come to an end.   Once again the lights in London and perhaps all of Europe - or at least their financial districts - are going out. I've read stories of huddled masses of bankers yearning to be free, setting sail from London for Asia to escape tyrannical taxes.  In these darkest of days, a few brave (financial) patriots have mounted the ramparts.  Suitable jeremiads  thunder from the editorial and op-ed pages as well as from what are labeled the news columns.  In the temples of finance, high priests perform ancient and powerful rituals over the entrails of distressed subprime loans and derivatives to cure this blight.  The books of Adam Smith are scoured for the right incantations, ignoring as usual the inconvenient "bits". 

Nearer to home, dark rumors have begun to circulate - a Kadaververwertungsanstalt for bankers has opened.  Since I don't have a subscription to either The Times or The Wall Street Journal, I haven't yet seen conclusive proof that it is in operation.   But then neither have I seen that it is not. And that perhaps is the most disturbing thing of all.

As a result, as a member of the banking guild, I am being more circumspect than usual when I leave my home and leaving more infrequently.   And, while at home I listen carefully for the black helicopters, though I am told they are very, very quiet.

On the other hand, much of the accompanying editorial comment in these same papers says that Mr. Obama cannot achieve victory.  Clever bankers will find ways around these new rules as they did the old.  Apparently, a populist surge holds little prospect of success.  Since the syndication of American Idol, there is little chance of a sahwa.  Rather than "stay the course" the only course of action these defeatist voices advocate is the immediate, unconditional and unilateral withdrawal of US forces from Wall Street. 

I am of two minds on this.

As a banker, the message that our way of life is not really under a serious threat at all is admittedly a comfort.  I also take solace in the demonstrated gap between previous rhetoric and reality.   

But, as a citizen,  I do worry that if we do not fight them over there on Wall Street we may end up  fighting them over here - on Main Street.  Any sign of weakness or hesitation is sure to embolden this already fearsome foe. 

Yet, all this remains quite confusing.

On the one hand, I am told this unjust war will lead to the end of the happy world we now know.  And therefore am suitably scared as I believe is every good citizen's duty.

On the other hand,  I am assured that it is all just a meaningless exercise that will be thwarted by the genius of the free market.  And, if needed, by the timely insertion of one or more brigades of the 101st K-Street Rangers equipped with the latest in both "smart" and "stealth" donation technology.

It is hard to know what to do. 

Caution would seem to be a wise tactic at the moment.

I am keeping a low profile.

I may grow a beard.  Or shave one off.

Borse Dubai - More on US$2.5 Billion Loan and Its Implications

A slip at Suq Al Mal.  In my last post I didn't deal with the background to the US$2.5 billion  loan.  And its potential implications. 

As I like to say, often the details of the story are more or equally interesting  as the story itself.  I should pay more attention to what I say.

With that as background, here goes.

First, where did this loan come from?

In 2007 both Nasdaq and BD submitted bids for OMX, the Swedish exchange.  BD topped Nasdaq's US$3.8 billion bid with one of its own for US$4.0 billion.  Subsequent negotiations among the parties led to BD and Nasdaq agreeing a strategic partnership.   BD was to sell the shares it had acquired in OMX to Nasdaq while at the same time purchasing from Nasdaq some of its shares in the London Stock Exchange and taking an interest in Nasdax/OMX.  When the dust settled, BD owned 19.9% of Nasdaq OMX and 22.2% of the LSE.  Nasdaq acquired OMX.

To finance the deal, BD incurred obligations (which included a guarantee facility) in the aggregate amount of US$3.8 billion equivalent. 

In February 2009, BD announced it had successfully raised US$2.5 billion to refinance these earlier facilities.  At the time this was touted as a sign that credit was available to Dubai Government linked entities, even though on less favorable terms than earlier.

How successful was the US$2.5 billion refinancing?

The earlier financing was multi-year and carried interest rates between 0.7% and 1.3% per annum.

The new financing was at 3.25% per annum (roughly 2.5X taking the maximum margin on the old facility).  The tenor of the new facility was for one year as opposed to the multi-year tenor on the previous.  Though the new loan gave BD the option to extend the loan another year.

Even with the higher margin and shorter tenor, the refinancing was only completed because government owned banks in the UAE joined the deal.

The participating banks included Bank of Baroda, Dubai Islamic Bank, Emirates Bank International, HSBC, Industrial and Commercial Bank of China (Asia) Limited, ING Bank London Branch, Intesa Sanpaolo Dubai Branch, National Bank of Abu Dhabi, Skandinaviska Enskilda Banken, The Bank of Tokyo-Mitsubishi UFJ, Ltd. and Union National Bank. 

What does the recent extension of maturity tell us about the acceptability of Dubai Inc credit in the market?

The cost of BD exercising its option was 0.75% of the loan amount.   I'm guessing this was paid up front.  This effectively represents an increase in the margin to 4%.  (Technically, assuming the fee is in advance and interest is normally paid in arrears, the effective margin on the loan is 4.025% p.a.).  If BD were able to borrow at a rate lower than 4%, it would have.   It did not.  Probably there were no real takers for a new loan because it would have made sense for BD to pay above 4% to secure term financing.

The refinancing hasn't really solved BD financing's "problem".  It has merely been pushed out 12 months.  Since the loan finances long term presumably strategic investments, it should be financed with term debt.  But there is more at stake here than short term refinancing risk. Or finance theory.

Why? 

Because of the rescheduling of Dubai World. 

If a rescheduling deal is not struck, it is unlikely that there will be banks willing to make a new loan in to a Dubai Inc entity.  And thus this loan will loom as a potential second rescheduling.  And complicate refinancings of scheduled maturities at other Dubai Inc entities.  And the raising of new financing for new projects.

If, on the other hand, as some commentators appear to believe, Dubai can dictate the terms of the restructuring, banks are going to react with pronounced shyness on new loans to avoid getting shorn again.  A lesson they should remember for at least two years.  And there will be the same implications for refinancings and new financing as above. 

Dubai Inc is, therefore, under intense pressure to conclude a reasonably acceptable restructuring quickly. 

So far there have been no apparent signs that Dubai is moving forward with any concrete action. 

Perhaps it is working feverishly behind the scenes to craft a deal.  Perhaps it hopes to jam the banks. by waiting until the last minute and hoping the pressure of an artificial deadline will cause them to roll over.  Perhaps it doesn't realize how critical time is.  Perhaps, it's just overwhelmed an the enormity of the task.  Perhaps I'm missing something. 

If it is not already doing so,  the Emirate needs to begin to move forward smartly (in both senses of the word) right now.

Ring in the Old: Part 1: Suq Al Manakh - The “Boom”

Symbol of the Suq Al Manakh Building

As promised earlier, a bit of background on the Suq Al Manakh market ("SAM").

The Previous Crisis: The Kuwait Stock Exchange 1977

In 1976 the (official) Kuwait Stock Exchange ("KSE") witnessed a dramatic increase in value. The market rose 135%. Some 176 million shares were traded versus 172 million the year before and 37 million in 1974.

Stocks were traded on both a cash and post dated check basis. Cash payments were at the current stock price. If the buyer wanted to pay in the future, he gave a post dated check. That is, the check would be dated for a date in the future. In effect the seller was granting a bi-lateral loan. The check would be for cash price of the shares (spot price) plus an agreed premium – effectively the interest rate on the loan. And just as in the typical "hire purchase" scheme, the seller delivered the goods (in this case the stock) ahead of the payment.

It's important to mention that in most GCC countries writing a check without cover isn't just a matter of bad accounting. It is an offense punishable by imprisonment. If one's account does not have sufficient funds and the bank refuses to pay the check and returns it to the presenter (in bankerspeak it "dishonors" the check),  jail beckons. On the other hand, if it allows the overdraft and creates a loan, jail vanishes. Generally dishonored check cases are relatively simple matters to adjudicate. The dishonored check is presented.  On its face it is both conclusive evidence and one's admission ticket to jail.

It's very important to understand the critical role of post dated checks in causing the crisis. The fundamental difference is that post dated checks operate outside the banking system. They are purely private transactions.

Within the banking system there are checks on the creation of credit. Authorities place limits on the total amount of lending a bank can undertake based on a leverage ratio.  At that time total assets to total equity.  Often they also set a loan to deposit ratio. Total loans may not be more than  some percent (usually less than 100% - at least in prudent jurisdictions) of total deposits. They also set maximum lending limits to individual obligors expressed as a percentage of capital - usually no more than 25% and more often 10% to 15%.  They specify the types of assets that may be taken as collateral.  In addition the banks have their own credit underwriting process. While as repeatedly demonstrated in Kuwait, this process has been deficient in many respects, it was still a hurdle to be crossed by a would-be investor.

As a purely private non banking form of credit, post dated checks were not subject to Central Bank of Kuwait restrictions on their creation. No ratios, no limits, nada. In theory the amount of loans that could be created was infinite. All that was required was a pen, a stock of checks and the acceptability of one's good name.

On the KSE this led to a dramatic increase in liquidity. With easy cash, investors could make a lot of wise investments. As noted earlier the market rose 135% in 1976.

In 1977 the KSE crashed. Shares declined roughly 40%. There was a severe knock on effect in the Kuwaiti economy.

The Kuwaiti Government took several steps to address the crisis. It bailed out investors by buying their positions at the lowest price during the 2.5 month period preceding the crash (which was the absolute peak of the market). The cost was KD150 million. As well, the Government temporarily suspended the creation of new Kuwait stock companies (KSC's) and halted the trading of other GCC shares on the exchange. However, no prohibition was put on the founding of closed Kuwaiti stock companies ("KSCC's"). At the time that seemed reasonable since by law the shares in KSCCs are not allowed to be traded until three years after the date on which the company was officially founded (the "lock-up" period). The authorities also placed fairly strong restrictions on the use of postdated checks, given their role in the crash.

The Suq Al Manakh

These moves restrained trading opportunities on the official exchange. Investors wanted to invest. Punters wanted to punt. So an alternative market sprang up in the Suq Al Manakh complex (whose front door is the masthead picture on this blog). The building itself is like many of the older small "shopping" malls in the GCC. Lots of small offices and shops. The ground floor was primarily real estate brokers – another local investment passion.

Because the trading of Kuwaiti stock companies (KSCs) was restricted to the KSE, the SAM specialized in the trading of Gulf Companies (companies established in other GCC states, primarily the UAE and Bahrain) as well as KSCCs. You will note that from its inception the SAM was engaging in what were illegal activities – the trading of KSCCs prior to the end of the three year "lock-up" period.

The SAM began operations sometime during the summer of 1979. As with the original KSE, real estate brokers were the first share brokers on this "exchange".

A major flaw was that there was no official regulation or oversight of the SAM, not to say that the KSE was then or is now known for its robust oversight and regulation. This not only affected the quality of securities traded on the market but also the practices associated their promotion as well as more mechanical operational issues. There were no uniform settlement and clearing procedures. There was no centralized record keeping system. Most trading was bi-lateral and dependent on the practice of the broker used. Deals were documented in the form of IOUs, post dated checks, and various other records of uneven quality and clarity. This lack of agreed trading procedures was later to greatly complicate matters when the SAM collapsed.

Like the KSE in 1976, trading was on a cash or a post dated check basis. At the beginning, the premium on such checks, the amount over the cash price reflecting the "interest" on the loan, ranged from 40% to 60% p.a. Clearly expected increases in the price of the stock had to be more than the certain premium for this method to be used. To "protect" themselves, purchasers of shares often immediately sold the shares they acquired in the spot market and used the cash received to buy other shares which they then sold on post dated check basis. Maturities were set so that their new sales would mature prior to the maturity of their own postdated check obligation. As such, they would have the funds to settle that obligation plus a neat profit. This works flawlessly as long as the market keeps moving up and as long as their counterparties fulfill their obligations.

While post dated checks had fueled a significant growth in liquidity in 1976, now they caused liquidity to explode. Liquidity drove prices to unbelievable heights with 100% returns not uncommon. Price increases of course "proved" just how great the investments were. Trading increased. Substantial (paper) profits were declared. Trading ramped up further. Even the KSE was affected.

Little focus was given to fundamentals. Investors demanded new investment opportunities. Kuwaitis began incorporating companies in other Gulf states (primarily UAE as well as Bahrain) to satisfy the demand. At the end of the market some 40 or so of these "Gulf Companies" were traded on the SAM. New Kuwaiti Closed Share Companies were created. Many of these began as real estate companies. At least that's what their founding documents said. But seeing the great opportunity in the financial market they quickly began investing in and trading shares. (Remember this point for later). Most of these firms had no business, no assets, no income, and no profit. Many published no financials. Yet, prices continued to climb. At one point the SAM and the KSE had trading volumes in excess of the London Stock Exchange.

My favorite story is that of Gulf Medical, a non Kuwait GCC company, which IPO'ed during the height of the frenzy. Originally founded as a real estate firm, things didn't work out so well in that endeavor. So the owners rebranded the company and offered its shares on the SAM. It was 2,600 times oversubscribed. After launch, it quickly went up approximately 790%.

Now in the Gulf when you subscribe for an IPO, you are required to make a deposit for the full amount of your subscription. How does one finance such large "tickets"? Well, one's banker is one's friend – at least until the due date of the loan. Banks happily advanced funds requiring only a small cash deposit. They knew that their loan was largely secure because the investor was likely to get only a small fraction of his requested amount. If the downpayment were equal or greater than that amount, the bank had nothing to worry about. And, as everyone knew at the time (except one really smart guy at the National Bank of Kuwait), this time it really was different. So even if the investor got all the shares, he could simply sell them and liquidate the loan. If not, the bank would take the shares, sell them and repay the loan. The bank then saw a risk free loan, though it did not offer the client the risk free rate on the loan for some inexplicable reason. As attractive as the interest was, the subscription fees - generally taken on the full amount of the subscription – were even more mouth watering. (Remember that bit of the deal economics: the fees dwarf the interest on what are essentially two week loans). At the end of the subscription period, the investor got his allotment. The bank had the excess funds returned to it and settled the loan after deducting its interest. Everyone was very happy.

As you probably have guessed, investors' practice of oversubscribing led to even greater levels of oversubscriptions. It was a bankers' (and fools') paradise.

With this sort of a compelling financial story and after careful and sober analysis, many of the local banks began lending against shares. Generally to "investment" companies so they could make a wise investment in these shares. And some highly creditworthy individuals. Many of whose most bankable collateral was their excellent family name. What excellent collateral these stocks proved to be. At least initially. With each passing day their prices increased. The collateral coverage on the loans increased. Why one might even increase a loan against this collateral so that one's client could make more wise investments.

Only one bank kept its head, the National Bank of Kuwait. From what I've been told it was Abu Shukry (Ibrahim Dabdoub) who recognized the irrational exuberance all around him for what it was and kept his bank out of the party. Even though the music was playing, Abu Shukry didn't dance. Other banks were not so restrained.

Accompanying the "boom" in the market was a boom in the premia. From 40% per annum to 70% then 80%. By 1982 the premium had risen to 200% and before the end of the saga 400%.

Everything was going really well. Or so it seemed.

A footnote on numbers: Since record keeping was not one of the Suq Al Manakh's strengths, many of the statements involving numbers are no more than estimates.  I've seen articles that state with certainty that 42 Gulf Companies were traded on the SAM. Absent a central clearing system, I'm not sure how one can know with the level of certainty required to use that degree of precision.  The same with premia on what were essentially bi-lateral deals.  The premia were whatever the two parties agreed. So I've used formulations like "about", "roughly", and "approximately" to indicate that these are not hard and fast numbers.