IMF Managing Director Less Sanguine About Financial Stability Than Federal Reserve Chairwoman

As per CNBC, The International Monetary Fund's Managing Director, Christine Lagarde, has said that she would not rule out another financial crisis in her lifetime, indicating that comments made recently by Federal Reserve Chair Janet Yellen may have been premature.

"I plan on having a long life and I hope she (Yellen) does, too, so I wouldn't absolutely bet on that because there are cycles that we have seen over the past decade and I wouldn't exclude that," Lagarde said.

In this debate AA's money is on CMOL.  Hope yours is too.

Tip of AA's tarbush to CNBC for the phrase "may have been premature".

Previous post on Ms. Yellen here.

Dana Gas Restructuring: Creditors, What Then Is To Be Done?

As outlined in previous posts, the creditors face two key issues with the restructuring:

1. Obligor Attitude:  If there are not already serious concerns about the obligor’s integrity and willingness to pay, then there should be.  The situation is similar to that of The Investment Dar Kuwait.  Back when it became evident that TID was headed for a restructuring, if not the shoals, its creditors petitioned the Central Bank of Kuwait to appoint an official “minder” to keep an eye on—or more accurately to “control”— TID’s management.  CBK did not.  By contrast creditors did not ask for one in the Global Investment House (Kuwait) restructuring a similarly uncertain large ticket exercise.  As DG is a commercial company and not a financial institution, there’s not even the extremely slim possibility of CBUAE intervention.  Creditors are “on their own”.  That has important consequences for what they should do.
2. Obligor Aptitude: Glacially slow collection of receivables and an apparent chronic weakness in operating cashflow indicate that the obligor is unlikely to repay principal and interest within the proposed five-year tenor. Factors largely outside DG’s control.  The path was cast when DG embarked on its business in Iraq and Egypt.  Given these facts, creditors are likely to find themselves in another restructuring “adventure” with DG in five years’ time.  Therefore, minimizing that future exposure should be a key goal. 

Что делать? 

In framing this post, AA looked to inspiration from other authors who wrote similarly titled pieces, though hopefully this post is free from excessive utopianism.  As you'll notice one such author is missing.  I believe he was in heated exchange on call-in program with the Governor of New Jersey when I called.

In any case, here's are potential steps that AA believes creditors need to take based on the assessment that protection of creditor interests requires measures beyond the usual ones in a restructuring. 

1. Legal steps –recast the deal or elements of the deal to reduce/eliminate exposure to Abu Yusuf-ery legal maneuvering by the obligor.  While this is an important step, it will not be sufficient to protect creditors’ interests.
2. Collateral – get more and to the extent possible, take possession now rather than relying on the exercise of legal rights to deliver it later when Abu Yusuf may have come up with even more clever arguments.
3. Amortization – use interim scheduled principal repayments plus a cash sweep to achieve reductions.  With DG’s weak/uncertain cashflow getting dollars now is wiser than waiting five-years as the past ten years unequivocally demonstrate. 
4. Tenors – Shorten to keep DG’s and your minds focused on repayment.  A five year bullet moves the payment far enough into the future that focus is lost: repayment is a lower priority, particularly for DG.

Legal

Transaction documents are meant not only to set forth the obligations and rights of both parties so there is no ambiguity, but also to provide protection by providing recourse through court ordered enforcement of the agreement if one party cannot fulfill its contractual obligations or decides not to.  DG’s maneuver in Sharjah and other courts to declare the Sukuk contract “illegal and unenforceable” shows the practical limits of that strategy. 

One response would be to change the form of the replacement contract.  If “Islamic” transactions are uncertain, then a conventional (non-Shari’ah) transaction would seem preferable.  If a starving Muslim may eat a ham sandwich in order to avoid death, then it seems to me that if confronted with an obligor that may not be trustworthy as originally assumed and uncertain protection from the courts, a Muslim creditor could legitimately change the form of contract to a non-halal one.  This is important because as shown with the English and BVI courts actions, non-GCC courts are likely to show deference at least initially to areas beyond their competence, e.g., the Shari’ah.

A less severe approach would be to recast the debt obligation into another form of “Islamic” transaction as discussed below.  Perhaps, the transaction could be split into two?  One tranche for only principal repayments in which case Shari’ah or non-Shari’ah distinctions might not apply. Or in other words, the first tranche would be both.  The second an Islamic structure for "profit" (interest), hopefully limiting opportunities for future Abu Yusuf-ery.  Dealing with default interest could be difficult, but creditors are going to have to make some hard tradeoffs following their initial and unfortunate underwriting decision. The ability to ensure cross default would be another key consideration with this no doubt utopian strategy. 

Other actions would be to ensure that entities critical to the success of repayment were incorporated and active in jurisdictions believed to be more likely to give the creditors a fair shake rather than relying on the uncertain existence of a  fair shakyh in local GCC jurisdictions.  Reducing as much as possible the impact of local law on the transaction would be ideal. 

Alternatively, could the DIFC be the jurisdiction for the restructuring suitably structured as an offshore transaction?

But such steps are unlikely to be definitive, even if they are theoretically possible. 

In particular, Argentina’s or the Arab Bank’s recent unhappy experiences in US courts should suggest more than abundance of caution is warranted with reliance on legal jurisdictions as providing a “fair shake”. 

Collateral

On the theory that the “old” deal is dead, then a new deal needs to be struck.  So the door is potentially open to new terms. 

It’s often said that possession is nine tenths of the law.  This should be a guiding principal for the creditors.

A wise move would be what is in effect a pre-emptive exercise of collateral/security rights. That argues for the creditors getting possession/ownership of collateral now to be returned upon full repayment. Transfers of ownership would take place at the inception of the transaction not after a default occurs and potentially lengthy and uncertain legal proceedings are concluded.

A potential replacement structure is a sale/leaseback with DG responsible for operations, capex, insurance, third party liabilities, etc.    DG would sell these assets (by selling the stock in the companies) to the existing Sukuk holders.  The holders would then lease the assets to DG for an x-year period.  No cash would change hands as the “proceeds” of the sale/leaseback would serve to retire the existing obligation.  Sukuk repayment would come from lease payments where perhaps a fixed profit rate would pose less of a problem if Shari’ah structures were chosen.  Upon its successful retirement of the sale/leaseback transaction, DG would have a bargain purchase option to reacquire the assets.

Additional collateral.   Zora is now free from debt and generating cash. It is perhaps the most saleable of DG’s assets.  More (stale) receivables, assignments of proceeds from arbitral awards, ownership of the holding and operating companies for Egypt and the KRG. But unless Dana Gas Ventures BVI owns shares in Pearl, then the KRG operations are not part of the Trust Assets. 

Creditors can expect a robust reaction from DG based on the Trust Assets (TA) being the only security offered. So obtaining new collateral not related to the original TA will be extremely difficult.

If no new collateral can be obtained, then the creditors should take possession of the Trust Assets as outlined above.  If the lessee fails to pay, then the bargain purchase option would be invalid. The assets could be sold to third parties in whole or part.Or investment “adventure” in Egypt or the KRG. Bon chance!  Of course, DG or its shareholders could be given pre-emptive rights in any asset sales. 

Principal Reduction – Amortization

As indicated in my earlier post, the Company’s cashflow is highly unlikely to enable it to retire the debt over the mooted five-year tenor. Creditors could rely as they have over the past ten years on the Company’s promise for principal payment at the end of the next five-years bolstered by no doubt a rosy projection. 

Or they could more wisely include binding (such as one can bind DG) requirements for principal repayments.

With DG’s uncertain cashflow, it’s hard to come up with repayment scenarios.  But that doesn’t mean that the new deal cannot contain some required interim principal repayments before the final principal balloon payment at maturity.  

A key problem with this approach is that it requires faith in DG’s compliance.  Fool me once shame on you. Fool me thrice – we’ll you know the rest. 

A more prudent option would be to include a cash sweep with the required principal payment structure.  As cash came into a newly established concentration account controlled by the security agent (both account and security agent located in a more reasonable jurisdiction), the cash would be divided by the security agent according to a pre-agreed formula.  This mechanism ensures (subject to there being a cashflow) that creditors are not forgotten. Cashflow for the creditors under the sweep would be directed first to scheduled principal payments and then to prepayments.  That is, the sweep should not be limited to only the scheduled payments, but to as much as can be taken limited only by the outstanding debt amount. The point is get the cash now not later.  Creditors would be wise to eliminate prepayment penalties as debt collection is the key issue they face.   

There is another very real benefit to this arrangement.  Just as taking ownership of collateral at the inception of the deal makes it difficult for DG to frustrate creditor rights so does a cash sweep. Under the cash sweep cash would be given to creditors on an ongoing basis as soon as practical after it were received in the concentration account.  Creditors would immediately apply the cash against principal due.  It should be more difficult for DG to later clawback the cash already “swept” to the creditors compared to making some bogus assertion about the transaction becoming invalid due to changing interpretations and then not paying.  

Shorter Tenor

Restructuring at the same or a longer tenor defers the day of reckoning far into the future, particularly if an inadvisable bullet structure is used.  Far enough so that it’s not a priority for either. To avoid this unhappy outcome the maturity of the debt should be shortened.  The debt could be divided into tranches (cross default protected) with a maturity ladder, i.e., 1, 2, 3, 4, 5 years.  Or left as a single amount with 2 or 2.5 year maturity.  This would keep the pressure on DG and hopefully prevent the creditors from lapsing into unwarranted somnolescence. 

The shorter maturities would offer creditors the opportunity to reopen the debt to impose additional terms more frequently as it is highly likely that DG will require more than five years to repay the debt, absent a miracle.  And as AA was once told by a local GCC banker, the only "miracles" in Islam occur in the financial statements of Islamic financiers.

  

Dana Gas Restructuring: Full Repayment of Sukuk Threatened by Weak Cashflow

Looking for the Flow

In a previous post I looked at DG’s stale Trade Receivables, today let’s take a look at the company’s ability to generate cash. 

If the title hasn’t given away the plot, AA’s analysis is that it is likely to be insufficient to repay the Sukuk within five years absent a non-operating event. 

We’ll base the analysis on the “Consolidated Statement of Cashflows” in DG’s annual reports in lieu of developing a more formal model because the intent is to provide a directional rather than locational result.  

This is historic information.  

Why on earth is AA using past data? 

Well, there's nothing on the horizon to suggest a fundamental change in DG's existing business, collection of receivables, etc.  Zora would have to grow exponentially to make a difference.  If new business with better paying customers could be found in other countries, DG probably would be hard pressed to secure financing for a variety of reasons and such business, if finance were available, would take time to develop.

To set the stage a few words about accounting cashflow statements. 

1. There are two methods for preparing / presenting a statement of cashflows.  One (the “direct” method) is based on actual cashflows both inflows and outflows.  This provides better information for analysis. 
2. The second is (the “indirect” method) which begins with reported net income and then makes adjustments for certain non-cash items (e.g., depreciation, allowances for impairment, etc.) producing Gross Cash Flow from Operations (“GCFO” or “GO” in this post).  Then a set of further adjustments for changes in the balances of non-cash current assets and current liabilities, resulting in Net Cash Flow from Operations. (“NCFO” or “NO”).   An increase in a current account is a “use” of cash a decrease a “source” of cash.  It’s the opposite for current liabilities where an increase is a “source” of cash and a decrease is a “use” of cash.   Another issue net changes in account balances are used.  This masks actual cashflows, e.g., for receivables it’s the net of new unpaid billings and cash collections on all outstanding receivables.  It’s important to understand that GCFO does not represent cash collected by the company which it then “spends” to increase current assets (e.g., receivables).  What has happened instead is, for example, that some revenue included in accounting net income has not yet been collected.   
3. There is a way to refine the information from an indirect cashflow using notes to try and disaggregate the “net” changes in accounts.  I haven’t done that for the reason noted above.  

The chart below shows DG’s cashflow over an eight-year period.  Note the “traditional” approach to presentation has been adapted to fit the margin constraints on the blog.  That is, years are vertical rather than horizontal. 

Dana Gas Cashflow Analysis  -  Amounts USD Millions
	GCFO	WC + Tax	NCFO	Invest	Finance	Net CF		NO/GO
2016	145	-63	82	-111	-120	-149		57%
2015	345	-142	203	41	13	257		59%
2014	386	-284	102	-55	-67	-20		26%
2013	358	-233	125	56	-141	40		35%
2012	408	-231	177	-57	-67	53		43%
2011	434	-335	99	-93	-53	-47		23%
2010	285	-154	131	-126	-59	-54		46%
2009	176	-71	105	-31	-78	-4		60%
Total	2,537	-1513	1,024	-376	-572	76		40%
Average	282	-168	114	-42	-64	8		40%

Source:  DG Annual Reports

Some observations on the cashflow. 

1. Over the period 2009-2016, DG has converted only 40% of its Gross Cashflow from Operations to “cash”.  The main culprit over the period is a USD 847 million increase in Trade Receivables.
2. If the future is like the past, then NCFO is unlikely to be significantly different than the USD 114 million average over the past eight years.  Note:  NCFO does NOT include finance costs, e.g., "profit rate" (interest).  
3. So USD 570 million is a reasonable estimate of NCFO over five-years.  That's before investments and finance.  
4. If DG needs to maintain investment at average levels—USD 42 million per year—that leaves USD 360 million for debt service.    
5. Assuming annual level principal payments of USD 138 million a year at a 9% p.a. interest rate total payments are some USD 876 million over the five years.  At a 3% interest rate total payments of USD 752 million. 
6. At 9% the shortfall is USD 516 million (roughly 60% unpaid) and at 3% USD 392 million (52%).   
7. Full repayment of the USD 690 million in outstanding sukuk principal and interest therefore appears unlikely (first euphemism of this post) absent significant new developments.
8. One such development would be a fundamental change in cashflow generation from operations, e.g., Zora generating significant cash, Iranian gas sales finally occurring, highly profitable business in a new market.  
9. Another would be a non-operating event or events that change this unhappy picture.  The KRG and Egypt could pay their past due receivables.  The KRG or IRI might pay DG all or some of the USD billions they owe DG according to arbitral decisions.   DG could sell some of its assets with the proceeds directed to creditors. AA is ruling out—perhaps prematurely—DG purchasing a winning El Gordo ticket given DG’s steadfast self-proclaimed adherence to Shari’ah.  Though I suppose a providential re-interpretation of   الميْسِر  and 2:219 by the Company's modern day Abu Yusuf might occur.  An event perhaps more likely than the others outlined in this paragraph.

With this as backdrop, AA is preparing a “What Then Is to Be Done?” post for the creditors chock full of "sage" advice. 

Because AA suspects that the probability of fundamental changes in operations or the occurrence of a non-operating event is low, AA is reaching out for readers' assistance.. 

Readers who know of an Islamic equivalent to St. Jude Thaddeus Patron Saint of Lost Causes or suitable دُعَاء‎‎ are invited to post details.  All five mathhabs are welcome. 

This could be an important pillar of the creditors’ recovery plan.  It would be shame if it was not included.

Dana Gas Restructuring: Not So Current (Assets) Trade Receivables -- UPDATED

Not Snow Not Sugar

They say that "even Homer nods".  If a comparison is to be made with Homer and AA, it's more likely Homer Simpson not Homer. 

In my haste to release this post, I failed to include one very key detail.  

The KRG trade receivables are payable to Pearl Petroleum Limited not DG.  The use of the word "share" in DG's financials Note 17 and 28 is crystal clear. 

What does that mean?

• DG's is unable to sell the TR because it does not have title. There could be restrictions imposed by PPL's contract with the KRG on transfer of title or assignment of proceeds by PPL to a third party, here DG.  As noted elsewhere, certain unspecified actions by PPL require 100% shareholder agreement.  It is not clear if this is one of those decisions.  If it is, then another shareholder--perhaps from among the three 10% shareholders--OMV, MOL, and RWEST--might frustrate a transfer.
• As PPL is the payee/owner of the TR, any payments from the KRG go to PPL.  As such, there is the theoretical possibility that such proceeds could be trapped at PPL.  Presumably, PPL has been structured to avoid third party debt with shareholders providing any needed debt financing.  But there ae other liabilities that could interfere with the transfer of funds from PPL to DG.  For example, claims of environmental damages by the KRG, other contractual liabilities, or other third party damage, etc. 
• As I read Note 28, the aggregate KRG TR owned by PPL are some USD 2.04 billion.  What that suggests is that if the KRG pays $100 to PPL, DG's share is $35.  Meaning in effect that for DG to collect the entire USD 713 million, the KRG will have to pay PPL USD 2.04 billion.  That certainly seems to lower the probability of a prompt payment and perhaps even payment. 
• And to state the obvious, sukuk holders' do not have direct access to PPL's assets including the TR, but have access through DG's equity stake in PPL.  Not  a particularly comfortable place to be in. 

One other note and that's Note 28.  PPL is charging the KRG interest.  Contrary to an earlier erroneous statement by AA, DG is accruing interest to income but is not increasing the balance of TR.  Rather it is deducting this amount from Provisions on its balance sheet.  

DG’s ability to repay its creditors depends on the company’s ability to generate cash.  

In this post we'll look at Trade Receivables.  These are accrued amounts owed by customers that have yet to be paid, that is, converted from receivables into cash. 

DG is having a problem (first euphemism of the post) converting TR to cash.  If you bill your customers and they don't pay promptly or don't pay at all, you have a problem. 

Dana Gas Trade Receivables - USD Millions
	1Q2017	2016	2015	2014	2013	2012	2011
Total Receivables	999	982	950	992	795	599	475
KRG	712	713	727	746	515	365	247
Egypt	283	265	221	233	274	234	228
% Total Equity	36%	35%	33%	37%	31%	25%	21%
% Retained Earnings	163%	163%	137%	172%	165%	172%	216%

  Source:  DG Annual Reports.

1. DG income is dependent on two customers – the Kurdish Regional Government (“KRG”) in Iraq and Egypt.  As AA learned in business school, a successful business needs a good product and a diverse and credit worthy base of customers who actually pay.  In baseball a 50% average (for a hitter) would be outstanding.  In business, however, it isn’t good enough!
2. Recently Zora UAE has begun generating revenue but only about 5% of the total.
3. Total receivables have more than doubled since FYE 2011 largely concentrated in KRG “paper".

Dana Gas Trade Receivables - Past Due Analysis
	Total Amount	Current	Past Due Not Impaired
Year	USD Millions		<120 Days	>120 Days
1Q2017	999	7%	5%	88%
2016	982	5%	14%	81%
2015	950	8%	8%	85%
2014	992	11%	19%	70%
2013	795	16%	18%	67%
2012	599	17%	17%	66%
2011	475	23%	33%	45%

DG Annual Reports Note on Trade Receivables.

1. Over the period FYE 2011 through 1Q2107, the proportion of past due receivables has almost doubled, while the amount of current receivables has declined dramatically.
2. While DG’s presentation is technically “true”, that information does not convey the extent of the past dues. 
3. Yes, some 88% of TR are past due by more than 120 days.  But that's akin to the difference between saying “I hit Jimmy” and “I hit Jimmy and killed him”.  Both are technically true statements about the same event.  Yet, the first is misleading.  (Second euphemism of the post.)
4. Reading DG’s financials one might think that because TR are classified as “Current Assets”, the outward limit would be one accounting cycle or 1 year.  So no TR would be past due more than 365 days. That’s clearly not the case.  
5. From Slide 11 in DG’s 1Q2017 Investor Presentation, it’s clear that a good portion of TR date from 2014 and earlier.   
6. Side Note: DG charged the KRG past due interest at 9% according to its no doubt “Shari’ah” interpretation of its contract beginning in 2013.  In 2016 following an arbitration award, some USD 121 million in accrued interest for 2015 and 2016 was reversed, being the difference between the accrued amount and the Arbitration approved rate of Libor plus 2%.  If you use the amounts of billing and collections shown in the slide, you will have an unexplained difference (even when including the 2015 and 2016 interest reversals) which likely is the effect of other interest transactions.   There's only a minimum problem of USD 4 million constant difference on the Egyptian TR.
7. As per Slide 11, KRG collections over the period 2015 through 1Q2017 were USD 175 million and billings were some USD 246 million.  Note  
8. For the purpose of this analysis, we’ll apply collections on a LIFO basis (against current billings) and FIFO (against the oldest billings).  Billings are actually applied as per contract terms, which are unknown, but this exercise will give us a range of possible outcomes. 
9. If the USD 175 is applied on a LIFO basis, then some USD 700 million plus is more than 2 years past due.
10. If the USD is applied on a FIFO basis, then some USD 500 million is more than 2 years past due. 
11. Either way that’s a dismal picture.  
12. As the table immediately above indicates, at FYE 2014 there were substantial past due amounts from prior years.  Given the KRG’s share of TR, there are likely to be substantial amounts of KRG receivables past due for many years.  AA is guessing 5 or more years.  Some clear present value implications.  
13. Collections from Egypt over the same period were some USD 217 million and billings USD 267 million.  Note Egypt TR at FYE 2014 were USD 233 million.  
14. On a FIFO basis, Egypt receivables would be more current with substantial amounts close to 2 years past due. 
15. On a LIFO basis, the past due tenor would lengthen out to more years. 

The presentation of past due receivables in DG’s financials raises some interesting questions for the Company and its auditors. 

1. As per DG’s financials, TR are generally contractually due between 30 to 60 days.  At what “time” point does a receivable that is past due cease to be a current asset?  AA would think that receivables past due over 1 year would no longer be “current” assets to say nothing of those overdue for multiple years. 
2. If receivables are overdue an inordinate amount of time, when does an allowance become necessary?

Let’s turn to DG’s 2016 Annual Report for their “case”. 

1. Accounting Policies Note 2 Page 58 "Loans and Receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They are included in current assets, except for maturities greater than 12 months after the end of the reporting period. These are classified as non-current assets. The Group’s loans and receivables comprise ‘trade and other receivables’."  
2. Accounting Policies Note 2 Page 59 "Trade and Other Receivables Accounts receivable are stated at original invoice amount less a provision for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off when there is no possibility of recovery."  
3. Financial Risk Management Note 32 Page 81 "(i) Trade Receivables The trade receivables arise from its operations in UAE, Egypt and Kurdistan Region of Iraq. The requirement for impairment is analysed at each reporting date on an individual basis for major customers. As majority of the Group’s trade receivable are from Government related entities no impairment was necessitated at this point." 

AA’s observations: 

1. Despite stated maturity, the Trade Receivables haves whiskers on them like the old undisposed of items in your refrigerator (see picture above) that start stirring around when the door closes and the light goes out.  Including them (the TR) in current assets on the basis of dishonored contractual maturities does not seem appropriate. (Third euphemism of the post).  Any more than referring to the feral food inhabiting the dark corners of your refrigerator as “fresh”.  At the very minimum, the “time” buckets in the aging should convey more accurately the extent of past dues, e.g., past due 1 year, 2 to 3 years, 4 to five years, and over five years. 
2. DG’s non-impairment argument based on obligors being "government related" is laughable.  Assuming DG are correct, then there is no need for provisions or worry about Puerto Rico. It’s not only government-related, it’s government.  No one seriously thinks that PR is a solid credit.  
3. But there's more. No one should be mistaking the KRG or Egypt for investment grade or even BB borrowers.  Both Iraq and Egypt are rated B (non-investment grade).  There is a world of credit quality difference between say Switzerland and Iraq. 
4. When a B credit does not pay for a prolonged period, provisions are not just a good idea.  They’re required. Even if the obligor is a government related. 
5. What makes the argument even more absurd is it application to the KRG.  Not only is the KRG a sub-sovereign, but at some point in the (near) future, Baghdad is likely to reinforce that sub-sovereign status with vigor, perhaps with the help of two neighboring countries.  Then DG may face an argument similar to the one it is making about the Sukuk: that the existing contract with the KRG is illegal and unenforceable and thus the debt is void.  

AA can understands why the DG has adopted its stance on the TR: self preservation.    

But AA does not understand their external auditors’ position, though I will give them credit for noting in their 2016 FYI audit report page 41: "Considering the uncertainty around recoverability of trade receivables from KRG, we have included an emphasis of this matter in this audit report."   

AA will be taking a look at DG's ability to generate cashflow in a coming post.  

Perhaps this post and that one will suggest reasons why DG have thought it “wise” to adopt their “clever boots” maneuver on the Sukuk.