The 1MDB Scandal - An Overview

Happier Days

This post is based upon the 20 July 2016 complaint filed by the US Department of Justice (DoJ) against Red Granite pictures. (the “Red Granite Complaint” or the “Complaint”), producers of The Wolf of Wall Street.    I will cite sources paragraph numbers rather than page numbers as “sourcing” for various points.

The Red Granite Complaint is one of at least fifteen other complaints filed to secure the civil seizure and forfeiture of assets alleged to have been purchased with the proceeds of an alleged misappropriation of approximately US$3.5 billion from Malaysia’s state-owned strategic investment and development fund, 1MDB.

The DoJ is making the individual complaints available at this website.   Also note the powerpoint with pictures of some of the assets.  Link here. 

This post will set the stage for subsequent posts here at Suq Al Mal.  Because SAM focuses on the GCC banking sector, those posts will look at GCC parties involved in transactions with 1MDB where those parties’ behavior raises questions –at least to AA.  Of course, if past is prologue, then you know that AA will not be able to resist the urge to venture beyond the GCC if something interesting catches his eye.

Before I begin one very important note.

The US DoJ has filed complaints.  The parties mentioned in the complaints have not been convicted of any crime, nor have they had a chance to neither respond to the charges made against them, nor have their responses and the original complaints tested by the judicial process.  At this stage all that can be said is that allegations have been made.  Please bear that in mind as you read this post.

According to the Complaint, the misappropriation of funds from 1MDB took place from 2009 through 2013.  The DOJ identifies three phases named for the vehicles purported to have been used in the theft.

1. The Good Star Phase (2009-2011)                US$1 billion 
2. The Aabar Investments BVI Phase (2012)     US$1.367 billion
3. The Tanore Phase (2013)                               US$1.2 billion   

The Good Star Phase (Para #8 and Paras 40-112)

In 2009 1MDB signed a joint venture agreement (JVA) with PetroSaudi International, a privately owned Saudi-registered firm, to develop properties in Argentina and Turkmenistan. 

According to the JVA, 1MDB was to contribute US$1 billion in equity to the JV. 

The Complaint alleges that in late September the Malaysian fund made payments totaling US$1 billion, but that US$700 million were transferred to an the Swiss account of Good Star, a company actually controlled by Malaysian LOW Taek Jho. 

In May 2011 and October 2011 an additional US$330 million was transferred to Good Star, ostensibly advances under a murabaha facility extended by 1MDB to the JV.

The Aabar Investments PSJ BVI Phase (Paras #9-10 and 112-226)

During 2012, 1MDB raised US$3.5 billion in bonds (arranged and underwritten by Goldman Sachs) and guaranteed by 1MDB as well as IPIC, an Abu Dhabi state-owned investment fund. 

The Red Granite Complaint alleges that US$1.367 billion of the bond proceeds were diverted to a Swiss bank for the account of Aabar Investments PSJ in the British Virgin Islands.  

Despite the similarity to an IPIC subsidiary Aabar Investments and Aabar Investments PSJ, the company in the BVI was not owned by IPIC or Aabar.  Curiously, according to Para #115 of the Complaint, the directors of the BVI were H.E. Khadem Abdulla al Qubaisi (Managing Director of IPIC) and Mohamed Ahmed Badawy Al Husseiny (CEO of Aabar).

Funds were later allegedly transferred from the BVI account to an account controlled by TAN Kim Loong, described by the Complaint as an associate of Mr. LOW.  Funds were used to acquire assets and transfers were made for the personal benefit of officials at 1MDB, IPIC, and Aabar.

The Tanore Phase (Para #11 and Paras #227-290)

The Complaint alleges that US$1.2 billion was diverted from a US$3.0 billion third Goldman Sachs arranged bond issue in 2013, which in part was to fund investments with Abu Dhabi in the Abu Dhabi Malaysian Investment Company (ADMIC). 

The US$1.2 is alleged to have been transferred to an account in Singapore for Tanore Finance Corporation, a company alleged to be ultimately controlled by Mr. LOW.  This amount inter alia is alleged to have provided funding to Red Granite for the production of The Wolf of Wall Street.

What Were They Thinking

For the sake of making a few comments, I will assume that the Complaint is accurate.  That is, that roughly $3.567 billion was misappropriated from 1MDB.    

As of 31 March 2014, 1MDB’s financials show roughly MR51.4 billion in total assets or approximately US$15.7 billion.

• 1MDB Financials
• BNM Exchange Rates

US$3.5 billion represents almost twenty-three percent of total assets. The size of the fraud is immense not only in dollar terms but as a percentage of assets. 

How did the perpetrators think a fraud of this size would go undetected?

In the future, assets booked to disguise the defalcation would prove worthless and have to be written down or written off.   This would have been very visible not only because of the amounts of the write-downs/write-offs but perhaps more importantly by their relation to the fund’s equity.

As of 31 March 2014, 1MDB had equity a shade over MR 2.4 billion (US$747 million), roughly twenty percent of the US$3.5 billion that is alleged to have been stolen.  Thus, even a partial write down would wipe out equity.

Often in such “operations” the proceeds of new misappropriations are used to partially cover the previous ones.  That is, for example, funds from the Aabar Phase would have been used to cover the Good Star Phase misappropriations, justified by a statement that the PSI/1MDB JV projects were not proceeding according to plan and to prevent further losses “prudent” management was terminating the JVA.  An amount could be written off ostensibly as costs incurred without necessarily ringing alarm bells. 

Or was there something else at play here besides simple greed and less than adept defalcation skills?

Global Investment House: The Future is Now and Likely to Remain So

For Some Now May Be the Only Future They Have

As promised in my first post, some thoughts on Global’s future.

As detailed below, Global faces a variety of very real constraints to growth—the primary one being control by its creditors. If it doesn’t or can’t grow, Global’s net income will remain modest, likely be volatile, and its ROE subpar. These obstacles are formidable and AA has a hard time seeing Global finding a way out of this challenge.

First a recap to set the scene.

Recap

In my previous post I identified a structural problem with Global’s revenues and expenses.  The latter (adjusted to exclude impairment and loan loss provisions) average roughly KD 14 million a year – 140% of the revenues from its core Assets Under Management (AUM) business.  Other lines of business (LOBs) then have to generate enough revenue to cover remaining expenses and produce a profit.

That’s a problem because Global’s other LOBs lack the scale to consistently generate enough revenue to do this –either in absolute or ROE terms.

Profitability is cobbled together from these “hobby” businesses plus one off items such as FX translation gains from a depreciating dinar or loan loss provision reversals—items whose persistence is unlikely.  

By way of example, if these latter two items had not been present in 2015, Global’s net income would be 10 percent of the reported KD 6.5 million.  Additionally, the non-AUM fee-generating LOBs (chiefly brokerage and investment banking) are market sensitive and thus add unwelcome volatility to earnings.

Strategic Options

In the face of this structural problem, Global can either: 

1. Accept its current position. 
• Live with the volatility. 
• Or rationalize its expense base to reduce the volatility. Without detailed information it’s not possible to determine if cutting what appear to be “hobby” operations – Bahrain and Oman brokerage, for example—would result in significant cost reductions without disturbing the AUM business.  
2. Seek to materially change its fate by significantly growing revenues as a way of eliminating volatility, increasing ROE, and making itself a more credible partner for clients and a more compelling opportunity for equity investors.

As my framing of options indicates, I think growth is the preferable path. 

Shrinking oneself to greatness is not really a business strategy.  Growth will also facilitate the sale of the creditors’ 70 percent stake which as argued below is the major current constraint on the firm’s development.

One caveat about growth.

FGB/NBAD is unlikely to challenge ICBC 'sor JPMorgan’s position.  Nor will Global rival the likes of Blackrock.  That’s fine.  There’s nothing wrong with being a fish in a small pond.  But even a fish in a small pond needs to grow to keep up with the other fish in the same pond. 

There is a third option: a sale to another institution that can fold Global’s business into its own, cut costs, and reap the benefits of scale. 

Two things would be required.  

1. A sale price that would satisfy the creditors.  This probably would be the main sticking point to this scenario.  This early in the life of the debt settlement there probably would be creditor price resistance to a “bargain” sale.  
2. A transaction that does not disturb the current client relationships, i.e., that maintains the KD 1.1 billion in AUM.  That is perhaps easier to achieve if current legacy management and board representation is retained.

If Global doesn’t increase revenues, net income is likely to be volatile, remain relatively modest, and ROE subpar.  As outlined below, Global faces some very real growth constraints. It’s hard for AA to see a way forward for the firm out of this conundrum.

Constraints on Growth

Current Majority Shareholders (Creditors)

The primary current constraint on growth is the majority shareholder (Global’s creditors) who by virtue of their 70 percent equity stake control the firm.  Their self-interest is directly at odds with a pro-growth strategy.    

In the best of times, bank creditors like other “bond” investors focus on return of capital and not like “equity” investors on growth and increasing return on capital.

A debt restructuring typically intensifies this tendency.  Cash extraction from the debtor becomes even more urgent and is imposed through aggressive repayment schedules and rescheduling covenants that severely constrain spending and business development.   

But Global wasn’t a typical restructuring.  Creditors normally don’t take assets to settle debts because they know that their track record in realizing assets is much worse than in underwriting loans.   

The fact that creditors demanded 70% of the rump firm’s equity and existing shareholders gave it is a very clear sign that a serious shortfall from asset sales was expected. That deficit and the need to maximize recovery have no doubt exacerbated the impulse for cash extraction.   

When equity in the borrower is taken, creditors cash out by selling the firm to investors or collecting dividends.  When a sale at an acceptable price is not possible, then dividends become “favorite”. 

At this time, price expectations of seller and buyer are probably far apart.

Since we are only three years into the settlement, an acceptable price for creditors is probably one that is no less than the value ascribed to the equity when the “expected” loss on the settlement was calculated.  To sell for a lower price would require booking a loss.  Over a longer period, the creditors’ price discipline could wane, if earnings prove volatile and that volatility requires a revaluation of the carrying value of the equity.

Given its current condition, Global is not a particularly exciting investment prospect for new investors.  Legacy shareholders probably haven’t changed their minds from 2012/2013 when they turned down an opportunity to infuse new cash.      

If creditors won’t let Global spend “precious cash” to build the business, what other ways could they help grow revenues?

Creditors could shift AUM from their own firms to Global.  They could solicit new AUM for Global.  But if they did, they would share the resulting profit with other creditors and the 30 percent “legacy” shareholders in the firm.  Little economic sense in that, particularly because relatively large amounts would be required and creditors have already taken a “hit” on the debt settlement, no doubt exhausting whatever minute amounts of generosity they may once have had.    

Global’s strategy confirms this analysis. It’s clear that the firm is being managed not for ROE or growth, but for cash extraction.   That involves retaining the “cash cow” KD 1.1 billion in AUM, keeping a firm control on costs, and following a conservative risk acceptance policy. 

“Souk legend” (the Gulf equivalent of urban legend) is that GIH’s KD 1.1 billion in AUM-the main driver of current revenue—is largely (almost all?) comprised of KIA funds that Ms. Maha played a key role in obtaining.  The creditors are smart enough to recognize that they need legacy management to keep current customers in place and perhaps incrementally add to AUM. This probably explains her continued presence in the board and in executive management as well as the retention of other “key” legacy managers.

As regards expenses, a glance at note 16 (2015 annual report) shows no evidence of significant investment in new assets, including computer equipment which would involve relatively small amounts.   Assets are almost fully depreciated.  While accounting useful life is not the same as economically useful life, this does suggest some replacement is likely needed.  That it has not occurred at any measurable level is revealing. Directors’ fees are also being kept at modest levels.  Usually, in the old boy (and in this case one girl) world of boards, cost control is not an urgent imperative.  The amounts are not just that large.  Clearly expense control is a key business focus.

In terms of risk aversion, the overconcentration in cash and cash equivalents is a very clear sign of heightened risk control and husbanding cash for dividends.  With 50% of assets in low ROA banks and cash despite there being no material debt obligations, it is clear the firm is being managed for cash not ROE.

Other Actors – Private Clients

Could other parties step up to deliver needed growth?

Retail investors aren’t going to provide the revenue required.  Too many small ticket transactions and portfolios would be required to change Global’s fortunes.  Many new retail customers would increase operational costs offsetting some of the revenue gain.

Large institutions and HNWIs could drive material change at GIH.   But what is their incentive to shift their portfolios? Global doesn’t appear to have any compelling investment product or products that differentiate it from its competitors and make it a “must have” for such an investor.  Why would such an investor select Global over NBK or another major regional or international firm?  

Global also still carries some remaining baggage from its 2008 difficulties, particularly in the treatment of investors in AlThouraia/Mazaya Saudi and Global MENA Financial Assets. This probably exacerbates non Kuwaiti GCC nationals’ general concerns about Kuwaiti business practices as well as the appetite of those Kuwaitis who invested in these funds.

But there’s another constraint. Assuming there are private institutional and HNW investors (and these are likely to be Kuwaiti rather than other GCC investors) willing to do business with Global, where would the funds come from?

As discussed in my post about the NBAD/FGB merger, the GCC is a minor financial market when measured in terms of assets and earnings and is highly likely to remain so for a variety of reasons (demographics, the nature and size of local economies, etc.). 

With GCC asset managers this is even more the case.  Major world firms have AUM in the trillions (Blackrock at $4.6 trillion) and net income is measured in billions (Blackrock north of $3 billion) or hundreds of millions. 

Currently, Global is mid-tier behind NBK Capital and KAMCO each of who have at least 3.5 times Global’s AUM.  A significant shift in Global’s fortunes would require a major shift away from these other firms.  Something that doesn’t seem highly probable to AA.  “Losing” 10% of your clients is a rare occurrence.  “Losing” 30% or more even less probable.     

Other Actors-Official Institutions

What would motivate a government-related entity to place investments with Global when 70% of the profit on the relationship will go into the hands of creditors, who include foreign banks?  And very likely include some investors who have acquired their positions at a discount.  Few like to feed vultures.

Another constraint is that non-Kuwaiti official institutions are unlikely to shift business to Global.  They have their own national firms to support and sad to say many in the GCC have a dim view of Kuwaiti business practices.

All in all a rather bleak strategic cul-de-sac.

Global Investment House - 2015 Financial Performance Reveals Structural Problems with Earnings

It's a small world after all, and for some even smaller

It’s been five years since Global signed its first restructuring agreement and three years since its final settlement with creditors.

How is Global doing?   What are its prospects for the future?   

The first question is the subject of this post.  I’ll cover the second in a companion post.

Catching Up with Global

 

When last I posted, Ms. Maha was Chairman, GIH had published financials showing about KD 1 billion in assets, and the firm was touting its first rescheduling deal with its creditors.

At that point, commenting on the deal’s principal repayment terms—10 percent the first year, 20% the second year and a whopping 70% the third year—I noted that:

“It's highly unlikely that Global is going to be able to meet the repayment schedule even with one or two small miracles coming its way.   With the short fuse and the extensive trip wires (by way of covenants below), the spectre of a second default has to be haunting Global's management and shareholders.”

Not surprisingly in mid-2013 GIH negotiated a second rescheduling deal that gutted the firm: almost all of GIH’s “fine” assets were transferred to creditors in settlement of the debt.  Because the assets weren’t that “fine”, the creditors took a 70 percent stake in the “rump” GIH.  For a variety of reasons, the firm focused its business strategy on fee-based not balance sheet intensive business.  Ms. Maha was replaced as Chairman, though she remains on the Board as Vice Chairman and retains a role in management.

Review of 2015 Performance and Financials

Overview

The structure of GIH’s revenues and expenses indicates a high probability of future earnings volatility. Normalized expenses are 140% of AUM related revenues.  Non AUM LOBs can’t consistently generate enough revenue to cover the remaining expenses and generate a meaningful profit. They are market sensitive (volatile) themselves and more importantly lack scale.  They are more “hobbies” than substantial LOBs.

Besides these structural earnings problems, I noticed a few things in the loan portfolio and murabaha receivables worthy of comment.  Nothing that is life threatening.

Income and Expense

Net Income:

Global earned KD6.5 million in 2015 versus KD6.4 million the year before.  However, 2015 net income was bolstered by a (non-cash) write back of KD4.3 million of loan provisions.   Without this “timely” reversal, net income would have been a much lower KD2.2 million.

Revenues:

Fees and Commission Income accounted for 89% of total revenues in 2015 and 66% in 2014.   Within this category, AUM related fees account for some 80% of revenues, and represent a relatively stable revenue stream.  The other key fee-generating LOBs-- brokerage and investment banking-- each generate about one tenth of the AUM fees but are more volatile.

In 2015 Global benefited from KD 1.8 million in FX translation gains (KD 2.2 million in 2014) due to depreciation of the KD against the US dollar.  Not a stable core revenue source.

Net interest income contributed KD 1.6 million.

Fair Value Through Profit and Loss a loss this year of KD1.5 million vice KD0.8 million in positive revenue the year before.

Expenses:

Excluding loan provisions and impairment losses, Global’s average expenses are about KD 14 million a year – 140% of its stable AUM related earnings.

Structural “Problem” with Earnings

That’s a problem because Global’s other fee-generating LOBs (chiefly brokerage and investment banking) are market sensitive and more importantly lack the scale to  consistently generate significant revenue  to both cover expenses and generate a profit.   Growing earnings by growing assets is constrained by policy and no doubt as well by limited market access. 

Global then is forced to rely on one-offs such as continued depreciation of the KD or provision write backs to turn a reasonable profit.  Note that if there had been no FX translation gain in 2015 and no write back of the provision, Global would have had a modest profit.   

Balance Sheet

As mentioned above, a couple things caught my eye in the loan portfolio and murabaha receivables.

Loan Loss Provision Write Back

According to GIH’s 2015 annual report note 13, the write back provision for credit losses “for the year include KD 3,292 thousand (2014: KD 130 thousand) written back as a result of settlement agreement with a borrower.” 

Note the term “settlement agreement”.  GIH did not restructure the loan. The amount was not repaid in cash. Rather the bank took securities to settle the loan as is clear from an analysis of the firm’s cashflow statement and note 11.  The absolute increase in assets in note 11 is much more than the amount shown on the cashflow statement.

A single customer was responsible for 77% of the write-back.   A quick scan of annual reports back to 2012 suggests--but does not prove--that GIH has held this provision since at least 2011. 

The same note states:  “Loans are granted to GCC companies and individuals and are secured against investments in the funds and securities held in fiduciary portfolios by the Group on behalf of the borrowers.”

Why didn’t GIH seize and realize the collateral long ago?  Why hasn’t done the same with the borrowers representing the KD 5.9 million in unused provisions?

One explanation might be that legal processes in Kuwait are painfully slow.  Thus, GIH was legally unable to seize the collateral and extinguish the loan, but rather forced into prolonged negotiations with the borrower. 

That the reversal came at just the “right” time to protect earnings is certainly a remarkable coincidence.  Perhaps difficulties in 2015 caused management to redouble its efforts to collect.  Perhaps a long period of negotiation finally came to a close.  From the financials, it does not appear that GIH gave the borrower a discount on the asset swap.

Loan Portfolio:

Is there room for more earnings positive settlements with borrowers?

Net loans are KD 1.6 million = gross loans KD 7.5 million less provisions of KD 5.9 million (note 13). 

That KD 5.9 million would appear to be able to fund a few “timely reversals”.  

Particularly because Global holds KD17.8 million (fair value) collateral as per note 25.2.2 page 57.  That’s 240 percent coverage of the gross amount of the portfolio.  One might argue and AA certainly would that there doesn’t appear to be a compelling reason to hold a loss reserve when collateral coverage is so high.   

But there’s more.

Global is accruing interest on the gross portfolio because KD 490K in accrued interest in 2015 equates to a whopping 21% per annum yield on the average net loan portfolio. (Simple average of 31 December 2015 and 2014 amounts).  It’s a more reasonable 4.8% on the average gross portfolio. 

To accrue interest, Global would either have to be receiving cash or have almost certain assurance of payment of the interest. 

The cashflow statement shows that Global did not receive cash payments in 2015 for about KD 500 million of interest accrued that year, an amount very close to the interest accrued on these loans.  Of course, the KD 500 difference could well relate to other interest bearing assets.  It could relate primarily to the loans but be due to timing difference:  the interest payment was received after 31 December 2015.  If cash is being received and Global holds such an excess of collateral, how does it justify maintaining the reserve to its auditors? 

On the other hand, if Global is accruing interest—but not receiving cash—, its justification is likely based on asserting that collection of interest is almost certain given the collateral it holds. If the interest is secure and again the collateral so much larger than the principal, then it would seem the principal is also secure and no provision is needed.

All this suggests to AA that Global has some “dry powder” for future contingencies.

Murabaha Transactions

Global is earning a princely 5.28% per annum on these one year transactions (note 12).  Not many good investments offer such a return for a one year tenor.  Kudos to GIH for finding this consistently attractive opportunity—5.24% in 2014, 5.3% in 2013, and 5.45% in 2012.

One would think that such rates would come at the cost of higher risk, but the provision is a modest KD 123K on some KD 3.1 million. 

One thing did catch my eye.  Note 25.2.2 page 57.   The murabaha receivables were more than 180 days past due (but not classified as impaired) as of 31 December 2015 and as well at 31 December 2014.  I didn’t see a reference to collateral for these transactions.  Of course, AA has been around the block a few times on “Islamic” banking transactions and knows that in addition to careful structuring (technically حيل) “Islamic” finance is one area of the faith where miracles occur with a dazzling regularity.

Notwithstanding the above, perhaps a provision of some sort would be warranted.  And could be accomplished by a simultaneous reversal of some of the loan provisions and booking of an equivalent amount as provision for the receivables.  But of course الله اعلم

In Memoriam Abdo Jeffi

 6 March 2016

Il n'est pas un banquier ordinaire.

Il n'est pas un homme ordinaire.

Global Investment House and National Bank of Umm Al Qaiwan - $250 Million Deposit

The Art of the Deal?

When last (18 October 2010 to be precise) we looked, Global Investment House and National Bank of Umm AlQaiwain were locked in an epic legal battle over a US$250 million “deposit” (if you’re GIH) or a “contractually binding pre-payment” for convertible securities (if you’re NBQ).

You’ll recall that in July 2008 NBQ and GIH had signed an MOU for GIH to purchase NBQ convertible bonds. GIH deposited the funds, but December that same year requested their return as it began to encounter debt problems of its own.  NBQ refused stating that there was a binding deal to buy the convertibles.  

The Dubai courts became involved shortly thereafter and the case was still live in early 2015 with no final ruling.    

During that period, the Supreme Court of Dubai several times reversed lower court judgements and sent the case “down” for a second look by the Appeals Court.  “Experts” from the Dubai Financial Market were asked to provide their input.  That apparently wasn’t enough.  So “experts” from the Emirates Securities and Commodities Authority were pressed into service.

AA is pleased to note that during 2015 the parties agreed an out-of-court settlement.  Of the $250 million original amount, NBQ kept $35 million plus the equivalent of another $34 million (the penal interest amount, the Dubai court had required NBQ to place in escrow with it).   The remaining $215 million was returned to GIH --more precisely to GIH’s creditors who acquired this asset along with no doubt many other “fine” ones in the debt swap.

NBQ is roughly $79 million richer.  GIH’s creditors $35 million plus lost interest/lost opportunities poorer.  GIH poorer as well but hopefully wiser.

Another chapter in structuring and legal documentation breakthroughs (or more precisely breakdowns) of convertible securities in the GCC comes to a close.     On that topic, relevant posts here: 

http://suqalmal.blogspot.jp/2009/11/one-billion-dirham-camel.html

http://suqalmal.blogspot.jp/2010/03/adia-investment-in-citigroup-time-for.html

While this saga has ended, AA’s interest has not.  Expect a post soon on Global Investment House.

Memory lane:

Earlier posts on GIH/NBQ can be found here. 

http://suqalmal.blogspot.jp/search/label/National%20Bank%20of%20Umm%20Al%20Qaiwain

If you’re interested, Note 14 in NBQ’s 2015 Annual Report provides a summary of the court saga.  

http://www.nbq.ae/annual_report/NBQ-2015-REPORT-EN.pdf 

The FGB/NBAD Merger in a Global Context

Both the Size of the Fish and the Size of the Pond are Important

Recently, the GCC financial market has been all aflutter following reports of a potential merger between First Gulf Bank (FGB) and National Bank of Abu Dhabi (NBAD).  

Weighing in at a hefty $170 billion plus in assets, the new entity would displace QNB as the largest bank in the GCC.

Reuters noted that the new bank’s market capitalization of $30 billion “would make it more valuable than Credit Suisse Group AG, Standard Chartered Plc or Deutsche Bank AG.”   

http://gulfnews.com/business/sectors/banking/what-you-need-to-know-about-abu-dhabi-s-plan-for-a-megabank-1.1849855

Quite impressive until one looks a bit closer.

First, as to the “more valuable” comparison.  Fair enough, but the banks mentioned aren’t exactly in ruddy health. 

DB currently trades at a princely 0.29x book value. CS at about .546x, and Stan Chartered at about .55X.  

P/BV ratios like these are not signs of robust positions.  It seems strange—perhaps only to AA—to compare the UAE and GCC’s new “champion” to banks in such situation. 

AA might be forgiven for also wondering if price discovery and thus market valuation in the markets that DB, CS, and Stan Chartered trade in is more robust than markets in the UAE, particularly when free float is considered.

NBAD is roughly 69% owned by a single non-trading shareholder and so free float is 31%.  FGB reportedly has about 88% free float.  AA was told some years ago, that the bank was actually majority owned by the two sons of Sh. Zayed who were Chairman and Vice Chairman. 

However, I will not contradict the records of the ADX nor the basis on which MS made the determination to include FGB in its MSCI index.  

http://gulfnews.com/business/sectors/banking/shareholders-of-nbad-and-fgb-expected-to-benefit-from-combined-valuation-of-both-stocks-1.1848715

Second, some comparative metrics to put the new  bank in a global context.

Total assets of GCC banks as of 31 March 2016 were some $2 trillion, according to AA’s analysis of GCC central bank reports.  Note that the data for Bahrain that I used was dated 3Q15, the latest information I could find on CBB’s website.   All the other central banks reported data as of 1Q16.

At 31 December 2014, ICBC of China held $3.3 trillion in assets.  Another 12 banks each held more than $2 trillion.  That means that each of these individual banks was larger than the entire GCC banking sector and obviously much larger than a FGB/NBAD merged entity.  That same data shows that the 50^th largest bank held $656 billion. 

By comparison, as per FRB data, $173 billion in total assets would earn the ranking as the 13^th largest bank in the USA.

https://www.gfmag.com/magazine/november-2015/biggest-global-banks-2015

http://www.federalreserve.gov/releases/lbr/current/

Even more telling, according to 2015 data, three banks had more than $173 billion in market capitalization (Wells Fargo, ICBC, and JPMorgan).   That is, the market value of their equity was larger than the NBAD/FGB merged entity’s total assets.  Based on that data, $30 billion in market capitalization would merit 50^th place.  

Second Look: Barclays 2008 Capital Raising – The Curious Case of the Warrants

Shaykh Mansour Cheers His English FC On

As I restart the blog after my lesser ghaiba, besides posting on new items, I’ll be taking a selective stroll through the past, disinterring old posts for a fresh look. 

Two “bits” of recent news motivate this post.

1. The GBP 1 billion court case by Amanda Staveley against Barclays that alleges illegal side payments to Qatari investors related to the offering disadvantaged her as she was a potential investor and not merely an adviser. 
2. IPIC’s involvement in the 1MBD saga reminded me of their role in the Barclays 2008 transaction.  

Attached below is a file with an account of key milestones in HH Shaykh Mansour Bin Zayed Al Nahayan’s (Sh. Mansour) investment in Barclays.   

Because Barclays is listed on the NYSE, it is subject to SEC filing requirements.  Barclays resulting 6K, Schedule 13-G, and Schedule 13-GA filings provide an excellent source of information on the MCNs and the Warrants.  The RCIs as debt instruments were not reported in the filings.  Note that Barclays relies on filings/information provided by investors in the instruments—information it is not in a position to independently verify.    I’ve provided sourcing in the file to save you the trouble of trawling through Barclays voluminous filings to find the UAE related parties’ filings.  However, key “bits” of information (terms and conditions of the disposition of the MCNs, RCIs, and Warrants) are missing so the conclusions drawn are educated guesses and guesstimates in some places.  I’ve used my judgement to make some estimates, but note the conclusions are not definitive. 

Below is a summary of key points.   You’ll find my usually fussy details in the attached file.

I’d like to highlight Point #10 which outlines the three step series of transactions that moved the Warrants from IPIC finally to a company controlled by Sh. Mansour.  There is no explanation in public information (none was required) on the prices, if any, associated with these transactions nor on their rationale.  AA is still scratching his head to come up with a compelling economic or business reason for this circuitous path.  Maybe some of you out there have your own theories.  If so, please post comments.

1. In late 2008 Barclays announced a GBP 5.8 billion “hard” capital raising with the potential for an additional GBP 1.2 billion if all the associated Warrants were exercised. 
2. The offering comprised:   
• GBP 3 billion in 14% perpetual Reserve Capital Instruments (RCIs) 
• GBP 2.8 billion in Mandatorily Convertible Notes (MCNs) 
• Associated with the RCIs, 1,516,875,236 Warrants entitling the holders to convert each Warrant to one Barclay’s common share at 197.775 Pence per share.   The Warrants were sold for a total consideration of GBP1.52.  (That’s not a typo).  In September Barclays had used Warrants to place 226 million shares at 336 Pence each and in June approximately 1.5 billion shares to various institutional investors, including the Qatari investors in the October 2008 capital raising.  
3. Two GCC “investors”, (a) Qatar Holdings and an associated company “representing the personal interests of the Chairman of Qatar Holdings” and (2) HH Shaykh Mansour Bin Zayed Al Nahayan subscribed respectively for GBP 2 billion and GBP 3.5 billion, later reduced respectively to GBP1.75 billion and GBP3.25 billion. 
• Not that long ago, a younger AA was told by a grey-bearded veteran that one of the benefits of working in the Middle East is the opportunity to bring one’s personal life into business to create a better “work-life balance”.   AA has no doubt that this “enlightened” approach is not limited to the MENA region.  
4. Sh. Mansour’s final allocation was GBP 2 billion of the MCNs, and GBP 1.25 billion of the RCIS.  The purchase of the RCIs entitled Sh. Mansour to Warrants to buy roughly 758.4 million shares.  The cost of the Warrants was 76 Pence. 
5. Barclays subsequently announced that Sh. Mansour would fund his investment through “an Abu Dhabi government investment vehicle”.  Enter IPIC of which Sh. Mansour was then and is now still Chairman.  
6. IPIC took the investments on its balance sheet, later recognizing an approximate US$2.2 billion profit in 2009 when it converted the MCNs to Barclays shares, then sold the shares, and placed the RCIs.  During 2009 it also sold the Warrants (more on that below).
7. Based on an analysis of IPIC’s 2008 and 2009 financials, it seems that the Warrants were  sold for a nominal price, perhaps the 76 Pence purchase price. 
8. IPIC does not appear to have benefited from the Warrants; instead these were sold/transferred in a series of three transactions ultimately to an investment company controlled by Sh. Mansour as per SEC filings.  Also Barclays paid Sh. Mansour a GBP 110 million fee on the transaction.  GBP 30 million of this was subsequently paid to Ms. Staveley for her services.  Based on the same analysis of IPIC’s financials, Sh. Mansour appears to have retained the fee.  It does not appear in IPIC’s earnings.  Nor does it appear to have been netted against the cost of the MCNs and RCIs. 
9. While IPIC earned quite a nice return for a roughly seven month use of its balance sheet, it was exposed to the potential decline in the price of the MCNs or RCIs unless IPIC received a guarantee against such losses from Sh. Mansour or another party.  The existence or non-existence of such a guarantee is not on the public record. 
10. Warrants Transactions:

• 1 June 2009 IPIC grants KAQ Holdings an Option to acquire Kadin, an IPIC subsidiary which holds the Barclays investments.  As per SEC filing, KAQH is owned 100% by HE Khadem Al Qubaisi, a member of IPIC’s Board and a familiar name in the 1MBD saga.  SEC filings do not require that the price or reason for a transaction be disclosed. 
• Since both Sh. Mansour and KAQ were members of the Board this does not appear to have been a transaction designed to avoid an appearance of conflict of interest, e.g., selling to the Chairman of IPIC.  It’s not clear to what were the good economic or business reasons for this transaction. 
• 1 September 2009, KAQH announces it has bought PCP 3 the Kadin subsidiary which holds the Warrants.  The earlier Option having been amended to allow this.  
• Note there is an apparent discrepancy between IPIC’s announcement in its 2008 financials that subsequent to 31 December 2008, IPIC had sold “all” its investments in Barclays.   If the Warrants were carried at cost or near cost by IPIC (e.g., 76 Pence), an explanation might that the carrying amount of the Warrants was “immaterial” and need not be detailed. 
• 12 February 2010, KAQH which also reports changing its name to Future Capital Management Ltd. announces that it has “transferred” (note the SEC filing does not use the term “sale” or “sold”)  PCP 3 to Nexus Capital Investing Ltd.  The reason for this transaction or the name change has AA scratching even harder.  Lucky I have a hard head!   NCIL is declared as 100% owned by Abdul Aziz Al Ketbi. 
• Old GCC hands will recognize the Al Ketbi name.  Fatima bint Mubarak al Ketbi is mother of key sons of the Sh. Zayed, guiding founder of the UAE.   
• 17 February 2010, NCIL exercises Warrants for 626.8 million shares. 
• 7 July 2010, NCIL announces it has “transferred” (again note the use of the term “transfer” as opposed to “sale”) 100% of NCIL (owner of PCP 3 the holder of the 626.8 million shares and remaining Warrants) to Abu Dhabi International United Investments LLC which is declared as 100% owned by Sh. Mansour.   
• 11 October 2010 NCIL exercises the remaining Warrants.   At this point the estimated unrealized profit on the exercise is some GBP 511 million or about $803 million.  
• Subsequent to this date, NCIL engaged in hedging transactions with institutional counterparty or counterparties finally ending its ownership of the shares 20 June 2013 as per SEC filing.  The actual profit realized by Sh. Mansour is not a matter of public record.

Apparently BlogSpot does not allow the uploading of documents and so instead of AA's elegantly conceived and executed table, you will have to work with text post available at the link.

Link to Detailed Time Line