GFG's "Tiny" Auditor = Rather "Large" Credit Red Flags

Even He Probably Couldn't Perform
Audits on 60 Companies

An introductory note to what follows.

Credit “red flags” in themselves do not conclusively prove there is a problem with an entity. Rather they identify areas for enhanced due diligence to determine if there is a problem.

According to research by the FT, one apparently very small English Chartered Accountancy firm, King & King, audited over 60 companies in Mr. Gupta’s Group. Companies with a combined Sterling 2.5 billion in revenues!

It is one of the long standing—but often ignored—rules of due diligence to scrutinize not only audited financial reports but also the auditor.

1. Is it a known firm? What is its reputation and track record?

2. Does it have the skills and resources to conduct an audit of the particular company? Horses for courses.

3. Is there an imbalance in the relationship between the company and the auditor that might make the auditor subject to undue influence on its work?

For example, if the auditor is dependent on the company for the bulk of its revenues, it might well find it hard to say “no” to the company.

I’d hasten to add that this is not a conclusive test.

There are more than a few cases where the “biggest” auditing firms appear to have failed in conducting sufficiently probing audits.

After reading the FT’s excellent article, I decided to do a bit of digging myself.

What better place to start than an electronic visit to the UK’s Companies House?

There I searched for the name King & King and the address 273-287 Regent St, London W1B 2HA, United Kingdom. This search returned three entities that appear directly related:

1. KING & KING LTD Company number 04871854. Listed as dormant. Last Financial Statements 20 August 2019. Net assets GBP 1.

2. KING & KING (ACCOUNTING & ADVISORY) LTD Company number 07597296. Listed as dormant. Last Financial Statements 30 April 2019. Net assets GBP 1.

3. KING & KING WILLS LTD Company number 07533423 Last Financial Statements 28 February 2020. Net assets GBP 685.

There is no doubt a reasonable explanation for what would appear at face value to be a discrepancy here. How could a dormant firm with so modest financials audit 60 companies.

However, what that explanation is eludes me.

I suppose it may be that the firm that does the audits is registered under another name. 

I did take the obvious step of using Companies House to search on the names of officers and directors at the above companies on the assumption that one or more of these might be at the firm with "with another name".  

However, I came up with a blank.

To make sure I covered as many bases as possible,  I then searched Companies House for the address alone.

To my surprise there were 20 pages of entities.

Companies House told me to refine my search as there were many many more.

So it may be that I missed that new name.

No results for K&K’s Middlesex Office at Companies House using both its name and the address.

But using Google, I quickly turned up at least 51 companies at the Middlesex address.

I did however find a related company at that address which shares a director with King & King.

RELANS LIMITED Company number 07317670. Latest Financial Statements 30 April 2020. GBP 127,284 in total equity.

While the income statement was not included, comparative figures would suggest it was a good year indeed for Relans as its retained earnings increased approximately GBP 120,000 year on year. Quite a remarkable change from previous years!

As to the numerous parties at both of K&K’s listed addresses, at first glance it would appear that both buildings are “rather large”.

Or perhaps more likely the address is that of virtual office or a corporate registration service.

Perhaps, K&K are “working from home” as part of a Covid inspired remote work initiative.

Turning back to the FT article, the FT asked chartered accountants at other firms what K&K’s reputation was. The answer they received seems to be “who?”.

According to the FT, K&K is registered at the ICAEW as having one CA and one professional staff.

On its face, that might make some question the “depth of its bench” in terms of ability to perform audits of large firms.

It would also suggest that GFG was the “father of the feast” at K&K. Loss of this relationship would be likely to dramatically reduce revenues.

Typically, scrutiny is focused on the auditor of the obligor or the counterparty to a transaction.

And that absent guarantees or other support from related parties, focus on those parties’ auditors would be minimal at best.

However, even with a limited one company focus, there are enough red flags to suggest weakness. That would include the questions posed by my Companies House search.

And those threads when pulled might well have revealed other issues. Or resulted in a clean bill of health for K&K.

For those with exposure to GFGroup, a wider focus would be appropriate.

Discovering that one very small CA firm was auditing a large number of GFG companies should have been a gigantic red flag, prompting further investigation..

It’s not just the three questions above, but the fact that K&K was auditing 60 companies but it had a staff of one CA and one other professional. Companies with Sterling 2.5 billion in revenues.

If we assume that one-quarter of these firms had their fiscal year at each quarter’s end as opposed to all at 31 December, it boggles the mind to think that K&K would be able to do the intensive work required for an audit even on “just” 15 firms.

The ability to repeat this intensive process quarter on quarter would have required probably more than a singe Stakhanovite.

More importantly one might reasonably struggle to understand how a firm this size could perform a proper audit on even one company each quarter.

If, as is more likely, 31 December was the FYE for all or the majority of the 60 companies,, then the improbable becomes the impossible.

One caveat K&K notes on their website they are affiliated with IRGlobal a network of accountancy, advisory, and tax firms and so would appear to have access to additional knowledge resources.

Somehow the extent of K&K’s audit work (and prowess) was missed.

The FT was able to discover this interesting issue apparently without undue or time-consuming exertion.

Admittedly, they benefited from hindsight: GFG’s woes were public knowledge

Also admittedly, the FT has a cadre of very savvy financial reporters who have been responsible for uncovering financial frauds. By their own skill, not just via whistleblower tips.

Bondhack and Cynthia O’Murchu made a significant pre-crash discovery regarding the weak state of NMC’s finances by the clever use of credit bureau information.

One-at least this one-would expect that financial institutions with money at stake would have at least as competent staff.

And perhaps because they were doing this for a living, or were supposed to be doing this, would have additional resources and experience.

Sadly, hope is not necessarily accompanied by change. 

Or so I have been told.

McDonald's New "BTS Meal" Where's the Garlic?"

Not Coleslaw
Not Available at McDonalds

I read somewhere that McDonald’s was introducing the new "BTS Meal" with a worldwide roll out planned. Touted was the fact that one couldn’t get these flavors elsewhere in the world!

What is the BTS meal I wondered?

And eagerly read on hoping to steal a march on my august and revered elder and wiser brother, expert in many things Asian. 

It is the favorite meal of the Korean group BTS.

10 Chicken McNuggets, fries, and a Coke.

The apparent “unavailable” flavors were in some specially devised sauces: “cajun” and “sweet chili”.

Didn’t sound very “Korean” to me.

Then I remembered Bon Chon chicken. Ah, the flavors of Korean deep fried chicken. No doubt, Colonel Kim's secret recipe.

So check one ethnic box.

I was once taken to a BC restaurant on a visit to the USA for the apparently “Korean” fried chicken. But as requested by my elder and wiser brother, I note he had nothing to do with this

Sensing an opportunity for some real Korean food, I ask for Kimchi.

The waitress brought me a small paper cup about the size of cups one can get a shot of ketchup in a USA fast food restaurant. 

It was filled with what looked like “coleslaw”. Sadly, that’s how it tasted.

As to the BTS sauces, I suppose there is an “ethnic” connection.

Cajun sauce: South Korea, South USA.

“Sweet chili” could be chojang, according to my august and revered elder and wiser brother demonstrating his in-depth knowledge of yet another Asian topic. Though he doubts it is.

“Hold the fermented soybeans, hold the garlic.” 

“외국인”orders don’t upset us.”

Progress inexorably marches forward.

H/T to my elder and wiser brother fount of unstinting wisdom on matters Asian, but not on pizza.

Custódio Castelo Sobre Lisboa

 

The Maestro

BCDR Issued USD 4.1 Million Judgment in Favor of Bahrain Middle East Bank ("BMB") Against Former Shareholders

A First Step
But Still a Long Way to Go

8 April BMB announced (somewhat belatedly) that on 1 February the BCDR had issued a judgment in its favor in its case against former shareholder AlFawares Group apparently over a loan made to Al Sawari Holding Company guaranteed by companies associated with AlFawares.

BMB has instructed its lawyers to initiate steps to enforce the judgment.

Since it appears that the AlF has fallen on very hard times, it's probable that collection will be very difficult.

Even if successful, BMB still has a "long" way to go to remedy its more than USD 116.6 million negative equity. 

“Foreign Investors Face Critical Test Over Chinese Bonds” Part 2

I bought US$10 Million in PUFG Bonds
And all I actually got back was this cheap T-shirt

Part 2:  More on the "Critical Test" facing PUFG bondholders. 

I’ll take a close look at the transaction structure quoting chapter and verse from the Offering Circular (prospectus).

I’ll break with what is sadly usual investment process by actually referring to the most important but usually least read section of the prospectus: Risk Factors. 

And in so doing “force” you to read along as well.

In this “exercise” I’m going to focus on structural/legal factors to the exclusion of other risk factors.

Why?

Because if the transaction structure is weak or the market has fundamental legal problems, you need to walk away.

Page 44 

It may be difficult to enforce any judgments obtained from non-PRC courts against the Group or its directors and senior management who reside in the PRC.

Page 48 

Additional procedures may be required to be taken to bring English law governed matters or disputes to the Hong Kong courts and the Bondholders would need to be subject to the exclusive jurisdiction of the Hong Kong courts. There is also no assurance that the PRC courts will recognise and enforce judgments of the Hong Kong courts in respect of English law governed matters or disputes.

These two items do not sound “promising”.

Page 45 

However, any claim by the Issuer, the Guarantor and/or the Trustee against the Company in relation to the Keepwell Deed or the Deed of Equity Interest Purchase Undertaking will be effectively subordinated to all existing and future obligations of the Company’s subsidiaries (which do not provide a guarantee in respect of the Bonds), particularly the Company’s subsidiaries in the PRC, and all claims by creditors of such subsidiaries in the PRC will have priority to the assets of such entities over the claims of the Issuer, the Guarantor and the Trustee under the Keepwell Deed and the Deed of Equity Interest Purchase Undertaking.

If you’ve read my earlier post about consolidated financials and what they mean, you realize that the holding company’s primary assets are equity in subsidiaries. Absent a guarantee from those operating entities, you’re already effectively in a “junior” position.

And, if by chance, you’re wondering about the PUFG guaranteed bonds, well the guarantee there is by the holding company only. There are no cross guarantees by subsidiaries. So it is limited to the assets of the holding company, which largely consist of stock in the subsidiaries.

Thus, while the PUFG “guarantee” is better than a keepwell deed of equity interest purchase undertaking, it still falls short of the sort of guarantee you would want. Another lesson from the tale of consolidated financials.

Here is the offering circular for the PUFG guaranteed US$250 million 7.875% 24 June 2021 bond if you’d like to check my analysis.

Page 46 

Performance by the Company of its undertaking under the Deed of Equity Interest Purchase Undertaking is subject to approvals of the PRC governmental authorities. (Five are listed)

No approval = legal bar to PUFG’s compliance.

Request for approval will come when the payment crisis has occurred. Not before. That seems a less than ideal situation. You don’t know if the Company is legally bound until default.

Page 47

Performance by the Company of its undertaking under the Deed of Equity Interest Purchase Undertaking may be subject to consent from third-party creditors and shareholders, and may also be restricted if any of the equity interests are secured in favour of third-party creditors.

That’s what we “professional” investors call “cold comfort”.

Page 47 

The Relevant Transferors have limited assets which can be sold to the Company pursuant to the Deed of Equity Interest Purchase Undertaking.

This sounds even less promising. If there’s nothing to purchase, the Company has nothing to buy.

Given all this, there seems little justification for bondholders’ complaints.

Or claiming there was a guarantee when there was not. 

Or even an “impression” of a guarantee as demonstrated by the quotes above.

They were warned in the prospectus.

As well, this isn’t foreign investors’ first “bad” rodeo in the PRC. 

If you’re planning to invest in a country, it’s probably a “smart” move to do a bit of due diligence on how other investors have fared with respect to laws, the legal system, legal structures, etc. 

However, on a positive note, this case does prove my version of the Efficient Markets Hypothesis.

The market is very efficient in separating the financially illiterate, the gullible, or the heedless from their money. And does not discriminate between the retail investor, the professional investor, and institutional investors.

H/T to AA's older wiser august and revered brother, expert in many things Asian, for the quote above as well as the T-Shirt picture.  "If you don't do stupid things, you won't end up in tragedy".

“Foreign Investors Face Critical Test Over Chinese Bonds” Peking University Founder Group Part 1

Failure is Most Often Preceded by Failure to Prepare Adequately 

The 9 April edition of the FT had an article about the “critical” test facing foreign holders of USD bonds supported by a “keepwell” from Peking University Founder Group and by extension other similar "Chinese" bonds.

It is indeed a sad story.

So sad that I'll have to discuss it in two posts.

A few quotes to set the stage for my commentary.

A “person” quoted in the article made two comments worthy of note.

Will a Chinese parent recognise its contractual obligations under a keep-well deed, which literally gave the impression to offshore bond holders the deeds are equivalent to a guarantee?

The person added:

The Chinese parent actually took the majority of subscription proceeds back to China for its own use.

And Simmons and Simmons:

The administrator’s decision has cast significant doubts concerning the validity and enforceability of keepwell agreements, at least under [mainland China’s] restructuring process,” the law firm said in a January report

Now to my commentary.

I think the real issue here is that the bondholders failed an earlier “critical thinking test” that got them into this fix.

This is similar to the case of not knowing “insurance” from a “guarantee”. Or a “promise” from a legally binding “obligation”. Or consolidated from legal entity financials. 

The equivalent of running with scissors and wondering why you got hurt.

What in the investment world might be characterized as a “rookie” mistakes, though sadly it’s not just rookies who make this mistake. At least as they are typically defined. 

If they are looking for someone to blame, a mirror would be handy

Background

I found six outstanding bonds issued by subsidiaries of PUFG listed on the HK Exchange.

As you will notice, four of them are guaranteed by PUFG (indicated by “G” in the table below).

Only two have the keepwell and deed of equity interest purchase undertaking (indicated by “K”).

If you had looked at this time last year, most of PUFG’s outstanding bonds were ‘”supported” by keepwells / deeds of equity interest purchase undertaking.

We turn now to AA’s elder wiser brother, expert in many things Asian, for an explanation.

As is often the case, regulatory avoidance “influences” PRC financing and investing structures. There are many regulators in the PRC, but usually avoidance of SAFE (State Administration of Foreign Exchange) requirements is the primary driver. Cross border foreign currency guarantees must be registered with SAFE. A process that can be time consuming, result in requests for disclosure of all sorts of information that one would prefer not to disclose, as well as refusal to register the guarantee. Keepwells do not fall under this regulation

According to press reports, this structure is used with only 16% of outstanding Chinese offshore bonds. But note that represents some US$96 billion. 

The FT article above refers to bondholder concerns about those with keepwell structures.

This is the group of bonds that I focus on this commentary.

It’s a sad but common fact that most investment problems begin prior to the actual purchase of the investment. 

That is, before the “wise” investor plunks down his or her cash.

The first mistake so often made is a failure to read the offering documents.

Here’s a link to the Offering Circular (prospectus) for the Nuoxi Capital US$400 million 5.35% 24 Jan 2023. To which I'll refer in this and a following post. 

I am presuming that the prospectuses for other keepwell issues are similar.

The first thing to notice is that this issue is for “professional” investors.

There’s a reason for that.

The issue contains risks beyond those considered normally acceptable for retail investors.

Even if you are a professional investor (or more likely imagine you are), that should cause you to think very very carefully.

Structure

The Issuer: Nuoxi Capital, is a special purpose company set up for the “special purpose” of borrowing money.

It has no assets of its own. It conducts no operation other than borrowing funds and upstreaming them to its parent.

The Guarantor: HK JHC Company, is an actual company with assets and operations.

According to the prospectus page 17, as of June 2017 the Guarantor had (drum roll) US$28.5 million in equity capital and US$856.2 million in total assets.

You may also have noticed and I certainly hope you did that the Guarantor has some rather “large” gearing (leverage) and some rather “small” equity.

At this point you should be wondering about the capacity of the Guarantor to guarantee some US$600 million in bonds. The Offering Circular is for two bond issues: US$200 million and US$400 million..

And perhaps what it is going to use the $600 million for.

Not to worry we learn on page 55, it is going to use the funds for “general corporate purposes”.

Well actually to worry.

First, this is a rather “large” amount. One might be forgiven for wanting a bit more detail as to what "good works" this money might be put to.

One might also think that the borrower would have concrete plans and be able to supply some details. 

After all, if you borrow money, you generally borrow only as much as you need. So before you borrow, you need to know the amount so you don't wind up with too little or too much money.  

Unless of course your borrowing is motivated by negative cashflow in your business.  

Second, if you know your PRC company behaviour, you know there is classic PRC MO: borrow money outside the PRC (HK is a favorite) and funnel it to China.

If you’re a serious international investor, you should know this.

If you don’t, you probably should stay in your home marker where you could buy today's Carillon, Thomas Cook, Tesla or Gamestock.

The Parent Company: PUFG, a PRC company, was founded in 1986. Its consolidated financials as of 30 September 2017 are prepared according to Chinese GAAP. 

If you’re not familiar with Chinese GAAP, you might want to pause to ask yourself if you should proceed with this investment. Can you evaluate PUFG's financial position?

The financials shows some CNY 56.7 billion in shareholders equity composed of NCI of CNY 35.8 billion (!) and CNY 20.8 billion to shareholders of PUFG.

If you’re wondering, the fine banks that prepared the prospectus had a very high opinion of readers’ ability to convert CNY to USD. 

Or perhaps thought we should all getting used to thinking in terms of CNY. 

So they didn’t provide conversion to USD.

As per my calculation using IMF data as of the financial statement date, those numbers are in sequence US$8.5 billion, US$5.4 billion, and US$3.1 billion.

Usually in consolidated financials the NCI have a smaller share of total equity than the shareholders of the Group.  That's why they are typically called "minority interests".

That might be another sign to take a deep breath and close the prospectus unless of course you are already sleep walking your way to a “wise” investment.

What the financial position of the three above parties indicates is that the “credit” rests on PUFG, assuming of course that we assess that PUFG is sufficient credit support. 

Otherwise, you should find another “prime” asset to invest in.

What’s key then is the ability to go after PUFG in their jurisdiction with a reasonable chance of prevailing in court.

That’s a matter of structure and the law. PRC law.

So let’s look at how the transaction has been designed to “achieve” that.

Governing Law and Jurisdiction: Laws of England and Hong Kong Courts.

Hmm. But we want to go after a PRC entity in the PRC unless of course PUFG has many cash rich subsidiaries in jurisdictions where we can get a HK court judgement enforced.

This structure is probably going to work as "well" as that in Golden Belt Sukuk did.

The Parent Company Undertakings

The Keepwell Deed (Page 78) tells us that

The Keepwell Deed is not, and nothing therein contained and nothing done pursuant thereto by the Company shall be deemed to constitute, or shall be construed as, or shall be deemed an evidence of, a guarantee by or any legal binding obligation of the Company of the payment of any obligation, responsibilities, indebtedness or liability, of any kind or character whatsoever, of the Issuer or the Guarantor under the laws of any jurisdiction, including the PRC.

And

The parties to the Keepwell Deed will acknowledge that in order for the Company to comply with its obligations under the Keepwell Deed, the Company may require approvals, registrations, filings, clearance or other authorisation of PRC government authorities. The Company will undertake to use its best efforts to obtain such approvals, registrations, filings, clearance or other authorisation. The Keepwell Deed and any non-contractual obligations arising out of or in connection with it will be governed by and construed in accordance with English law.

In “little words” not a guarantee. 

May require PRC government approvals which Company will use its “best efforts” to obtain. 

Oh, and they will do that at perhaps the least convenient time to learn whether there is an obligation--after payment default occurs.

A keepwell is best written on soft paper, either Charmin tough and soft or Kleenex soft, so that one will be able to obtain the maximum benefit from it. Because it’s likely to be a limited use in getting your money.

The Deed of Equity Interest Purchase Undertaking (Page 82) also repeats that same bit of information

The Deed of Equity Interest Purchase Undertaking is not, and nothing therein contained and nothing done pursuant thereto by the Company shall be deemed to constitute, or shall be construed as, or shall be deemed an evidence of, a guarantee by or any legal binding obligation of the Company of the payment of any obligation, responsibilities, indebtedness or liability, of any kind or character whatsoever, of the Issuer or the Guarantor under the laws of any jurisdiction, including the PRC.

This disclosure appears several times in the prospectus as early as page 6.

If as the unnamed person above says you got the “impression” you had a guarantee, I suppose you can similarly conjure up the “impression” that you were repaid. 

One delusion is as good as the other.

But wait there’s more!

See Post 2.

GFH 2020 Financials – Another Festivus Miracle!

 

Theological Question
If the holiday was invented, are the miracles as well?

Time for a look at GFH’s 2020 financials.

First at reported income. 

And then to what isn’t in the income statement but is economically income or loss.

Summary

GFH reported consolidated net profit for the year of USD 49 million.

98% of that amount was due to two revenue streams from “special” items, not GFH’s main lines of business.

What that means is that GFH’s ”mainframe” LOBs in aggregate are basically breaking even.

It also suggests that the quality of reported earnings is low.

Turning to Retained Earning (Consolidated Statement of Changes in Owners’ Equity) there are two items totaling USD 37 million that I believe represent economic losses. 

The only difference is that accounting principles do not require that they be included in Income Statement.

On that basis, GFH’s adjusted consolidated net profit for 2020 was some USD 12 million. Or 24% of what it reported.

Reported Income

GFH reported FY 2020 “consolidated profit for the year” of USD 49 million compared to USD 53 million the prior year. Roughly an 8% decline.

Net income was then further subdivided with USD 45 million attributed to Shareholders of the Bank versus USD 66 million the year earlier. Roughly a 32% decline. Or 4x greater than the decline in consolidated net profit.

The remaining USD 4 million (of 2020 consolidated profit)  was ascribed to non controlling interests (NCI). In 2019 NCI share of net income was a negative USD 13 million.

2020 was an extraordinary year.

Covid caused significant economic disruption across the globe.

So perhaps not so bad for GFH.

But the problem though is that GFH doesn’t really have a good track record in terms of return on average equity (ROAE).

The chart below shows ROAE attributable to GFH Shareholders and then to GFH Shareholders plus Non Controlling Interests (NCIs).

There is another “negative”.

GFH’s revenues and thus net income tend to be dependent on “special” items not on recurring income from its primary LOBs.

So it’s not just a case of low returns but of low quality returns.

Two particular 2020 revenue categories are worthy of a closer look. As you will notice, these two items account for 98% of net income. 

Without them, GFH would have essentially “broken” even. 

Before we start our “excursion” I’d note that we are using consolidated figures as revenues and expenses are not “broken out” by those belonging to shareholders of GFH and those belonging to NCI.

First, Note 22 other income of USD 39.026 million (79% of net income) is composed of:

1. USD 23,2 million in “settlements and write back of liabilities no longer required”
2. USD 8.4 million in “recoveries of expenses from project companies”
3. USD 2.0 million in “income from non financial subsidiaries”
4. USD 5.4 million in [unspecified]

These are hardly what I would consider typical operating income. 

Does that mean that they are bogus? Of course not.

But they are the sort of flows on which a typical bank/FI does not have to depend for a significant share of its net income.

Usually items like this are a minor portion of net income and more similar to the icing on the cake than the cake itself. 

Here that is not the case. 

Without them there is no “treat”.

Also management may have some discretion over the timing of recognition of some or all of these sort of items. Perhaps a useful feature in times of “need”. 

Nice to have hats with rabbits in them.

Second, Note 21 (i), USD 8.418 million gain on the purchase of additional 21% in GBCorp Bahrain. (17% of 2020 net profit). 

This amount is included in Direct Investment Income under Income from Proprietary and Co-Investments where it is roughly 41% of the amount shown.

This is based, as the note tells us, on GFH's preliminary assessment of assets and liabilities of GBCorp.

Also GFH paid the consideration for the purchase by transferring to the sellers “investments held by the Group” not cash.

When one in-kind asset is exchanged for another (in-kind) valuation can be “trickier” (that’s a technical financial term) than usual because two sides of the transaction have to be valued.

Based on a purchase price of USD 21.571 million for a 21.72% share in GB Corp, the sellers ‘ valuation of GB Corp was USD 99.3 million. Or a discount of some 23% from GFH’s preliminary assessment of fair value.

Now it is certainly possible that GFH is better positioned to extract more value from GBC’s assets than the original GBC shareholding group could.

And perhaps the sellers thought they could extract more value from the investments they acquired than GFH could. Or maybe they had pressing financial needs and so had to “fire sale” these assets.

Who sold their shares?

On that point over to the MOICT website to check the CR of GBCorp (CR 65708). From the change in shareholding data there it appears that the two selling shareholders were:

1. Oras Investments (CR 63525) owned by National Amlak Investment AlKhobar KSA for 13.0313%
2. Special Projects WLL Qatar for 8.6875%

National Amlak’s website doesn’t appear to be active. What little information is on its website is “little”. Perhaps a sign of just how motivated a seller they might be.

No idea on SP Qatar.

Typical AA semi-irrelevant but hopefully interesting side note. 

Other GBC shareholders who might be inclined to sell in the future are:

1. Soura Investments (CR 4380) at 12.5% which is held ultimately through a chain of companies leading to Premier Group W.L.L. – a name you may have heard if you “know” Bahrain. For "some" reason, I couldn’t find the Premier Group’s CR on the MOICT’s website. But kindly note AA is not throwing even a single “Stone” here.
2. UGB Holding Bahrain at 12.5%.
3. 2 Seas Investment at 9.043%
4. The rest of GB Corp’s shareholders have relatively small percentages.

Those are the major points I want to make about reported earnings.

Now to other items not appearing in the Income Statement but which have an economic impact on GFH similar to those on the Income Statement.

As usual for this exercise we’ll turn to Retained Earnings section of the Consolidated Statement of Changes in Owners’ Equity.

First is the USD 59.9 million adjustment to retained earnings to reduce the carrying value of the USD 159.1 million KHCB AT1 Murabaha Sukuk that GFH purchased at a premium of BD 12 million (USD 31.9 million) for a price of USD 191 million. PPIt’s important to note that there is a different impact depending whether we look at GFH Parent Only financials or GFH consolidated financials.

GFH Parent Only still “holds” a BD 60 million instrument and will be paid the 10% p.a. murabaha profit rate on the nominal (face value) of the instrument. On GFH’s consolidated financials, the AT1 instrument and earnings thereon will not appear.

Conversions to common shares (not expected to occur) will be based on the nominal value of the AT1 divided by the price per common share as determined. 

Thereafter, if this were to occur, GFH Parent would have a gain or loss on the price movement in shares. And would show an increase in its equity holding in KHCB. 

On the consolidated financials, GFH’s ownership share in KHCB would increase – assuming a going concern and no other common stock issuance-- the share of KHCB assets, liabilities, and income appearing on GFH’s consolidated financials.

If I am right, the immediate economic impact on GFH Parent of this is zero. The lost BD 12 million premium GFH paid is offset by the BD 12 million subscription/underwriting fee GFH received.

On the chance that GFH is able to sell the AT1 to third parties in the future  it would record a loss or gain depending on the sale price versus its cost.

Such profit or loss would also be reflected in GFH consolidated financials, assuming such transactions did not involve “Group” entities. 

Second, there is a USD 14.016 million charge related to modification of financing assets that was not required to be passed through the income statement. Think of it as a provision or other write-down. Wherever it appears in the financials, it is an economic loss.

Third, a loss of USD 22.985 million on Treasury Share sales. That brings the total cost of this pointless exercise to some US $161 million. That includes the cancellation of roughly 45% of GFH TS to occur this year, but excludes the cost of TS trading this year. Most recent post on this topic here.

So, the additional economic events from 2020 not recorded in the income statement are USD 37 million loss.

That makes “economic” earnings for 2020 USD 12 million. USD 49 million (Income Statement) less USD 37 million (Changes in Shareholders Equity).  

And should you discount the "special items" in reported income even lower than USD 12 million.