A Pandora's box of information about Bahrain's troubled Arcapita Bank is emerging into the public sphere, illustrating the scrutiny that will fall on the privately owned Islamic investment bank as it files for bankruptcy protection in the United States.
The bank's 50 creditors, including the lenders on a $1.1-billion (U.S.) Islamic loan due to be repaid on March 28, will be nervously eyeing the outcome of proceedings in the U.S., where a judge will decide how to restructure the investment bank's balance sheet.
Hedge funds, whose aggressive tactics were blamed for pushing the bank to seek refuge in U.S. courts, are initially set to challenge New York courts' jurisdiction over the matter and press for the case to move to the Cayman Islands where creditors may have more room for action.
Challenges to directors' responsibility could also be launched later, say people aware of the hedge funds' thinking.
People close to the process are questioning one deal made recently by Arcapita, which invests money on behalf of wealthy Gulf residents.
At the same board meeting at which Arcapita decided to file for Chapter 11 protection, the board also approved a decision to enter into a $200-million "sale leaseback transaction" with Qatar Islamic Bank over Arcapita's stake in the Lusail property project in Qatar.
Jassim bin Hamad al-Thani, the son of Qatar's powerful prime minister, is the chairman of QIB as well as a board member of Arcapita. He did not attend the board meeting that approved the sale and lease back between Arcapita and QIB.
"One would have to question the timing of this deal," one person close to Arcapita's creditors says. "Lenders will want to know why a transaction has taken place that gives security to another party, when this security could more fairly be distributed among the lender pool."
A person familiar with Arcapita's thinking says the transaction was a loan provided by QIB, with the Lusail project stake acting as security. "Whether or not people like it, this was a legitimate transaction, which is allowed under the documentation of the $1.1-billion loan," he says.
Arcapita's court filing also revealed that the bank was facing other large debt claims before filing for Chapter 11 protection, beyond the $1.1-billion loan.
On March 12, Germany's Commerzbank, the second-largest creditor, made a demand for Arcapita to repay a €125-million ($165.3-million) guarantee on one of its subsidiaries, HT Troplast, a Berlin-based plastics manufacturer.
Atif Abdulmalik, Arcapita's chief executive officer, has blamed the action of some "non-bank creditors" for forcing the Islamic investment bank to file for Chapter 11 protection this week.
In a filing at the court, Arcapita says it had to rely on Chapter 11 protection because "precipitous action" had been threatened by hedge funds "who purchased their interests at deep discounts and [were]seeking to leverage their opposition to a restructuring to obtain a buyout at par."
The documentation filed at the insolvency court has also underlined the political ramifications of Arcapita's financial woes.
Arcapita's biggest creditor is the Central Bank of Bahrain (CBB), which is owed $255-million. A year of sustained pro-democracy protests has undermined the island's financial sector, leading to the departure of foreign bankers and offshore banking assets.
Financiers in Bahrain's capital, Manama, say the disclosure of the central bank's support for Arcapita will raise further questions about the prudence of the island's regulator.
One of Bahrain's main selling points for financial services firms is the reputation of the regulator, but that has been tarnished by the collapse of a Bahrain-based banking subsidiary involved in the multibillion-dollar Algosaibi financial scandal in Saudi Arabia.
"This looks bad for the central bank and for the financial sector more broadly in Bahrain," says one Manama-based banker. "Given the [perilous]state of Bahrain's finances, this looks like an imprudent use of state cash."
The person familiar with Arcapita says the commercial loan was a legitimate means to support Arcapita through the financing difficulties it had faced since mid-2008, and also to underpin the broader integrity of the island's banking sector.
"The CBB during the past three years has placed some deposits in the local banks to underline the CBB's support for the banking sector in the Kingdom of Bahrain in light of the global financial crisis by the end of 2008," the central bank said in a statement
The central bank said it granted Arcapita a $250-million murabaha facility, a type of Islamic debt structure, "in line with the policy of directing deposits to local banks."
The Financial Times