If everything goes according to plan, Gulf Finance House (GFH) will be well positioned to lead the region’s Islamic banks as growth returns to the Gulf financial markets in 2012.

That is the hope of Ted Pretty, chief executive officer of the Bahrain-based bank and architect of its current restructuring. Making that hope a reality will be a tough challenge, however. If GFH does survive the next few years, it will likely be unrecognisable from the institution it was in the heady days of the Middle East’s projects boom.

GFH has been at the heart of many problems that have emerged as a result of the global financial crisis. An over-reliance on real estate projects with GFH acting more like a masterdeveloper than a bank, mismatched short-term funding and long-term assets, as well as increasing costs, all left the bank in a perilous position as asset prices dropped and credit markets seized up.

Restructured debt

Since taking over GFH in late 2009, Pretty says much of the clean-up operation has now been done. Debts have been restructured, pushing out maturities until 2013 and $220m of debt has been repaid. Some of this has come from asset sales, such as the Bahrain Financial Habour, where GFH is based. The final part of the debt restructuring, concluded at the last minute before the facility was due to be repaid in August, has pushed out the maturity of $100m loan arranged by Germany’s WestLB by two years.

“Now we have a good, sensible maturity profile and have managed to reduce the profit rate [interest rate] on the WestLB facility,” says Pretty.

Next GFH plans to raise $300m to fund future growth. “We decided to take action early on the balance sheet and on cost-cutting,” he says. “We are through that now and the final stage is to go to the market and recapitalise GFH to give us the money that will be used to fund growth.”

The new cash will be raised before the end of the year through an equity-linked Islamic finance instrument. Germany’s Deutsche Bank, which invested $100m in GFH through a similar product in 2009, is advising on the capital raising.

“We have the initial approvals from the Central Bank of Bahrain and once we get the final approval from the regulator we can hold an extraordinary general meeting to get shareholder approval in late October,” says Pretty.

We are well progressed in at least two markets. So expect to see us in Turkey, Syria, Jordan and North Africa

Getting this far may have been done with relative ease, but GFH must now find longer-term revenue sources that will provide the income needed to repay its rescheduled debt. At the end of June 2010, the bank had debts of $412m.

Key to securing the cash to pay off the debt will be how GFH uses the proceeds of its capital raising. “We have allocated a third of the proceeds from the capital raising to making new acquisitions, a third to investments in new businesses and a third to working capital,” he says.

Acquisitions will be used to gain access to new sectors, such as brokerage services, where GFH could acquire multiple small companies and merge them. Pretty sees GFH evolving to be a holding company for Islamic financial services assets. “We are looking at small to medium-sized businesses in areas such as asset management, brokerage and foreign exchange,” he says. “We already have some targets in mind and discussions are already happening.”

New markets

For new investment opportunities, the bank will focus on creating Islamic finance houses either through the acquisition of an Islamic licence holder, or by having a new licence issued. “We are well progressed with this in at least two markets,” says Pretty. “So expect to see us seed new investments in Turkey, Syria, Jordan and North Africa.”

I’m not concerned about capital adequacy, my main concern is ensuring we have the right capital structure

GFH has already had a role in creating several financial institutions including Khaleeji Commercial Bank and First Energy Bank, both in Bahrain, Malaysia Finance House and Solidarity Takaful, also in Bahrain.

Pretty insists the new capital will be ring-fenced and used for growth, not paying off debt. Esam Janahi, executive chairman of GFH and one of the banks founders, will also subscribe to the offer.

Progress will have to be made quickly. Netherlands-headquartered auditors KPMG drew attention to the bank’s $480m of accumulated losses at the end of June 2010. It said the capital adequacy ratio of the bank, which stood at 12.92 per cent, “restricts the group’s ability to absorb further losses or undertake additional exposures”.

That assessment fails to take into account the two-year extension of the WestLB facility, says Pretty. “As far as the Central Bank of Bahrain is concerned, we are above the capital adequacy threshold. I’m not concerned about capital adequacy, my main concern is ensuring we have the right capital structure and that will solve long-term liquidity issues and capital adequacy issues.”

Creating opportunities

In February 2010, Pretty outlined plans to dispose of $420m-worth of assets to help raise cash to pay off debts. That now seems unlikely to happen. One of the key divestments expected at the time was the 37 per cent stake held in Bahrain’s Khaleeji Commercial Bank, along with three Energy Cities projects in Qatar, Libya and India.

“If approached with a sensible offer for Khaleeji, we would take it,” says Pretty. “But, at the same time, we have a large stake and our renewed focus on Islamic financial services means this could be used as a growth vehicle.”

He says one of the opportunities GFH missed was maintaining controlling stakes in the financial institutions it created. “We could have consolidated them and become of the largest financial holding companies in the region,” Pretty adds.

That idea will now inform how GFH buys or creates new financial institutions. “We have got business plans to create institutions in Islamic bancassurance, in retakaful, and in wealth management and brokerage. We see it as a logical return to what GFH has done in the past,” he says.

Plans to sell off the Energy Cities are also being revised – in one case, the project is actually being expanded.

“We have negotiated a larger concession area from government of Libya,” says Pretty. “So now we are speaking to sub-developers from other countries who want to come on board and develop parts of the project. We are under less pressure with Libya because we have a large portion of that on our own balance sheet, other investors are under no pressure for exits.”

Pretty says that for the Qatar scheme, “sales continue to be made, but if we could sell the balance of the land to a Qatar sovereign fund or developer that would be our most desirable outcome”.

For the India Energy City, more resources are being deployed to ensure development work continues. Ultimately, Pretty says the project could be listed to provide initial investors with an exit opportunity.

Despite the change of plans on asset sales, Pretty says he is not concerned. “I am much more relaxed about this business now than I was nine months ago,” he says.

Resiting operations

Pretty has achieved much during his time in charge, but there is still plenty of work to be done. He has been aggressive on stripping costs out of the business and plans to continue this for the rest of the year. “I view the optimal size of this bank as around 70-80 people,” he says.

This figure is about a third of the size the bank was at the end of 2008, when it employed 270 people – and indicates further cuts will be necessary as GFH ended 2009 still with 207 employees. Pretty expects to get to the right number of staff by the first quarter of 2011. He also plans for Bahrainis to comprise the majority of employees, rather than expatriates.

Cost-cutting and debt rescheduling may well prove to have been the easy task. The bank must now rebuild its battered reputation, rescue some of its stalled projects and make good on plans to start investing for growth. All that will need to be done quickly to ensure that debts can be repaid on time. A $137m sukuk (Islamic bond) needs to be repaid in 2012.

Investors are clearly nervous about the company. Its shares are trading at around half its net asset value – the value of its assets minus liabilities. Pretty says this gives new investors the potential for a good return, but convincing them to take the risk could be challenging.

“In 2011, I expect to do a lot better than just break even,” he says. That would be a remarkable turnaround for a bank that lost $48m in the first six months of 2010, although GFH has narrowed its losses significantly since losing $92m in first six months of 2009.

“I don’t want to over-promise and under-deliver,” says Pretty. “But next year I want us to be in a good cash position, cover our costs, and anything above that is good news for investors.”