Tuesday, July 6, 2010

Gulf Banks: Some Wilt and Some are Apparently Ruder (At Least Healthwise)

A couple of interesting articles in the Financial Times over the past two days.



In one the remarkable recovery of Gulf Bank Kuwait is diagnosed.   Indeed quite a dramatic recuperation.  Its health much "ruder" than before.

Though with a third of its loan portfolio distressed, a need to provision just about all its earnings (except a cosmetic profit) to cover its currently recognized bad loans, and an ongoing fire sale of the ubiquitous but apparently solid "non core" assets to fund its core assets (the loan portfolio?), Gulf Bank is not yet out of the intensive care ward.

One does have to wonder how a bank achieves both a meltdown in loans and derivatives in the same time period.  Success in achieving just about every commercial banker's dream?  Building an investment banking business to rival its commercial business. 

Hopefully, Michel will be able to turn around the bank.  With a chronic case like this one, careful clinicians will want to ensure that (temporary) remission  is not confused with a (permanent) cure.  The surgical removal of the old Board  and elements of management by the KIA no doubt a necessary but not sufficient part of the treatment.  As to core competencies in commercial banking, - another element in the  cure - I'm assuming Michel is speaking prospectively and not retrospectively. 

Now to the next article:   a "blistering" analysis of defects in business models at the Gulf's so-called "investment banks".   You'll have to look rather closely in the picture immediately below to glimpse the wilted remains of some former investment banking titans of the GCC.  But I assure you they are there.

Sahara Desert

There has been a lot of soul searching at GCC investment firms to determine what went wrong.  

As I've pointed out before, many experienced and serious thinkers have come to the conclusion after no doubt very careful study that it was someone else's fault.  When the going gets tough, the tough find a scapegoat.  And an excuse.  The global financial crisis is generally identified as the villainous culprit.  As a matter of good form, I will again note that as a matter of definition that term is all lower case. 

In his article Robin Wigglesworth adds:
"The financial crisis has highlighted severe shortcomings in risk management, over-exposure to real estate and a reliance on paper gains on proprietary investments rather than recurring fee-based revenue, with disastrous results for some houses."
Some firms.  Indeed!  But not all.

While a generalized macro economic shock will lower all boats, it is usually the weakest links that get hurt the most. 

What then explains how the uneven effects on firms?

A study which considers "sharp" business practices and the state of ethics as causative factors might be quite enlightening.  A potentially "tricky" topic for discussion with financial firms that profess to follow the teachings of a noble religion, I suppose.

It would also have been informative to hear from some of the regional investment banks who emerged as "going concerns" after the crisis.   But then reporters cannot compel interviews.  With the summer months no doubt many have fled for more temperate climes.  Others may feel that discretion at this time is advised.

7 comments:

Laocowboy2 said...

Ref Gulf Bank. It was always a bank with a strong and (in the right way) innovative retail banking business. International was always an afterthought so how they loaned so much to AHG and Saad is a mystery. I understand that the derivatives loss was indirect - they essentially guaranteed a customer who entered into some structured derivatives products with a foreign bank that went horribly wrong.

Looking ahead, they may be able to regrow the retail but why would a corporate bank with them rather than one of the others? A merger candidate for 2011-12?

Laocowboy2 said...

Ref GCC "investment banks". I actually thought the article erred on the generous side! Apart from the known caualties, there are a lot of walking wounded out there that may not make it unless someone comes up with significant new capital. I (smugly) recall once writing a memo in which I compared Markaz and Global to the tortoise and the hare - and saying where I would prefer to have my money. The region could have done with more Markaz-type business models, and less private equity funds masquerading as banks.

Abu 'Arqala said...

Laocowboy2

Re Gulf Bank.

Yes, a strong retail franchise and an "aggressive" commercial bank. I've seen some of the loans!

On the topic of the derivatives, you probably know more than I do.

Here's what I've been told.

(1) GB enters into derivatives contracts with a client. Related party so the story goes. But in a small place like Kuwait, isn't everyone related in one sense or another?

(2) GB then takes matching position in its own name with unnamed foreign bank.

(3) Rates move the wrong way. Loss on the contract.

(4) GB client claims it cannot settle. Since the contract with the foreign bank is in GB's name, they are on the hook.

As I see it, the banking problem with Kuwait arises from several market conditions:
(1) Rentier state
(2) Small economy
(3) Crowding out of private sector by government in key areas
(4) The presence of regal big fish "investors" who crowd out further
(5) Focus on wealth generation through trading rather than building businesses. A not illogical strategy given the zip code.
(6) Weak business ethics
(7) Laughable supervision particularly at the KSE
(8) Too many banks and "investment firms" - which spurs intense and often silly competition with marginal "investment" schemes, marginal loans for marginal schemes, asset based (or perhaps more accurately asset imagined) lending as opposed to cashflow based lending,

All that being said there are strong factors which mitigate against mergers. The time for a merger of GB would have been when the derivatives fiasco blew up. And the creation of new banks continues apace, e.g. Warba.

Abu 'Arqala said...

Laocowboy2

Re "investment banks", spot on.

Most properly investment companies. And with a focus on illiquid assets of in many cases imagined values.

Long ago when a young and eager AA joined the banking fraternity on the bond side of the business, one of the first thing we were taught is to look at the "people". No need to crunch the numbers if the client doesn't pass the sniff test.

A wise rule that can substantially shorten the due diligence process whether one is lending money or deciding to buy an investment or hire a fund manager.

Walking wounded. As I'm sure your personal work experience bears out, more often that not in most markets there is serious disguised stress in the banking sector even in such "developed" markets as the USA.

During the Latin Sovereign debt crisis of the 1980s, all the major US banks were technically insolvent. The solution was to pretend they weren't. Later when the real estate crisis hit, at least two of the major US banks were technically insolvent. One went on to become a merger luncheon special some years later. The other a serial acquirer.

After the Manakh, really only one Kuwaiti Bank (other than the Central Bank of course) was solvent.

And so on ...

Robin W said...

Think an article on Markaz is coming soon... And the tortoise and the hare analogy is very apt.

Robin W

Vanguard said...

Whats your take on NBK? though it sports solid financials, I have heard from insiders that it has around $400M -$600M to Kharafi Construction for providing all those cranes etc in Kuwait and Dubai.

In addition, it has the tallest towers in Kuwait such as Raya II and under construction Al Hamra. It occupies first 20 floors of Raya because Salhiya (developer) could not service the construction loan and NBK had to take the floors rent free in lieu of debt servicing. A similar arrangement is heard to be in place for Al Hamra tower once it gets completed

Abu 'Arqala said...

Vanugard

My first reaction from quite a distance is that NBK is pretty solid. But I have no inside sources and am relying on their financials being fairly stated.

Could they have a problem with MAK? Or other real estate? "You betcha" as our more educated politicians say here in the USA.

Banking "virtue" is relative not absolute.

Looking at NBK's financials, the top range of the MAK exposure would be 9.3% of equity as of FYE 2009.

Also there are no distress signs in 2009's Note 28.1.4. Past due and impaired loans are relatively modest. There's no sign of massive loan renegotiations. 2008 is in line with 2009.

Note 26 (Related Parties) provides some comfort as well in the collateral coverage of loans. Some Zain shares in there perhaps? You'll also note that related party loans are down.

No sign in the Cashflow of any large acquisition of real estate.

But in the final analysis banks are black boxes. One never knows for sure. That being said, the signs are good here.