Monday, August 9, 2010

Kuwait FSSA: Snapshot of the Investment Company Sector

This post uses the data in the recent IMF update to its Financial Sector Stability Assessment to look at the Investment Company Sector in Kuwait. Building on that information, we'll do a bit of "back of the envelope" analysis on what distress in that sector means for the economies of other GCC countries.

You can find the earlier post on the Kuwaiti Banking Sector here.

Page 13 of the update gives a breakdown of the assets of Investment Companies in percentage terms.

Asset CategoryPercent Total Assets
Cash  7%
Bonds  1%
Real Estate20%
Private Equity  6%

That's somewhat useful. However, the large "Other" category at 31%  hides a lot of details.  

For a more detailed picture, let's turn to the Central Bank of Kuwait's Quarterly Bulletin for March 2010. Figures below are in KD millions and are from Tables 19-1 and 19-4 as of 4Q09.

Asset Category
Cash & Banks   403.3   401.5     804.8
Domestic Loans   808.9   622.6  1,431.5
Domestic Financial Assets1,925.21,753.6  3,678.8
Domestic Non Financial Assets   143.3   376.8     520.1
Foreign Assets3,821.02,675.6  6,496.6
Other   823.01,374.4  2,197.4
Some observations. 
  1. First, you'll notice that the percentages derived from this table don't agree to that from the FSSA. There's no explanation for this.  Presumably, some reclassification of items.  Perhaps, Global's blocked deposit at NBUQ reallocated back from Other Assets to Cash? Plus of course some other assets - domestic and foreign loans to Other etc.
  2. Second, foreign assets are 43% of total assets. At a rough exchange rate of KD1=US$3.50, that equates to US$22.7 billion dollars.   Clearly, the activity of Kuwaiti Investment Companies is not just important in Kuwait but elsewhere.
Where are those foreign assets?  Are they concentrated? 

The FSSA update has some answers.
  1. Stocks, Bonds and Real Estate: 43% Kuwait, 43% Other GCC, Rest of World 14%. 
  2. Stocks: 47% Kuwait, 36% Other GCC, Rest of World 17% (7% Emerging Markets, 10% US/Canada, Europe, UK, Asia). 
  3. Bonds: 15% Kuwait, 72%  Other GCC, 13% Emerging Markets. 
  4. Real Estate: 38% Kuwait, 53% Other GCC, Rest of World 7%.
As the above indicates, Kuwaiti Investment firms have significant exposure to Other GCC markets.  This suggests is that distress in Kuwaiti investment firms will have a direct impact on those markets.  If we use the 43% in stocks, bonds, and real estate (as per the FSSA) as an overall proxy for GCC investment, then very roughly some US$10 billion of demand for assets will be affected  -- primarily in equities and real estate.  Note: Since as mentioned earlier the data in the CBK's Quarterly Bulletin doesn't appear to exactly tally with the FSSA's, there is a bit of approximation in these numbers.  But I'd argue close enough for a directional analysis.   

The impact  - both in Kuwait and other GCC states - will come from distressed companies:
  1. Selling assets putting pressure on prices. 
  2. Scaling back or abandoning existing projects. 
  3. Reducing or eliminating new projects and investments thus constraining future investment flows in these asset classes.
Now to the IMF's conclusions about the Kuwaiti Investment Sector:
  1. In its Risk Assessment Matrix (Page 7), the IMF notes the Sector suffers from (a) high leverage, (b) significant dependence on foreign funding, (c) maturity mismatches – long term often illiquid assets financed with short term funds, (d) large exposure to equity and real estate, (e) weak disclosure, and (f) fragmentation of industry. Negligible exposure to European assets.  No real big surprises here.
  2. In terms of a severe realization of threats in the next three years, the IMF assigns a high probability (PD) and a medium impact (LGD).  But note this is in terms of impact on the Banking Sector.  The impact on the Investment Sector is much more dire and outlined in the stress test results.  Again this is no surprise.
On that latter topic, as it did with the Banks, the IMF stress-tested the Investment Companies.  However, it only tested an 11 member cohort out of the 100 Investment Firms.    It used three scenarios (which differ from those used in the Bank stress tests) outlined in Appendix Table 6 (page 40): a mild case, a moderate case, and a severe case. 

Let's take a look at the results using Table 7 (page 41) and not the summary on Page 22:
  1. In the mild case, 3 firms had capital adequacy less than 10%. 
  2. In the moderate case, 3 firms had negative capital and 3 more had capital adequacy under 10%. 
  3. In the severe case, 7 firms had negative capital and 3 additional firms had capital adequacy below 10%. Recapitalization of these firms (note the 11) would require an outlay equivalent to 2% of GDP.  
  4. You'll recall that for the Banks the recap required from the "Severe" scenario was 3.8% of GDP.  However, that was for the entire Bank "universe".  Here the 2% is for 11 out of 100 Investment Companies!
  5. Given the distress in the Investment Sector, one expects that the results using the entire universe would be much worse.  And the total recap much much higher.


The Rageful Cynic said...

Given the fragmentation of the investment sector, a focus on maybe the top 30 or so firms (by assets) would be more appropriate.

The listed firms make up a sizable sample of the universe, i'm surprised the IMF didn't test all the listed firms...

on a similar note, i heard a bit of news that the CBK is gonna stress test the sector, but given the history in this part of the GCC, i wouldn't hold my breath for much clarity or transparency on the process...

Abu 'Arqala said...

The CEBS has a highly successful stress test model. By that I mean that there's a high success rate among those who take the test.

Maybe the CBK could borrow it?

BTW the IMF recommended that the CBK stress test its financial institutions as part of the FSSA update.