Tuesday, December 20, 2016

Khaleeji Commercial Bank Poor "Fit" with New GFH Financial Group Strategy

As promised in an earlier post, a more detailed look at KHCB.
Key Points of GFH’s 2014 Strategy
To set the stage, a recap of the key elements of GFHFG’s new strategic focus:
1.     “stable and recurring income, profitability and cashflow”—while they didn’t use the term “annuity business” that seems an appropriate characterization
2.     reduce its holdings in “land-based business” (real estate) from 50% to 40% in the midterm and to around 30% in the long term
3.     “ensure greater stability from global financial issues”  
For citations for above, see the 1 December posted linked to above.
In a series of posts to follow, I’ll explain in typical-AA excruciating detail why I think that KHCB is a poor fit with GFH’s new strategy.  Here’s a summary of my main conclusions:  
1.     Historically KHCB’s earnings have been highly volatile probably as a result of some of all of the following:  the nature of its business (long term fixed rate lending), underwriting standards, the limited size of its national market (note KHCB is only 3% or so of the Bahrain bank market by assets), possible earnings management catching up with management, etc.
2.     As a long-term fixed rate lender, KHCB is exposed to significant “profit (interest) rate risk” which threatens future earnings because KHCB’s long dated fixed rate portfolio offers less opportunities for repricing than say a shorter tenor portfolio like that of Qatar Islamic Bank. As well, if rising rates squeeze KHCB’s income, it may be forced to pay lower profit rates to depositors increasing the risk of depositor flight.  Both outcomes are particularly a threat because interest rates for the US dollar—to which the BHD is pegged—appear poised for more increases.  
3.     KHCB’s portfolio has weak credit quality metrics that suggest credit related problems will weigh on future earnings, e.g., consistent renegotiation of significant amounts of its portfolio; the sudden dramatic increase in 2015 in loans classified as “past due but not impaired”, particularly in the 90 day plus past due category; and declining loan loss provision coverage.
4.     Substantial indirect exposure to real estate—an interest rate sensitive asset class—through reliance on real estate collateral.  While direct real estate exposure may be under KHCB’s 40% limit for assets, the indirect exposure through collateral is at 55%.  To the extent that loans may have been made to marginal borrowers based on real estate, the indirect nature of this risk will become more proximate.
So with all these negatives why did KHCB become a key pillar of GFH’s new strategy?

AA thinks the answer is in GFH’s AR 2014 Report by Executive Management page 39. 
“During the year, our sale transaction for Khaleeji Commercial Bank (KHCB) fell through. However, with the revised strategy of evolving as a wider financial group, GFH is now looking to retain its investment in and grow the operations and businesses of KHCB.”

What this seems to say is that if the sale had gone through KHCB wouldn’t be a pillar.  Looks like a third party (the prospective buyer) played a critical role in developing GFH’s new strategy.  

Or in other words “If life gives you chickpeas, make hummus.”

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