The fine folks at Markaz have issued a report on the Central Bank of Kuwait's proposed new regulations for the Kuwaiti "Investment" Firm Sector.
Markaz is generally supportive of the CBK's actions.
The "headline" story here (and sadly not a surprising one) can be summed up in this quote:
As to the CBK's analysis, of the 100 firms in the sector:
The detailed results of Markaz's analysis are in Appendix 2. On an aggregate basis, of the 32 firms in their sample.
Markaz is generally supportive of the CBK's actions.
The "headline" story here (and sadly not a surprising one) can be summed up in this quote:
The report has three main parts:The sector lost over USD 2 bn in 2009 following a monstrous loss of upwards of USD 3 bn in 2008, and continues to post an aggregate loss of over USD 100 mn in 1Q10 (an annual run rate of USD 400 mn). The losses are tied to impaired assets which companies have been writing-off in an attempt to restore some health to their balance sheets. Liquidity and over-leverage have also been an issue for the sector, whose assets are often comprised of difficult to value and illiquid investments which are then pledged as collateral against further borrowings. These issues were not bothersome during the boom periods; however, when the global financial crisis hit, it exposed the sector’s vulnerabilities resulting in a massive destruction of wealth.
- A discussion of the ratios. This is well worth a close read.
- The CBK's analysis of compliance. (Discussed below)
- Markaz's own analysis from a sample of 32 companies.
As to the CBK's analysis, of the 100 firms in the sector:
- 94 meet at least one of the new criteria.
- 82 at least two of the new criteria.
- 49 all three of the criteria.
The detailed results of Markaz's analysis are in Appendix 2. On an aggregate basis, of the 32 firms in their sample.
- 75% met the Leverage Ratio.
- 44% the Acid Test (Liquidity Ratio)
- 34% both ratios.
The problem arises in the valuation method used in this segment which can be vague at best and completely misrepresentative of “actual” value in the worst case. By misrepresenting the fair value of Assets Available for Sale, a company can inflate its Fair Value Reserve (and therefore Equity figure) by booking Unrealized Gains, which would produce a lower leverage ratio."Earlier post on this topic here.
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10 comments:
While reform was certainly overdue in this sector, I see some unintended (at least i assume unintended) side effects. Non-bank financing companies are all lumped in with the investment companies - and the new rules will severely restrict their activities. This may or may not be a good thing given the excessive consumer debt overhang in Kuwait (and other GCC countries) but the business model of CFC for example will be constrained.
Laocowboy2
Excellent catch on the regulation snaring the likes of CFC.
Perhaps, intentional given their slogans "Our loans easier than drinking water" or "We can when they cannot"?
CFC will have problems with the third ratio (FX borrowings) given their reliance on US$ financing. A hat tip to them for their dislosure on this topic.
Any insight into the quality of their their loan portfolio (mostly consumer loans)?
If I believe the "wise" members of the Majlis alShura (or at least some of them) the average Abdullah in Kuwait can't pay his loans and needs debt relief. And so it would be natural to look a bit more closely at CFC's as it's concentrated in that area.
From the 2009 financials, CFC have roughly KD50 mm in past due but not impaired loans (mostly around 90 days). Up KD11 mm from 2008. They use 12 month past due as the criterion for "impairment" - which since more than half their loans are one year term seems a bit optimistic.
In any case a quick and dirty calculation shows about 28% of the portfolio impaired or past due: impaired plus past due divided by gross loans less unearned interest.
That leads me to wonder if they are rolling over (renegotiating) troubled credits as a way of keeping the impaired and the past due loans down.
Do you know?
This brings, at least to my mind, the issue of proper classification of companies. This is a real issue in Kuwait which is starting to show some repercussions, especially with the fairly ridiculous classifications in the KSE.
The relevant authorities need to do a much better job of classifying companies, if its not a classic, investment company business model then perhaps it could be exempted from the new regulations.
(although I think CFC, given its primary operations, should not necessarily be excluded from the regs).
As a number of questions in your post, I have cut and pasted replies with the original text below.
Perhaps, intentional given their slogans "Our loans easier than drinking water" or "We can when they cannot"?
CFC will have problems with the third ratio (FX borrowings) given their reliance on US$ financing. A hat tip to them for their disclosure on this topic.
I believe third ratio is foreign (not FX) borrowings as in identity of lender. Much of CFC funding is domestic.
Any insight into the quality of their their loan portfolio (mostly consumer loans)?
Good by standards of industry/sector (as in consumer lending generally) but NPLs likely to be rising (as with everyone else)
If I believe the "wise" members of the Majlis alShura (or at least some of them) the average Abdullah in Kuwait can't pay his loans and needs debt relief. And so it would be natural to look a bit more closely at CFC's as it's concentrated in that area.
Main problem here is that parliamentary posturing on debt forgiveness had led some borrowers into “won’t pay” just in case they can get relief. Most CFC borrowers are names they have lent to previously.
From the 2009 financials, CFC have roughly KD50 mm in past due but not impaired loans (mostly around 90 days). Up KD11 mm from 2008. They use 12 month past due as the criterion for "impairment" - which since more than half their loans are one year term seems a bit optimistic.
Whatever the financials say, CFC have to follow the Central Bank rules on both classification and provisioning – and so would start at 90 days past due for substandard, 180 or so for doubtful and 1 year for loss loans.
In any case a quick and dirty calculation shows about 28% of the portfolio impaired or past due: impaired plus past due divided by gross loans less unearned interest.
That leads me to wonder if they are rolling over (renegotiating) troubled credits as a way of keeping the impaired and the past due loans down.
Cannot be sure but unlikely – unlke the banks, the contracts are usually (say) for three years with monthly payments of part principal and part interest. Hard to roll over something like that.
Do you know?
TRC
Thanks.
Part of the problem is that many companies which are not investment companies (in a formal sense) are in a practical sense. How many Kuwaiti "industrial" companies' primary source of income is punting in the KSE?
What I think really needs to be done is for the MOCI, KSE and Central Bank to agree a definition of what constitutes being an investment company - say a certain percentage of assets or income from investments - and then enforce compliance with Articles and Memorandum of Association corporate purpose/powers and licensing requirements from the CBK.
That requires not only appropriate regulation/legislation but also a will to enforce both.
Laocowboy2
Thanks for your detailed comment. I really appreciate getting feedback - particularly when I may need some "adjustment" to my analysis.
Here's some redirect. In several relatively (at least for me) short messages.
(1) FX Loans
It's pretty clear from CFC's 2009 Annual Report that it's running a substantial short US$ position.
(a) Note 21 Segmental Information - International Liabilities at KD92 mm out of KD171mm. Even higher in 2008.
(b) Note 22 Market Risk/FX Risk also indicates a substantial short position in the US$. And the decline in "risk" between 08/09 mirrors the decline in International Liabilities from 08 to 09.
Note 12 suggests one explanation - interest rate arbitrage. Borrow "low" in US$ and lend "high" in KD.
But if so, why wouldn't these FX liabilities be shown as "Kuwaiti" if they were from Kuwaiti banks in Note 21?
That's where I'm "hung up" and so have took the alternative hypothesis that these are borrowings from abroad.
Laocowboy2
Second message on Provisioning. This time no "have took's"!
Again from the 2009 AR.
Note 8:
"At 31 December 2009, non-performing loans and advances amounted to KD 26,020 thousand (2008: KD 23,251
thousand). The criteria for classifying a loan as non-performing are based on installments which are due for more than
12 months. These classifications are in accordance with the CBK regulations."
I checked the Arabic version and it uses the term غير المنتظمة which I believe means "non performing" as opposed to "impaired". In Note 22 Page 42 Arabic version the term منخف†ضة القيمة is used for impaired.
That's the primary basis for my confusion. It seems that it's 12 months' delay before a loan is non performing - and that presumably is when non accrual starts.
There is a distinction between non performing (when accrual should cease unless there is collateral or other assurance of repayment) and provisioning - when an impairment is recognized. And generally minimum provisions are set according to arbitrary dates - the longer past due the higher the provision.
Continuing on that topic Note 3 Page 27 ("Interest income which is considered an integral part of the effective yield of a financial asset, are recognised using the
effective yield method, unless collectability is in doubt") suggests that interest accrual continues on past due loans if they are not considered impaired (provisioned against). Unless I've missed a statement to that effect - which is a non trivial possibility.
The presumption I'm making is that if collectability is in doubt, then a provision is required.
Any guide for the perplexed?
Laocowboy2
And finally on the topic of renegotiations.
No, I have no specific information but experience has taught me to be fairly skeptical about financials. So this is a natural line of inquiry.
The time-honored process of rolling over troubled installment debt would work as follows. Borrower can't pay. Lender makes him a new loan which pays off the old. Suddenly, everything is "current". This could sometimes be caught by an increase in loan renegotiation fees - if these were disclosed separately. Or an outsize jump in loan origination fees - as lenders generally took more than their going rate to restructure a troubled borrower.
Anyways your comment inspired me to take a closer look at CFC's portfolio. They're clearly running down the portfolio. Net loans are down some KD57 mm from 2008.
The proportion of loans due within the next 12 months has jumped to about 47% - in the 2006/2007 period it was a lower 36%. Seems they started the belt tightening in 2008 - when the due in 12 months ratio increased to 41%.
Note these figures are on gross loans - before deduction of interest. So lower interest rates are probably also playing a part. Gross loans are down some KD79 mm between 2008 and 2009. The primary balancing factor with net loans change of KD57 is the decline in interest from KD52.1mm to KD31.3 mm. Lower loan volume and lower interest rates.
That's what you'd expect if the new loan machine was shut down - an overall decline in the total portfolio and a higher percentage due in a year.
They've also reduced Term Loans - a large part of that was paying off US$ denominated loans. As a side note, their funding strategy cost them KD5.4mm in 2009 due to unfavorable moves in the US/KD FX rate. So no doubt a reason why they focused on FX loans. Probably also local and regional banks would prefer to husband their US$ liquidity
as well as earn the higher KD loan rates.
Assuming they stay the course, the implications are probably for a further decline in interest income for 2010 as well as additional contraction of the loan portfolio. Presumably accompanied by additional debt reductions.
I would be surprised if CFC kept any loan on an accrual basis once it had been classified as substandard or below - doing so may polish up the short term earnings picture but means a large reversal hit to the P/L down the line.
More generally I believe that after all the pain is over, CFC and KFH (for the Islamics) are likely to remain the last two non-bank consumer lenders standing (albeit that KFH is (sort of) a bank).
Laocowboy2
Thanks.
You're clearly better informed than I am.
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