Gulf Bank: How "Improved" Are Their Financials?

One of our newest readers  raised two interesting questions via our contact page:  

1. He's heard rumors that GB is engaged in restructuring of several large exposures and wondered if I had any insights.
2. Indirectly he asked about the seeming improvement in GB's financials.

Gulf Bank Loan Restructuring

I have no special insight into what's going on at GB.   Perhaps some of our regular readers/commenters - Laocowboy2, The Rageful Cynic, Advocatus, or anyone else out there - may.  If so, please post a comment.

In the interim some speculation. 

Banks restructure loans for a variety of reasons:

1. To agree a repayment schedule with a distressed borrower that provides a reasonable probability of repayment.  The rationale here is to avoid legal proceedings unless absolutely necessary as these generally result in "wastage" of the debtor's estate, particularly in those jurisdictions where creditors' rights are weak.
2. As a pre-emptive strike to keep a loan from falling into the NPL category. 
3. To surgically remove NPLs from the distressed column and transfer them to "restructured" and eventually "performing" loans.  This lowers the total of NPLs and improves the provisions/NPLs ratio.  At FYE09, GB's Specific Provisions covered 43% of NPLs versus 63% a year earlier.  Between FYE08 and FYE09, GB's NPLs increased 138% from KD482.5 million to KD1,148.6 million.  2009 Annual Report here.

The last two can be largely cosmetic - to "manage" problems or at least the appearance of problems.  

Certainly, GB has a sufficient stock of NPLs that it should be busily restructuring away for the substantive first reason mentioned above.  Whether it is engaged in any cosmetic restructuring is not known.

Gulf Bank's Financials - Improved or Not?

Many have noted that for 1H10, GB reported  KD2.1 million in net income versus a loss of KD7.5 million for 1H09.   That certainly looks like an improvement.  But is it?

Two factors were responsible for this apparent improvement:  an increase in the net interest margin of KD11.2 million and an increase of KD22.7 million increase in Operating Income (excluding interest).  Let's take a look at each of them to see where the improvement arises - and if it is due to improvement in the business or to other factors.

The improvement in the net interest margin can I think be explained by three factors.  

1. First, interest expense in 1H09 driven by the aftermath of GB declaring a KD359.5 million loss for FY2008.  If you look at FY2009, GB had total interest expense of some KD119.4 million for the year.  From the comparatives in the 1H10 report, we see that interest expense for the 1H09 was KD72.1 million - 60.4% of the full year total.   Once GB had successfully recapitalized itself, its cost of funds declined in 3Q and 4Q09.  So is the improvement here an improvement in market sentiment due to the raising of KD376 million in new equity? And not a fundamental improvement in the underlying business.
2. Second, pricing increases.  There was an interview with Michel Accad in which he mentioned that GB had repriced (upwards) its facilities.  For some reason, GB no longer breaks out interest income by LOB which would allow an approximation of the gross yield on its loan portfolio.  It stopped with its FYE2009 Annual Report.  Wonder why the change?  With this info we could attempt to quantify the impact of any pricing change between 1H09 and 1H10. to see if indeed  margins had improved.  Using that method for 1H09, we get a gross annualized yield of about 5.6%.  Using this method through 3Q09, the yield is about 5.4%.   If we use the same split between Commercial Banking and Treasury interest as in 2009 (83% as of 1H09 or 84%  for the first nine months of the year 2009) for 1H10,  the 1H10 yield on the loan portfolio is actually lower:  4.9% (1H09 interest split) or 5.0% (Full 3Q09 split).  But that may be an incorrect assumption.  Note to Regulator:  More transparency rather than less is highly desirable.  Note to GB:  Unless you've got something you'd like to hide disclosing this information would be very helpful. Final Note:  This analysis is not conclusive.  The missing step is to see what happened at other Kuwaiti banks'  gross yields to get an idea about the macro environment.
3. Third, as GB continues to aggressively provision for loans (some KD108.5 million so far this year) it reduces its funding cost.  One would expect that the NPLs were already on non accrual so that the provisioning would affect interest expense primarily. One might say that provisioning is inversely related to problems.  On that score, there really doesn't seem to be a fundamental improvement in  the business.

The improvement in Operating Income (excluding Net Interest Margin) is largely explained by "Realised Gains on Disposal of Available for Sale Investments" of KD22 million roughly KD18.2 million over 1H09's earnings for the same category.  A decrease in "Impairment Losses on AFS Investments" of 3.8 million accounts for the rest.

Some observations.

1. Without the AFS asset sale (not a core constituent of GB's commercial banking franchise but a Treasury activity), GB would have recorded an Income Statement loss of KD20 million for 1H10 as compared to the KD7.5 million loss it recorded for the comparable period in 2009.
2. But there's more.  Since GB had already recognized KD20 million of profit on these assets in its fair value reserve (Statement of Comprehensive Income), its Comprehensive Income  for 1H10 was  a KD18.5 million loss versus a KD11.4 million gain for 1H09.  Looking at the Balance Sheet, you'll notice that Shareholders Equity declined KD21 million between FYE09 and 1H10.   And that's the bottom line on financial health - growing equity.  If you're wondering, the extra bit (KD2,5 million) is movement in GB's Treasury Share Reserve.

On a segmental basis, GB's commercial banking division did not make a profit in 2008, 2009, or 1H10.  And I'd note that GB was unable to allocate KD246 million of its 2008 "expenses" to either segment.  Perhaps, they properly belonged as "management overhead"?  

So at this point taking all these factors into consideration, I'd suggest a pause before speaking about "improved" financials.  

There's still a way to go.  To determine when real progress has been made keep your eye focused on:

1. Comprehensive income, looking for a positive number and an increase in Shareholders' Equity from "income" from one period to the next.
2. NPLs and provisions, looking for both to decline.  For provision coverage ratios to increase.
3. Meaningfully positive results in GB's core commercial banking franchise.  As Michel Accad said in part in the 2009 Annual Report in discussing GB's strategy:  "We have redefined our Vision; we seek to dominate the local retail and commercial banking space ..." If commercial banking/retail banking is the key, then GB will be healthy when those businesses are healthy.  Today they're not.