Analyzing KHCB’s Prospects – The Way Forward and a First Step

B&B Prepare to Launch AA on His "Deep Dive" into KHCB's Financials and Prospects 

If You Look Closely You Can See AA Holding a Candle Inside the Bathysphere

My 2017 New Year's resolutions include greater use of corporate buzzwords, but not at work where my boss fines the staff at ever increasing levels for repeated use. Hence "deep dive" above.  

As mentioned in the previous post, KHCB’s earnings history doesn’t indicate it is a likely candidate to provide GFH a stable recurring source of earnings to enable GFH’s new strategy.  But past performance is no guarantee of future results. 

Is there information in KHCB’s 2015 Annual Report that can give us an insight into possible future performance?

Yes. 

As a commercial bank, KHCB’s financial health is based on the performance of its financing (lending) activities.  In 2015 and 2014 lending (financing assets and assets for lease financing) were 59% and 57% of total assets.  Financing revenue was 69% and 78% of total revenue in 2015 and 2014 respectively.   As KHCB’s lending business goes, so goes the bank.

How do we get an insight into the future from historical financial data?

One way is to look at potential stress points and the direction and magnitude of trends.  Credit problems at more traditional short tenor commercial banks aren’t quickly fixed.  KHCB is a harder ship to turn around because it is a long tenor fixed rate lender.  

But this exercise like all other forms of fortune telling is not necessarily conclusive.  Banks are black boxes of risk.  Financials do not always capture those risks for a variety of reasons.

Road Map

Before we set out, here’s the proposed itinerary.   

1. Accrued income receivable  
2. Portfolio yield and “profit rate risk” 
3. Provision coverage  
4. Renegotiated loans  
5. Past due but not impaired loans       
6. Collateral coverage 

Let's start our journey of one thousand li with the first step as the Master would.

ACCRUED INCOME (“INTEREST”) RECEIVABLE

An early sign of problems in the loan portfolio often—but not always--is a build-up in accrued interest receivable (AIR) or the “Islamic” equivalent of accrued income receivable as I noted in my earlier post on ADCB.  In such a situation—and this is not a reference to ADCB because we don’t have enough data points to establish a definite trend at that bank—a bank books income into AIR which later turns out to be “air”.  

Think of the UAE banks merrily capitalizing interest on perpetual overdrafts—which meant they were booking interest on accrued but unpaid interest—back in the late 70s until they well and truly hit the wall. 

Or Bahrain International Bank (BIB) capitalizing interest on a loan to a “great” US fast food investment it had made, but not so “great” it could even pay $1 of interest.  Each year AIR went up by the amount of interest on the loan.  Year after year.  That wasn’t the only “funky” thing with BIB’s financials. All of which savvy investors, rating agencies, and others “missed” until BIB’s sudden impact with the wall.

KHCB doesn’t provide any explicit information on AIR, presumably because of the amounts are not “material” as a percentage of assets.   AR FYE 2015 Note 12 “Other Assets” provides information on sukuk income receivables.   A catch all category “other receivables”—where FA & LA AIR most likely is booked—increased by about BHD 3.9 million from 2014.  But no explanation was provided. Other Assets dropped to BDH9.6 at 3Q16.   Even more abbreviated details here don't allow even cursory analysis.  The 2016 AR will have more details, but is likely to have the same opacity as At 2015 so we still won't have conclusive evidence.  If there is an air problem, the amounts don't appear to serious and the drop in 3Q16 suggests there probably isn't a problem. 

The Statement of Cashflows (SOC) sometimes but not always discloses if AIR is increasing (it sure did with BIB as well as BIB’s Other Assets Note).  KHCB’s SOC is of little analytic use because FA & LA income (interest) received seems to be buried along with principal payments and disbursements in a net figure. 

The comments on disclosure of other assets and the SOC are not only meant as criticism but also encouragement for changes to financial reporting, assuming there is an interest in providing financial statement users with useful information. 

As our journey progresses deeper into KHCB's financials expect more criticisms/suggestions, particularly as AA's candle depletes the air in the bathysphere.