Markaz: Review of Kuwait Investment Sector

 Renovation of Yet Another Proven Business Model In Progress
(Or, Perhaps, A Half Built Mega Project)

Markaz has issued “Kuwaiti Investment Firm Sector Taking Stock Two Years After the Crisis”. The report is an update to one they issued in June 2009.

As usual, good analysis and commentary.

You can obtain a full copy of the report by sending an email to info@markaz.com referring to the title above.

In the interim, some key points from the report.

Let’s start with Markaz’s Conclusion:

“The investment sector in Kuwait has a long way to go on its path towards health especially in light of the Central Bank’s increased oversight on the sector, which may lead to reduced activity among some firms that need to clean house. Given how unpredictable and difficult the sector’s assets are to value, it is difficult to predict the future performance of the sector, especially given the wide variance in case-by-case health.

We are optimistic that 2010 will show a further narrowing in bottom line losses, though we remain skeptical of a return to profit. Not only will companies be looking to offload more of their investments, booking impairment losses in the process, but regional/global equity markets have shown lackluster performance for the year, which may have an adverse impact on both the firm’s quoted investments in addition to the AUMs (thereby reducing fee income), all of which will put downward pressure on the bottom line.”

Historical Performance

I’ll start by noting that the report does not cover all investment companies in Kuwait. It is based on a set of 34 listed companies of which only 28 have reported for 2009. The missing reports include The Investment Dar – which hasn’t issued a financial since 31 December 2008. Nonetheless as with many such studies, it gives a good macro picture.

Earnings in KD millions.

2005	2006	2007	2008	2009
945	281	846	(810)	(778)

1. The graph in Markaz’s report gives a good pictorial sense of the variance.
2. In lieu of a graph, let’s look at statistical measures. All of which are rounded to the nearest integer. The Mean Income over the five-year period is KD97 million. The Standard Deviation (Sample) is 852 and the Standard Deviation Population (762). The SD is between 8x and 9x the Mean. That gives an idea of the variability of income. 
3. During the first three heady years of hefty profits, no doubt equally hefty bonuses and dividends were paid based on reported income -- largely non cash capital appreciation. Many of these payments also no doubt financed by “wise” lenders - who are now left holding the proverbial bag.

Asset Classification

IFRS 7 requires that companies disclose the basis for the valuation of assets held for sale (similar to FASB 157).

1. Level 1: Based on quoted market prices in active markets for identical or similar securities. 
2. Level 2: Based on observable market data – either direct or derived. 
3. Level 3: Inputs into valuation models are not observable market data.

Markaz’s set of companies assets are distributed as follows. Amounts in KD millions.

	FVTPL		FVTE	TOTAL	% TOTAL
Level 1	264		535	799	34%
Level 2	213		365	578	25%
Level 3	236		708	944	41%
TOTAL	713		1,607	2,321	100%
% Total Investments	31%		69%	100%	----

As Markaz notes, the IASB allowed companies to “move” assets from the then inconvenient FVTPL (Fair Value Through Profit and Loss) classification to FVTE (Fair Value Through Equity) which neatly “solved” earnings problems in a time of decline in values.  And, no doubt, achieved its goal of fooling more than a few "wise" investors and lenders.

It would be interesting to see how many Kuwaiti firms availed themselves of this exception to manage their apparent earnings.

It’s not surprising that overall there is a concentration in Level 3 assets given business models. And one could point to firms in the “Developed West” with similar concentrations. But out of national chauvinism I won’t point but merely link.

Appendix 1 lists the ratio for some 32 firms. There’s wide variance.

1. Gulfinvest International and Al Qurain have 100% of their assets in Level 1.   Noor 85%.  Bayan 84%. Coast 72%. 
2. On the other hand, National International Holding has Level 3 assets at 87%, First Investment at 70%, Al Safat and Al Mal at 67% and Global at 55%.

The Kuwait Investment Firm Sector in the GCC

Markaz notes that the KIFS dominates the rest of the GCC. No one is bigger. No one fell with a larger thud except two Bahraini-based firms in 2009. Markaz provides some income statement data for Fiscal 2008 and 2009 plus 1H10. What would be even more illuminating would be sector balance sheet size.

Leverage

The new Central Bank of Kuwait regulations impose a maximum 2x leverage ratio on the sector. Even after the debacles in 2008 and 2009, the KIFS’ leverage ratio (Total Liabilities/Total Equity) is a “comfortable” 1.84. It’s only when one starts drilling down into the details that one sees the variance.

Below my calculations based on FYE 2009 financials as in Appendix 2.

FIRM	LEVERAGE (TL/TE)
Kuwait Finance and Investment	8.32x
Aayan Leasing and Investment	5.96x
The International Investor	5.88x
Global Investment House	4.12x
International Investment Group	3.57x
IFA	3.29x
Aref Investment Group	2.78x

Note: I have not adjusted the above for minority interests – so these are not strictly speaking Central Bank leverage ratios as will become apparent later when we review Markaz’s calculations, though the number of firms with significant minority interests is limited.

When Aayan’s substantial minority interests of KD42 million are eliminated from the calculation the Leverage Ratio jumps to an eye popping 14x (using the financials reported on the KSE).

Asset/Liability Mismatch

Details are on page 7 of the report. Briefly, conventional firms are more balanced than “Islamic” ones. The former with S/T debt of 40% versus S/T assets of 49%. The latter with S/T debt at 79% versus S/T assets at 36%. But this is largely due to the greater progress made in restructuring conventional firms. (Also note this data excludes The Investment Dar).

Review of the Top Five

Markaz then reviews the top five firms: Global, Aref, IFA, TID (using 2008 data) and Aayan.

Here in tabular form are the results of Markaz’s review of these firms’ compliance with the newly imposed Central Bank of Kuwait regulations.

FIRM	LEVERAGE RATIO	"QUICK" RATIO
Global Investment House	4.11x	17%
Aref Investment Group	2.78x	16%
IFA	3.28x	9%
The Investment Dar*	4.97x	2%
Aayan Leasing and Investment	13.90x	7%
CBK Regulations	2.00x	10%

*TID calculated using 2008 financials.

Markaz then discusses these five firms’ financial position.  If you want a quick insight into them and the investment firm sector in general, this report is a must read.

A Tale of Two Markets: Saudi Arabia and the UAE

"It was the best of times.  It was the worst of times."

Those who read my previous post (6 November) of the Oliver Wyman/Zogby International poll and saw the stark disparity between business sentiment in the UAE and the Kingdom of Saudi Arabia may be inclined to apply Dickens' description of England and France quoted above to these two GCC states.

What is a key factor which affects and as well reflects business sentiment?  And which might be responsible for the views of Saudi and UAE businessmen?

Liquidity in the market - the availability of lendable /spendable funds: 

1. So one's customers can buy whatever one is selling.  
2. So one can borrow to support one's own ongoing business activities (working capital) as well make any needed long term investments in plant, equipment and property.  And perhaps an acquisition or two.  And of course to refinance existing debt as it matures.
   

The nice folks at Markaz up in Kuwait kindly provide a highly useful tool for exploration of this topic and even "nicer" they do so for free: Their "Daily GCC Fixed Income Report."

Let's take a look at the 4 November 2009 issue.

Look at the "Interbank Rate Section":

1. The first thing to focus on is the dramatic decline in interest rates from 31 Dec 2008.- save for Oman.  This decrease reflects increased liquidity.  That's a good thing, though too much liquidity can be a bad thing.
   
2. Next notice that Libor (the London US Dollar rate) is much much lower than the rates in any of the GCC states.  That gives a relative indication of difference at the macro level in liquidity between the Gulf and Europe. 
   
3. Then notice that the UAE ("AEIBOR") has the second highest rates in the GCC - an indication that liquidity is relatively strained.  Only Oman is tighter.
   

Notes:  

All the rates shown are for local currencies.  Libor is the US Dollar.. Euribor is the Euro.

These rates reflect the interest rate one bank would charge another creditworthy bank to place a deposit with it.

Loans to corporations or less creditworthy banks would have a margin added to this "base" rate.

 

Another interesting bit of  information in the report is the table of  5 Year Credit Default Swap Rates.  These reflect the cost of buying "insurance" on a 5 Year Bond.   The lower the price the better.

Here the takeaway is that Dubai's CDS rate is well above  that of other GCC States and even above Turkey and Lebanon.   Using these rates, one can construct a relative market price based "sovereign risk rating" matrix.  Saudi the "best" credit and Dubai the "weakest" in the GCC.  But note that prices can also be affected by  other factors than just the obligor's credit.  For example, the volume of bonds outstanding and number of "market makers" willing to write  insurance are important factors.

  

Turning back to AEIBOR, it's possible to perform a more detailed in-country liquidity analysis. 

Before we do that, a bit of "tafsir" on AEIBOR or as the Central Bank of the UAE calls it "EIBOR". The rate is determined (in banker-speak "fixed")  by getting quotes from 12 banks in the Emirates.    The two highest and lowest quotes are excluded.   An arithmetic average of the remaining quotes is then computed.  That result is the EIBOR "fixing".

As we ranked liquidity at a country level above by looking at rates, we can do the same with individual banks.    Unfortunately, I couldn't find the CBUAE's report for 4 November on their website.  So let's work with the CBUAE's  current report.   Select "Today's Eibor Rates" for the fixing report.

At first glance, one can draw some quick impressionistic conclusions about relative liquidity.  Those banks with higher prices are less liquid than those with lower prices.

But one big caveat to our study of individual banks.

This is but a single data point.   The rates from a single day.

To really understand the liquidity situation of banks one would have to look over a longer period to see if there was a persistent pattern.

Why?

Bank interest rates reflect not only liquidity but management of their interest rate "books".  Most banks do not match fund assets with liabilities.  An example of match funding would be to take a six month deposit to fund a six month loan made by the bank.  Rather banks deliberately create interest rate mismatches by taking, for example, a one month deposit to fund a six month loan.  At the end of the one month when the deposit was due, the bank would then take another deposit.  The tenor it would take would depend on its existing interest rate gap book and its gapping strategy.  The result is (in banker-speak) interest rate "gaps".  If you take a look at the notes to your favorite bank's financials, you'll see an interest rate risk table which will show the gaps that bank has taken.

The Central Bank of Bahrain has fairly extensive disclosure requirements so let's use Bank of Bahrain and Kuwait's 2008 financials.  Note 28 provides a maturity (but not a repricing gap analysis).   That will be good enough to illustrate the point. Bear in mind that the typical 5 year loan  resets interest every 3 or 6 months.  And the interest rate reset is what drives the interest rate gap.  But close enough for both government work and this blog's purpose.   

The bank's treasurer uses the interest rate on deposits as the tool to achieve the desired gap position. With deposits, he can adjust his bank's bid rate (the rate which the bank will pay another bank or a customer for a deposit placed with it) and his bank's offer rate (the rate at which the bank will place a deposit with another bank) to attract or discourage transactions.