KHCB Strategic "Fit" with GFH - Historical Context

At the End of a Wild Ride One Winds Up Where One Started 

For the discussion about KHCB’s strategic fit with GFH, a bit of context by way of historical data, though as I noted in my 1 December post, the success of GFHFG’s strategy depends on future performance not past.

Some introductory comments.

Since my earlier analysis, I’ve introduced two comparable, Bahrain Islamic Bank (BIsB) and Qatar Islamic Bank (QIB) and provide data for two periods:  the last ten and five years. 

Definitions:

1. GFH includes income from KHCB.  
2. GFH X KHCB does not.
3. Amounts are in millions of US dollars (GFH's base currency).
4. BD and QR have been translated to US dollars using respective official peg rates. 
5. As before, STDVP = Standard Deviation of the Population and STDVS = Standard Deviation of the Sample.

Let’s start with the long view – ten years financial data.

Net Income Statistical Analysis 2006-2015
	Mean	STDVP	STDVS
GFH	-$22.87	299.36	315.55
KHCB	$15.41	31.34	33.04
GFH X KHCB	-$30.04	293.96	309.86
BIsB	-$6.82	59.71	62.94
QIB	$386.18	68.55	72.26

Over the ten-year period, KHCB generated some $154 million equivalent in net profit.  But this was largely due to two fat years—2007 and 2008—whose net profit of $128 million (note that’s 83% of the ten year’s total) was driven by investment banking fees (revenue not net profit) of $128 million.  Revenue that has not recurred and is likely to in the future. As that indicates, the commercial banking business by itself has not been wildly successful (first euphemism of this post) over the period.  

That being said, KHCB increased GFH’s net income by about $71.7—GFH’s share of the $154 million—but really didn’t “move the needle” much (AA’s corporate buzzword of the post).  The mean improved slightly, but volatility barely moved.

The ratio of STDP and STDS to mean for GFH, KHCB, and BIsB indicates the high volatility of results.  These metrics are definitely not indicators of “stable or recurring” income or profitability.  The negative means and rather “modest” (second euphemism) positive mean is another indication of weakness.

The story is much different at QIB.  There the STD is a fraction of a rather healthy mean.  In the case of QIB, we’d predict positive earnings as the most likely outcome using the above data.  Not so with the others.

Now for a five year view.

Net Income Statistical Analysis 2011-2015
	Mean	STDVP	STDVS
GFH	$0.44	11.55	12.91
KHCB	-$4.17	24.27	27.13
GFH X KHCB	$2.42	9.21	10.29
BIsB	-$14.32	49.23	55.04
QIB	$411.87	70.45	78.77

During this five year period, two things are clear about KHCB’s performance: 

1. It was more volatile than GFH’s. 
2. KHCB had a net loss over the period driven by credit problems. GFH did not, but just barely.     

In this period, GFH would have been better off without KHCB as net income would have been higher by some $10 million and volatility lower.  But GFH’s earnings would still not be stable.  Thus, with or without KHCB GFH did not achieve stable earnings.  It doesn’t require sophisticated math or even a calculator to figure out that ROE was dismal.  My earlier post has comparative ROE figures. As well, net income over the period did not rise even to “hobby” levels on an absolute basis.  

Based on a historical analysis, there is little to support KHCB as a pillar of GFH’s new strategy. 

What GFH needs is for KHCB to deliver not only a stable income but also much larger quantum of positive net income.  Neither of which KHCB has shown any ability to deliver.

But things change.

Blackberry was once the leading provider of business cell phones.   At  that point no one had ever heard of an IPhone.     

We’ll turn our attention to that issue in coming posts.

Insolvency of PrivatBank Ukraine: Euphemisms Abound

Моя Україно,За що тебе сплюндровано, За що, мамо, гинеш?

Would his anger be tempered today by knowledge that the perpetrators are Ukrainians? 

AA doubts it.

Now to the post.

AA prides himself on his skill in using euphemisms to describe financial weaknesses and ethical slips. 

This Tuesday The Bloomberg lit up with news that The National Bank of Ukraine—the country’s central bank—announced it had declared PrivatBank insolvent and that Ukraine’s Government would assume complete ownership. 

By way of background, Privatbank is the largest bank in the country.  It is privately owned with two biznesmen—described by some as “oligarchs” but always as “pro-Western”—holding over 90% of the bank’s shares. Besides his many business ventures, one of them, Mr. Kolomoiskyi, has been accused of funding the Azov Battalion.

As I read the speech by the Governor of The National Bank of Ukraine and other news, I was in utter awe at her and her colleague’s command of euphemisms. 

Professional honor compels me to acknowledge their skill.  Frankly my own efforts seem rather small and paltry in comparison.  Therefore, I offer a humble tip of AA’s enormous tarbush to Governor Ms. Gonatraeva and to NBU First Deputy Chairman Yakiv Smoliy.  

First, to the Chairman’s 19 December speech reported at The NBU website in English.  Strangely, AA was unable to find the Ukrainian language version. Italics courtesy of AA.

Inspections and stress tests carried out by the NBU revealed that PrivatBank had capital shortages. As of 1 April 2016, the bank had capital shortages amounting to UAH 113 billion, which, apart from crisis-related factors, were caused by imprudent lending policies pursued by the bank. As of 1 November 2015, related-party loans accounted for 97% of the bank’s loan portfolio, totaling UAH 150 billion.

Now for the comments: 

1. Capital “Shortage”:  As per its 3Q16 financials, Privatbank had some UAH 30 billion in capital and total assets of UAH 271 billion.   Given those amounts, calling a UAH 113 billion capital deficit— which is equivalent to 380% of equity or 42% of total assets—a “shortage” is like calling The Grand Canyon a “river valley”.  Or 2008 a “recession”.  Technically correct to be sure, but somehow the full picture is lost.
2. “Imprudent” lending policies:  When a bank needs to raise new capital equal to 380% of existing capital or equivalent to 42% of total assets, one doesn’t need a lot of financial analysis to figure out that lending standards left quite a lot to be desired.  The good folks at Bloomberg had a slightly different translation “ill-considered loan policy” which is an even better euphemism. 
3. “Related Party Loans”:  When related party loans are 97% of loans and 4 times the maximum limit set by The NBU, such behavior seems to rise to a level well above “imprudent” or “ill-considered”.  AA might apply descriptors such as “patently immoral” and perhaps even “criminal”.   That being said, AA is not familiar with the legal status of Ukrainian banking regulations.  It may be that they only rise to the level of “suggestions” sort of like the Pirates’ Code, which seems apt given the location.  On a positive note, lending to oneself has certain advantages in streamlining the underwriting process.

But at SAM we never fail to be “fair and balanced”. 

So let’s let Privatbank speak for itself.

As per its unaudited 3Q16 financials, Note 13 shows the bank’s related party exposure as minimal only UAH 8 billion down from about UAH17.8 billion at 31 December 2015.    

One note, there is no auditor’s review statement in the 3Q16 financials and so it’s impossible to know if they were reviewed (but not audited) and whether these are IFRS statements. I believe they are not.  

Privat’s IFRS AR for 2015 shows a higher figure for related party loans roughly twice the UAH 17.8 billion above (see note 31) but quite a long way from 97%.  PWC’s local firm did qualify its audit report but related to collateral seized on past due loans and the economic/security situation in the country. 

Beyond that Interfax Ukraine reported that

“Oleksandr Dubilet, who had headed PrivatBank (Dnipro) for a long time prior to the decision on its nationalization, has said the National Bank of Ukraine's (NBU) statement on 97% of insider loans in PrivatBank's portfolio of corporate loans is exaggerated.”

Also that

"At the same time, NBU First Deputy Chairman Yakiv Smoliy said the share of loans to related parties in PrivatBank exceeds 90%.  At the same time, he stressed this cannot be classified as withdrawal of funds from Ukraine."

What FDC Smoliy appears to be saying is that the related party lending scheme cannot be “classified” as a ruse to loot the bank and transfer the loan proceeds offshore.  This may be the biggest “euphemism” (one last attempt by AA to score a point) in the story. 

A side note on the dickering over percentages.  

Corporate loans comprise some 74% and 84% of total gross loans as of 3Q16 and 4Q15 so the key question is whether the percentage is of “total” loans or “corporate” loans and of course whether the percentage is being figured against net or gross loans. 

But when a bank is in this range, the exact figure is in some sense meaningless. 

What’s the practical difference between 75% and say 97%?   The bank is bust and its management and board have some explaining to do at the very least.

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.”

Misleading Report about UAE Central Bank “Changes” to AML Regulations

Another cold Dubai December and to top it off AA's Biggles' hat was at the cleaners.

If you’re like AA, you might have been confused when you read WAM’s 14 December 2016  (Arabic version here) article or others in the media that the Central Bank of the UAE had amended three paragraphs in Circular 24/2000.

Without any explanation or context provided, a reader might conclude that the CB UAE has only recently moved to prohibit the opening of numbered or anonymous accounts or require fairly standard CDD on customers. 

If you read the article in Gulf News yesterday, that's certainly the impression you'd get from the article's subtitle:  "New rule strictly prohibits the opening of accounts with assumed names or numbers, among others".

If true, this would represent a serious shortcoming in the UAE’s AML/CFT efforts.

However, it’s not the case. 

The 2000 Circular already contained such requirements.  Article 4 in that Circular is quite unequivocal, e.g. "يمنع منعا باتا فتح حسابات ".  The English version is similarly strict.

So what’s going on?

The three articles are being amended to permit reliance on UAE national ID cards as proof of an individual's identity.  The 2000 Circular only permitted the use of passports. 

Someone at WAM or CBUAE missed the bus by not including this information.

AA did not. 

Ever since the fateful day pictured above, AA has been doubly careful or at least tried to be.

GFH --Rebranding Rituals

At Suq Al Mal, we continuously drill down to leverage key learnings to  synergistically align our core competencies and core values to create scalable opportunities to move the needle while maintaining bandwidth capacity best practices .....

Over the years of AA’s imagined illustrious career, he has seen employers, competitors, and clients launch strategic changes.  As a result, AA has developed a keen “appreciation” (euphemism of today’s post) for the rhetoric and corporate rituals associated therewith.  AA certainly cannot let the opportunity pass to comment on GFH’s participation in these customary rites. 

One further introductory note. 

What follows is not so much a criticism of GFH’s new strategy as a commentary on how that strategy was presented. 

Image, morale all have their part to play in corporate success.   As a participant in such exercises, AA always felt that these rituals and the rhetoric that accompanies them need to be controlled to avoid overstatement–which can well undermine their fundamental intent.

  To start things off a headline blurb from GFH’s 2014 Annual Report (AR):

“There are those who prepare for change and grow stronger because of it, while others struggle to come to terms with the inevitable. We believe our remarkable brand needed a bold and considered change and we have been preparing for the right time to make the required transformation.

That time is now.”

“Bold” yet “considered”.  Launched at just the “right time” to make a “transformation”.    

Some initial reflections on the above:

“Come to terms with the inevitable” sounds rather ominous.  Apparently, it wasn’t only a question of business.  GFH didn’t see much of a future as a mere investment bank nor retaining the Gulf Finance House moniker--one element of the “remarkable brand” that unfortunately had to be jettisoned.  Coming to terms has also resulted in a strategic decision to continue what the ill-destined investment bank GFH was doing but not to do so much in real estate.  Luckily GFH’s preparations were finalized in time!  From a more philosophical and perhaps even theological perspective does the new GFH’s change in strategy represent a repudiation of the regional adage that “real estate may get sick, but it never dies”?

“Remarkable brand” – it’s interesting that the focus is on “brand” rather than “business”.   A case of corporate babblespeak?  Or an indication that image rather than substance is the key focus?     Sadly of late, the brand has been remarkable primarily for unremarkable (two euphemisms in a single post!) results.

“Bold and considered change”—what does it entail? 

Besides changing its name, GFH the “financial group” has boldly separated out activities that Gulf Finance House—the apparently inevitably doomed investment bank—undertook. Its new strategy is to develop these businesses under newly created LOBs and thus diversify its portfolio.  

In AA’s opinion this seems less bold than proclaimed. 

Essentially it is largely more of the same in terms of activities. GFH is not entering the insurance business or exiting real estate completely. Either of these would be bold moves.  The plan to diversify the business away from real estate is eminently reasonable given performance.  Sensible rather than bold.  Yet real estate will remain the core business.  Fine-tuning not radical change. 

From investment bank to financial group.  By AA’s reckoning none of the new LOBs are outside the range of investment banking activity. Even the Goldmine and Morgan Stanley are now pitching middle market commercial banking services.   And shudder some are into retail lending!  Diversification is also a concept that is not foreign to most investment banks. 

So why is “GFH transforming from investment bank into a financial group designated to offer a unique financial portfolio and maximize value potential to its shareholders” as we’re told on page 33 of the 2014 AR?  For that matter why is GFH more concerned about maximizing value potential than in maximizing value realization?  Should it be pursuing return of financial portfolios rather than their uniqueness?

Is there a compelling business reason or is this corporate imaging?

From where AA sits, this seems to be either

(1) rebranding: an attempt to create a new corporate persona to put some “daylight” between the new brand and what then is highly likely to be the old tarnished brand and/or

(2) kotodama.   Names have power.  If we change our name, our fate will change.  In earlier days those who perceived the need for a name change consulted religious figures, numerologists, astrologers, etc. to help find appropriate and powerful new names and symbols.  In these imagined more enlightened times, corporations hire corporate image consultants. 

GFH now ventures forward as a self-identified “financial group” under a somewhat new (brand) name with a new and no doubt more powerful logo and apparently new corporate colors—all part of the customary and sacred corporate rituals that accompany this exercise.  AA sadly did not notice if the preferred corporate font had changed—a step that some consultants say irrevocably seals the transformation. 

In case you’re wondering given the apparent cynicism of the remarks above, AA bears his employer’s logo and corporate colors proudly by day with pitchbooks (yes, we have a preferred font and font size!) and by night with specially made pajamas.  Pinstripe of course!    And a more casual pair but only for use on nights of officially sanctioned casual dress days.

Before closing one further quote, this from GFH’s 2015 Annual Report cover which is a nice collection of corporate babblespeak favorite terms  Boldface and comments are AA’s.

GFH Financial Group is on course to achieve steady and sure financial growth by following a clearly defined strategy [AA’s practical business experience suggests clearly defined is a key element in a good strategy, but while necessary, not sufficient].  As our 2015 Annual Report & Accounts illustrates, our brand’s vision to discover, innovate, and realise value potential [perhaps proof not that any is needed of corporate personhood.  It’s unclear though if “vision” relates to imaginings of things that never were or of things that might be, etc.  Special kudos for linking “vision” to action verbs.], has empowered us to diversify our sectors of excellence, as well as expand our geographical footprint.

I was hoping for “one-stop shopping”, “leverage”, “best of breed”, “best practices”, “global architecture”, and maybe even “evisculate”. 

Something perhaps for 2016.