What is the Qatari Banking Sector’s Foreign Currency Exposure? Part 3 – Consolidated Annual Financial Reports “Approach”

Just the Kit to Go Deeper and Deeper 

CONSOLIDATED FINANCIAL REPORTS APPROACH

Earlier posts here,  here, and here. 

As mentioned in the previous post, while we can use Qatar Central Bank reported data to get a more comprehensive understanding of Qatari banks’ net foreign asset (NFA) exposure than that contained in the QCB’s single NFA “number”, we still need more granular information. 

1. An allocation of the banking sector’s risk by geographical region to identify potential concentrations of exposure.  In this case, are FA and FL primarily to other GCC states? Or states likely to be influenced by them? 
2. A disaggregation of that data into FA and FL position of individual Qatari banks. As argued earlier, we should be primarily focused on those banks with negative NFA positions, unless we assume that those banks with positive NFA positions will make their foreign assets available to banks with negative position.  As well to properly assess FA exposure, we need to know if a bank with overall positive NFA has negative NFA with other GCC states.  

We can use the geographic allocation of assets and liabilities provided in the risk management notes in the consolidated financial statements of individual Qatari banks to get closer to an answer, but admittedly this is an imperfect exercise.  

1. Banks only provide this information as of fiscal year end so it quickly becomes stale. Basel Pillar 3 disclosures would provide an additional data point as of June.  But Qatari banks do not publish Basel Pillar 3 disclosures. Presumably the QCB does not require them for some no doubt excellent reason, though AA presently cannot imagine what on earth that might be.
2. More importantly, consolidated financials include the assets and liabilities of subsidiaries and thus overstate the strictly legal exposure of a bank.  It’s important to note that consolidated financials are an accounting construct not a legal entity. Subsidiaries are treated as though they are directly part of a fictional consolidated “entity” that has direct ownership rights in the subsidiaries’ assets and is directly liable for the subsidiaries’ liabilities.  That’s not the case. The only legal entities are the parent and its subsidiaries.  There is no legal consolidated entity.
3. The parent of a consolidated entity owns shares in its subsidiaries. Therefore, because it is an equity holder, its rights in its subsidiaries assets are subordinate to creditors of those subsidiaries. There are also almost certainly additional legal or other restrictions on the parent’s right to access its subsidiaries’ assets.  Likewise the parent is not responsible for the subsidiaries’ debts, unless it has provided a guarantee. 
4. So if we use consolidated financial data we are including FA that are not available to the parent as well as FL which are not the obligations of the parent. 
5. On the other hand banking groups have an incentive to maintain their subsidiaries’ health not only to protect their equity investment but also their reputation. Distress at a subsidiary may be taken as a sign of poor controls, financial distress at the parent, etc. and lead to creditors rethinking their relationship with the parent.  And while FA are not legally available to the parent, it is possible that a subsidiary could place a deposit with its parent instead of with another bank.  Transactions of this nature would be legally constrained by legal lending limits, particularly those to related parties.  
6. On a positive note, consolidated financials provide another way to look at the NFA position of individual banks. 

Ideally to avoid the issues with use of consolidated financials, we would use parent-only financials.  However, not much more than balance sheets and income statements for the parent-only are provided.  There are no comparable risk management disclosures. 

So what is to be done?

Let’s look a bit closer at the consolidated process.  When a consolidated statement is prepared, the assets and liabilities of the subsidiary are added to that of the parent category by category after eliminating any transactions between parent and subsidiary. Note the latter are included in the parent-only and subsidiary-only financial statements.

As well, the carrying amount of the investment on the parent-only balance sheet is eliminated, based on the accounting concept that the difference between the subsidiary’s assets and liabilities equals its total equity, i.e., paid in capital, surplus, reserves, and retained earnings. 

Where the subsidiary publishes its own standalone financials, information in those financials coupled with information in the parent’s financials can be used to estimate the consolidating entries and back them out.  That information can also help in adjusting the geographical allocation of assets in the risk management note.  That’s important when we want to get a more accurate picture of the parent’s exposure to regions on a gross basis, i.e., FA and FL not just the NFA position. 

Why is that? 

Because the carrying value of the equity in the foreign subsidiary on the parent-only balance sheet is carried at a value that is probably close to the difference between the assets and liabilities of the subsidiary included in the consolidated financials.  Differences could result from income reflected in the subsidiary’s books but not reflected in the parent’s (parent-only) financials.   

As the above discussion indicates, de-consolidation can be a rather extensive process made even more difficult by the absence of information.  Also AA is not inclined to undertake this exercise, if it is of limited use.

To that point, the central goal of this analysis is to determine if the banks and/or the GOC have the resources to successfully “handle” their NFA positions.  For that we don’t need the exact NFA position, but an approximation.  For example, if the NFA position is equivalent to negative US 1 trillion or so, we really don’t need more precision to come to the conclusion that the GOC is unlikely to be able to handle the position.  If on the other hand it’s negative USD 100 billion, we can be reasonably certain the GOC has sufficient resources to support its banks, though this amount might impose some financial strain.  

As a first step in this “exercise”, let’s determine if the differences between Qatari banks’ consolidated and parent-only financials are significant enough to warrant at attempt to de-consolidate.  The chart below compares each bank’s consolidated financials to its parent-only financials.  Sadly, the banks whose names in red boldface do not provide a full geographical analysis of assets and liabilities which makes it frustrates compiling an accurate picture of their individual FA and FL as well as the overall total.

Total Assets of Qatar Banks 31 Dec 2016
Billions of QAR or USD
Banks	Consolid	Parent	Diff	USD
QNB	720	588	132	$36
QIB	140	135	5	$1
CBQ	130	115	16	$4
MAR	92	86	6	$2
DOHA	90	90	0	$0
AL KHALIJI	61	55	6	$2
BARWA	46	46	0	$0
QIIB	43	43	0	$0
AL AHLI	38	38	0	$0
IBQ	36	36	0	$0
TOTAL	1,395	1,231	164	$45

Total Liabilities of Qatar Banks 31 Dec 2016
Billions of QAR or USD
Banks	Consolid	Parent	Diff	USD
QNB	649	513	136	$37
QIB	120	116	4	$1
CBQ	111	95	16	$5
MAR	79	73	5	$1
DOHA	77	77	0	$0
AL KHALIJI	54	48	6	$2
BARWA	39	39	0	$0
QIIB	36	36	0	$0
AL AHLI	33	33	0	$0
IBQ	31	31	0	$0
TOTAL	1,228	1,061	167	$46

1. For 8 of the banks above, there are no differences between consolidated and parent-only financials (5 banks) and relatively minimal differences for 3 banks, suggesting that we can use their geographical allocation of assets and liabilities are a close approximation to their parent-only financials. In aggregate the difference is equivalent to some USD 4.7 billion.
2. Two banks—CBQ and QNB—require a further look.  And look we will a bit later. 

But first before we dive deeper into the analysis, let’s compare QCB data as of the 31 December 2016 QSR  (Tables 22 and 23) to aggregate parent-only data compiled from individual bank FYE audited financial reports by OCD AA. 

Why?  To see how close the two numbers are. 

Do the parent-only financials suggest there are additional liabilities or assets, including FA and FL that are not included in the QCB NFA statistic? 

In presenting its data QCB provides separate aggregates for Traditional Banks, Islamic Banks, and Specialist Banks (QDB).  That makes analysis easier and we can spot if there are anomalies by bank type. Since QDB does not publish financials and is a سمكة صغيرة  I'm not including them in the analysis.  Of course, differences are to be expected.  The QCB would likely take a more conservative view of the value of intangibles, unrealized earnings from subsidiaries, etc.  The charts below summarize what we see.

Qatar Banking Sector Total Assets
QAR Billions
	Parent	QCB	Diff
Traditional	921	899	22
Islamic	309	323	-14
Total	1,231	1,222	9
Qatar Banking Sector Total Assets
QAR Billions
	Consol	QCB	Diff
Traditional	1,075	899	176
Islamic	320	323	-3
Total	1,395	1,222	173

1. The difference between QCB and the AA-compiled parent-only data arises primarily from differences in loans.  QCB shows QAR 12 billion more in loans for Islamic banks and QAR billion 13 less in loans for Traditional Banks compared to the data I compiled. Note this also reflects adjustments by AA for apparent differences in definitions of asset and liability categories by QCB and the individual bank’s financial reports.  For example, with Traditional Banks, the QAR 14 billion in the net of DFBs and Financing Assets. 
2. If you decide to pursue the interesting exercise of comparing the two sets of data in detail, a few pointers.  First, as noted above, QCB appears to have definitions of DTB, DFB, and Financing Assets that differ from those used in the individual bank financials so you will see for example, differences in DTB category and loans which AA netted.  Second, there are some QAR 24 billion of debt qualifying as Tier 1 capital that QCB reflects as “debt” in its statistics while the individual parent-only financials reflect these amounts in equity. 
3. In any case we seem to be within a range that suggests that there are not material differences between the total assets in the QCB data and the parent-only financial report compiled data, and thus presumably in FA and FL. 
4. Clearly, there are material differences between the consolidated data and QCB’s due to QNB and CBQ as discussed above. 

Let’s take a deeper look at the data derived from consolidated financials and see if we can narrow the difference.  As noted above, two banks are responsible for the difference: CBQ and QNB.

CBQ’s Turkish subsidiary Alternatifbank (“ABank”) accounts for the difference between its consolidated and parent-only financials. ABank’s 2016 TA were some USD 5 billion equivalent and TL USD 4.6 billion equivalent.  ABank’s 2016 IFRS financials have a credit risk note (page 29) that provides a geographical allocation of assets: some 99% are domestic.  Absent similar disclosure on liabilities, we’re left in guestimate territory.  No useful detail on customer deposits or DTBs.  There is some USD 1.6 billion in syndicated loans, sub-ordinated debt (CBQ holds some USD 125 million) and “other borrowings” all to unspecified foreign investors. 

What about QNB?  Here the gap between parent-only and consolidated financials is some QAR 132 billion equivalent to USD 36 billion. Thus, sharpening our focus on the NFA position of Qatari banks is largely a one bank “issue” – QNB. 

I’d expect that QNB’s subsidiaries in Turkey, Egypt, and Indonesia are largely funded in country in local currency to support in-country lending and investing activities.

If that assumption is correct, that means a good portion of the “increased” consolidated assets are offset by “increased” consolidated liabilities in the same currency and obtained from banks and depositors in the country of operation.

Further analysis of QNB’s subsidiaries (Turkey, Egypt, Indonesia, Tunisia, etc.) could allow us to get closer to a “parent” only allocation of FA and FL.  As you might expect, since AA doesn’t like to rely on learned assumptions even his own despite a fervently imagined sterling track record, AA took a look at the 2016 financials for QNB Al Ahli Egypt (USD 10 billion), QNB Finansbank (USD 29 billion equivalent in assets), and QNB Indonesia (USD 1.8 billion) assuming these are the larger fish in QNB’s subsidiary pool.   Sadly, there are no cross-border geographical allocation notes of any use in their financials. 

Looking at QNB Al Ahli’s 2016 annual report it seems assets are primarily in Egypt. On the liability side, cross-border liabilities appear modest, Due to Foreign Banks (DTFBs) equals USD 45 million equivalent just around 47 bp (.0047) of Total Liabilities. 83% of these DTFBs are owed to QNB Qatar.  The only other foreign liability is a EGY 3.9 billion (USD 218 million) loan from the EBRD representing 2.31% of TL.  

Similarly QNB Finansbank states that its business is primarily in Turkey with negligible business in Bahrain.  That’s borne out by a May 2017 drawdown prospectus for its MTN program which shows that foreign loans are not even 0.005 of total loans.    Looking at liabilities (TL = USD 26.2 billion equivalent) there’s no breakdown on DTBs USD 3.3 billion equivalent (12.8% of TL).  Of some USD 1.8 billion equivalent in Debt Securities Issued roughly USD 1 billion are Eurobonds.  Of other borrowings of USD 4.1 billion some USD0.6 billion was provided by QNB.  

QNB Indonesia really didn’t say much.  Or if they did, I missed it.

But note this is not conclusive.  References to “business” focus on the asset side of the balance sheet.  Here we’re also very concerned with cross-border funding.  

Turning back to QNB Qatar’s 2016 financials, note 40 describes the 2016 acquisition of Finansbank disclosing that TA acquired were QAR 120 billion and TL assumed QAR 109 billion.  If you look at Note 35 on geographical allocation of assets and liabilities in QNB’s FYE 2016 annual report, you see that these amounts primarily explain the change from FYE 2015 to FYE 2016 in the “Europe” (!) region.  (CBQ reflects its Turkish subsidiary under Other MENA.)  The aptly named “Other” region probably contains Egypt and Indonesia and no doubt Syria, Iraq, and other subsidiaries. 

What this suggests at least to AA is that we can refine the geographical allocation quite easily by subtracting the TA and TL of each of these three banks from their respective “regional” allocations.  This then gives us a “close enough” geographical allocation to enable us to make a judgment on parent-only geographical exposure. 

Is the number 100% accurate?  No, but as argued above it doesn’t need to be. 

What we also have at the end of this “exercise” are two sets of NFA.  One consolidated and one estimated parent-only that will enable us to construct various NFA scenarios.  NP Let’s look at the results of that analysis, starting with the unadjusted consolidated financials.

QNB NFA by Region 31 Dec 2016
Consolidated Financials
Billions of QAR
REGION	FA	FL	NFA
OGCC	32.3	24.1	8.2
EUR	149.5	224.9	(75.4)
NorAm	12.3	3.8	8.5
Other	83.8	102.5	(18.7)
TOTAL	277.9	355.3	(77.4)
Qatar	418.7	265.8	152.9
TOTAL	696.6	621.1	75.5

Now the adjusted financials.

QNB NFA by Region 31 Dec 2016
Consolidated Financials
Ex- Turkey, Egypt, and Indonesia
Billions of QAR
REGION	FA	FL	NFA
OGCC	32.3	24.1	8.2
EUR	40.5	115.9	(75.4)
NorAm	12.3	3.8	8.5
Other	43.6	62.5	(18.9)
TOTAL	128.7	206.3	(77.6)
Qatar	418.7	265.8	152.9
TOTAL	547.4	472.1	75.3

1. You’ll immediately notice that the NFA did not change significantly.  That’s because the adjusting entries of FA and FL are equal. I removed the TA of the subsidiaries from FA and then added back the difference between TA and TL to reflect the estimated carrying value of equity in the parent-only financials.  On the FL side I removed the TL of the subsidiaries. 
2. For Europe (QNB Finansbank) the adjusting entries are FA – 120 + (120-109) and for FL -109. 
3. For Other (QNB Ahli Egypt) the entries are FA -38 + (38-34) and for FL -34.  For Indonesia FA -7 +(7-6) and FL -6.
4. What has happened though is that aggregate total of FA and of FL has reduced some QAR 149 billion (USD 41 billion) from FA QAR 277.9 billion to QAR 128.7 and FL QAR 355.3 billion to QAR 206.3 billion. 
5. Also note that QNB's negative NFA position is concentrated in Europe and appears driven by international borrowings and capital market transactions which have staggered maturities so that absent events of default creditors only access to funds is secondary sales.  That being said there are substantial maturities in 2018. 

If you’ve been paying attention, I expect there are a few out there who would like to ask AA to hold on a minute and explain how he made a QAR 149 billion adjustment between QNB’s consolidated and estimated parent-only financials when the difference between the two sets of financials as shown above is QAR 132 billion on the asset side and QAR 136 billion on the liability side. 

Good question.  I don’t have a numerical analysis to back up the assertion that this is due to transactions between subsidiaries and QNB the parent that would be included in parent-only financials but eliminated in the consolidated ones, plus perhaps some differences in the carrying value of equity in subsidiaries on the parent-only balance sheet versus the FA-FL methodology used by AA.