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. 

GFH –A “Bold” and “Considered” New Strategy

Out With the Old

In With the Powerful New

As outlined in my previous post, GFH’s performance has been disappointing since 2008.

In 2014 GFH announced what they touted as a “bold” and “considered” strategy. They also changed the “brand” name from Gulf Finance House to GFH.  No longer a mere Shari’ah compliant investment bank, GFH became a self-described Shari’ah compliant financial group.  

Let’s let GFH speak for itself to set the stage.

GFH’s Chairman’s Report page 29 FYE 2014 AR.

It is the beginning of a new era where GFH adopts a new strategy and transforms from an investment bank into a financial group.  This transformation began during the year when we announced a new structure, which has seen us embark upon a path to further diversify our activities to include the full spectrum of Asset Management, Wealth Management, Commercial Banking and Real Estate Development.

2014 AR -- Page 23. 

A strategic shift.   Historically GFH has been a real estate-centric investment bank, whereby a large proportion of its holdings was centred on landbased investment dealings. With its strategic shift towards finance, the bank is looking to reduce its holdings in this class from its current position of 50%, to a more even distribution of under 40%, in the mid term, and closer to 30% in the long term.

Sometimes though you have to reclaim the own land!

2014 AR – Page 19

GFH’s interest in its key commercial banking asset Khaleeji Commercial Bank is part of it’s (sic) strategy to ensure greater stability from global financial issues. The group will undertake to grow this asset through operational and brand developments.

2014 AR – Page 37

GFH launched a revised business strategy during the year, targeting various operating parameters; prime amongst them is to evolve as a ‘Financial Group’ having operations across a range of financial service businesses, thereby having a stable and recurring income, profitability and cash flows.

To summarize diversification away from over dependence on real estate, more stable income and cash flows with a key focus on Khaleeji Commercial Bank (KHCB) and commercial banking.

AA has prepared three charts using info from KHCB’s and GFH’s annual report to analyze the impact of KHCB on GFH over the past five years.

Impact on Net Income

GFH Net Income Shareholders Only 2011-2015  USD Millions
	2011	2012	2013	2014	2015	Total
GFH	$0.38	$10.03	-$17.66	$14.98	-$5.52	$2.21
w/o KHCB	-$0.27	$9.09	$6.35	$11.23	-$14.29	$12.11

Over the past five years, if KHCB had not been part of GFH, net income would have been roughly US$10 million higher. 

Impact on Volatility of Net Income 

GFH Net Income Statistical Analysis 2011-2015
		Mean	STDV Pop	STDV Sample
GFH		$0.44	11.55	12.91
AA w/o KHCB		$2.42	9.21	10.29

Technical notes:  STDV=Standard Deviation.  STDV Pop=Standard Deviation of the Population.  Amounts in millions of US$s.

Without KHCB the distribution of net income would have been tighter (smaller but still large STDV relative to the mean) and around a relatively higher—but by no means (pun intended) adequate—mean.  Volatility would have been somewhat less.

 Impact on ROE

GFH ROE 2011-2015
	2011	2012	2013	2014	2015
GFH	0.22%	3.26%	-4.00%	4.79%	1.80%
AA	0.22%	3.26%	-4.01%	2.62%	-0.83%
AA w/o KHCB	-0.15%	2.96%	1.44%	2.59%	-3.68%

Technical note:  “AA w/o KHCB” GFH's share of KHCB's net income has been eliminated for the entire period.  Since consolidation of KHCB only took place in 2015 with an accompanying restatement of 2014, KHCB equity only needed to be removed for those two years. 

Here the picture is more mixed.   In 2013, ROE would have been higher.  In 2015 lower. 

Recent legal victories promise to provide GFH additional “dry powder” to fund diversification efforts, particularly those involving the UAE defendant.  It’s really too early to pronounce on the overall strategy.  Time will tell. 

But, a key element of that strategy—commercial banking—depends on KHCB. 

As indicated above, there is a credible case that GFH might be better off without KHCB. 

Past performance is no guarantee of future performance.  Thus, GFH’s strategy depends on KHCB’s future prospects and performance. 

A separate post on that topic will follow.

GFH Bahrain: What’s Changed Since 2010?

Heading Up But Still Lots to Climb

I last posted about GFH in 2010. 

At that point, its financials were a mess.

Along with Global Investment House and The Investment Dar it was part of the trio of once high-flying regional investment banks that hit the wall at high speed. 

What’s happened since then?   

On a positive note, GFH escaped the fate of Global Investment House.  Its shareholders remain in control, cases have been lodged to recover funds, additional capital has been raised, and assets have not been stripped off to creditors. 

Nor is GFH in what would appear to be the nearly persistent vegetative state of The Investment Dar –a chronic condition punctuated by infrequent bouts of apparent lucidity in which TID announces yet another restructuring plan. Sadly during those periods TID is insufficiently lucid to issue financials, the last to see daylight being from FYE 2009, or to even update its website.  Love the Board members’ pictures.  Despite the difference in surnames, three of them look remarkably similar.

So how has GFH performed since 2010?  

Short answer:  not so well. 

On page 36 of its 2015 Annual Report, GFH kindly provide five years of financial highlights.     

GFH ROE 2011-2015
	2011	2012	2013	2014	2015
GFH	0.22%	3.26%	-4.00%	4.79%	1.80%
AA	0.22%	3.26%	-4.01%	2.62%	-0.83%

As you see from the above, AA has a different analysis of the last two years’ ROE.

1.      For 2014 and 2015 GFH used total net income— both GFH shareholders and those of non-controlling interests (NCI)—and equity attributable only to shareholders of GFH (excluding NCI’s share of equity) to determine ROE. 

2.      AA used net income—actually a loss of US$5.5 million—attributable only to shareholders of GFH and like GFH used equity attributable only to GFH shareholders.   Why? Because the point is GFH’s ability to generate income for its shareholders.  Also this choice is related to the nature of consolidated statements as outlined in #5 below. 

3.      As consolidation only affected 2014 (restated) and 2015 results, those are the only two years where there is a difference in calculation methodology.  

4.      Both GFH and AA used beginning and end of period equity to determine a year’s “average” equity to calculate ROE.  Because there were significant capital increases over the five year period (an almost three times increase), this method overstates ROE for certain periods because it understates average equity.  But what’s important here are trends, directional rather than locational statistics.

5.      One very important note:  consolidated financials are an accounting construct.  They are designed to provide a way to analyze the economic performance of a “group”.   But the consolidated "group" is not a legal entity.  That is, the group does not really (legally) directly owns the assets or receive the income shown.  Parent only or individual financial statements show the legal status ownership of assets, cash flows, etc.  Take a look at note 34 in JPMC’s 2015 AR and compare the data to the consolidated financials.  Parent revenues are largely dividends and assets are largely investments. This fact has important implications for investors and creditors that buy holding company equities or unsecured debt securities. Or for lenders to holding companies.  Access to cashflow, access to assets, priority in bankruptcy, responsibility for subsidiary/affiliate debt (absent parent guarantees) are some of these. 

Whether you take GFH’s or AA’s calculations, performance has been “disappointing” (euphemism of the post).  Earnings have been volatile.  ROE has been subpar.

Some of this is economic:  a “weak” (second euphemism) legacy portfolio, the cyclical nature of GFH’s businesses, etc. 

Some of this is a function of internal management: legacy leadership—responsible for the high risk portfolio—was only conclusively removed in late 2013, no doubt delaying remedial action.  GFH has also conducted successful legal actions against “two of its ex-Chairmen for bonuses illegally obtained during the period 2005-2008”  which some readers may interpret as indicating less than the ethics one might hope to find in a self-described Shari’ah compliant institution.   الله اعلم

A coming post will take a look at GFH’s attempt to address its problems.