The wrath of the Credit Reaper has shaken the second largest Kuwaiti bank and has left little room for compassion. I have just received news that Mr. Bassam Al-Ghanim, Chairman of Gulf Bank of Kuwait, has resigned. It is unclear at the moment who will take his place but since the Al-Ghanim family represents a large holding in the bank another member of the family might step in. Mr. Kutayba Al-Ghanim has been made aware of this and the family is addressing the situation accordingly. I have full faith that this matter will not jeopardize the bank’s clients. It is also expected that the CEO and Head Treasurer face pressure from the Central Bank to step down as this derivative debacle is sorted out.

The total estimated loss for the derivative trade is greater than the Euro 700 mm noted in my previous post. As the markets opened on Monday the 27th Gulf Bank offloaded the first US$ 1 bn leg at approximately EUR/$ 1.2580. Later in the day the other portion was closed out at EUR/$ 1.25. This amounts to a total loss of US$ 1.2 bn or  KD 313 mm, which represents 70% of Gulf Bank’s Tier 1 & 2 Equity.

I think the greater issue at hand here is determining which party will bear the risk of the loss. These are the scenarios that I see playing out (Please feel free to discuss):

Responsible party

• Gulf Bank: In this situation the bank will need to be recapitalized. This can be done either through a merger, acquisition, or capital increase. However, it is possible that the Central Bank extend a facility to GBK to cover the loss in which case the repayment terms will be lenient or the Kuwaiti government may want to acquire a stake directly in the bank, following in the footsteps of the Bank of England.
• Clients: Given the clients currently exposed to the derivative trade, it is highly unlikely that they can afford payment. I will include a more detailed analysis of their financial health in my next post as I am currently gathering all the information. Therefore, as mentioned in my previous post a rise in bankruptcy filing of individuals or corporations would not be unexpected.

In any case either party will try and avoid payment and seek the legal route, a process which can take a long time before a decision is made. However, the Central Bank along with the new Crisis Management Council headed by the Governor Shaikh Salem Abdulaziz Al-Sabah, might be able to expedite the process if need be.

Again, I would reiterate my position that I have full faith in the members involved in this unfortunate incident to act accordingly and in the best interest of the bank’s clients and shareholders. I also have full faith in the Central Bank Governor to honor his statement to secure the bank’s deposits, as he has shown considerable leadership in the past.

Please do not hesitate to contact me if you have any inquiries or would like to discuss further. All comments are welcome.

Disclaimer: All values are internal estimates and actual numbers may vary significantly from  stated numbers.

Update: Mr. Kutayba Y Al-Ghanim has been appointed Chairman of Gulf Bank. He currently holds the following positions in Kuwaiti incorporated companies:

• Chairman: Gulf Bank of Kuwait K.S.C. [Bloomberg: GBK.KK EQUITY]
• Chairman: Alghanim Industries (Private)
• Chairman: Kuwait China Investment Company K.S.C.

Mr. Adel M R Behbehani has been appointed Vice-Chairman of Gulf Bank. He currently holds the following positions in Kuwaiti incorporated companies:

• Chairman: Kuwait Pipes Industries & Oil Services K.S.C [Bloomberg: PIPE.KK EQUITY]
• Vice Chairman: Gulf Bank of Kuwait K.S.C. [Bloomberg: GBK.KK EQUITY]
• Director: The Investment Dar K.S.C. [Bloomberg: TID.KK EQUITY]

Press interview with Mr. Kutayba Y Al-Ghanim at Gulf Bank’s Board Room [Link]

The Credit Reaper has been a world tour this year, staying at the world’s best cities and footing the bill to the local investment, commercial, and central banks. Starting off in the US,  he then went on to take a tour of Europe via a short layover in Hong Kong. To date, the reported cost of his trip is estimated at US$ 650 bn with the US and Europe accounting for 95% of the cost and Asia only representing US$ 24 bn of that amount [1]. The banks have been calling this cost ‘credit losses and writedowns’ and with the aid of the respective central banks have been able to raise capital to cover the losses.

For a brief period things seemed to quiet down and the G7 were active in trying to clean up the mess. Little did they know that the Credit Reaper was partying in Beirut, apparently seen at Sky Bar, getting ready for the second leg of his tour. He arrived this morning at Kuwait’s International Airport carrying a large scythe with the word ‘Derivatives’ carved down the wooden shaft. First stop, Gulf Bank of Kuwait [GBK].

It was a quiet morning on the treasury floor at Gulf Bank’s HQ (MAK as referred to by the bank’s employees) until about 9am. The news spread like wildfire of the Reaper’s arrival and soon enough the Central Bank of Kuwait requested that the Kuwait Stock Exchange suspend trading of Gulf Bank shares [Bloomberg: GBK.KK Equity]. Here is a summary of that statement:

09:08:25 – Suspend trading of Gulf Bank shares at the request of the Central Bank of Kuwait [2]

• The bank’s clients have refused to settle losses on derivative contracts
• Gulf Bank will incur the losses until the matter is settled between the bank and its clients
• The Central Bank is working with GBK to resolve the issue and will appoint a member of its team to oversee all treasury trading and risk management
• The Central Bank will support the bank during this time and will ensure its deposits
• Kuwait’s government will pass a bill, brought forth by the Central Bank, to guarantee deposits at the Kuwaiti banks

After further investigation into the matter the following points were revealed:

• One of the counter parties with derivative exposure is POKREC. There are 5 – 6 other investors with similar exposure.
• The derivative product was short US$ and short volatility (That means if the US$ appreciates vs the Euro the investor losses money)
• The current estimated loss is Euro 700 mm. That is approximately US$ 882 mm or KD 240 mm. Gulf Bank’s Tier 1&2 Equity is estimated at KD 445 mm as per the bank’s 3rd quarter financials.
• Mr. Y Al-Muzaini is the appointee chosen by the Central Bank to oversee the treasury department’s activities
• GBK board members have been placed under country arrest and are not allowed to travel outside Kuwait

To help understand the magnitude of the situation and to put this in perspective, here are some of my observations and comments given the information so far:

Central Bank statements: The fact that the Central Bank has come out to support the banks is a good move to help promote stability. I wouldn’t be surprised if depositors are already lining up to take their money out of GBK [I will post pics of GBK branches]. With respect to the oversight, part of their mission is to ‘Control the banking system in the country’, and so they are being proactive in that nature. [3] However, I would not expect the Central Bank to start bailing out institutions that fail to be prudent in their risk management and investments activities. Such behavior will only promote companies on the edge of collapse to seek the aid of the government. I believe that the markets should determine their outcome and the industry leaders and participants to think about a possible consolidation where only the strong survive.

Derivative losses: As of now, it is not clear who will bear the losses incurred so far. However, the two possible scenarios play out as follows:

1. Counter party refuses payment: Gulf Bank takes the hit and records the loss on its own books. This will have major implications for the bank as the loss represents approximately 54% of the bank’s equity. In addition, GBK is suffering a KD 45 mm loss from treasury shares and if the stock continues to tank this will erode their ability to maintain an acceptable capital ratio. GBK has also classified a major portion of their investment holdings as Available for Sale. As these investments incur losses due to the faltering word financial markets, the bank will also find it difficult to maintain the capital required. This will mean that the bank will have to be recapitalized either by issuing additional capital via the public market [capital increase] or seek additional capital from the Central Bank or Kuwaiti government. GBK will then have to seek the losses from the counter party legally and battle it out in the courts for many years to come. If it fails to recapitalize then the bank will have to consider filing for bankruptcy.
2. Counter party accepts losses and makes payment: Depending on the financial health of the respective company, this will have a material effect on the company’s balance sheet. I have gathered a list of the names with exposure but will follow up this post with more specific analysis on each company as the names become public. In any case, there will be a general de-leveraging of institutions as well as individuals in line with what is already happening across the globe. We will see asset prices falling and I would not be surprised to see individuals and corporates filing for bankruptcy.

I would not rush to pull my money out of Gulf Bank but I would greatly reduce my exposure to the bank. I currently have an account with National Bank of Kuwait [NBK] , Gulf Bank, and Burgan Bank. I will be looking to reduce my assets in Gulf Bank and Burgan Bank and increasing my NBK account and open an account with Commercial Bank of Kuwait.

I am not an advocate of rumors that promote harm to a company or its employees. However, as information becomes public it is imperative that it is analyzed and distributed to ensure people in need of such information make their decisions accordingly. As mentioned before, I will follow up this post will some more analysis as more information comes to light.

Please note that certain information has been abbreviated to ensure this blog is not held accountable for any slander charges. If anyone wishes to obtain further information or would like to discuss the issue further please post your comments below or email me.

[1] Bloomberg

[2] Kuwait Stock Exchange

[3] Central Bank of Kuwait

In an effort to stay true to it’s stated objectives, ‘Direct credit policy to assist social and economic progress’ [1], the Central Bank of Kuwait met with banks and financial institutions last week. The purpose of the meeting called for by the CBK Governor Shaikh Salem Abdulaziz Al-Sabah was to inform the attendees that the CBK will extend all ‘necessary aid’ to institutions facing problems stemming from the current global credit crisis. The Governor also reassured his audience by stating that the government will not allow Kuwaiti institutions to fail. Although the CBK oversees both the Banking and Financial sector, they are not treated equally as financial institutions cannot access CBK liquidity.

The three institutions facing trouble and being supported by the CBK include:

• Global Investment House . The stock has returned -43% from its 52 week high and currently has a market cap of KD 875 mm. [Bloomberg symbol: GLOBAL.KK EQUITY]

• The Investment Dar. The stock has returned -36.5% from its 52 week high and currently has a market cap of KD 639 mm. [Bloomberg symbol: TID.KK EQUITY]

• Al-Madina. The stock has returned -54% from its 52 week high and currently has a market cap of KD 98 mm. [Bloomberg symbol: ALMADINA.KK EQUITY]

I think it will be interesting to see how things play out within the next few months and how this will effect the markets. I also think that it is unfair for institutions that have not been prudent to receive special treatment and bailout packages while those who have behaved merely get a pat on the back. For those of you invested in the local markets, expect downward pressure for the upcoming months as more dirt is uncovered. I hope that the markets punish the feeble and reward the strong, as they should.

All numbers are as of Oct 16 closing prices.

[1] Central Bank of Kuwait. www.cbk.gov.kw