Gulf Bank of Kuwait Shipwrecked

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

26 thoughts on “Gulf Bank of Kuwait Shipwrecked

  1. Hasan.B

    Thanks for the info. Few questions;
    If the government starts backing up banks will it have to back up investment companies as well? And are other banks at risk as well?

    Reply
  2. MAR

    Hasan.B
    The government has no obligation to back investment companies. But, as mentioned in my previous post that some companies are seeking help. I think the government will do its best to ensure than things are operating smoothly but not to bail out anybody as of yet.

    Other banks have not come out with anything. But any bank can have exposure, it all depends if they have managed their risk well. Also, if people or companies start refusing to pay for their losses this would escalate into a huge problem.

    Reply
  3. f

    I think we havn’t witnessed anything like this since ilmanakh.. the most affected by this are gulf bank employees.. very sad.

    Reply
  4. steve

    i tend to agree with rational suggestion to leave market sort out the good institutions from less professional ones and government should stop bailing the looser’s, but history taught us in kuwait that goverment will help gulf bank out at the end.

    Reply
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  7. abdulla

    L dont believe this crisis is limited to gulf bank, Burgan bank is facing similar issues. NBK & BKME are more conservative in terms of risk management. Sadly our central bank acts only when a crisis happen, they dont think ahead. As a central bank they should have questioned each bank exposure to derivative and other risky instruments as soon as the collapse of real estate, mortgages, and equities started.

    Reply
  8. Abdulmohsen

    Great article, I would also like to mention that since CBK tightly regulate Kuwait’s banks, then it would also be aggressive in defending them. NBK owners are looking on with a grin on their faces, waiting for deposits to spill over from GBK. Mr. Dabdoub made sure to make himself heard yesterday in the news.

    Reply
  9. DR

    Thanks for the article….it was a joy reading something both informative and well-written :)Good to see that not everyone relies purely on jargon to get the msg across!
    In principle i agree that the market should sort itself out & survival should be for the fittest but im not sure how practical that is?

    Reply
  10. Thomas

    @Abdulmohsen, True that… the article is well written for a layman. a basic on a Bank’s operations should be made aware to the public. Good stuff!

    Reply
  11. Mishari

    I was gonna mention that you made a mistake in the following “The derivative product was long US$ and long volatility (That means if the US$ appreciates vs the Euro the investor losses money)”

    but you’ve changed it since.

    Reply
  12. mentabolism

    Sure, it sounds good to say let the market sort itself out. That’s only because the CBK has guaranteed deposits (or perhaps the exposure of those persons saying that is limited :)) – imagine the poor guy who loses money when the bank closes.
    A regulatory mechanism would be better, which keeps an eye on the risk exposure of these banks.

    Reply
  13. AS

    Crazy days.

    You say: “The derivative product was long US$ and long volatility (That means if the US$ appreciates vs the Euro the investor losses money)”

    If you are Long US$ then an investor would make money should the USD appreciate vs the Euro (which it has). Surely you mean the instrument was short the dollar, or perhaps long the Europe. Being Long vol would also have made money if it was the VIX that was referenced – currently at all time highs.

    Reply
  14. MAR

    @Mishari & AS: True, typo. I have already corrected statement.

    @Abdulmohsen: Thanks! Yes he is quite happy i hear. Same happened to HSBC when other banks started to fail, ppl rushed to deposit there. Btw I like you coverage of financial events. Keep it up!

    @Thomas: Agreed, but I was trying to reach a wider audience. Will try and follow up with something if ppl are interested in learning the basics about how a bank operates.

    @Jasem: I think I ordered that book as well. Hopefully I will be able to post mini reviews about finance books as I finish reading them

    CBK letting banks fail: I think there comes a time when ppl in a position to influence decisions that ultimately affect the general population should be thoughtful. My view is that they should not penalize investors nor clients of the bank but rather the ppl responsible. I think the issue here is that GBK is not allowed to take positions on its books, as per CBK regulations, but did so bcz of poor risk management. As you all know, in Kuwait rules are usually bent for ‘certain’ ppl. But I also think as the Kuwaiti banks move toward Basel II compliance regulation will have to play more of a role. In addition, as more investors look to allocate their capital in Kuwait regulation from the securities side will also have to adjust accordingly.

    Reply
  15. JAS

    GBoK wouldn’t alllow any bank to fail. That’s just not an option. I wonder if they would be more open on bank mergers though…

    Reply
  16. MAR

    @Hasan.B: I think the employees should be fine, despite the fact that all they are talking about is this issue. In any case there might be some downsizing (firing some people) if GBK decides to cut down on costs. In addition, even if the bank is taken over somehow the new controlling shareholder will still need the employees.

    @JAS: I think that bank failure would be major and you bring up a great point. I wouldn’t be surprised to see merger talk emerge within the next few weeks. We already went through that last year with bank merger talk. The banking license is worth something though, as they are limited to 7 at the moment (9 if you include KFH and Boubyan). In any case, I think you could shed more light on any merger issue as you are the expert in that space.

    Reply
  17. MAR

    Since it has been made public today by Al Zumorroda Holding Company I will clarify that the counter party mentioned in this post.

    POKREK: Pearl of Kuwait Real Estate Company [Bloomberg: PEARL.KK EQUITY]

    Reply
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  19. Arsala K.

    I seem to have woken up to this bit of news extremely late!
    I would just liek to know if you have been able to access information with respect to the “counter parties” involved in this transaction.
    I suspect that most of these transaction were relate to credit default swaps.
    Also, how much money was “loaned”out to institutions or individual borrowers, to enable them to engage in this transaction?
    In America, so far the government is presently busy trying to bail out institutions, rather than planting onus on their directors and decission makers. However, as noted from your article, there seems to be some regulatory action waiting to be taken as against the directors of the bank.Inofrmation is that the Board was asked to resign, what in this instance, wcould be the legal proceedings brought against the Board?How much of teh blame can actually be put on the Board for their “venturesome” investing and lending tactics?

    Reply
  20. MAR

    @Arsala K: Well from my sources I know that counterparties are C and N. However, I do not want to be the source of this kind of information. Lets just say that they have a French origin. Their names will be announced as soon as the investigation is over. Actually, the trade had nothing to do with a CDS. The bank might have written a few but I do not have confirmatio of this. It was rachet put option on the Euro that was sold.
    As far as the legal action with respect to the Board, I believe that the authorities will be able to shed more light on the situation. I also hope that the other shareholders take necessary action to make sure the responsible parties are held accountable.

    Reply

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