2008: Year of the Dove

The Chinese zodiac is quite unique in its construction. Based on a cyclical perception of time, the twelve animal signs are structured around a 12 year cycle. Starting with the Rat, they each represent various characteristics of people that are born during the Chinese year. [1] In China it is currently the Year of the Rat, a year symbolizing hard work, shrewdness, and ruthlessness. 2008 is also considered a lucky year as the number 8 is very auspicious and in Chinese, sounds similar to the word for prosperity or wealth.

The white dove and olive branch is arguably the most recognized worldwide symbol for peace. References of the dove range from The Holy Qura’an to Pablo Picasso’s artwork. [2] You can even purchase a War & Peace watch with a rotating Dove from the United Nations online bookshop for US$45.95. [3]

In the finance world however, references to doves are not exactly meant to illustrate peace. Instead, financial jargon defines these words as follows:

  • Dovish: A Central Bank that is cutting (reducing) interest rates
  • Hawkish: A Central Bank this is increasing interest rates

Simply put, a Central Bank that reduces the interest rate at which commercial banks can borrow at is said to be Dovish and vice versa. In general, interest rates lower debt cost. For example, in Kuwait, loans are usually quoted as a percentage over the CBK rate and most of the loan terms are actually pre-determined by the Central Bank of Kuwait. That means that if you took out an Al-Afdal loan from Gulf Bank today [4% + CBK rate] your interest would be 8.5%.

As we all have come to know, 2008 has been terrorized by the banking and financial crisis and according to the latest SMS circling Kuwait, a year where only two banks are expected to remain – the Blood Bank and the Sperm Bank. However, the Central Banks have many tools at their disposal to deter such an event from becoming a reality. Increasing or decreasing interest rates are one of the many gadgets used to promote financial and economic stability. During these moments of crisis the Central Bank policy makers have joined together in a coordinated effort to reduce interest rates hence making this year a Dovish one.

The graph below highlights the year to date interest rate for the US Federal Reserve, Bank of England, and the European Central Bank. The US has been more aggressive than its peers in reducing interest rates as it struggles to keep its economy afloat.

Interest Rates – YTD %

Source: Bloomberg

  • ECB: 3.75%
  • US FED: 1.00%
  • BOE: 4.50%

Policy Effectiveness:

Merely noting the net change in the interest rates does not give a clear picture as to whether the policy was effective in achieving its objective. One measure of credit and liquidity risk in the banking system is the TED spread. It is calculated by taking the 3 month London Interbank Offer Rate [LIBOR] and subtracting the 3 month T-Bill yield.

  • LIBOR: It is a measure of how much banks are willing to lend US dollars to each other. The reported rate is an average of participating banks.
  • T-Bills: The interest rate at which you can borrow, essentially risk free, from the US government.

As a rule of thumb, when the TED spread is:

  • High: Banks are less willing to lend to each other as they believe other banks are not safe
  • Low: Banks are more willing to lend to each other as they expect to get their money back

In this particular case, policy makers reacted to a nosedive  in global equities during September and scrambled to take action. From September until about mid October, the TED spread continued to rise as banks simply stopped lending to each other. However, after interest rates were reduced globally the TED spread started to come off its high.

  • All time High: 4.57% [October 10, 2008]
  • All time Low: -0.034% [September 12, 2001]

TED Spread

Source: US Federal Reserve. Bloomberg. Al-Hamour.
Source: US Federal Reserve. Bloomberg. Al-Hamour.

We can see that the coordinated rate cuts were effective in reducing the credit risk in the banking system as banks became more willing to lend to one another. As of November 1, 2008 these are where things stand:

  • TED Spread: 2.41%
  • LIBOR: 3.02%
  • T-Bill: 0.61%

However, when comparing the TED spread to the May 1987 average of 1.7% and the October 1987 average of 2.26% we are still at higher levels. This is somewhat anticipated as the current crisis is far greater in depth and breadth than The Crash of 1987 which started on October 19, 1987 in Hong Kong. [4]

TED Spread

Source: US Federal Reserve. Bloomberg. Al-Hamour

Source: US Federal Reserve. Bloomberg. Al-Hamour.

In summation, I would like to leave you with a recap of the main points discussed in this post and what you can anticipate going forward:

  • Dovish Central Banks help reduce the overall cost of debt and aid in de-leveraging of the economy
  • The TED Spread is a measure of credit and liquidity risk in the banking system
  • Expect LIBOR rates to decrease as liquidity is injected into the system and inter-bank trust is restored
  • Expect Central Banks to continue to reduce interest rates
  • Consider making a deposit at your local Blood Bank and/or Sperm Bank

I will be posting a follow up to this topic later this week and will discuss the various Central Bank actions year to date.

Please do not hesitate to leave a comment or send me an email if you have any inquiries or would like to discuss the post.

[1] Chinese Culture Center

[2] Dove of Peace. Pablo Picasso.

[3] Online Bookshop. United Nations.

[4] Investopedia

Gulf Bank Chairman submits resignation

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]

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

Kuwaiti damsels in distress

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

Living under a rock

I would like to start by saying that this is in no means a research piece on the markets, but a commentary that will hopefully shed light on the current frenzied global situation.

Deciding to spend more time with my family this weekend is the main reason I was inspired to write this piece. In fact, it was my father’s birthday and I got to spend a few hours discussing various topics, among which was the ‘Dead Cat Bouncing Theory’ – a theory he introduced me to. So before I begin, I just wanted to say ‘Thanks Dad’.

Trying to make sense of current capital markets is like trying to understand someone speak during a rave: the music is deafening and you are being shoved around to the point at which you feel that you are in a pinball machine. There is so much ‘noise’ that you lose track of the conversation’s crux and end up feeling very confused. Therefore, it is important that you remove yourself from the situation and quietly assess the events taking place. As I mentioned before, I am not here to predict the outcome of the global marketplace; I simply want to block out some of the noise and share my two sense.

For those of you who have not been following the financial news and have been living under a rock, the global markets have experienced a downturn over the past few months with an estimated $7.9 trillion of wealth just vanishing into thin air[1]. To put this into perspective, imagine the site of destroying 26 Airbus A380’s! The US Federal Reserve Bank Chairman, Mr. Ben Bernake, is taking drastic measures to try and quell the markets by slashing interest rates and rescuing financial institutions, and in the process coining the term the Bernanke Helicopter. The reason why so much attention is being given to the US market is simply because it represents roughly a quarter of the world’s GDP output equating to the largest share amongst all the other countries. The phobia has always been related to the notion that if the American economy sneezes then the rest of the world will catch a cold. Now although I believe in that statement, I am not sure it is completely true.

Today’s financial and economic markets are facing paradigm changes in the underlying fundamentals they were based on for the past half a century. China, currently the world’s third largest contributor to the global GPD, is estimated to overtake the United States’ 23% contribution to global GDP by the year 2020. In addition, the Middle East economies, benefiting from an insane $100 per barrel oil price have a combined reserve account relative to that of China’s currency reserve of $1.5 trillion[2]. Both regions are facing continuous inflation, which pressures the respective Central Banks to behave in a more hawkish manner, cubing their double digit GDP growth. The contagious effect from the US sneeze will also have a lagged effect on the rest of the world’s economies but nothing that a shot of fresh lemon juice and spoon full of honey won’t fix. So although the Asian and Middle East economies are slowing down, the strength of corporate balance sheets aided by strong government surpluses and spending will lessen the extent of the overall cold and will aid in a swift recovery, relatively speaking.

In other parts of the world – in places where there are more burger joints and hot dog carts than shawarma stands and noodle bars – the situation is quite different. In an economy driven by consumption, any hiccup to the average American’s ability to spend has a material effect on the overall growth of the economy. Just try to imagine a scene in which a woman who is out on a mission to find that perfect dress finally succeeds, only to realize that her husband’s VISA card was declined. Trust me, it is not a pretty sight. To give more color to the magnitude of the situation I should remind you that the 213 million middle class (those with annual income of $18,000 – $55,000) Americans, representing approximately 70% of the population, are already witnessing their savings plans – and, more importantly, their home values – dwindle away like the strong scent of a beautiful woman in a cool summer breeze. Additionally, in a flat to negative savings rate environment where the average American is no longer able to borrow in order to quench the never ending thirst of the US economy, the canvas is starting to look more like Edvard Munch’s The Scream rather than an exquisite Monet. I am not implying in any way that the sky is falling but simply want to prepare myself for the strong gales ahead.

From an economic standpoint, the current situation is being compared to the Great Depression in the 1930s, a tragic event that left the US economy crippled for many years. The reason for the resemblance is highlighted in the anticipated similarities to the extent of the damage. Although the current situation has also been compared to the late 1980’s market crash and Dot-com bubble crash in the earlier part of the 21st century, I do not agree that they are comparable.

During the mid 1980s, the scene on Wall Street was filled with high powered investment bankers driving around in exotic sports cars, buying up anything that tickled their fancy. The introduction of junk bonds enabled corporate to issue large amounts of debt at high interest rates which gave birth to the leveraged buyouts, merger and acquisition mania, and an era of hostile takeovers. I highly recommend watching Barbarians at the Gate and Wall Street to get a sense of what was going on during that time. On October 19, 1929 a day later know as Black Monday, the Dow Jones Industrial Average Index (DJIA) tumbled 22.6% translating into $500 billion of value evaporating like a puddle of water on a hot summer’s day in Kuwait. The Fed intervened and scrambled frantically to stabilize the situation and the market retraced back to post new historical highs.

As for the bursting of the Dot-com bubble, this is another example of an industry specific situation in which the actions of the Fed had managed to mitigate and contain the spillover effects that would affect the rest of the economy.

I will follow up with an article explaining how the Dead Cat Bouncing Theory conveys the resemblance between the current crisis and part of the Depression.

[1] World Federation of Exchanges. July 2008

[2] IMF