A Blog by the Editor of The Middle East Journal

Putting Middle Eastern Events in Cultural and Historical Context

Friday, August 28, 2009


I'm tired of always calling this "Weekend Reading," and my daughter starts fourth grade Monday so we've been talking about the imminent return of homework, so I think I'll call it that for now. Should you feel the need to spend still more time reading about the Middle East, here are some items:


A. Reeder said...

Part 1

The public squabble between Ahmad Hamad AlGosaibi and Brothers (AHAB) and Saad Investment has been making headlines for some time now.

Allegations by AHAB that Maan AlSanea (the son in law and founder of Saad) misappropriated US$ 10 billion in AHAB’s funds, the subsequent freezing of Maan’s accounts in Saudi (KSA) by SAMA (the Saudi Central Bank), the freezing of US$9 billion of his non KSA assets by the Caymans Islands make for quite a compelling story. Maan’s personal history – former Kuwaiti Air Force fighter pilot, entrepreneur, major investor in HSBC, and his reported personal participation – machine gun in hand – in battling the terrorists attacking his Oasis Compound in AlKhobar in May 2004 add to the drama.

What’s perhaps missing is how this story fits into the current distress in the GCC financial sector and what the implications are.

Since the stated goal of your blog is to put ME affairs in context, here is an attempt to provide that larger context on this story.

The AHAB/Saad dispute takes place against a larger backdrop. The fact that it has occurred is due in some measure to developments in the global and regional financial sector. As the tide of liquidity recedes from a market, the true state of hulls of the ships in the harbor becomes evident. And, if only temporarily cautious, bankers are likely to be more circumspect with their commitments.

The first shoe dropped when the subprime crisis hit and local banks had to take the hit on their direct exposure to the US market - largely in their 2008 financials. While pain was felt across the GCC region, it was primarily concentrated in three large institutions. Arab Banking Corp (ABC) and Gulf International Bank (GIB) both in Bahrain -- each took hits of approximately US$1 billion for their US subprime related exposure. Gulf Investment Corp Kuwait a lesser US$300 million. Sovereign shareholders dutifully ponied up the lost sums, though at GIB reluctance by shareholders led to the Saudis increasing their ownership stake to 53%. GIB’s woes weren’t over. Shareholders were asked to buy US$4.8 billion of troubled assets to complete the clean up the bank’s balance sheet. Only the Saudis stood up. As a result, they now own roughly 98% of the Bank. Thus, the original vision of GIB as the GCC countries’ joint megabank champion has come to an end. More importantly there have been dramatic staff cuts. Rumors that the bank will relocate its main activities from Bahrain to Saudi (KSA). ABC (owned by Libya, Kuwait and Abu Dhabi) has also retrenched. Management was changed and new “highly frugal” CEO brought in. With this episode following on earlier yeas’ disappointments in commercial lending, the new focus is retail lending with a pan Arab focus as the Bahrain market is too small and already well served.

The second shoe dropped when global interbank liquidity (banks lending one another) dried up and markets seized up. Two effects. First, an abrupt withdrawal of liquidity and paralysis in markets led to declines in asset values around the world. Declines that eventually had to be recognized in financial statements. Second, foreign banks stopped providing liquidity into the Gulf market. Naturally, local banks reacted by reducing their own lending activities. This led to reduction in local asset values. GCC stock markets retreated. The value of real estate – a local investment favorite – dropped. Example, residential prices in Dubai are some 50% off the peak. This following consecutive particularly silly seasons of increases in real estate values. The fallout affected other markets and instruments. Gulf Bank Kuwait – the second largest in the country- reported a loss of KD360 million for 2008 as related party clients defaulted on foreign currency derivative bets (on strengthening of the Euro versus the US Dollar) that went wrong. New equity was issued with a healthy participation by KIA -- Kuwait Investment Authority – which now owns 15% of the bank.

A. Reeder said...

Part 2

The third shoe dropped as the decline in asset values forced a wider swath of banks to report earnings declines or losses. The investment banking sector was particularly hard hit. Investcorp hammered by significant losses in global hedge funds and declines in its private equity portfolio recently reported a US$757 million loss for its fiscal year ending June 2009. (Unlike other local banks Investcorp’s fiscal year ends in June as opposed to December). A timely but highly expensive US$500 million preferred share issue (reflected in the annual report even though the cash subscriptions were not paid in as of 30 June) translated into “only” a $300 million decline in equity. Global Investment House Kuwait saw its net worth decline from KD723 million in June 2008 to KD294 million in June 2009. The Investment Dar Kuwait has yet to release its December 2008 financials or any interim reports for 2009 – not a good sign some 8 months into the new fiscal year. Both GIH and TID have missed debt repayments leading to defaults and attempts to reschedule their debts. Some KD650 million for GIH and KD950 million for TID. Particularly hurt were those firms whose past earnings had consisted of primarily capital appreciation (often self determined) rather than more prosaic cashflow.

The fourth shoe dropped with the Ahmad Hamad AlGosaibi Brothers and Saad Group defaults. As noted above, at least US$10 billion in bank debt is involved. The distress also touches these entities’ Bahrain-based banks, The International Banking Corporation and Awal Bank. In July, the Central Bank of Bahrain appointed two English law firms, each to act as administrator for one of the banks. Because of the allegations of fraud and resultant lawsuits between AHAB and Saad, the lenders, the problem is compounded. Until the suits are resolved, lenders do not know the true financial conditions of their debtors. And thus no idea of what rescheduling terms they will have to swallow. Or their ultimate recovery on these loans. Since the court cases are unlikely to be resolved soon, this paralysis will continue for some time -- hanging over local markets.

A long list of international and Gulf Banks are caught up in the mess -- a cautionary tale that is it always better to lend based on old fashioned credit and cashflow analysis than just on reputation or “name”. As usual with bankers, lessons are learned but only after the final exam has been held. And then usually forgotten before the next exam. Currently chastised, banks -- particularly those in KSA -- are curtailing lending to family owned groups. Thus, potentially frustrating the Saudi authorities’ attempts to kick start the economy.

The sixth shoe is the sovereign debt of Dubai. The emirate has some US$80 billion in foreign debt coming due in the next several years. This is the largest foreign debt of any GCC sovereign entity. When one considers that Dubai’s oil revenues are modest, the practical difficulty of repayment becomes apparent. Refinancing or rotation of creditors is required. In a credit constrained market and with Dubai’s main business – real estate- suffering, lenders are scarce. Recently, Abu Dhabi stepped up (yet again) to bail out Dubai by funneling US$10 billion through the UAE Central Bank. One presumes that Abu Dhabi reasoned it would be more difficult for the ruler of Dubai to stiff the CBUAE than a fellow amir. The loan is designed to provide liquidity so that Dubai owned companies can make payments.

A. Reeder said...

Part 3
One shoe remains yet suspended in the air – retail debt – potentially the most dangerous from a political/social stability standpoint. For at least the past 7 years, local banks have been on a binge in retail banking. Consumer loans and credit cards with particularly egregious terms. Five year tenor loans for vacations. 95% financing for real estate. Aggressive marketing of credit cards and promotions to shift balances. All in a landscape where there are no credit bureaus to report on the indebtedness of the potential borrower. Or such bureaus are newly established.

Many locals may caught in debt traps (e.g., credit cards) where even if they make the minimum required payment the quantum of their debt keeps increasing.
All this retail lending fueled a consumer boom.

With the loss of jobs, sharp declines in real estate and in local stock markets, repayment is going to be difficult. Problem loans will be on the rise causing pain to banks. And the consumer driven support for local markets and economies is going to be missing or severely diminished.

Couple this with the distress in real estate and the knock-on effect on construction companies, building materials suppliers, and there are the ingredients for continuing difficulties not only in the financial sector but in the real sector as well.

Local governments are going to be challenged – fortunately most have the financial resources or a friendly neighbor to lend a hand.

Where the impact will be more acutely felt is in those countries whose major export is labor and where foreign currency remittances play a significant role in national income and the balance of payments. Countries that are less endowed with resources to cope or friendly neighbors will face relatively larger issues than those better positioned.