November 2010 Industry Research Kuwait Investment Sector Report Contents Summary Industry Overview Kuwait Investment Sector Reasons for the poor performance & liquidity problems of Kuwaiti Investment Companies New CBK Regulations Financial Performance Best performing investment companies in Kuwait Investment company debt levels Investment company assets Conclusion Recommendations for the Investment Sector Analyst Victoria Monteiro v.monteiro@capstandards.com +965 22258822 ext.514 Capital Standards (CSR) Al Nassar Tower, 11th Floor, Fahad Al-Salem St., Kuwait City P.O.Box 26620, Safat, 13127 Kuwait Office: +965 2225 8822 Email: services@capstandards.com Website: www.capstandards.com Summary There are a total of 100 investment companies operating in Kuwait with 54 operating within the confines of the Islamic Sharia provisions and the rest operating as conventional investment companies. Further, 51 of these companies are listed on the KSE. Kuwait's economy in general recovered at a slower pace than expected in the first half of 2010, after shrinking 21 percent in nominal terms in 2009 due to the economic crisis and depressed oil prices. The government intervened with a stimulus package of KWD 1.5 billion to help stabilize the financial sector. However, there still remain obstacles for the general economy to reverse the downtrend. Currently the investment sector is in the process of going under a major overhaul by the regulatory agencies due to the numerous defaults and regulatory breaches by the various companies that were affected by the financial crisis. This could help with improving transparency and prevent excessive leverage in the system reducing the overall systematic risk. One of the repercussions of the financial crisis on Kuwait was that the investment sector - consisting of listed companies - lost approximately a cumulative KD 864 million in 2009, which followed the losses of KD 927 million in 2008, and record profits of KD 903 million in 2007. Further, the 2009 losses were marginally lower than 2008 which in effect signaled the very slow pace of recovery in the investment sector in Kuwait. Subsequent to the financial crisis some investment companies were suspended from trading on the KSE due to the non-compliance issues related to late submission of financial statements. KSE trading suspensions peaked in the first half of 2010 with a total of 23 companies being suspended from trading pending the release of their financial statements. Other companies faced major debt repayment problems such as Dar Investment and Global Investment House. Lack of confidence in the markets has led to a slowdown in trading activity in the securities of investment firms. This resulted in a cycle of further asset value declines and an overall negative sentiment regarding participation in the capital increases offered by these firms. The fundamental mismatch between short term liabilities and the ability to service these obligations were one of the major reasons behind the insolvency of some investment companies. Kuwait Investment Sector P a g e 1
Industry Overview Kuwait Investment Sector Kuwait's investment sector witnessed strong growth from 2003 until 2007. However most of this growth was attributed to the availability of cheap credit as opposed to fundamental growth in the economy. The investment and real estate sectors contributed positively to the overall economy and helped with the development of a more dynamic capital market which encouraged the private sector to actively increase their contributions in various funds operating both on a local and international scale leading to a subsequent surge in prices across all asset classes. The Kuwaiti investment sector continued to witness significant losses in comparison to the other Gulf countries. As of 2Q 2010, the total losses in Kuwait amounted to KWD 422.7 million. Although Kuwait is the largest investment sector in GCC, the significant losses are mainly attributed to the relatively risky business model of the companies in Kuwait, which have been stated below. Figures are in USD mn No of Cos. Table 1: GCC Comparison 2010 2009 2008 Q2 Q1 Q2 Q1 Annual Annual Kuwait 51 (422.7) (19.8) (26.6) (861.2) (3,118.1) (3,881.9) KSA 11 157.6 174.1 46.4 (19.4) 282.1 162.6 UAE 7 85.4 104.3 214.1 62.6 369.5 773.7 Qatar 6 431.7 390.2 384.7 437.9 1,541.1 2,069.4 Oman 18 (9.6) 49.9 60.9 (56.6) 65.1 (47.3) Bahrain 13 (11.1) 22.5 (67.6) (12.7) (901.5) 567.7 Total 106 231.3 721.1 611.9 (449.4) (1,761.8) (356.0) Source: Zawya, CSR Analysis Reasons for the poor performance and liquidity problems of Kuwaiti Investment Companies 1. Excessive short term debt, which created asset-liability mismatches 2. Aggressive expansionary policies during the boom economy period 3. Exposure to risky asset markets such as equity and real estate, which resulted in significant impairments 4. Inadequacy of risk management 5. Not in full compliance with regulations 6. Lack of transparency by the investments companies and timeliness in disclosing their financials A combination of the above reasons and weak transparency and corporate governance standards, significantly contributed to the crisis, resulting in losses and decline in the value of assets of the investment companies. Kuwait Investment Sector P a g e 2
New CBK Regulations: In June 2010, the Central Bank of Kuwait (CBK) issued new regulations regarding the liquidity and leverage ratios of investment companies effective immediately; however, CBK has allowed these regulations to be fully implemented until June 2012. The new regulations cover three aspects of investments company finances as follows: 1. Leverage Ratio: The ratio as per the recommendation of the CBK should not exceed 2:1 (Total Liabilities/ Total Equity) 2. Quick Ratio: This ratio has been defined as; (Cash&Eqv. + Government or Sovereign debt rated BBB or above)/total Liabilities). As per CBK, this figure should not exceed 10 percent. 3. Foreign Exposure Limit: Debt should be limited to 50% of total equity or 25% of total liabilities. According to CBK, about half of the listed and unlisted investment companies comply fully with all three criteria. It is worth noting that the top three investment companies by asset size; Global Investment House, Aref Investment Group and International Financial Advisors have high leverage ratios of 4.1x, 2.7x and 3x respectively as of Q2-2010. CBK s initiative on the new regulations for the investment sector, which was triggered by the global financial crisis, aims to increase oversight on the investment sector. This will help improve the liquidity and leverage positions of the investment companies as the new definitions are more stringent than the traditional ones. The implementation along with effective supervision and enforcement of the regulation could help restore investor confidence in the sector. However, regulations related to risk management and corporate governance developed in line with international standards should also be imposed by CBK on the investment sector. This will go a long way in strengthening the sector as well as the increasing the transparency and credibility of investment sector in Kuwait. Financial Performance Top Performing Investment Companies in 2009 Table 3: Top 10 Performing Company Results in FY2009 (based on highest net income)* FY-2009 KWD(mn) Net Inc. Cash&Eqv. Total Debt T. Equity T. Assets Debt/Equity (%) C&CE/STD Kuwait Projects Company (KIPCO) 46.3 1,444.7 1,692.0 553.8 5,335.1 305.50% 140.66% Commercial Facilities Company 14.3 17.0 159.0 153.3 324.1 103.72% NA Kuwait China Investment Co. 8.7 31.5 0.0 84.4 88.0 NA NA Securities Group Company 2.7 2.4 47.2 65.6 116.8 71.98% 5.18% Kuwaiti Fin. Center (MARKAZ) 2.6 12.1 32.7 82.2 119.5 39.79% 300.32% Al-Tamdeen Inv. 2.3 13.8 218.6 86.0 445.0 254.17% 20.30% Gulf North Africa Holding Co. 1.2 5.1 0.0 19.3 20.0 0.00% NA Kuwait Bahrain Int. Exch. 0.8 12.8 5.6 6.6 13.4 85.67% 226.48% AL Salam Group Holding Co. 0.3 0.0 17.1 24.1 42.8 71.12% 0.42% Amwal International Investment 0.1 0.18 0.0 24.9 25.4 NA NA * KAMCO has been excluded from the above list as it operates under the KIPCO Group Source: CSR Analysis Kuwait Investment Sector P a g e 3
The top performing investment companies in FY2009, recorded large increases in net income figures mostly due to the turnaround in the equity markets and the quantitative easing measures implemented by the central banks of various countries in order to spur growth and avert further deterioration in the world economy. Kuwait Projects Company (KIPCO) held one of the highest debt levels relative to equity levels at 305%; however, the company is considered one of the largest in terms of asset size. KIPCO s earnings outperformed the rest of the group by a significant margin, registering a KWD 46.3 million in earnings at the end of 2009. It is worth noting that only 10 companies recorded positive net income figures at the end of FY-2009. Most of the investment companies maintained sufficient amounts of cash & cash equivalents to cover their short term debt obligations, while other companies such as Securities Group Company (SGC) had significantly low levels of cash signaling liquidity problems in the short term. To deal with the financial crisis, a number of investment companies resorted to rescheduling of debt obligations and/or merger activities. Companies such as Global Investment House and Investment Dar which faced large debt repayment problems had to resort to restructuring their debt payment schedules and implement various steps such as cost cutting, asset sell-offs and reducing their exposure to risky assets which they had accumulated during the pre-crisis period. From CSR s analysis on the Restructuring Debt Obligations Kuwait 1, it was observed that mostly companies in the investment sector had to restructure debt from short term to medium term. On the other hand, merger agreements are almost at the final stages for Gulf Investment House First Investment Company and the deal between International Finance Co, Kuwait Invest and Jeezan Holding. The merger deals in Kuwait will also allow companies to have more diversified sources of income and geographic reach. Investment company debt levels The total debt of the total investment sector peaked in 2008 with an accumulated figure of KD 8,853 million. Total debt grew at a CAGR of 25% from 2003 till 2008. This was due to the cheap credit available in previous years and the aggressive expansionary policies undertaken by these companies. Since 2009, the total debt in the sector has been showing a declining trend. As of Q3-2010 the total debt amounted to KWD 7,416 million. KWD mn 10000.0 9000.0 8000.0 7000.0 6000.0 5000.0 4000.0 3000.0 2000.0 1000.0 0.0 Year No. of Companies 2853.5 15% 3275.4 Trend in Total Debt of the Kuwait Investment Sector 28% 4205.2 50% 6315.1 8147.2 29% 8852.6 9% 7851.3 7715.1 7467.6 7415.5-11% -2% -3% -1% 2003 2004 2005 2006 2007 2008 2009 1Q2010 2Q2010 3Q2010 41 42 56 73 79 99 100 100 100 Total Debt Growth (%) 0.6 0.5 0.4 0.3 0.2 0.1 0-0.1-0.2 Source: Central Bank of Kuwait, CSR Analysis 1 CSR s report on Restructuring Debt Obligations Kuwait : http://www.capstandards.com/restructuring-debt-report-2010.pdf Kuwait Investment Sector P a g e 4
Prior to the financial crisis, many investment companies both Islamic and conventional were able to refinance large amounts of debt as a result of low financing costs and inflated asset prices which were used as collateral for further leverage. This situation proved to be unsustainable, when the majority of the banks had to write down their assets as the markets experienced sharp declines, constraining the liquidity in the market. This resulted in a number of debt restructuring deals, exposing the vulnerable investment sector. Also, a number of investment companies either delayed or stopped publishing their financial results and subsequently were suspended from trading on the KSE. In November 2010, KSE suspended 21 companies from trading due to delay in submitting financials. Of these 21 companies, 14 companies were from the investment companies reflecting the ongoing challenges in the sector. Investment company assets Assets as shown in the figure below grew steadily from 2003 till 2008 for both conventional and Sharia compliant investment companies. However, this growth was attributed to the liquidity available and the composition of the assets which were significantly impaired during the crisis. The large impairments resulted in defaults by investment companies across the GCC and Kuwait. The inability of these companies to refinance their debts was mainly due to the high assetencumbrance and the act of further leveraging the assets during the pre-crisis period. The ultimate deleveraging process resulted in triggering defaults across a spectrum of both conventional and Islamic investment companies. Conventional investment company assets grew along with their Islamic counterparts from 2004 with the availability of numerous options for fueling growth with more excessive amounts of debt. This helped increase the asset composition of these companies with more debt and boost their ROEs and ROAs. However as the markets corrected and large amounts of assets were impaired, these high return figures were reversed along with equity levels. As indicated, debt to equity levels were on a decline from a period of 2003 to 2005, however this trend reversed at the beginning of 2005 as more companies opted to finance their operations with debt fueling the overall increasing debt levels as a portion of total assets. KWD mn 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 Total Investment Sector Asset Breakdown 51.6% 51.5% 53.1% 54.4% 50.7% 52.9% 53.6% 52.7% 48.1% 44.6% 2003 2004 2005 2006 2007 2008 2009 1Q2010 2Q2010 3Q2010 Conv. Inv. Islamic Inv. Total Assets Debt/Asset 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Source: CSR analysis, CBK, Company Reports Kuwait Investment Sector P a g e 5
Conclusion Large investment companies which over the years witnessed explosive growths had to struggle to repay their debts and often had to resort to restructuring their outstanding debts with encumbering covenants and other restrictive measures. The highly leveraged asset base of investment companies was another contributing factor in the overall volatility and the inability to cope with the large asset impairments and the regulatory requirements. A recent report by the IMF underlined the need for further regulatory supervision in the investment sector to mitigate the effects of future downturns in the financial sector and to offset any systematic risk. Recommendations for the Investment Sector 1. Investment companies should reassess their business model, diversifying into and focusing on stable sources of income (such as fee based activities from asset management etc.) 2. Change financing strategies towards larger term debt as well as consider bond/sukuk issuance to help create local currency yield curve and subsequently reduce financing costs 3. Better compliance with Corporate Governance best practices since it will eventually lead to better performance and increase transparency and restore investor confidence 4. Consider consolidation options and opportunities to increase value Kuwait Investment Sector P a g e 6
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