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Government-owned National Bank of Abu Dhabi (NBAD), the nation’s second-largest bank by assets and largest by market value, was ranked among the 50 safest banks in the world in 2009, per Global Finance. The annual ratings compare the long-term credit ratings and total assets of the 500 largest banks around the world. This on the heels of a second-quarter profit fall of 9.3% from a year ago (though net profits were up 17.7% from the first quarter).
Earlier this month NBAD formally announced its intentions to not only double its operations in Egypt, but also to expand into the “fast-growing” Indian market. Earlier this year, the government-owned bank set up a representative office in Libya, with the aim of strengthening its presence in that country and North Africa. And sources also suggested last month that the bank, which already has three outlets in Sudan, plans to be one of the principal financial institutions in that market.
Instead, they’re also a commodity trader’s best friend.
FT laid out the case nicely on Thursday for why tea–which is already trading at an all-time high–may indeed have further to go:
“Traders now fear that the poor monsoon in India [one of the world’s top exporters along with Kenya and Sri Lanka] and scanty rains in Kenya’s Rift Valley will cut output in the second half of the year.”
Meanwhile, raw sugar futures, which have surged some 90% this year already, may also have more upside given a global supply deficit (due to drought in India and excess rain in Brazil), growing demand as well as El-Nino related weather effects hitting India, the second largest producer.
Regular readers need to accept my sincerest apologies…updates for the next week will be rather itinerant due to a taxing MBA orientation schedule.
In the meantime, I’d like to mention that Silk Invest CIO Daniel Broby, a friend of the blog whom I consider to be an (the?) authority on frontier market investing, will be presenting a paper entitled “The case for frontier market fixed income” that he co-authored along with Silk’s Director of Fixed Income, John Bates, at the “Challenges of Globalising Financial Systems” conference to be held at the Hashemite University in Jordan on October 21-22, 2009.
The paper, which Daniel allowed me a sneak preview of, and surrounding which Mr. Bates was kind enough to answer some of my questions, posits that frontier fixed income “should be included in strategic asset allocation using a technique known as reverse asset allocation,” in order to benchmark the currently off-benchmark instruments “to the way the world will be, not the way it is now.” Significant spread differentials still exist within the frontier debt market universe, even though corporate issuers “tend to have relatively strong balance sheet fundamentals and are generally well managed.”
The following appeared in the August edition of Business Diary Botswana. Right now I find myself fascinated by the role that securitization and a mature credit derivatives market will ultimately play in frontier economies; as J.P. Morgan once penned, “credit derivatives allow even the most illiquid credit exposures to be transferred to the most efficient holders of that risk.” Despite its perils (notably the lack of respect issuers had for the potential correlation on mortgage defaults), it is my belief that the underlying concept supporting derivatives is a sound one if handled correctly. As wealth continues to flow to developing markets in the coming decades, so too will the management of risk continue to mature.
Back in late March, not long after the S&P registered its ominous 666 low, an understandably seething writer in The New York Times charged that above all, the “key promise” of securitization–a process involving the pooling and repackaging of cash-flow producing assets into tranche-laden (arranged by risk rating), tradeable vehicles that was effectively born in the late 1970s at then Salomon Brothers in relation to mortgage-backed securities–“turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.” The column raised eyebrows, not only because of its vociferous and encompassing indictment, but because of the man behind it: Paul Krugman, winner of the 2008 Nobel Memorial Prize in Economics. Moreover, the charge ran counter-intuitive to previously uncontroversial financial theory; on its face, the concept of securitization should be a boon to issuers and investors alike. As J. David Cummins, Professor Emeritus of Insurance and Risk Management at Wharton wrote in 2004, “securitization provides a mechanism whereby contingent and predictable cash flow streams arising out of a transaction can be unbundled and traded as separate financial instruments that appeal to different classes of investors. In addition to facilitating risk management, securitization transactions also add to the liquidity of financial markets, replacing previously un-traded on-balance-sheet assets and liabilities with tradeable financial instruments.” In other words, improved market efficiency in the form of an increased rate of capital utilization (asset and liabilities moved off-balance sheet to a special purpose vehicle (SPV) are free of capital requirements and in turn reduce the expected costs of regulatory intervention arising from any deterioration in them), simultaneously lowers transaction costs and spreads risk as once static, embedded cash-flows mired on balance sheets become pliable. In the context of residential mortgages, this meant cheaper sources of funding for a wider pool of applicants. Credit card and corporate loans soon followed.
Yet along the way something went terribly wrong, and it’s this hiccup that so infuriates detractors of the practice like Krugman, who conclude that far from “bringing securitization back to life” through increased scrutiny and regulation, the Obama Administration shouldn’t even try. ‘What went wrong’ is that securitization was effectively hijacked, its role of transferring assets and ultimately shrinking a bank’s balance sheet pirated and replaced en masse by a new form of structured finance that involved a hitherto underutilized credit “derivative” called a credit-default swap (CDS), in which contract buyers are essentially insured by sellers of a given entity’s continued solvency. When J.P. Morgan began to slice, dice, arrange and then sell its burgeoning corporate exposure in order to reduce its corporate-based risk in light of the 1997 Asian crisis, it became the first bank to free up capital not by reducing its balance sheet by selling loans (which would damage client relationships), but rather by expanding it under the guise of having perfectly hedged against the risk of default. The most liquid portion of the market revolved around synthetic collateralized-debt obligations (CDO), in which investors insured against an entire group of loans in exchange for regular premium payments, and banks often kept the (allegedly) riskless, “supersenior” tranches on their own balance sheets with little or no capital in reserve. Over the course of a decade, such “loans” began to be manufactured across Wall Street (“originate and distribute”), and CDOs became increasingly supported by increasingly dodgy borrowers in a vicious cycle as banks succumbed to pressure (by directors, manages and shareholders alike) to continually accelerate returns. The rest is history. But lost in the clamor and media frenzy over the industry’s reckless abandon has been much in the way of level-headed, objective analysis. In particular, little has been concluded as to the broader economic impact of securitization. If you listen to the likes of Krugman (and in a “science” as convoluted and cryptic as economics, you’d almost be foolish not to), the jury is in, and securitization should be ‘out’. Yet as one commentator prudently surmised, “the problem with a lot of what looked like securitization over the past decade was that many banks thought that they’d sold off all their risk, when in fact they hadn’t.” Moreover, there is a growing amount of research that quantitatively supports the model–in its fundamental form at least. A study published in late June by NERA Economic Consulting, for example, assessed the long term impact of securitization, with a focus on the residential mortgage-backed securities market. The study found that: (i) securitization lowers the cost of consumer credit, reducing yield spreads across a range of products including mortgages, credit card receivables, and automobile loans; (ii) increases in secondary market purchases and securitization of mortgage loans have positive and significant impacts on the amount of mortgage credit available per capita, particularly among traditionally underserved populations; and (iii) conversely, declines in secondary market purchase and securitization activities negatively impact the amount of available mortgage credit. Moreover, the study reported, a reduction in securitization activity has a negative impact on all types of lending activity, including but not limited to residential mortgages; as such, it stated, bank lending activity is likely to be significantly and negatively impacted if securitization remains at its current, depressed level. The findings add further support to a seemingly pre-crisis consensus that the practice of trading cash flow streams allows parties to manage and diversify risk, arbitrage, and otherwise invest in previously unattainable classes of risk–all of which in turn enhances market efficiency.
Such rationale cannot be stressed enough if securitization is to continue its spread into developing economies and increasingly illiquid markets. As for African markets, the practice is still in its infancy. “Securitization is a bit more sophisticated than the reality in Africa,” said one asset manager. “The Commercial Paper (a money market instrument) market is where most of this activity is centered.” According to South African investment banker Stephanus de Swardt, aside from both the proper regulatory environment (which “allows for the special capital treatment of securitization bonds”), as well as the right legislative one (in order to “structure the transfer of assets”), securitization also depends on relatively developed capital markets that already feature both a government bond market and at least some form of corporate bond market, as well as “at least partially liberalized exchange controls” already in place. Some countries are naturally ahead of the curve. Botswana, for one, initiated the issuance of government debt in 2003 precisely with its market’s maturation in mind. Said the central bank at the time: “the [government] bond issue is a momentous event as the objective of the issue is not driven primarily by a need to raise revenue or funding but to develop the domestic capital market. The bonds are expected to help Botswana establish a relatively risk free yield curve that will serve as a benchmark for other private sector and parastatal bonds.”
In further happenings, last fall the Botswana Stock Exchange (BSE) hosted a conference on how to change illiquid assets into instruments that can be issued and traded in order to provide corporations a “new and potentially cheap form of funding.” Said a research note, “for banks and finance companies that have successful loan programs but are faced with capital constraint, securitization is a means of removing assets from the balance sheet and freeing up capital to support further lending.” Furthermore, new products may ultimately emerge in such markets even as more traditional ones begin to take root. For instance, as per capita income grows in developing countries, it can be expected than products such as life insurance and annuities will become more in demand. As Cummins pointed out in his 2004 treatise on the subject, the securitization of life insurance and annuity cash flows and risks “can increase the efficiency of insurance markets by utilizing capital more effectively, thus reducing the cost of capital and hence the cost of insurance, for any given level of risk-bearing capacity and insolvency risk. Securitization can accomplish this goal by spreading risk more broadly through the economy rather than by warehousing risk in insurance and reinsurance companies, which have lower capacity and diversification potential than the capital market as a whole.” Finally, securitization may even play a vital role in reducing poverty and improving lives in the SADC region. In a 2008 paper, World Bank Senior Economist Dilip Ratha and fellow economists Sanket Mohapatra and Sonia Plaza estimated that Sub-Saharan Africa could raise up to $30bn a year and further access international capital markets by “exploring previously overlooked sources of financing such as remittances and diaspora bonds, and strengthening public-private partnerships.” Said Ratha: “Preliminary estimates suggest that Sub-Saharan African countries can potentially raise $1 to $3 billion by reducing the cost of international migrant remittances, $5 to $10 billion by issuing diaspora bonds, and $17 billion by securitizing future remittances and other future receivables,” such as remittances, tourism receipts, and export receivables. In this latter form,future foreign-currency receivables are pledged as collateral to a SPV which issues debt to an offshore collection account that the borrowing country can then access. These securities have a higher investment grade rating than “the generally unfavorable sovereign credit ratings” given to Sub-Saharan countries, the Bank reports, which effectively opens them up to new, larger classes of investors.
Botswana Stock Exchange (BSE)-listed junior copper miner, African Copper, announced that it would restart its operations at the Mowana Mine near Dukwi–which it shelved back in January–upon receiving $41 million in funding from mining investment firm Zambia Copper Investments Ltd (ZCI). The firm also reported a pretax profit of 27.7 million pounds ($45.91 million), compared with a loss of 2.6 million pounds last year, for the six months ending June 30.
Copper prices dropped from US$7,000 per ton at the beginning of the third quarter of last year to US$3,000/ton by the end of that quarter. But copper prices have double this year, and according to Zijin Mining Group, China’s largest gold producer, “a recovering world economy and loosening bank credit will bolster copper prices in the second half of the year.” The estimation echoes that of GFMS, a precious metals consultancy, which opined on Thursday that global copper supply was expected to fall increasingly short of demand from next year, which should see prices rising every year to 2012:
“In the short term, copper prices were expected to soften, with inventories reported by the London Metal Exchange (LME) now rising after a surge in Chinese imports earlier in the year while Chinese industry rebuilt depleted stocks. But the increase in the surplus was likely to be brief and a market deficit would become evident early next year,” GFMS said.
While stocks in the Nigerian Stock Exchange (NSE) All-Share Index slid by 2.4% this week, and trading was halted in shares of the five banks that saw their CEOs unceremoniously sacked late last week, there may ultimately be attractive values forming among sound companies. For instance, Renaissance Capital, a Moscow-based investment bank, gave a ‘buy’ rating to Skye Bank last month and named it the ‘fastest growing tier-two Nigerian bank’. Of note, analysts remarked on the bank’s leading role in retail public sector collections for federal and state governments and tax authorities, as well as utilities, customs agencies, commercial subscriptions, regulatory institutions and examination bodies. Moreover, as noted earlier this year by RTC Capital, it is a “dominant player in Lagos state, Nigeria’s largest revenue collecting state. [And] with increased focus on diversifying revenue away from oil, this competence can only acquire more value.” Renaissance gave Skye a N12.20 share target price on the strength of the fact that it trades at a “2009 price earning ratio of 4.4x and 2009 p/b of 0.64x, representing discounts to our universe of Nigerian banks of 37% on 2009ep/b and 65% on 2009ep/b”. Yet Skye’s shares have suffered along with just about every other NSE listing, falling under N5 on Monday. Broad-based and swiftly declining asset values are as unsustainable as indiscriminate and rapidly rising ones, meaning that in the case of Nigerian stocks and financial services ones in particular, the likelihood of a significant market overshoot is probable. As Silk Invest’s Baldwin Berges noted this week about the country, “our view is that, in time, this clearly presents a fantastic opportunity for the alert and well informed investor to invest in well managed companies that find themselves valued well below their intrinsic value.”
EFG-Hermes, a Cairo-based investment bank, noted to investors last week that it expects the Egyptian pound to fall to LE 5.70 by the end of 2009 and LE 5.90 by the end of June 2010 relative to the U.S. dollar. The pound has strengthened by 2.2% against the dollar since March, hurting exports and in-turn stalling GDP growth–which is set to fall to 3.1% in 2009-2010 from 4.1% in the year prior, the firm posited. “With credit growth slow and low loan-to-deposit ratios, exchange rates are a more effective channel than bank lending for supporting growth, by improving export competitiveness. The Nominal Effective Exchange Rate (NEER) has been stable since June, but we think that the [Central Bank of Egypt (CBE)] will encourage some trade-weighted EGP depreciation before the end of 2009,” speculated EFG economist Simon Kitchen to investors. Yet while Kitchen’s theory makes sound economic sense, it may not pass muster with authorities. One risk of currency devaluation is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can lead to inflation, which in turn might require the CBE to raise interest rates–a prospect most central banks will balk at until a bona fide global recovery is indeed upon us. Moreover, inflationary pressures could wreak havoc with habitually volatile food prices that will already be tied to increased and impending consumption and preparations for post-Ramadan festivities.
Sharjah-based Dana Gas, the Gulf’s first privately run natural gas firm, reported a 31% increase in gross profits compared to the same period last year. Concurrently, net profits grew more than eleven-fold. As usual, the firm’s Egyptian operations played a central role to its financial results; in fact, during the second quarter alone two new fields there came on stream, the firm made a new gas discovery, and it realized three successful appraisal wells–all adding to gas reserves. However, according to CEO Mr Ahmed Al-Arbeed, condensate sales stemming from its operations in the Kurdistan Region of Iraq were just as pivotal to the firm’s recent success. Dana Gas signed strategic partnership agreements with both an Austrian and a Hungarian-based integrated oil and gas group during the second quarter, the beginnings of the culmination of a $400 million investment in the region made in 2003 when the company became the first Middle East firm to venture into the Iraqi energy sector post U.S.-invasion.
Dana Gas makes a wonderful long-term play, in my view, based not only on the fundamentals of natural gas and the expanding role I expect it to play in global energy markets, but more broadly speaking as a proxy on MENA growth. I’m adding it to this site’s long-only, mock frontier portfolio, which will be used to manage and grow a mythical basket of capital. Dana Gas will be our first holding, as of today.
Per The Jakarta Post, bank lending in Indonesia grew by just 2.09% from December last year to June compared with 16.26% a year earlier. Working capital loans slid the most, a sign of firms’ reluctance to expand, and banks also cutback loans out of fear that non-performing loans (NPL)–currently at 3.94%– would increase beyond the central bank’s accepted 5% threshold. Yet central to the reasons why businesses are reluctant to borrow, argues Erwin Aksa, chairman of the Indonesian Young Entrepreneurs Association, are their lenders’ self-imposed, high deposit rates. Large sovereign bond issuances have driven up the cost of money, as do the demands of large depositors–most of whom are state-owned companies, and which currently account for roughly one-half of banks’ third-party funds. The vicious cycle impairs liquidity, however, as banks fear above anything else a loss of depositors and a sudden run on funds. High deposit rates thus persist despite the fact that Bank Indonesia (BI) again slashed its benchmark rate (for the ninth-straight session) to 6.5% earlier this month, as banks, ever weary of NPLs, place a premium on large capital bases.
A legislative solution, however, may be in the works. Pundits point out that liquidity concerns would lessen if a proposed bill on the financial system safety net (JPSK)–which would allow the central bank to provide funds for banks in short supply of liquidity–is passed in the coming months by the House of Representatives. Last winter, however, the bill was widely shot down by lawmakers who argued that it would overly empower the government and create moral hazard.
Interesting comment by S&P Fund Services lead analyst Alison Cratchley, made to Business Intelligence Middle-East, on the possibility of an impending correction across MENA markets:
“Relative to other emerging markets, the MENA region significantly underperformed (12.7% rise compared with 37.8%) in the six months to the end of June 2009. This probably reflects investors’ perception that the MENA region is highly leveraged to a U.S. recovery due to its dependence on oil revenues, whereas other emerging markets are supported by robust domestic demand.”
Several fund managers quoted, including Shakeel Sarwar, Head of Asset Management at the Manama (Bahrain)-based SICO, an investment bank, as well as Mashreq Bank’s Ibrahim Masood, concurred with this cautious sentiment, citing the region’s potentially unsustainable rally to date, low liquidity levels, as well as its perceived correlation with U.S. equity markets, which are considered equally overbought by many estimates. Last Friday, for example, the equity-only put/call ratio saw its most-stretched level since December 20, 2007, with more than twice as many call options being traded as put options–a possible sign of institutions’ collective desire to reduce risk.
JGW
Frontier Markets 