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Analysts note that with expansionary fiscal policy boosting money supply growth (14.4% y/y in August) and [private-sector] credit expansion, “GCC countries remain well positioned in the event of a global downturn”. Yet said effects seem especially and comparatively potent in Qatar where, per Barclays, “M3 growth jumped the most, by 24.4% y/y [versus] more moderate growth observed in Saudi Arabia (15% y/y) and the UAE (12.4% y/y), while concurrently headline inflation, which [GCC weighted-average] region wide turned upward for the first time in 2011 in September, remains somewhat subdued given a still shaky real estate sector. Said M3 jolt, in turn, continues to jostle its way onto regional bank balance sheets, with deposits registering double-digit growth in August–Qatar again leading the pack at 18.6% y/y. Coupled with Abu Dhabi’s International Petroleum Investment Co.’s (IPIC) $3.75b, three-tranche foray into capital markets alongside Union National Bank’s international debt debut, pundits and punters alike now envision a rash or rally of sorts revolving around Abu Dhabi and Qatar issuers in particular given both “ongoing funding needs” as well as a “need to enhance/diversify” said funding bases. Thus investors eying an increasingly stable and profitable sector (GCC collective average bank ROE stood at 13.9% in June, versus a 2005-2010 average of 18.9%) would be wise to perk up should debt capital markets indeed entice new concessions in the near term.
Dubaibeat reports that Daman Investments, a private sector UAE-based investment management firm, announced today the launch of the Daman Fifth Fund, a $54 million closed-ended fund. Per its press release, the Daman Fifth Fund is “a new mutual fund that will focus on blue-chip equities listed on the GCC financial exchanges, debt products and commodities, and targets an IRR of 25% per year.” Commented Managing Director Shehab Gargash, “[The fund] is an opportunity fund that capitalizes on the upcoming GCC market recovery. Our first closed-ended fund since the launch of the Daman UAE Value Fund back in 2001, which was also a market recovery fund that netted an impressive return of 273.84% over its lifespan.”
The release also highlighted the firm’s 2010 and beyond market outlook, reproduced below:
The GCC markets were serial underperformers in 2009 in terms of both absolute and relative numbers, when compared to EMEA (Europe, Middle East and Africa) and developed markets.
Immediate growth drivers
• The regional GCC markets are currently trading at forward estimated valuation multiples of 10.2x for year end 2010 earnings estimate which are at a discount when we compare to then historic PE average range of 18x for the past 5 years.
• Taking P/B ratios we continue to find further support for the valuation case with the GCC region trading on 1.4x 2010e.
• The FYE2010 dividend yield at regional markets is estimated to be at an average of 3.9% with many individual stocks having yields in excess of double digit figures making the region an attractive play for income related investors.
Catalysts for Long term growth
• The outlook for oil prices remains positive with most investment houses predicting stronger outlook for global growth, lower interest rates and a more realistic acceptance of the limits of energy supply.
• The IMF continues to forecast a benign macro environment for the GCC economies looking for them to increase their GDP some 10 fold from 1980 levels to 2020 equating to some US$2trn in GDP by then.
• The governments of the region continue to pursue stimulatory policies through increased infrastructure spending. This is proving to be a counterbalance to some of the pullback of private sector spending.
• On the Banking sector, we expect the banking sector NPL curve to peak in H1’10 and to start coming down in H2’10 releasing more liquidity into the system as the appetite to grant loans increases with the strengthening economic recovery.
• Petrochemical sector to remain strong for the year on strong global growth rebound trend. GCC players continue to enjoy a strong cost advantage vis-à-vis their global players.
• We continue to view the Real Estate market across Saudi Arabia and Abu Dhabi market as favourable with an improving credit environment and increased deliveries leading to both primary and secondary market demand.
• On the Telecom sector, we are positive with the Industry getting aggressive on price competitiveness and on new product introductions such as VoIP, and upgraded 3G technologies. Strong cash flow and dividend yield characteristics with a lot of the recent deal flow beginning to bear fruit this year provides us the level of comfort to remain bullish on this sector.
Per Abdulaziz Z. Mahasen, managing Partner at Optimead, a Rijadh-based consultancy:
Saudi Arabia, the Arab world’s largest economy, is in no rush to raise interest rates and will keep plowing its oil revenue into kick-starting growth. The kingdom, the world’s largest oil exporter, last year announced that it would spend $400 billion on infrastructure over a five-year period to bolster the economy, the largest stimulus package in the [G20]. The country is allocating almost $70 billion to investments this year, a 16% increase on 2009. Rising oil prices, which have rebounded to about $75 a barrel from less than $35 in February, are also likely to boost growth in 2010].”
The view echoes that of those observers wh0 foresee static rates during the year across the region’s dollar-pegged Gulf economies–Saudi Arabia, UAE, Bahrain, Qatar and Oman–given that historically their tightening has coincided roughly with the Fed’s. Aside from that, however, central bank Governor Muhammad al-Jasser noted to Bloomberg that low inflation and tepid loan demands are not condusive to a rate hike. Credit may begin to flow by the spring or summer, however, as domestic banks especially should have a better handle by then on the increase of NPLs forecasted in November.
GCC insurance markets are still underdeveloped despite the relatively recent rise of takaful, a type of Islamic insurance wherein members contribute money into a pooling system in order to guarantee each other against loss or damage. Conventional insurance is incompatible with Islamic law because of Sharia’s prohibitions on transactions inherently founded on uncertainty/elements of luck. Moreover, conventional insurers store money in interest-bearing investments, which are similarly prohibited. In the face of increased wealth–Accenture, a consultancy, forecasts that household Islamic savings will amount to $24bn a year by 2020–analysts posit that the global takaful industry will grow by 20% and reach US$10-15 billion within the next decade, led mainly by the GCC countries and Malaysia. Per Ernst & Young’s inaugural World Takaful Report 2008, accepted contributions are expected to rise to more than $4.3 billion in 2010.
Two further developments should provide a catalyst to the industry. One, a proposed law to mandate the use of the still nascent “re-takaful market” should help fuel its development, in turn boosting the underlying takaful industry as well. Second, the expected passage of a GCC-wide insurance law will ensure compliance with international standards through the automation of underwriting, per consultancy A.T. Kearney, a practice it argues would improve insurers’ loss ratios, and also decrease the intermediation costs–thus making processes cost effective:
“In the UAE insurers cede more than 50% of their insured premiums to reinsurers with an obvious impact on their bottom line, as risk and profit is shared with the reinsurer. In comparison international benchmarks show that reinsurance is only 5-15% for global leaders with state of the art in-house underwriting operations. The companies that get underwriting right can hence look at exactly which segments require reinsurance and which are better kept within the company. It is however vital to get the underwriting process in place first so risk/premium profiles are optimized. Currently some segments (corporate mainly) have premiums which vary up to three times for the same risk. This can negatively impact competitiveness of insurers if premiums are above market evaluation or negatively impact bottom-line and risk profile of the insurer if too much risk is attracted at too low premiums.”
Continued Cyril Garbois, Principal, A.T. Kearney Middle East, “the [insurance] market is currently underpenetrated and the size of the prize remains significant – we estimate that insurance companies regionally can improve profitability with 20-30% while at the same time increasing market share if they get underwriting right. I believe the use of international best practices in underwriting along with the required level of sophistication in distribution is a key to driving future growth of the insurance market regionally.”
Such a move could bolster insurers’ balance sheets even in the event of prolonged economic slowdown reverberating from the credit crisis, which causes a reduction in new policies and also a larger cancellation of existing ones. It’s perhaps with this relatively rosy future in mind that insurance stocks in Kuwait, for instance, showed resilience in November by dropping only 1% while the broader market shed 5.48% during a one-week span that saw the country’s broad index fall to a seven-month low on the 15th.
According to various reports, central bankers from Saudi Arabia–whose capital Riyadh is slated as the home of a planned future regional central bank–are increasingly pessimistic as to the odds of the once much bally-hooed 2010 transition to a single Gulf currency and monetary union across the six-member GCC. This despite the fact that prices rose 10.5% in the Kingdom in April, the fastest pace in over three decades, and UAE inflation touched the 20-year peak of 11.1% last year. In the meantime, dollar pegs forced various countries to mirror declining U.S. interest rates despite windfall oil profits and domestic price increases. Yet certain countries, such as Kuwait and Syria, have already dropped their dollar ties. Moreover, there is scant evidence that dropping the peg did much for Kuwait’s inflationary pressures. Some analysts reckon, for instance, that inflation is less tied to fuel and more tied to factors such as food prices, construction materials such as cement, and other key commodities.
Meanwhile, investor confidence in the Gulf is predicated upon a hearty balance of payments which is predicated largely on resources such as crude oil or, in Qatar’s case, LNG. Yet as OPEC noted last fall, “retreat of the U.S. and European economy has a negative affect on the balance of payments in GCC countries.” That is to say that investing on the basis of the region’s reserves is still just a proxy on global demand. The real question may be at what point said demand rests less on the West, and more on the BRICs. Until it surely does, Gulf finances arguably remain flimsy and its markets will be that much more volatile.
A short piece in this week’s Economist focuses on the Gulf’s “nascent” bond market, which comprise only 3% of the world’s capital markets (debt in general makes up one-third). Global sukuk sales halved last year and were pretty moribund in the first quarter of 2009. That said, recent activity suggests not only resilience, but the seeds of a long-term trend that will grow into liquid secondary trading and provide a benchmark for private sector firms. For instance, PLUS Expressways Bhd., Malaysia’s biggest toll road operator, sold 600 million ringgit ($171 million) of Islamic bonds due May 2023 last week in order to repay maturing debt. A week earlier, Aldar Properties, Abu Dhabi’s largest developer sold $1.25 billion of 5-year notes, becoming the first UAE real-estate developer to issue debt after prices tumbled. Concurrently, Dubai Islamic Bank, the emirate’s biggest bank, announced a $50.6 million buyback of its sukuk maturing in 2012.
An examination of GCC banks recently published by AT Kearney, a financial consulting firm, concluded that the region’s banking industry will likely undergo consolidation via M&A in the face of changing conditions in the global and regional financial markets. The study foresees first the rise of “national champions”, as well as a plethora mergers between regional investment banks and retail banks. “In the long run, true regional players will emerge,” it states.
Middle East banks have been a boon for much of the decade–from 2002 to 2007, for example, banks in the UAE experienced a 39% increase in net profits and a 34% increase in total banking assets. Moreover, their assets/GDP ratio is still comparatively low in most GCC countries, which leaves room for growth. And banks are relatively tiny compared to their bigger, international-mined brethren and will ultimately need to expand externally. AT Kearney’s study notes that the banking market in the GCC is largely fragmented, as the top three banks account for just 14% of market share. “We see great potential for regional banks to consolidate and grow regionally,” said Dr. Alexander von Pock, senior manager of the Financial Institutions Group of AT Kearney Middle East. Finally, analysts point out that market conditions–specifically the dwindling market capitalizations of regional banks, as well as the large proportion of public ownership of many banks–have created a favorable environment for acquisitions.
International Petroleum Investment Company (IPIC), an Abu Dhabi-based investment company, announced on Monday that it has been assigned Aa2/AA/AA long term credit ratings by Moody’s, Fitch Ratings and Standard and Poor’s, with a stable outlook. “While we have no immediate plans to raise external capital, the ratings will facilitate future engagement with the debt capital markets if IPIC wishes to pursue this,” commented its managing director, Khadem al-Qubaisi, who added that the ratings were a means of “reinforcing strong corporate governance principles and enhancing transparency.” According to one analyst, the ratings are “a signal that [state sovereign] funds are eager to keep spending and [are] willing to borrow to increase their buying power.”
IPIC’s ratings acquisition comes on the heels of a similar move by another Abu Dhabi investment arm, Mubadala Development Corp, which issued its first annual report last week and also recently announced plans to set up a medium-term bond program. According to news agencies, “both companies have taken on billions of dollars in debt to fuel their growth in recent years, some of which soon needs to be refinanced. That sets them apart from the secretive and far larger Abu Dhabi Investment Authority (ADIA), which likens itself to a pension fund and is not understood to seek out external sources of funding.”
Most importantly, the move is a another step in the early maturation of Gulf fixed income, on both a state and corporate level. In March, Abu Dhabi raised the first $3bn of a $10bn sovereign bond program to secure funds for state entities and to help develop a domestic bond market, while Qatar and Bahrain followed suit. Pundits at the time noted that such benchmarks are vital to the emergence of local credit markets, as corporate issuers in the region can ultimately price their own debt against them.
The Gulf Cooperation Council (GCC) will realize faster growth in the Islamic bonds (sukuk) market and “tap into the massive potential that the segment hold” by adopting regulations and measures such as credit ratings, say analysts. “Sukuk is important when it comes to overall financial market. The region, with its huge capital needs, but [only] a small debt market needs to look into opportunities,” said Kamal Mian, Head of Islamic Finance, Saudi Hollandi Bank. While the GCC holds a significant share of global sukuk market (estimated at $130 billion, Dh477bn) when it comes to volume, regulations and policy guidelines are relatively sparse, especially when compared to Malaysia, according to Moinuddin Malim, Head of Corporate and Investment Banking, Badr-Al-Islami, Mashreq. Malaysia, with its proper regulatory measures and incentives, has managed to create a success story of its sukuk market and “investors from various countries such as Korea and Japan too are going there to issue sukuks”.
“Rating for sukuks in Malaysia is mandatory. Besides, they have created a platform to quote sukuks on a daily basis so people would know the fair value of the instrument,” said Dr. Mohd Daud Bakar, Managing Director, Amanie Islamic Finance Learning Centre. “The government in Malaysia has also incentivised issuances when it comes to the taxation aspect of it,” he added. “From the day of issuance to redemption, everything is clear.” Analysts also point out that credit enhancement structures in bond market can be used for sukuks as well and should be studied.
A recent report issued by Fitch Ratings concludes that the more challenging operating environment has negatively affected prospects for retail banking in the Gulf Cooperation Council (GCC, consisting of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE), although the degree of severity will vary. Fitch views the potential risks from retail lending as high in the UAE (particularly Dubai) and Oman, moderate in Bahrain, Kuwait and Qatar, and low in Saudi Arabia.
The report notes further that the most negative impact could be realized in the UAE, particularly in Dubai, because the UAE retail sector is the largest in size and UAE retail loans grew the quickest in the GCC. Dubai’s economy has been hit especially hard by the global recession, as the UAE has an exceptionally high proportion of expatriates, at more than 80% of the population (90% in Dubai). Expatriate residence visas are nearly always linked to employment in the GCC; rising redundancies are therefore likely to result in higher defaults as expatriates leave, Fitch notes. Furthermore, the regulation of retail loans is not as tight in the UAE compared with certain other GCC markets.
Risks is also high for Omani banks as their relative exposure to retail lending is the highest in the GCC, at 38.5% of end-2008 banking system loans. In addition, Fitch views the levels of leverage available to retail customers as among the highest in the GCC, and regulation of the retail sector as not as tight compared with certain other GCC states. Finally, the negative impact from retail lending will be least severe in Saudi Arabia, where the market is relatively strictly regulated; demand is sustained by a large, growing young indigenous population rather than expatriates; and the local economy has been more insulated from the impact of the global recession than many other GCC states, though declining energy prices are of concern.
JGW
Frontier Markets 