A study of rated Gulf banks by Standard and Poor’s analysts Emmanuel Volland and Mohammed Damak shows that the region’s banking sector has had a limited exposure to US subprime mortgage-related instruments. Executive interviewed Volland to assess his opinion of the study’s results.
E Which banks did Standard and Poor’s select for the survey and what was their exposure to subprime mortgage-related instruments?
We selected 20 of the largest banks in the Gulf region. Among those were the ones that have the largest subprime exposure. We came out with a figure of total exposure to subprime of less than 1% of total assets. At the time we did the survey, we did not include exposure to structured investment vehicles (SIVs). If you added the SIVs, the exposure would be higher.
E How much higher?
I would say it’s still below 2% of assets. Comparing exposure to assets is useful, but probably not the best ratio one can use. It’s probably better to compare it with the size of their equity base or the size of their net profit. If you look at the total equity the figure would be less than 10%. Also, with total exposure it is meaningful to look at the details in terms of what is investment grade and non-investment grade and the way things are moving. The assets that were investment grade at the time may no longer be investment grade. Some have seen significant downgrades from our structured finance group.
E Is the exposure still investment grade?
I would argue that the majority is still investment grade but that the proportion is lower than at the beginning. So overall I think we keep our roughly positive message on the Gulf banks’ exposure to the US subprime market and other structured instruments. We don’t expect a significant downgrade or change in our ratings. According to the results of our more detailed survey, overall the exposure is manageable. Also, some banks may have larger exposure than others. And the profile of the banks with more exposure would be the wholesale banks, including Bahrain and probably also a few banks in the UAE.
E Some programs, like Eurobonds and shari’a-based bonds, have postponed issuing debt. Could you please discuss this dynamic?
Well, as you said, since the beginning of the meltdown we have rarely seen any banks going on the market for debt. We don’t suggest that they would not be able to do so. It’s just that the pricing has increased substantially. These banks are not in desperate need of liquidity. So they took the decision to wait for the market to calm down and hope the spreads will go down. I don’t think the spreads will ever come down to the very low level they reached in early 2007. There were many investors claiming that while the spreads reached something like LIBOR plus 20 business points it was not reflecting the real credit risk of these institutions.
E Will we see GCC banks getting involved in bailouts of Western banks echoing the recent activity of sovereign wealth funds?
We will not see GCC banks providing a significant amount of liquidity for the US and European markets. We are talking about small institutions. I think the largest bank in the Gulf region has total assets of $50 billion and total equity of $6-7 billion. So they might have an extra liquidity of $2-3 billion, which they would have already partially placed in US or European equities. So we are not talking about hundreds of billions sitting on their balance sheets, waiting to be invested. This is a different story for sovereign investment funds like the Kuwaiti Investment Authority, the Abu Dhabi Investment Authority and private individuals like Al-Waleed bin Talal.
E What do investments in Western banks by these sovereign wealth funds tell us about the future of the Middle East financial sector?
First, it is a structural trend that started before the problem. There is a clear willingness by these governments to take into account that oil resources will disappear at some point and they need to diversify their investments outside of the Gulf region. So we’ve seen mainly investments in Europe and the US before the crisis. But at the same time this is an opportunistic strategy where we see a very low valuation for banks and they will try to take advantage of that.
E Are these investments by sovereign wealth funds in the banking sector wise at this time of financial uncertainty? Is this a new trend?
That’s a good question. We don’t know where market prices will go. There is potential for more of a drop in equity prices. But the sovereign funds really have long-term strategies. So there might be a point when they are underwater in terms of price of longer-term investments, but if you really believe there is not critical risk of bankruptcy then the market price will likely come back to higher levels. But then again, there is an intermediary risk that the problems will increase up to the point where you lose your investments. Obviously, it is more risky than investing in US Treasury bills or government debt. I would not argue that this is a new trend. We have seen massive investments from the sovereign wealth funds even before the crisis. Not so much in the banking sector, but definitely in the corporate sector.
E What can you tell us about sovereign wealth fund exposure to mortgage backed securities and the subprime crisis?
We don’t rate the sovereign funds and the level of public disclosure is close to nil for most of them. They are well-kept secrets. It may be that they don’t have any exposure or they may have large exposure. We just don’t know.
E How will the subprime crisis affect Q4 2007 and 2008 numbers?
The Q3 impact has not been significant. Very few banks have taken positions that reflect a lower valuation on structured instruments. I think we will see slightly more of that in Q4 numbers and maybe more in 2008. I think the banks have been relatively slow to change the pricing on their books. GCC banks have some of the best performance in the world, so performance in Q4 and 2008 will be pretty solid regardless. A small number of banks, maybe two or three, might need to do a massive cleaning of their balance sheets with regard to these instruments. But the impact should be manageable and will not be big. Also, some of the banks are owned by the government so this will make things easier. And finally in terms of raising capital, there is currently tremendous liquidity in the Gulf. In closing, the region’s financial sector does not have too much to fear from the ongoing American subprime crisis.
