Gulf banks likely to need $35bn of capital by 2019

Regulation, tight pricing cloud capital-boosting bonds

DUBAI: Fast-growing Gulf Arab banks plan to bolster their reserves by issuing capitalboosting bonds, but uncertainty over regulation and ultra-tight pricing increase the risks for issuers and investors. Basel III standards, now being phased in around the world, will require banks to hold more capital. While Gulf banks have very high capital adequacy ratios, their rapid expansion, and the fact they operate in emerging markets with lower sovereign ratings than the core developed economies, mean they will be hungry for more capital in coming years.

The banking sector of the six-nation Gulf Cooperation Council (GCC) is expected to need an additional $35 billion of capital by 2019, according to a study by consultants Strategy.

Retained earnings and equity issuance will provide some but not all of that money. So banks are turning to other instruments, especially perpetual bonds with equity-like characteristics that boost Tier 1, or core, capital. Contingent capital securities known as “CoCos”, convertible into shares in certain circumstances, may also be used.

Kuwait’s Burgan Bank and Abu Dhabi’s Al Hilal Bank issued Tier 1 bonds designed to be Basel III-compliant last year. Dubai Islamic Bank (DIB), the United Arab Emirates’ largest Islamic bank, sold $1 billion of Tier 1 Islamic bonds last month at 6.75 percent.

Qatar Islamic Bank, Qatar’s Doha Bank and Oman’s Bank Dhofar have all announced plans to issue Tier 1 bonds since the start of this year. Capital-boosting bonds are good options for banks in the region as they provide efficiency, flexibility and diversification, said Christoph Paul, head of Middle Eastern and North African capital markets at Morgan Stanley.

Regulation

But the trend to issue such bonds has been slower in the Gulf than in many other parts of the world, for a good reason: details of how national regulators will treat the instruments remain unclear in some countries. Saudi Arabia, a member of the committee which drafted Basel III, as well as Kuwait and Bahrain, have clarified what conditions the bonds must meet for their regulators to count them towards Tier 1 capital totals.

The United Arab Emirates, Qatar and Oman have not yet finalized their guidelines, however. This creates considerable uncertainty for the issuing banks - in theory, they could issue bonds only to discover months or years later that their national regulators do not recognize the instruments as capital-boosting.

“We are in that limbo where everybody is trying to figure out what is required or not to issue capital instruments,” said a senior banker at a UAE lender, declining to be named because he was not authorized to speak to media.

A key issue is loss absorption: unlike the previous Basel II regulatory regime, Basel III rules call for all capital instruments to absorb losses fully when a bank becomes non-viable, but leave it to national regulators to decide exactly how and when investors would shoulder the losses. GCC governments have in the past been very supportive of their banking systems - most of the big banks have large state shareholdings - so in some cases, banks seem to be assuming that their regulators would never take the inconvenient step of disallowing their Tier 1 bonds.

But making such assumptions is not comfortable for some institutional investors, who tend to prefer legal and regulatory certainty. One risk is that an issuer, finding its outstanding bond was not Basel III-compliant, might decide to try to revise the terms - a strategy which India’s IDBI Bank adopted last year, angering investors.

Pricing

In these circumstances, the tight pricings being achieved by GCC issuers of Tier 1 bonds are remarkable, and not necessarily healthy. In developed markets, the pricing difference between Tier 1 bonds under Basel III and Basel II has been about 250 to 300 basis points, bankers said. DIB, however, achieved a tiny difference.

A regional asset manager noted that $1 billion of Tier 1 sukuk from DIB, callable in 2019, were issued under Basel II rules in 2013 at 6.25 percent. He calculated that represented a spread of only about 25 bps to the bank’s latest sukuk, taking into account the fact that DIB’s latest issue is not callable. Such a small spread may mean investors are not fully appreciating the much higher risk of loss embedded in the new Basel III structures. The willingness of some Gulf investors to shoulder this risk threatens to price international investors out of the market.

“In reality, these new-style notes should pay a much higher premium since they don’t seek a rating and stand way behind existing subordinated bonds because of the loss absorption trigger,” said one senior Dubai banker. “Consequently, they would be wiped out before the old-style bonds in the event of bankruptcy, however unlikely this is.” —Reuters Dinar stable against

dollar at KD 0.294 KUWAIT: The exchange rate of the US dollar against the Kuwaiti dinar was stable at KD 0.294 yesterday, while the euro rose to KD 0. 333 compared to yesterday’s rates. The Central Bank of Kuwait said in its daily bulletin that the sterling was stable at KD 0.444, the Swiss franc dropped to KD 0.318, while the Japanese yen was unchanged at KD 0.002. Meanwhile, the US Federal Reserve released reports on a decreasing level of inflation and a strong growth of economic activities in January 2015 compared to a medium growth last December. As for the euro-zone, the focus is on Greece which is working on a new economic program, as the government is determined to call off all austerity measures. Meanwhile, inflation rates had decreased in Germany last January compared to the same month in 2014. UAE’s NBAD to meet investors from today DUBAI: National Bank of Abu Dhabi (NBAD) plans to meet fixed income investors starting today for a potential U.S. dollar-denominated bond issue, a document from lead managers showed yesterday. Rated AA- by Standard and Poor’s and Fitch, NBAD will meet investors in Asia and Europe, it said, adding that it would issue a bond during the course of 2015 subject to market conditions. NBAD, owned 70 percent by the government of Abu Dhabi, mandated Citibank, HSBC, Standard Chartered and itself to arrange the investor meetings.

Egyptian pound weakens to new low CAIRO: Egypt’s pound weakened to 7.53 per dollar, from 7.51 at the last sale, at a central bank auction yesterday, the weakest level it has been allowed to reach since auctions began in December 2012. The bank offered 40 million dollars and sold 38.4 million at a cutoff price of 7.5301 pounds per dollar, the central bank said. The rates at which banks are allowed to trade dollars are determined by the results of central bank sales, giving the bank effective control over official exchange rates, though there remains an active black market in the pound.

Saudi buys 690,000tn

of hard wheat HAMBURG/ABU DHABI:

Saudi Arabia bought 690,000 tons of hard wheat via a tender, the country’s main state grain agency Grain Silos and Flour Mills Organization (GSFMO) said yesterday. The wheat, with 12.5 percent protein content, is for shipment during April and May, GSFMO said in a statement. The accepted origins are the European Union, North America, South America and Australia at the option of sellers, the GSFMO said. “I think there will be expectations that some of the purchase will be sourced in Europe, perhaps in Germany or Poland,” one trader said. Saudi Arabia has become a major importer of hard and soft wheat since abandoning plans for self-sufficiency in wheat in 2008 as farming in the desert drained away precious water supplies. The country aims to steadily reduce agriculture and plans to be completely reliant on imports by 2016 to save water.