Gulf Bank: What next for a bank brought back from the brink?

Euromoney, January 2014

When Michel Accad announced his resignation from Gulf Bank in October, it was a signal that one of the most successful turnarounds in Middle Eastern banking was coming to a conclusion.

Accad had overseen a transformation in a bank which in 2008 would unquestionably have gone under without state support. He leaves it stable, streamlined and well capitalised.

But his departure, first covered in Euromoney’s November edition, raises questions too. He says he is leaving because his work is done, and that it is time for someone else to take on the role of growing the bank anew. That means a new leader with new ideas, at a time when rating agencies, having upgraded the bank in faith with four years of restructuring, want it to stay as conservative as it is today.

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Kuwait’s Gulf Bank was one of the worst affected banks in the region by the global financial crisis. At the heart of its problems were derivative contracts which ran into serious trouble when a client was unable to settle them in October 2008. This would lead to a loss of KD359.5 million in the 2008 financial year, the vast majority of it because of losses on these derivatives and some other loans and investments.

The precise circumstances of these trades are still somewhat open to debate. “It’s public knowledge now that what happened were some derivative transactions that were either not monitored sufficiently by, or even sanctioned by, the internal risk management department,” says Paul-Henri Pruvost at Standard & Poor’s. “It was something completely out of the scope of that department, and the whole bank capital was wiped out by the losses incurred.”

It wasn’t just derivatives, although those losses were themselves debilitating; Gulf Bank was a major lender to two Saudi institutions, Saad Group and Ahmad Hamad Algosaibi and Brothers, both of which would default a year later owing the bank about $500 million. But the derivative losses, once known, sent damaging rumours about the bank’s solvency, and it suffered a run, one of the first ever in the region. In October 2008, shares were suspended pending a restructuring. One chairman, Bassam al-Ghanim, resigned; his brother, Kutayba, took his place. The entire board agreed to resign. It was as low as the bank could go without formal liquidation.

The first of many challenges was capital: Gulf Bank had lost most of what it had, and needed more. So in December 2008, the bank’s shareholders approved a rescue plan ordered by Kuwait’s central bank. The first step was to launch a 100% emergency rights issue to raise KD375 million in order to cover the derivative losses. Crucially, the Kuwait Investment Authority offered to take up whatever the existing investors did not, and this vote of confidence, and the sense of state support it conferred, convinced people to buy. Existing investors covered most of the raising, with a 68% subscription to the capital increase, covering KD255.17 million. KIA, in taking up the remainder, ended up with 16% of the bank.

The KIA’s involvement would prove to be critical early on. Although it is best known as an internationally diversified sovereign wealth fund, it has a long-standing track record of investing in local companies. It wouldn’t like the term ‘bail-out’, instead preferring to think of these as shrewd investments at low prices, and indeed, in many instances its assistance has been rewarded by a considerable improvement in the value of the stake. KIA is invested in many major companies, from telco Zain to most of the asset management companies in the country, and in 2008 launched a fund to invest broadly in the local market through existing Kuwait mutual funds in order to support it.

When the KIA committed to buy into the rights issue, it “made the support statements of the government very credible,” says Stathis Kyriakides, analyst at Moody’s. “The Kuwait government had the capacity to provide support; the fact that the KIA took a stake in Gulf Bank was tangible evidence of that support.” Other arms of the state intervened too: the central bank provided emergency liquidity of $1.5 billion, and a government-wide guarantee was enacted on customer deposits, stemming outflows and preventing contagion.

The KIA is often a hands-off investor – one doesn’t find it seeking to effect change in holdings like Daimler-Chrysler, BP or ICBC, for example, instead believing in existing management. But with Gulf Bank, it got involved. Ali Rusheid Al-Bader, former chairman of the KIA, was elected as Gulf Bank’s chairman in early 2009. Accad describes him as “instrumental in the Gulf Bank turnaround,” and says that his election as chairman “right after the crisis was very much supported by the KIA, the CBK and the government.”

The capital raising and the sense of state support steadied the bank, but there were still clearly deep-seated problems that needed fixing, and in August 2009, a new chief executive was appointed: Michel Accad, a Citigroup veteran who had risen to be MD of the Middle East and North Africa at the US bank by the end of a 27-year career there before a spell as assistant CEO at Arab Bank. It was a vital step. Post-capital raising, “the new management, headed by Mr Accad, drove the restructuring and recovery of the bank,” Kyriakides says.

There was a lot to fix, but fundamentally, it came down to going back to basics.

“When we did our initial turnaround plan, it was based around four pillars,” Accad recalls. “One of those was about isolating the bad bank from the good bank and focusing on how best to exit those bad loans.” At one point in 2009, Gulf Bank’s NPL ratio was 30%: “Close to a world record for a bank that survives,” Accad says. Standard & Poor’s estimated a peak of 30.3%. “Effectively one third of Gulf Bank’s lending book was delinquent,” says Pruvost.

Dealing with that required decisiveness. “You have to make difficult calls and take difficult decisions on loans that need to be written off,” Accad says. “You need to face it.” Other loans were sold in the secondary market, including several batches at around 30 cents on the dollar in 2009 and 2010. That no doubt felt painful at the time, but many of those loans are in single digits today; it was the right time to get out. “And another part of it is working out the customers you believe are salvageable: that are going through a rough patch but you believe will survive.” Many of those, he says, have returned to good health.

Another pillar was, as Accad puts it, “to build a fortress balance sheet. What had happened to us would not have impacted us to that extent had we had a better liquidity position, stronger capital position, and more reserves.” The position he found upon arrival was weak in the extreme. “Our extra provisions were practically zero, our liquidity was zero so we were funding ourselves short, and that is not a healthy proposition.” As well as improving the numbers, both in terms of bank capital and day-to-day liquidity, the whole infrastructure and governance process around risk was developed. “We’ve done enormous work on the risk side,” Accad says.

A third was to get back to what Gulf Bank was good at in the first place. “Our core competencies were simply the retail and commercial banking businesses,” Accad says. “But we had become active in proprietary trading, in derivatives, in hedge fund investment: the sort of products which are not within our DNA. We had to exit all of those activities.”

The fourth pillar, which has the tendency to sound like a cliché but is nevertheless important, was about differentiation, “by providing the best and fastest service in Kuwait.” He knows how this sounds. “Lots of banks will say we want to differentiate ourselves by service quality, but very few put their money where their mouth is.”

So how did Gulf Bank put its money where its mouth is? “You know how Domino pizza works? If you order in 20 minutes, and if it’s not delivered in 20 minutes you get it for free? This is what we promised our customers.” A survey showed that the main thing that riled customers was queuing times, so the bank set out to set standards for speed. It set a policy in which, if a consumer loan is approved, the money reaches the account the same day. Likewise credit cards: “you will get the plastic the same day.” If the bank failed to do so, then either the first month’s interest on the loan, or the card fee, would be scratched. “And if we don’t serve you within 10 minutes of you entering the branch, the branch manager will come and apologise to you.” Getting to this point, Accad says, took a year of designing processes and approval systems. “Since the end of 2011, we have kept that promise.”

Analysts began to like what they were seeing. “The management was quite methodical in addressing the problems at Gulf Bank,” says Kyriakides. “One thing they did early on was to assess risk management in order to understand why the problems arose in the first place, and making sure the gaps that existed in risk management were closed. “ He notes that, as well as working out the problematic exposures, they did not neglect the healthy parts of the bank, “which were able to generate sufficient revenue to support the rehabilitation effort.”

Slowly but surely, progress was made. When last disclosed in early November, for the first three quarters of 2013, the NPL ratio had fallen to 7.3%. Liquidity has been dramatically improved: Accad says more than 50% of time deposits at the bank, “the bulk of our funding sources”, are six months or longer. The third quarter numbers showed precautionary general provisions of KD150 million, total assets are over KD5 billion and deposits KD4.185 billion, and the net profit for the first nine months of 2013 was KD24.1 million.

Also, the bank looks much more like it used to before the crisis. Corporate and wholesale accounts for about 60% of activity, retail a little under 40%. There is no proprietary product anymore. “Before we were doing a lot of prop trading and derivatives, I’m not sure whether for the client benefit,” Accad says. “Maybe in some cases, but in others, it was speculation on the bank’s part. Today, we don’t allow this. If a client wants a derivative type of transaction, it will involve risk reduction for them, not an increased risk profile.”

What still needs to be done? “The bank has achieved quite a lot,” says Kyriakides. “We expect this will continue, and that in 2014 we will continue to see, for example, elevated provisioning charges as the bank continues to clean up the residual legacy problems.” He also believes the bank has more work to do to reduce its concentrations both in terms of industry and single-party exposures. “These have been a weakness of the bank, and efforts to alleviate those are going to need to continue.” He expects continued improvement in capitalization, profitability and asset quality measures over time, provided that rehabilitation efforts remain on track.

Pruvost at S&P says: “We are looking at an institution which for us is still grappling with some legacy issues, still with a NPL ratio that is in excess of 7%, and with a business environment in Kuwait that is not conducive for rapid growth. But on the positive side, it is a bank that has been able to do a great deal of cleaning up and restore its capital levels at strong levels, and we expect it to keep those levels.”

Standard & Poor’s has twice upgraded the bank since the crisis, and has a positive outlook on the rating. The latest upgrade came in March. “The view was that the bank was very well on its way to the completion of its recovery,” says Pruvost, author of the most recent S&P report on the bank. “It had met all its targets in time and for us the dynamic was very positive, working on the assumption that some more cleaning up would be done, and that we were expecting the strategy to remain over the next 12 to 24 months. That strategy, in a nutshell: to be conservative, to continue to clean up, and to focus on key core banking business lines.”

And that is the key question: does Accad’s departure mean a change in strategy? Accad’s comments on his departure suggest that it might, not, of course, that it will be his decision where the bank goes next. “I came here to Kuwait with a very specific mission, and the mission was to turn around the bank, and rebuild trust with our key constituency,” he says. “This has essentially been achieved. So now the bank is in a position to dream about more ambitious plans for the future; about growth plans. It would be very difficult for a person who has led the turnaround and has exited businesses and focused on core competencies, for that same person to come in and say I’ve got a new strategy and we need to grow and expand. It’s not credible.

“For the bank and the team itself, it is proper that they have a new leader that is able to take them forward.”

The thing is, the rating agencies don’t seem to want anyone to take them forward if that means a return to aggressive strategies. S&P hasn’t taken any rating action because of Accad’s resignation, but: “We will be monitoring if there are significant changes to the existing strategy,” Pruvost says. “In our last full report we clearly said that one of the things that could change our assessment is if we see the bank getting more aggressive. It can take multiple forms: it can be buying into new business lines, being more aggressive in terms of capital management, going abroad – there are two or three scenarios that could be contemplated. We will monitor the situation in the coming months.”

Naturally, Gulf Bank’s strategy for the future will depend a lot upon who is selected; Accad has agreed to stay into the new year in order to ensure a smooth succession. “We have seen some succession planning issues in Kuwait,” says Kyriakides. “In some banks it has taken a long time to find a permanent replacement.” But Moody’s, like S&P, has not flagged any likely change in rating because of Accad’s departure. “As long as the process in Gulf Bank is managed successfully, ensuring that continuity is maintained without disruptions in the normal operations of the bank, the resignation of a CEO is part of normal operations at an institution,” he says.

Whoever gets the job, they are unlikely to see the same level of involvement in the day-to-day running of the bank from the KIA as would have been the case back in 2009. Over the years, the KIA’s level of involvement within the bank has faded to the background, even if its actual ownership stake has remained intact. At first KIA provided the chairman; today, it is simply on the board, through Farouk Al-Bastaki, who also chairs the Board Audit Committee. “We believe that the KIA has taken a less proactive stance towards looking at what is happening at Gulf Bank,” says Pruvost. “It is still a large shareholder that is looking for financial returns and opportunities. We are looking at KIA being involved in the medium to long term.” Even if the KIA was to sell down its stake, it should not affect S&P’s view, Pruvost says.

That said, maybe state involvement does still cast a shadow over the bank. It was noticeable that every well-regarded bank analyst we spoke to in Kuwait outside of the rating agencies, including many we have interviewed before, declined to speak to us about Gulf Bank, citing local sensitivities. Accad aside, senior staff at Gulf Bank stepped back from a previous agreement to speak with us, and the KIA declined to comment.

There is also a question about the health of Kuwait itself. It is enormously wealthy, but where is the growth coming from? Kuwait has a national development plan, announced several years ago, but execution has been sluggish. “The implementation has been slow, and we expect this to remain the case in 2014,” says Kyriakides. “Despite a possible pick-up we expect that capital expenditure will remain below 15% of total government pending”. The situation has not been helped by uncharacteristic uncertainty at the political level in Kuwait, with the opposition boycotting last December’s parliamentary election after the emir changed the voting system, and with some repression of protest. That, however, has faded from the news since early 2013. Pruvost adds: “The situation at the political level seems to have eased off a bit, and there rare some grounds for optimism. Government-backed projects are usually driving private sector credit growth, but given the stalemate at the parliament level, they have seen lengthy delays.”

Nevertheless, a place with this much wealth is still fertile ground for a bank. Overall government spending remains high, and, as Kyriakides says,

“although it mostly comprises current account spending, on salaries and other social benefits, it supports the economy and creates benign operating conditions for the banks.”

Not such a bad place to take over a revived bank that has learned hard lessons and redirected its fortunes with panache. Where it goes next will be fascinating to watch.