(Part 1 of 2) Conversation with Michel Accad, CEO of Gulf Bank in Kuwait on – impact of the ‘Arab Spring’ on banking in the Middle East – managing a bank in the modern world – lending weakness and portfolio quality.
Here is the transcript of the video.
1. Managing a bank in times of crisis
Emmanuel Daniel (ED): I am speaking today with Mr. Michel Accad, the CEO of Gulf Bank here in Kuwait.Gulf Bank is a very interesting institution here in the heart of Kuwait city, a bank that has gone through several crises but has been able to survive because of its strong retail franchise.In the last three years, in the time that Mr. Accad has been CEO, the bank had gone through a crisis generated by its investments in variables and then through bad loans.
Michel Accad was brought into the bank to strengthen the balance sheet and take it forward.I am speaking to him at a time when the Arab world is going through a huge transition and so this interview is also a statement on Gulf Bank’s future in the wake of the Arab Spring.Thank you very much for speaking to us. Give us a sense of the bank that you inherited when you became CEO.
Michel Accad (MA): Well, you know the bank had gone through a very traumatic time in the end of 2008. The bank had huge derivatives exposure, and they had to record losses for the year 2008 – a bit over a billion dollars.The bank had to be recapitalized and the board was changed in its entirety.I came just after that.But the bank had gone through obviously a very traumatic experience.
ED: You were brought in as a professional manager to the bank.How were you sourced, and what did the bank need to do to reach out to you to hire you?
MA: The bank was facing obviously very serious problems and I think what they realized was that they needed to close the family managed business and move into a more professionally managed one.I was not the only one actually that joined the bank around that time.As you know following the big problems that the bank was facing, what happened was that about a bit more than half of the senior executives had to leave and a new team was brought in.So I was brought in at about the same time as a new chief risk officer, a new chief financial officer, a new had of legal and so on. It was a big change for the bank, and they had to go to people who had experiences with international institutions and who knew the market well.
ED: Give us a sense of the transition of a journey that Middle East banks make from being family owned to becoming more professionally run.You yourself have had a distinguished career as the Citibank regional head for North Africa and for the region.What has forced domestic banks in the Middle East to become more professionally run and are they making that transition successfully?
MA: You know, sometimes, unfortunately it does take a crisis for people to realize that you cannot manage in the modern world a bank the same way as youuse to manage it twenty years ago, even ten years ago in the region. The business of banking has become so complex and there are so many different products and so many different businesses within banking, that you cannot manage it as a family owned business.
Now, as I said in the case of Gulf Bank, it took a crisis for them to change.In other cases, sometimes the board realizes that they need to move to the next step even for banks that are very closely owned.Sometimes they realize that they are closely owned but the owners are not necessarily the best managers, especially, in this very rapid year of changing environment.ED:How drastic did the management of a board of your bank allow you to make changes that you made?How drastic were they willing to allow you to go?And how much of the back debt that was on the books in 2009 still remain today?
MA: I came in at a relatively good time to do this because after the experience of 2008, as I said the board was changing and the new board of course was more professional. I think the profile of the new board is in general much more professional.They include lawyers and they include people who do not have for example direct interests even in Gulf Bank but are known in the industrial circle.Of course they include, out of the nine board members, two representatives of, let us say the main family that owns a large portion of the bank.But, they also include for example, people from the KIA, the Kuwait Investment Authority and they are of course very professional managers in general.Therefore, they do understand the different role between the board and the executive management.
The board has to supervise, has to set the directions in terms of strategy, has to control the overall risk environment, but does not necessarily have to come and deal with the day-to-day issues that are left to the executives.And indeed because of the problems of the past where there was, in my view, a lack of governance between the ownership, the board, and the management that will essentially in single hands, that did not work very well.So they were very open to doing all those changes.
2. Lending weaknesses and portfolio quality
ED: You were quoted recently saying that the liquidity position of the bank has advanced tremendously in recent times. How much of the old story still remains on the book and how long do you think it will take to resolve them or are there some loans that are unresolvable?
MA: Well, the first crisis that we had, the first billion dollars that we lost was essentially due to derivatives exposure.At that time, we did not necessarily realize that there was a large amount that was also lying there in terms of nonperforming loans.The first part was very specific to Gulf Bank.The second part, the credit aspect was generic.All banks in the region tend to have large exposure to, for example, the real estate market because their security is real estate or shares so they also have exposure indirectly to the stock market.
When you lend simply against the security, then you find yourself uncovered when the asset values are reduced.This started to happen by 2008 and it continued into 2009 and even 2010.Therefore, we had to take additional credit hits in 2009 and 2010 that added up to another one billion dollars.We were able to absorb them, because if you take 2009 and 2010 together, then the net we ended up the two years more or less breaking even.
So, in terms of the quality of the portfolio, it has improved enormously simply because we have been very aggressive in taking the provisions and taking the write-offs that are necessary. It’s easier, and that is why it is good when you have a crisis to have new management.Because it is easier when you have new management to recognize that, many of your assets on the book are of that quality, because there is no vested interest in keeping them.
So, you come in and you say well, let me recognize that many of those assets are nonperforming and let us move forward.That allows you to move forward at a much faster pace.If you have had the responsibility in building those loans, it is much more difficult for you to recognize that the loan that I did is just not performing, it is more difficult to do this.
ED: Coming back to the point of the liquidity portion of the bank, is this a trading bank or asset liability bank in the sense that where does your profitability come from?
MA: I will give you a sense of the liquidity because I think it is a critical point.When the new team took over the management of the bank, we decided that we do not have the luxury of a five-year plan or because we were in a hole.So we had a two-year window and we had a two-year plan to rebuild trust in the bank and rebuild profitability to pre-crisis levels.So we made the plan by the end of 2009, and this was a plan for 2010 and 2011, and we are very much on track.
The key aspect of the plan is that while we wanted to be a dominant local commercial and retail bank, meaning that there were businesses that we needed to exit.All those proprietary trading businesses we have exited.All our investments in hedge funds or our direct investments we were exiting.All those sophisticated products that do not serve the customer well we have exited.So the key was to focus on our core competency of commercial and retail banking and within that comes a second aspect, which is building a fortress balance sheet. And the fortress balance sheet means very strong liquidity.Very strong liquidity doesn’t just mean you have to have a lot of deposits. It also means, for instance, that the structure of your deposit cannot be just a short-term deposit or cannot be just a few deposits depending on a few big names.You need to diversify your deposits.But also, you need to lengthen the maturity date of your deposit.We have done that so early that in fact, about three-quarters of our deposits are in fixed term deposits.A bit more than half of these are six months and over.I do not know of many banks in the region that have such a structure.At first we had to pay, of course to get it, but very quickly, as we got the funds, then we decided that on the short-term funds, we did not need them anymore.Therefore, if you want to, we intended to pay lower for short-term funds then our competitors after a few months and a bit higher for the long-term deposits.Today we pay the same for the long-term deposits and still lower on the short-term.
3. Operating profitably in a restricted market
ED: I want to contextualize your business and the points that you just raised in the context of the rest of the world.The Middle East is a very liquid marketplace. The big problem is finding investible assets that are able to generate returns. So where do you find that?How do you find it?
MA: This is our biggest challenge. In the case of Kuwait, we as Gulf Bank have really restricted our target market. We are not lending internationally because we don’t have an international presence and therefore it doesn’t add value to the franchise.Second, we have decided to reduce our exposure to the real estate sector and to the stock market or to loans that are based on such securities.
By the way, that used to account for about half of our portfolio.Today it accounts for a third of our portfolio.It is a huge shift and we have maintained our total asset base.So it looks like the loans haven’t budged but they have reduced significantly in certain sectors and they have increased significantly in others.
What are the sectors we are focusing on?Today, Kuwait is talking very seriously about a five-year development plan.In my view, maybe it is a bit naïve to believe that everything will happen exactly as they say. But at the same time, I think it is naïve to believe as some do, that nothing will happen this is just talking facts.Things are already happening in certain sectors and we are participating. Whether it is in the power sector or in infrastructure, we are punching way above our weight in those sectors and that is how we are maintaining our loan base or even increasing it slightly. It is not just loans, of course.It is going to be contractor finance, bonds, and guarantees and so on, as well as trade finance.
ED: How does the Arab Spring work out in terms of the issues that you need to be careful of in the long term – I can already see that asset valuation is a challenge and keeping profitable will probably continue to be challenging.
MA: Absolutely, look at asset valuation, the best protection is not to have fifty percent of your portfolio dependent on those asset valuations.Of course, it is not because it is a direct loan for that but it may be loans that are guaranteed.What I would like is that over time maybe less than twenty-five percent of my portfolio would be depending on such asset valuations.If you look at the quality of the balance sheet today verses what it was a few years ago it is just incredible.
So this is how we protect ourselves in terms of loan quality.Of course, where does the profitability come from? A lot of it will still have to come from net interest spreads. There are other products and services that are wrapped around loans.Somebody who takes a loan from you also open letters of credit and guarantees with you.So, the profitability comes, from the net interest spread and another part comes from those customer related fees.
You can make a profit of five to ten million dollars a year but then lose a billion when derivatives fall apart. Since the middle of last year, every quarter has been better than the previous quarter.My expectation is that this is going to continue until early next year when we reach our cruising speed.
ED: In a way that is an amazing development because considering your own background has been in corporate and investment banking and here you are trying to build a retail house.Give a sense of what you have been learning, and what have you achieved to build the organic sustainable long-term business of this bank? And how hard is it to resist the temptation of doing proprietary trading?
MA: Every bank has a different story.I think in the case of Gulf Bank, you really need to look at what made us different. What is it that made customers want to bank with us?Gulf Bank had a very good time from 2000, to 2005.That is when they created themselves as a truly retail and commercial bank. This is the core DNA of Gulf Bank. And then we thought we could be Goldman Sachs and many other things. I do not think that was within our DNA. So, in the two-year plan, the view was that we should concentrate on what we do well, what gets the client back to us.
Maybe this view will change slightly in the long term. But products that expose clients to risk we will never do. Proprietary trading or direct investment, in my view, will never happen under this management team.But there are certain things that we may consider, such as the corporate finance and advisory type of investment banking, which are fee-based services.
ED: Is there a temptation to build a wealth management or a private banking type business as well?
MA: Yes, to a certain extent.But what is the value of the proposition? We have a lot of very wealthy Kuwaiti customers.But what is it that they want from you as a local bank?They want deposits, convenience, and service.They would want maybe some local funds, which we are now offering again as distributors.However, I do not think that they want you to offer them international products or access to international markets because wealthy customers have that access directly. If they want specific products, they go to UBS, to Credit Suisse, to JP Morgan, to Deutsche, to others who have very good service at that. I think that is wrong for us because of our local profile.
ED: And finally, with the governance rules that have been put in place and with the commitment of the Kuwaiti regulators to Basel III, does that put pressure your need to be capitalized and given the organic way in which you want to build, your business is time on your side? Because it is just a matter of time before, even a foreign bank with a limited license can override your business.
MA: I don’t think so.In fact, I think the tables have turned the other way in Kuwait and other GCC [Gulf Cooperation Council] countries as well.The banks are theoretically over-capitalized.The requirements are twelve percent of capital ratio, and the average for the GCC countries is eighteen percent and we are at eighteen percent as well.This prepares you very well for Basel III. No matter how you define it, we are either there or practically there.
Liquidity ratios can be met.Now certain banks like us meet it because the capital ratio is the lead capital ratio.We have taken all of the provisions that are required. My view is that this is true of many of the banks but if the management has not changed, maybe they need a little bit more time to be able to take all those actions.
But frankly, they have the time and therefore I believe that the Kuwaiti banking system, even though has been affected by the asset valuations and so on, is in fact in pretty good shape compared to practically any place you could compare it to.
