Islamic RMBS is heading our way now…

The headlines that grabbed my attention was ‘Deutsche Bank and Saudi Investors launch Shariah mortgage Financing company targeting Saudi Arabia’. DB and retail home loans and that too of a Shariah compliant variety was a bit of a surprise. I told a colleague of mine ‘…the brand does not necessarily have top of the mind recall in the mortgage industry…’ Before I could finish he said ‘..but remember they have some fabulous expertise in packaging mortgages off as nifty products and selling them back to us in those halcyon days.’

What I found hilarious was that the moment this was said, my eyes hit upon the huge quote by the Managing Director and Global Head of Residential Mortgage Backed Securities Lending and Trading at DB. He said ‘We are pleased…..Islamic Home Finance is going to boom!..DB will be partnering with local big big biiig Saudi family…. etc’. ..ok I got it! So more than the CEO and COO of the Finance company, we had the MD of RMBS who was drolling all over the press release.

To make the press release more balanced DB had pulled out some moth eaten complex research saying ‘the total outstanding home finance provided by the private sector in Saudi Arabia aggregates to less than 1% of GDP compared with well over 50% in most developed countries, and approximately 6% in Kuwait and 7% in the UAE’. Ok, so now I get it, that’s why you guys started a home finance company in Saudi. Darn!

I mean it is so obviously evident that DB is only interested in the securitization part of this whole game and has no interest whatsoever in the loan business

Inherently by launching it in Saudi Arabia, a few things are taken care :
- Credit Risk: Surely would be low in these loans. Credit scorecard validation algos would be a fairly easy to set up and unless your name is George Bush, most of you who have the right name will get a loan. (and if you or me get this loan and default, you don’t want me to tell you the gory details of what can happen if you don’t pay your Shariah compliant loans off in Saudi Arabia…do you?)
- Pricing: Residential prices are pretty sensible in Saudi Arabia (the last time I asked an estate agent for a nice duplex in Riyadh, he told me I was searching for it in the wrong country, he said the whole middle east quota got completed in a 3 sq km stretch in Dubai)
- Early Redemption risk: The super rich taking to the novelty of the home loan concept for their new pad on the hand bag shaped building in Riyadh, may just forget about the loan linked to their bank account. I mean who will bother changing from a variable rate loan to a lower fixed rate loan in the future etc. so don’t fret on your prepayment risk and interest rate risk on your MBS

So overall we’re all set up nice and cozy on this whole Shariah complaint loan thingy being launched by BD.

So what are the plans for 2012: Shariah compliant securitization, Shariah compliant Residential mortgage backed securities, Shariah compliant collateralized mortgage obligation with a guarantee against home owner default risk with full faith and guarantee from one of the richest families in Saudi Arabia.

...and if anything goes wrong, DB has only put in USD 44 Million of initial capital into this experiment

Small change for creating a new world order in the Kingdom and the world of Islamic Investment management

Exchange Traded Funds (ETFs) – Middle East's Flavour of the month

National Bank of Abu Dhabi lists its ETF on ADX on 25th March– First in the region screamed the headlines. Back in Riyadh there were some grumbles at Falcom Financial Services for losing out on the ‘first’ tag because of a technicality that they listed their ETF on 28th March. So now UAE and Saudi Arabia join the elite club of 36 countries where there are ETFs listed in their exchanges.

It was a coincidence that I was sitting with an executive of one of these firms, when the regulator faxed across the ETF approval to their office. There were whoops of joy, shoulder pats and a general sense of achievement across the office. A few days after that eventful day, I got a call from a fund house asking me how the heck will they manage to generate an iNAV( Intraday NAV) for the ETF. (We figured out how they could do that in quick time, but that is too boring for an average reader to know)

In a region where 9 out of 10 fund houses have no clue on how to generate an NAV every day, and will never manage to generate one even if they wanted, managing an ETF’s iNAV ( Intraday NAV) will be a steep learning curve. This got me thinking on how infantile ETFs are to the region and may be one of the reasons why every fund house CXO I bump into nowadays wants to launch its own ETF yesterday.

It is also a strange correlation, that as I write this blog today, the European ETF industry celebrates its 10th anniversary this exact week. It also needs a mention that the European ETFs which are only 10 years old have been outpacing the AUM growth over their American cousins who started off way back in 1993.

I knew about the existence of ETFs (Exchange Traded Funds) as an investment class, but when a certain private banker shared an ETF handbook with me about 6 months back, I never expected him to give me a 200+ page A4 sized book listing all the global ETFs in the industry for reading (Barclays Global Investors Handbook, though I think the name of the hand book for 2010 may have got changed to BlackRock in 2010).

As per Barclays Global Investors/ BlackRock latest compiled data (As of December 2009)

- Global Exchange Traded Funds (ETFs) assets under management total a whooping $1 trillion (US$1,032 Bn) at the end of December 2009 – 45.2% above US$ 710.9 Bn at the end of 2008, according to the latest figures from BlackRock published today in its ETF Landscape Year End 2009 preview report.

- The global ETF industry had 1,939 ETFs with 3,775 listings from 109 providers on 40 exchanges around the world at the end of December 2009.

- Over the past decade the compound annual growth rate for ETF assets globally was 56.3% (I rechecked it.., there’s no typo mistake here),it was 58.1% in the United States, 53.1% in Canada and 90.5% in Europe

- As of December 2009 – Exposure type of these 1939 ETFs could be broadly divided into Equity ETFs– 1,545 ; Fixed Income ETFs – 279 ; Commodities ETFs – 62 ; Currency ETFs – 14, Mixed ETFs – 37 and 2 Alternative ETFS (If you’re interested in the actual document with further break up of this info, drop me a message or leave a comment on this blog post with your mail ID and I shall mail you the link to get access to this detailed document)

Here we are sitting in a market place where you and I have over 1900+ ETFs to choose from. From a simple equity ETF to a mind boggling Alternative ETF (I have no idea how this ETF is being run), there are so many options available.

Though there are so many types and variants available, My personal reading on ETFs is highly bullish for the Middle East region

- Shariah Compliant ETFs :Malaysia may have taken the leads on Sukuks before the Middle East region, but clearly the Shariah Compliant ETFs wave is eomthing that Middle East can claim as its own. There are some amazing Shariah investment managers in this region, they could take the reins from some lip service Islamic ETFs available in the European market. Clearly, there is a potential to launch Islamic ETFs in the market and the product would have quite a few takers.

- Institution focussed Mutual Fund market: Mutual Funds market space in GCC is still very institutional focussed and has still not become retail’esque. ETFs are perfect fit for such a largely institution dominated mutual fund market.

- Regulations on ETFs: Unlike the European market space which has kept ETFs out of regulatory red tape, the American Regulatory industry regulated ETFs quite well. (which is also why you find a huge amount of complex ETF products in Europe against Americas). From the way things look regulators in the Middle East don’t want to leave ETFs outside their regulatory purview, which is very good for a nascent and developing ETF Market space.

If you have managed to read through this blog post till this line, here’s one more for the road… ‘What the caterpillar (Mutual Fund) calls an end of the world, the master calls a butterfly…(ETF)'

A warm welcome to the world of Middle East ETFs

Why don't you shut down a few branches, Mr.UAE Banker!

In 1953, Stanley Miller, a graduate student of UCLA took two flasks, one containing a little water to represent the primeval ocean and the other holding a mix of methane, ammonia and hydrogen sulphide to represent the earth’s early atmosphere, connected them to rubber tubes and connected them with some electrical sparks to represent lightning. After a few days of passing electricity, the water turned a murky yellow and there was a healthy broth of amino acids, fatty acids and other organic compounds. Miller’s supervisor, Nobel Laurent Harold Urey was delighted and said ‘If God didn’t create life this way, he missed a good bet’. When this news went public, the press hailed this and made it sound as if, all that was now needed was to give the flasks a good shake and life would crawl out of it. Half a century has passed since then, and we are not yet anywhere close to creating life in a bottle.

So what is the intent of referring this story to all of you? I was reminded of this story and Stanley Miller’s experiment when I read two news paper articles yesterday on how the UAE Banking Industry is trying certain experiments to bring life into their balance sheets.

Without naming the financial Institutions (you could do your own research on that one, and I’ll save from getting sued), here they are:

- A certain financial institution in the capital of UAE opens its 100th branch in the region and had put out a full page ad proudly stating the same

- Another financial Institution again based out of the capital opens a 24 hour branch (no its not an ATM, its a full services branch) in an airport. How brilliantly convenient, the next time I go to the airport, I can apply for a home loan, a personal loan and cash a cheque.

The big million dollar question is that, do UAE Banks need another branch, and with another branch and its added operating expenses (salaries, electricity, real estate etc.), will it bring more life into their balance sheets.

I did a quick research and arrived at the following. The UAE has 24 full fledged commercial banks (locally incorporated banks), with 655 Branches across UAE (without including the two branches mentioned above as this data is as of 31-Mar-09). The UAE also has 28 foreign banks authorized to undertake commercial banking operations (these are not the DIFC licensed banks, these are CBUAE licensed ones) and they have 149 Branches in the country. This brings the total tally of branches in this country to 804 Branches.

What’s happening here!

Out of the population of UAE at 6 Million, there’s 1.75 Mn Indians, 1.25 Mn Pakistanis, 0.5 Mn Bangladeshis (Source: Zawya) and out of this 3.5 Million IPBs, 60% don’t necessarily take a car loan for buying a Ferrari or take a credit card for their weekly grocery shopping convenience (Oh come on, I’m not being racist here, I’m just being practical, so don’t give me that look and roll your eyes here). I divided a Banking capable population of 4 Million (out of 6 Mn) by the total number of branches in this country (remember 804 branches is on 31-Mar-09) and arrived at a figure of 1 branch for 4900 people in this country. Now the question was that the branch figures have only gone up in the last nine months and the population stats I have taken is definitely questionable.

What’s happening there!
I then looked at the per branch per person penetration in some of the wealthiest neighbourhoods in New York and compared it with our UAE and this is what I got. Even Upper West Side, Manhattan (1 Branch for 7100 people) and West Village Manhattan (1 branch for 5400 people), typical higher income neighbourhoods in the ex-financial nerve centre of the world had lesser bank per person penetration than what we have in the UAE!!!! Now you’re not trying to tell me that some CXO just figured out that this country needs more branch banking services than Residential NY. Are you?

Questions here!
- What do you think would be the per branch operating cost in the UAE
- What is the per branch per account holder penetration in the UAE
- What is the desired level of per person per branch penetration and profitability required
- At what per branch operating profitability do UAE Banks currently run
- Can they not outsource non core branch processes and make the branches more like outposts than 24 hr club lounges in airports
- Can UAE Banks start strategizing about centralizing business processes in one location and make their branches leaner

Opening a new branch in a over crowded market like UAE looks more like Stanley Miller’s empty idea from the 50s (of creating life out of glass flasks). Do our UAE banks really need more branches in the country or do they just need to shut down some branches, come up with creative branch banking strategies and make their balance sheets more sensible.

Mr.UAE Banker CXO, are you reading this and please correct me if I am wrong?

Disclaimer : All comments are purely personal

Memento Mori! – Obituary of the GCC Insurance Industry Asset Management

In Ancient Rome, when the Roman General paraded the streets after a victory, standing behind the General was a slave who would continuously whisper into the General’s ears the words ‘Memento Mori’. Roughly translated to English, ‘Memento Mori’ means ‘Remember you’re human, and remember you must die, stay humble and plan’. The reason for saying this was so that the General realizes that even if he has been a victor today, he should remember that he could fall or be brought down. I wish someone had whispered in the ears of the Insurance Industry Portfolio managers way back in 2007 and 2008, the same thing.

Here’s why!
I was reading a really interesting report compiled by Alpen Capital - UAE on the state of the UAE Insurance Industry and also the Takaful Industry in GCC and came across some amazing nuggets of information.

The report states and I quote

• All insurance companies in the UAE surveyed, other than XYZ Insurance Company, have adopted very aggressive investment strategies, with an average of 65%+ of Premiums invested in equities and real estate, mostly locally
• To break it down further, in 2008, the Investment profile of UAE Insurers read as follows – 41.7% in Securities, 34% in Liquid Investments and 23.5% in Real Estate/ properties
• Contrary to insurers in developed markets, the UAE peer group has a very high exposure to regional equity and real estate markets.This has resulted in high volatility in investment returns
• A whooping majority of companies in the UAE has a proportion of over 80% of their investments in ‘risky’ asset classes, some of them going more than 90-95% in high risk assets

So virtually, if you had made any investments into a Insurance company’s stock in UAE, you were virtually investing into nothing more than a highly toxic Mutual Fund with a cocktail of ridiculous investments.

The world over there is regulation that binds Insurance companies to adopt more traditional strategies of investment methods offering assured yet non-extravagant returns. Most Insurance Industry portfolio managers do not even know how to spell equity and only understand Fixed income investment vehicles, while here in UAE and GCC, we have Insurance industry portfolio managers who don’t know anything other than Equity.

US, UK, European and several Asian Countries have regulations which prohibit Insurance premium investments beyond High/Low grade Govt Bonds, Corporate bonds, Cash and short term investments and miniscule amounts of PE/ RE. Life Insurance Industry is even more regulated world over and the composition of High grade fixed income instruments and cash as a major component in the asset allocation mix.

I fail to understand the thought process behind these Investment managers to invest in Equity and Real estate in such high concentration. Portfolios require short term liquidity to cover early surrender of policies, where were they planning to cough up the money from if they had investments over 30% in Real Estate? Did they never visualize a world where they could face defeat? I can understand that if this were a pension fund, they could have strategy like Warren Buffet to hold stocks forever to squeeze stupendous amounts of returns after something like 20 years of holding it.

With the way, the local equity and real estate markets moved between 07/08 and now, I would presume these ‘smart’ insurance fund investment managers have been napalm bombed into Kingdom Kong already.

Who is to blame out here – Regulator, Insurance Industry associations, Company Owner/ Senior management, a virus in the computer? I don’t know and honestly I don’t want to know, all I hope is that whoever was responsible comes out of this alive and safe.

Memento Mori…Memento Mori…Sorry General, I said it too late. You’ve already been wiped out I guess

The Chinese Altruistic Angel lands in the Arab World

While we were busy worrying ourselves grey with the Dubai World issues, I don’t know if any of you missed this small piece of news, (well I certainly did) ‘Chinese and Egyptian Premiers shake hands on North West Suez Gulf Development’. We've known of this Chinese Alchemy working very well in East and West Africa, but the fact that they were in our backwaters (well not really the GCC backwaters, but Egypt is nearly there, I can see the :) guys) is an interesting development.

In July 2009, TEDA (Tijuan Economic Development Authority), a Chinese SEZ Maker was shortlisted from 29 others, to develop a five sq.km special economic zone, about 120 Kms away from Cairo, with a port available stone’s throw away. As of Nov-09, when the Premiers shook hands, 1.07 sq km had been developed and18 Chinese companies with a Paid up Capital of USD 180 Mn had already set shop there (how conveniently located to export to the EU, no more long ship voyages for those Chinese 'Rebuke' Shoes and 'Mokia' mobile phones). There are a few hundred more companies readying themselves to set shop here, apart from the 800+ Chinese companies already operating in Egypt.

On the Egyptian Ministry of Investment website, it states that, this development will provide huge job opportunities yada yada yada..but I guess someone in Egypt who signed the dotted line does not know that, when the Chinese come, they come with their kitchen sink into the camp. Why do I say so..well here goes:

When the Dragon went to Panama
Someone once told me a story about the Chinese investing in Panama some time back. China bid for a site on Panama Canal to construct a cargo loading and unloading site. A no-brainer that they were obviously the lowest in their bid. Their plan was to use Chinese labour to get the job done. Turned out some smart aleck in Panama forgot to mention to the Chinese that there was a law requiring 90% local labour workforce, and on top of it there’s a minimum wage law in Panama. Last heard, the Chinese were sitting with this piece of land wondering if it was ok to grow poppy on it.

I am sure that after the Panama Debacle, the Egypt story would be different. Firstly this is an SEZ, so i'm presuming there will not be any local labour employment regulations applicable. So guess what, its going to be Chinese labourers, building the site for Chinese companies to manufacture and export Chinese goods using Chinese workers to everywhere except China. So now if you thought Mokia phones had only reached Africa, Europe and the Arab World are not too far away now.

And then again in Afghanistan
Here’s one more example for the road. China Metallurgical Corp (another state company) bid USD 4.3 bn (USD 1 Bn more than closest competition) and won hands down with the most extravagant quote for the development of copper mines in Afghanistan in 2009. Their quote involved development of villages (to house the Chinese), power plants (to run the copper mine), highways and a 580 km railroad (to transport the copper) and much much more. None of the American, European or Indian companies which bid came anywhere near the project bid.

So while the Americans and the rest were busy burning their govt exchequer fighting for the the Af-Pak strategy/cause, the Chinese without even firing a shot took away one of the richest known copper fields ever discovered in history!!!2010 will see the second mine site bid opening and there are 7 finalists in the same, no prizes for guessing, but yes the 7 finalists have only Chinese and Indian mining companies in the race.

I am not someone who is against free market, I fully support free market and capitalism;and I envy the Chinese for having capitalized on a loophole in capitalism, with this capital idea of 'new age altrusim mixed with business'.

Do we need to worry about the Chinese in our backyard now? I don't know, I’ll have to leave this blog post here, I’m getting late for my Chinese Language classes :)

(All views expressed in this blog post are purely p-e-r-s-o-n-a-l)