The banking and financial sector has long been a favoured focus of Gulf financial institutions for investment. This focus looks like becoming more noted over the year ahead as investment opportunities arise both regionally and internationally.
The expected increased corporate investment activity in the banking and finance sectors is related to two factors. Gulf financial institutions, including large regional banks, investment houses and sovereign-linked wealth funds, have substantial and growing resources, aided by oil-generated liquidity.
Secondly, the sub-prime crisis and the subsequent global credit squeeze has created many investment opportunities as affected financial institutions look for cash injections to shore up their financial positions and improve their capital resources. Moreover, there are still many investment opportunities in emerging markets, particularly in Asia.
Global financial stocks have had a bad year in 2007. Most global financial stock indices are down by well over 10 per cent since 2006-end. Banks have been reporting figures containing significant write-downs. As a result, sentiment has deteriorated, stoked by worsening news from the US mortgage market. Emerging market equities, however, appeared to be little affected by the Western credit market turbulence, at least so far.
Large private equity groups are vying for stakes in various financial firms, ranging from investment banks to hedge funds and specialist bond insurers. Many deep-pocketed buy-out investors are beginning to see attractive opportunities in the most troubled areas of the financial services industry. The floodgates have started to open in terms of capital infusions in the financial sector. Companies are looking to improve their balance sheets, and investors want to see these kinds of public endorsements.
When the credit squeeze began last summer, the question was whether the series of mortgage-related write-downs in the banking sector would lead to consolidation in the financial services industry. The answer so far has been that while there is too much uncertainty for mega-mergers, the sector is ripe for capital infusions. The trend began with investors from China and the Middle East putting money into Wall Street banks, such as Bear Stearns and Citigroup.
Most large private equity groups have earmarked pools of money to invest in financial services and they are eager to put that money to work. Any time you have the chance to make an investment at tangible book value or less, it is likely to be a good deal. Many believe the risk-reward trade-off is the best it has been in a decade.
A string of capital infusions by buy-out firms into the most depressed segments of the banking and insurance sectors could help overall merger and acquisition volumes in the industry, but is unlikely to make up for the reluctance of chief executives to strike full takeovers in this environment.
Dubai International Capital acquired a 9.9 per cent outstanding equity stake in Och-Ziff Capital Management Group, a US-based hedge fund, for more than $1.1bn. Abu Dhabi-based Mubadala Development Company bought a 7.5 per cent stake of the management operations of one of the world’s largest private-equity firms, Carlyle Group, for $1.35bn.
Regional stake-building across the GCC banking sector continues to grow. Commercial Bank of Qatar (CBQ) recently bought a 14.7 per cent stake in the Sharjah-based United Arab Bank as part of a regional expansion plan. Commercial Bank bought 104.6 million United Arab shares through an “off-market” transaction.
Dubai Financial has acquired a 15 per cent stake in Bank Muscat through a $619m private placement. More recently, Dubai Financial acquired Bahrain’s Taib Bank, a small private bank but with interests in Turkey, Kazakhstan and India. This is the group’s second bank stake buy in Bahrain after Al Salam Bank, adding the overall bank portfolio to Bank Muscat in Oman, Marfin Popular Bank in Cyprus [stake recently increased to 20 per cent] and Bank Islam in Malaysia, besides Dubai Bank in the UAE.
Abu Dhabi Commercial Bank is negotiating to buy a 25 per cent stake in RHB Capital, the fourth largest banking group in Malaysia. ADCB will not only help it grow its business in Asia but also in the Middle East.
There are ways in which this credit squeeze could spread to Asia and other emerging markets. Direct trade is one, financial sector linkages another. But the most likely link is through asset markets: Asian equities would not be immune to a sharper US equity sell-off. However, some market players eschew bearish equities as a lead theme, while the Federal Reserve is cutting rates. Preferable is how central Middle East and Far East are to this bi-polar liquidity story that raises more demanding policy questions. The risk/reward of targeting a stable currency against a weak dollar is deteriorating.
Since August, the Federal Reserve has commenced an easing cycle as a result of the continuing domestic problems arising from housing and credit strains. Consistent with past easing cycles, the spread between treasury bonds and bills will continue to widen.
This should allow the financial sector to “heal itself” by simply capturing the yield curve spread through higher investments in treasuries and away from risk-based transactions. In addition, real interest rates are falling, which should keep the global economic picture strong, particularly in emerging markets. These developments are long-term positives for the financial sector.
Banks with potential sub-prime exposures or disclosed exposures are trading at significant discounts to their underlying values. Such stocks do, therefore, have considerable recovery potential on a long-term view. Many investment groups are seeing the current turmoil as being near the bottom of the financial sector, as well as creating attractive opportunities and are launching financial funds. Financials as a group are coming under severe pressure due to the concerns post the sub-prime collapse. This indiscriminate sell-off has left significant opportunities for long-term capital appreciation.
Although most believe there will be good opportunities in the emerging markets, others are more sceptical about some of the larger Western markets, including the United Kingdom and the US. The collapse of Northern Rock exposed the tripartite regulation of the UK financial system as being ineffective. Globally this has not only dented the confidence of equity investors but also fixed income investors too.
In six months, for example, UK banks’ paper has gone from being the most tightly traded in Europe to the widest – access to funding has been severely challenged. This is all because the banks no longer trust each other. Ultimately, the liquidity crisis has been driven by a fundamental shift in the perception of systemic risk. Nevertheless, shrewd global investors are seeing the current weakness in financial sector as an excellent buying opportunity.
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