Remembering Lehman Brothers: GCC financial markets five years down the line
Five years ago as news of the collapse of investment bank Lehman Brothers rocked the global financial system, shares across world’s stock exchanges plummeted.
The reaction in the Gulf was no different. The meltdown on Wall Street spread fear and panic among the region’s investors and on September 15, the day following Lehman’s announcement of filing for bankruptcy, Saudi Arabia’s Tadawul Index sank 6.5 per cent, Qatar’s QE Exchange Index plunged 7.1 per cent, Kuwait lost 3.8 per cent and Abu Dhabi and Dubai indices fell 4.4 and 1.7 per cent respectively.
However in the following week, except Saudi Arabia, all the others recovered and ended the week in positive territory. But the gains were short lived.
As the world came to terms with the severity of the West’s debt crisis in the following weeks and months and governments and central banks went out of their way to stem the deepening credit crunch with massive bailouts—US unveiling a $700 billion (Dh2.5 trillion) package in October and subsequently by bringing interest rates down to close to zero—reality was starting to hit home.
Initially there was smugness among some analysts, fund managers economists and retail investors — not to leave out high government officials — that the region was immune from the sharp downturn being witnessed in the West. But it was fast becoming clear that the financial disaster that was rapidly impacting most parts of the world was impossible to stave off. It was simply all engulfing, given the correlation between the markets here and US’s S&P 500.
To prevent the liquidity shortage that hit the global markets from spreading to the Gulf state, UAE’s Central Bank was the first in the region to pump in $13.6 billion (Dh50 billion) in September that led to what was again a temporary relief in the stock markets. In October the Central Bank again offered the banks another $19 billion. But haemorrhage of shares here and elsewhere continued and by the end of the year, Dubai stocks dived 72 per cent, Abu Dhabi 47 per cent and Saudi Arabia 57 per cent.
In January of 2009, as oil prices plunged to $33 a barrel and Sabic, the world’s biggest petrochemical company, reported a 95 per cent slump in its fourth quarter net income, Gulf markets were hit by selloffs — Dubai dropping to a new four-and-half-year low. Later in 2009, the region’s own blowouts came to the fore amid the seismic shake up of the world’s biggest economies, hurtling towards what many feared to be an economic depression, similar to 1929.
Dubai’s real estate boom, which was led largely by speculators buying off plan and used excessive leverage unravelled quickly. Dubai felt the heat as leveraged and speculative flow of capital reversed. Foreign capital that aided in the construction projects froze. Real estate prices in Dubai were in free fall, falling by more than 47 per cent at the end of the second quarter, according to Knight Frank. CDS (credit default swaps) spreads on sovereign debt shot up and around $575 billion worth of projects were put on hold.
Overstretched banks, with loan to deposit ratio well beyond 100 per cent and also, having equities and real estate on their balance sheet were faced with losses, leading to huge write downs. Saudi Arabia’s banks—as well as some of the global ones—were staring at what was the biggest corporate meltdown in their history with prospect of billions of dollars in unpaid loans resulting from a family dispute between Al Gosaibi and Saad Group.
In Saudi Arabia for example, as Rakan Himadeh, analyst at Mashreq Asset Management, points out, loan growth stalled to a 2.8 per cent clip between 2008 and 2010 after growing 27 per cent in 2008. In the UAE, after growing 47 per cent in 2008, loan growth stalled to 2.6 per cent during 2008-10.
And as 2009 was coming to close, on November 25, Dubai government announced a “standstill” on its $59 billion debt, asking providers to extend maturities until May 30, 2010. Markets, not just here but across Asian and developed countries, crashed after the sudden decision and until 14 December, when Abu Dhabi decided to help with $10 billion to state owned Dubai World to avoid defaulting on a $4.1 billion bond payment, the market had lost 19 per cent. The fund injection led to the DFM General Index climb 10 per cent, the most in 14 months.
Yet, from September of 2008 to the end of December 2009, the Dubai benchmark was the worst performing in the Gulf, down a dismal 62 per cent. Abu Dhabi, during the same period, sank 37.8 per cent, Saudi Arabia, lost 30.1 per cent; Kuwait, declined 51.5 per cent and Qatar and Bahrain stock measures declined 33.4 per cent and 45.8 per cent respectively.
The accumulated reserves from oil in years when it rose to record highs (close to $150 a barrel) enabled governments to take quick measures to address and revive growth. The banks were able to tide over the crisis—none went belly up — because of higher capital adequacy ratios.
The banks’ deterioration of asset quality led to increased provisioning norms and tighter covenants for future lending. Central banks played a crucial role in this regard. Policies were redrawn, significant provisions were shored up and banks took impairment charges, which is still ongoing though declining.
The earliest sign of things moving back to normal again was the opening up of the debt market, particularly in Dubai. Following Dubai World’s decision to renegotiate debt, there was a total shut down of debt market, which put a lot of pressure on the emirate as there was a lot of refinancing to be done by different government and government-related entities. Downgrade of various Dubai companies by the rating agencies didn’t help. But as the debt market slowly started to get active, liquidity pressure eased and that had a positive impact on stocks.
The issues and subsequent solution that came about in Qatar and Saudi Arabia were different than in the UAE.
“While Qatar had a similar fate to the UAE, their government supported the Qatar economy in a big way with fiscal and monetary support,” said Himadeh. “Saudi’s banking system was nowhere nearly as stretched compared to the rest of the GCC (Gulf Cooperation Council), though it did face restructuring issues on some of their loans. “In terms of the UAE, liquidity slowly began to improve and it wasn’t until the second half of 2012 did bond markets really take off, which eventually helped liquidity of banks and supported real estate prices, allowing banks to reverse previously taken provisions,” added Himadeh.
But from 2009 to 2012 as global equity markets staged a recovery led by the emerging markets, which rose by 105 per cent and the US market, which increased by 72 per cent, the GCC markets underperformed, gaining 42 per cent. Besides the Dubai World’s announcement seeking to renegotiate its debt obligation, Eurozone debt crisis and events surrounding the Arab Spring in 2011 were a drag on the Gulf markets.
“The revival has not been so swift like what we have witnessed in other emerging markets and hence, long-term investors are still licking their wounds,” said Raghu Mandagolathur, senior vice president-research at Kuwait Financial Centre.
Even though Dubai has been doing well for the last two years it is still down a whopping 60.1 per cent from its historic high. So is the case with all other GCC markets when you compare with their 2008 highs (see table).
However as Fadi Al Said, head of equities at ING Investment Management, pointed out that in 2008, the Dubai stock market was expensive. Some companies were way overvalued.
“The fact that we are not back to those levels doesn’t mean that the market or the economy is not healthy,” he said.
“If you look historically, when markets are in a major bubble and then they correct by 50 to 70 per cent and this is what we saw here — to recover from this, it takes at least three to five years. That’s happening now,” says Al Said. Also, as Vijay Harpalani, assistant fund manager at Dubai-based Al Mal Capital, points out that in the eyes of global investors the regional markets are still “frontier markets” -with the exception of the UAE and Qatar which was recently upgraded to emerging market status.
“So when a cyclical market recovery happens, it usually first starts from developed markets; frontier markets are possibly the last beneficiaries in the recovery phase.
“Level of transparency, disclosures, regulations and corporate governance sets apart regional markets from global and emerging markets,” Harpalani says.
It appears that stocks of petrochemicals, consumer and telecommunication sectors performed strongly during the recovery phase, while the financial sector lagged behind.
“This could be explained by the fall of the regional real estate market, especially UAE — whose stocks retreated too — defaults and resultant provisions and finally, decline in net interest margins,” said Shakeel Sarwar, head of asset management at Securities and Investment Company (SICO), Bahrain.
In 2011 Saudi Arabia and Qatar performed relatively better due to substantial recovery in hydrocarbon prices in the first-half of 2011, pointed out Harpalani. In case of Qatar, the governments help provided to various sectors, including the stock market. Winning the World Cup bid also had its dividend for the stock market when in 2011.
During 2013, the GCC markets have thus far outperformed their global peers. During a time in which emerging markets have been battered by worries surrounding the global economy and the “tapering” of US quantitative easing, regional markets have been boosted by the UAE real estate sector and the regional consumer sector. MSCI upgrading UAE and Qatar this June boosted the sentiment in the two markets.
After the sharp correction in the market on August 27, 2013 and subsequent week amid murmurs of a possible Western limited military strike against Syria and a rebound this week, Dubai and Abu Dhabi markets were up by 56 per cent and 39.2 per cent year-to-date respectively.
Looking ahead, all fund managers sound optimistic about the Gulf equity markets based on the strength of the fundamentals.
Going forward, Sarwar expects the regional markets to consolidate in the short run.
“We believe that, the recent rally driven by the UAE equities and the consumer stocks have run ahead of the fundamentals. However, the long term fundamentals of the region are still intact.
“With QE tapering expected in the next one to two years, we think that the Saudi based financials stand to benefit from the rise in interest rates. Furthermore, regional petrochemical companies are also trading at reasonably attractive valuation levels,” said Sarwar.
In the long run, factors such as continued government spending and MSCI upgrade are likely to boost the markets.
“The MSCI upgrade and positive momentum in UAE and Qatar will build a better investment case for institutional investors to look at regional markets. Massive spending on infrastructure in Saudi Arabia and Qatar will also act as a key catalyst in supporting the rally,” said Harpalani.
Kuwait and Bahrain are the wild cards.