Oasis Capital Bank New Investment Strategy and Assessment of Bahrain Political Risk

Interview with Dr. Farid Al Mulla, CEO of Oasis Capital Bank

How is Bahrain different from other countries such as Libya and Egypt? Can you put Bahrain into regional and local perspective? Also, how do you think these events will play out in the future?

First of all, there is no doubt that the events of Bahrain were, to some extent, influenced by the Arab Spring. However, there were also political and economical dynamics in the Bahrain setup that contributed to those events. Some of these issues were legacy issues that were not well resolved and as a result the Arab Spring accelerated the events.

It would be a misstatement to put Bahrain in the same mold as Egypt and Libya. If we take the situation of Egypt and Libya, the Arab Spring was born out of political frustration and a lack of economic opportunities.

However, when we look at the well being of the people of Bahrain as opposed to their counterparts in Egypt and Libya it is clear that economic opportunities were there. When it comes to political issues Bahrain is also at a different level, though not necessarily at a better level. Bahrain’s democratization process started ten years ago and it could be argued that ten years is not sufficient time to gauge progress.

However, having said that, Bahrain, as the rest of the region, does face challenges going into the future. If we look forward at the region in twenty years, I do not believe the political, economic or social fabric of the societies in the Middle East, do not have the means to meet the challenges in twenty years time. Therefore, there is a need to change and amend. This does not mean we have to go through ‘the tsunami’ we have seen this year, but it does mean being serious about change. We must make changes to political, economic and social setups that will create sustainable societies to meet the challenges of the future.

What are some specific, long-term reforms need to be undertaken that would help created a stable and sustainable society?

Specifically to Bahrain, one of the first things that needs to be taken into consideration is that when His Majesty the King conceived the idea of the democratization of Bahrain, there is one aspect of it that was missed. When you start to give people certain freedoms, there are also certain obligations on the society as citizens of the country.

Somehow this has been forgotten. When you look at Bahrain’s society, there is always a demand for the government to do things for the people but never the other way around. It is impossible to develop a society where the relationship between the government and the people is one-sided. We have a situation that is one party giving the other goods and services and the other offering little, and never happy with what he is given. I think it should be a two-way relationship.

The people have a certain obligation to participate in the decision making in a mature and responsible way. Setting up the institution of the parliament is not sufficient for democratization. There are still a number of people who are not part of the democratization whose opinion needs to be sought. This is one of the major shortcomings I see in the political situation we have at the moment. There is an insufficient amount of consultation that is taking place to capture, not only the angry words, but the wise thoughts and words of the people who helped build this country.

When you listen to people on the street, you get a reaction of what has been done but no direction to how to build the country. To get enough information you must not only listen to the people on the street, but other opinion that can offer wise solutions for the problems of the society.

Is there a political will to reform to the system to make the society sustainable or is there not a will and the country will face ‘a tsunami’?

I believe there is a will. The Bahraini people, at the end of the day, are mature enough to work through their own problems and create their own solutions. The challenge that you face are the challenges and pressures from outside. These come from not only people who do not share the same view as you, but also from so-called friends. It’s like having a quarrel in the family, the whole neighborhood gets involved, everyone has an opinion and their own advice.

But, at the end of the day, you have to accept it, this is the 21st century, we must manage the media, we must manage our neighbors, we must manage domestically and internationally and we must try to keep everyone in balance but be strong enough to tell others that while their opinions are very important, the most important views are those of my people. You must be disciplined enough to keep people at bay, and listen to them at the same time. Decisions must come from within.

Concerning the uncertainty in Bahrain and its business environment, there has been downgrading in Bahrain credit ratings, there have been repercussions on the private sector. How has the banking sector been effected since the events in February and what is the outlook for the banking sector for 2011?

The events have had many negative effects. The biggest risk that faces an investor or a banking sector is political risk. If you have problems with political risk then you have major problems. Having said that, Bahrain has, by and large, been able to meet its challenges. When you look at the commercial banking sector from a number of perspectives, from capital adequacy ratios to liquidity ratios they are in a very comfortable zone.

Going forward, if we do not see an improvement in the economy, there is likely to be a deterioration of the quality of the underlying assets, the assets they book in the country itself. For a certain amount of time, this can be handled, but going forward you cannot have such an unstable situation because the biggest factor in these assets is uncertainty. When there is too much uncertainty people will not participate in the market but delay purchases and investment decisions.

Bahrain just announced a large budget expansion that, hopefully, will get the entire economy moving. But I anticipate that the first thing the government wants to do is to settle the political issues and this is why there is the talk of a political dialogue to begin next month. Hopefully, when that is over, the plan to move the economy forward can begin.

There is another aspect of the banking sector which I have not yet mentioned, the investment banks.  They face the challenges brought about by the global financial crisis much earlier. Because of this, those banks still have legacy issues, regardless of what happened in Bahrain, going forward will be very difficult for them.

There are other banks who have been in a different situation that are still quite well capitalized, therefore, the future for these investment banks still holds some promise. I say that because the regulations for the investment banks are going through major changes that need to be looked at. The economic model for investment banks here is quite different from the model used in Europe and the United States.

What are the biggest challenges for the banking sectors in Bahrain? Also, do you think that more regulations are and answer to problems facing investment banks?

People have been looking for someone to blame for the global financial crisis and banks, particularly investment banks have been on the forefront of being blamed. This is a very simplistic way of reacting to a problem, it will not make the problem go away. There is a global movement to try to control and regulate investment banking to avoid repeating the crisis. The challenge for us is not having too many regulations, we are in a ‘global village’ and we must consider having similar regulations as in other places, we must have a common ground to work together.

I am less concerned with the change in regulations as I am with the speed of adoption. What I see in banking sector in the region is the pressure to adopt a lot of new regulations in a very short time. The alternative is to stretch the adoption of regulations over a longer time period to create a smooth transition into a new business model. Adoption of new regulations is not an immediate change, there are a lot of details, the banks are making a very big mistake by undertaking these changes so quickly.

They should stretch the time they are taking for these changes to a proper time line, perhaps 10 years, to make sure the proper changes are taking place. The alternative is the failure  of the investment banks and such activities will not come back for many years and all we will be left with will be commercial banks. Even in America, the investment banks were given plenty of time by regulators to change.

Also, with a few exceptions, most investment banks in this part of the world that have been effected by the global financial crisis have not been supported, unlike what happened elsewhere. Part of the reform that needs to be considered, in Bahrain and the rest of the region, is not just give support to housing projects etc. but also to assisting market institutions. Market institutions that stand on strong grounds will be better able to participate and be more active in the economy.

It is true that in the United States the major investment banks were saved by the government, but isn’t it a good thing that the market over here will take care of their inefficiencies, that only the strong ones will survive, the argument between to much regulation and government involvement and free market?

The theory is interesting, it reminds me of medicine in the middle ages, the first instinct was to bleed the patient and the patient eventually was bled to death. You can talk about ‘let the fittest survive’ but the damage that will cause in both the economy and trust in banks is far too great. What I am suggesting is a middle road. Try to save what can be saved, many investment banks only problem is liquidity. They invest and need to wait a few years before those investments mature enough to sell them. They have assets, they just do not have the cash flow that they need to survive.

It could be a question of liquidity, rather than a question of the quality of their assets. I’m not talking about supporting a bad practice, if there are bad decisions being made, one can replace the person making bad decisions with someone more competent. Surely, we don’t have to make the whole market suffer because of individual actions instead of isolating those actions and dealing with them.

You were established in 2008 and you have already posted a net income of 7.5 million dollars for 2010. How would you characterize you investment strategy vis-á-vis other investment banks in Bahrain and regionally? How are you different? What is your edge?

When we were established in July 2008, within two months the world was faced with the global financial crisis. We started looking very closely on what the repercussions of the crisis were on investment banking. At that time, this was very difficult, there were many different opinions, from doomsday to the beginning of a new era, much like the Arab Spring. Now, three years after the crisis, we are still seeing its effects, for example in Greece and the United States worries over governmental debt, we are certainly not out of the woods. Therefore, we decided our priority to manage the investor’s risk in a better way.

When we bring a product or an investment to a client we try to ‘de-risk’ it as much as possible, of course, it will never be risk free, but the more transparent you are, they fewer risks you will have to face. It is often less yield, but lower risk as well.

We first started in student accommodation in London for many reasons, education is a defensive sector and London is a large city very sought after in terms of its education both domestically and globally. We built three sites below budget with 90% occupancy and we are very happy with the entire investment. We began looking at niche markets and that produce income for the investor. Investors today in the GCC do not want to wait a long time for their return on investment and  and have as low a risk as possible.

This is possible to achieve by giving them a yield, for example, in the student accommodation, we give 6.5% on an annual basis and we hope to also achieve more when we exit. We started to produce three other products from student accommodation to a specialty finance company in the U.S. Also real estate and another London based investment in cinematic special effects. We are looking very closely at the region, especially at GCC.

The business model that is adopted in the region is that to underwrite a transaction, sell down the transaction and then move on. The challenge we are facing is that the regulators are putting pressure on use of balance sheets. They are concerned because if you are not able to achieve a sell down, that transaction gets stuck on your books and you have less liquidity to go for the next transaction. To deal with this they are limiting how much you can hold on your balance sheet and therefore, how much you can underwrite and commit to the market.

Basically, we are looking as the European, U.S. model where you have a general partner and a limited partner. The bank is the general partner, therefore it does not use it’s balance sheets and acts as an admin to the limited partners. They could call it, Student Accommodation Fund in London, and they will bring in a number of investors and investment opportunities, distributing the risk among a number of investments, rather than concentrated as it is now. It also limits the use of your balance sheet, using that of the investors themselves and you are getting a fee for it. This is how the major investment banks conduct themselves in Europe and the U.S. It is the transition from our present business model to this one that we need time for.

You must do this? By law?

If you want to continue to call yourself a bank and be allowed to take deposits, regulators will impose heavy restrictions on your business mode.

What makes you think that you business model and your investment decisions will succeed in the future? What would you identify as your main strength?

We do not have legacy issues and have the liquidity. We are also trying to come up with innovative products.

Would you have made the same mistakes as they did and heavily invested in real estate?

I very well could have, but, luckily when we started it was the end of the boom and we did not participate in that. After the financial crisis we had do decide how we would differentiate from the other banks and what our future would be. Not having an impaired balance sheet is very important for us, it gives us both confidence and liquidity. The first question that will be asked when you start a new investment is if you have the money and if you do you are in a much stronger position. I am feeling cautiously confident because the global economy has new challenges every day.

There is a lot of uncertainty in the global economy, some say that by 2012 the American dollar will have fallen. How do you, as an investment bank, manage this uncertainty and risk?

Unfortunately, this uncertainty makes it very difficult to take a long term view. You are likely to look at things on a shorter end which is not good for the global economy. You need long-view investors, they are around, but they are in much fewer numbers than they used to be because so many people are scared of the market.

You need to remain relatively medium-term, you also need to diversify your risk. We are looking at a fund today for mid-market private equity firms in Europe and the U.S. We are setting up the fund with another major European entity. There is value in this exercise because it manages and distributes risk.

You must manage your risk and, if you can, get a cash yield from your investments. With real estate that is possible by adding some value to your property and earning a cash yield. However, with private equity you usually take over a company, add some funds to it and try to sell it four or five years later at an enhanced price. That is going to be the challenge going forward, managing risk and liquidity.

Who are you talking to? Who are your clients? Who are you trying to attract?

We have a number to counter parties. We look at institutions as well as high and ultra high net worth individuals in the GCC. People with a surplus of funds who want to have a diversified or complimented risk. If they are in real estate and real estate is a big market with several sub-asset classes, they could be residential but like the student accommodation or health services or elderly homes because these compliment the investments that they already have. At the same time we are trying to build investment capabilities in the region as well as a number of projects in the region.

The private equity model in this part of the world has its challenges because a lot of the private sector institutions are family owned, it is very similar to Germany a few years ago, with large numbers of mid-market companies that are very well managed by the families for generations and very profitable. Getting these families to let go is next to impossible.

We have the same thing here. I had an experience with this a few years back, after a talk with the family I called my guys and just said, ‘forget about it’ the family wants the money to expand but their heart is in a different direction. We were prepared to allow them to continue to manage it but we would have the majority ownership and final say.

Where do you see yourself in five years? What is your vision? Your dream?

What I hope would happen to Oasis Capital Bank in five years time is that we will have the stability and foundation to continue to do deals on a regular basis.

We hope the name will be known in the market. It takes time to create brand awareness and time to create trust in a brand. The cycle of one of our investments is three to five years, so what you’re asking is really ‘what do you hope to accomplish in one cycle?’ and I hope I can deliver. But is that sufficient to create deep trust?

Realistically, no. I am hoping in five years time there will be the beginning of trust and the beginning of a cycle of an institution that will develop the market. I still see the development of the capital market here having some way to go, we have not had enough desires translated into action to build the pillars of the capital market, hopefully in five years, we will have these pillars.