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Stocks Brace for Iraqi Election

By Mark DeWeaver.

This hasn’t been a particularly good year for Iraqi stocks. So far the Rabee Securities Index (RSISX) is down 3% year-to-date and off 8% from its recent high on January 28. The ISX index has been dropping all year. It’s now down 5% year-to-date.

Uncertainty in the run up to Iraq’s April 30 parliamentary elections seems to be the most obvious explanation for this downturn. Market participants may well be expecting a repeat of the last elections, on March 7, 2010, after which the government formation process lasted until November 11. That year the RSISX was already down 12% from its November, 2009 pre-election peak by election day. It fell a further 8% before finally rebounding in October. (See chart.) Investors could hardly be blamed for getting cold feet this time around.

But this year is unlikely to be a rerun of 2010 for three reasons. First, Iraqi oil production is set to jump sharply. This should lead to strong growth in the money supply—always a positive for asset prices. Second, bank capital increases will be less of an overhang than they were four years ago as many banks have already met the central bank’s final capitalization target of IQD 250 bn. Finally, there isn’t really that much uncertainty about the outcome of the election. Presumably some compromise will once again be reached after a protracted period of government formation. The situation will continue to be bad but there is no reason to expect it to get worse.

This time, look for Iraq’s strong economic fundamentals, rather than its fractious politics, to be the main driver for stocks.

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Why Two Exchange Rates?

By Mark DeWeaver.

Since the Central Bank of Iraq (CBI) began changing the rules for its USD auctions in 2012, Iraq has been operating a de facto dual exchange rate system. (There’s a summary of some of the CBI’s recent rule changes on pages 12-14 of this report from Sansar Capital.) For those with access to the CBI auction—mainly banks and (as of March, 2013) importers using letters of credit—the rate has been fixed at IQD 1,166: USD 1.00. For the rest of us, the dinar has ranged from 1,194 to 1,292, with two major episodes of depreciation in mid-2012 and mid-2013 (see chart).

The ostensible purpose for this arrangement is to limit illicit outflows of foreign exchange to Iran and Syria. In practice, it serves mainly as a subsidy to banks, large importers, and anyone in a position to generate phony trade documents. The losers include everyone from foreign investors in Iraqi stocks to the government itself, which gets the CBI rate on its oil-export revenues.

Iraq is unusual in this regard. Dual (or even multiple) exchange rates are usually only found in countries suffering from chronic trade deficits and foreign exchange shortages. Typically the objective is to make foreign exchange available for “essential” imports or to control inflation by lowering import prices. Examples include Hitler’s Germany, China in the 1980’s and early ‘90’s, Burma prior to 2012, and Venezuela today. (See this note from the Asian Development Bank for an excellent introduction to this topic.)

It’s hard to see why Iraq belongs on this list. The country has a trade surplus, inflation is low, and the central bank has ample foreign exchange reserves. Even USD outflows to Iran are presumably no longer a major issue.

One exchange rate should be enough.

Posted in Investment, Mark DeWeaver on Investments and FinanceComments (9)

Another Look at Corporate Actions

By Mark DeWeaver.

In this old post from 2010, I considered the possibility that ISX share prices might fail to adjust completely for corporate actions. There didn’t seem to be much evidence for this but it was a bit hard to be sure. In those days, stocks would generally be suspended for a number of months following rights and bonus issues. Discrepancies between theoretical and actual ex rights prices might as easily be due to developments during the long intervals between cum rights and ex rights trading dates as to a failure to reflect changes in the number of shares in issue.

In September, 2011, the ISX changed the rules on stock suspensions to allow trading to resume within four weeks of shareholders’ meetings (see this post). Following this dramatic reduction in suspension periods it should be now easier to identify departures from theoretical ex-rights prices. Given the importance of corporate actions to ISX investors, I thought it would therefore be worth revisiting this question with some more recent data.

Since the end of 2012, the “Corporate Actions” table in the Rabee Securities monthly gives 78 examples of rights, bonus, and dividend issues. Taking out cases where the cum rights price was below IQD 1.00 (in which case minority shareholders would be unlikely to subscribe) and a few others where I thought the stocks were too thinly traded for the prices to be meaningful, I ended up with a sample of 49 observations.

The chart shows the premium/(discount) of actual to theoretical ex-rights prices, where the theoretical price is the last traded cum-rights price adjusted for rights, bonuses, and dividends. For example, if the cum-rights price were IQD 2.00, following a 50% rights issue, a 30% bonus issue, and a IQD 0.25 dividend, the theoretical ex-rights price would be: (2.0+0.5-0.25)/(1.0+0.5+0.3)=1.25. (Note that the dates following the ticker symbols on the x axis are for the start of ex-rights trading.)

In half of the cases actual prices deviated by no more than 5% from the theoretical prices; two thirds of the time the difference was no more than 10%. Extreme examples of over- or under-adjustment were relatively rare.

Once again there doesn’t seem to be much reason to expect outsized gains or losses following corporate actions.

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Does ‘Mental Accounting’ Matter?

By Mark DeWeaver.

ISX observers sometimes blame share price declines on people selling their recently listed bonus or rights issue shares. Such behavior would be interesting to document because it seems to imply a departure from perfect rationality. From the point of view of conventional finance theory, there just isn’t any reason to differentiate between different lots of the same name.

If you’re holding twelve shares of company X and today’s market price is IQD 2.00, for example, the only thing that should matter to you is that your position is now worth IQD 24.00. And the only thing that should matter for your sell decision is what you think the shares will be worth tomorrow. What you originally paid for them shouldn’t make any difference.

Yet it seems that some investors tend not only to sell winners more readily than losers (see this article) but also to keep track of rights and bonus shares in separate “mental accounts.” The person with twelves shares worth IQD 2.00 each might think of herself as holding three positions. Perhaps she imagines one 10-share position, originally acquired at IQD 2.50, on which she has lost IQD 5.00; a rights share position on which she has made a IQD 1.00 profit; and a bonus share position with a IQD 2.00 profit.

If this kind of thinking is common, listing dates for new rights and bonus shares would take on a special significance. They would generally be occasions on which large numbers of people suddenly found themselves in a position to close mental accounts at a profit. There might then be a tendency for these to be times when the shares in question significantly underperformed the market.

To test this hypothesis, I looked up all the rights and bonus issues since the end of 2012 and identified 31 for which I could find the listing dates for the new shares. (Perhaps the most user-friendly source for this information is the “Corporate Actions” table in the Rabee Securities’ monthly.) And indeed there was some underperformance. In the average case, I found that the shares underperformed Rabee’s RSISX index by 1.05 percentage points on the initial day of rights and bonus share trading.

But it turns out that 1.05 percentage points isn’t statistically significant. The trouble is that the variation of the listing-date relative returns is quite high. While there were 20 cases of underperformance—by as much as 9 percentage points—there were also 11 cases of outperformance—by as much as 7 percentage points. Unfortunately for anyone hoping to base a trading strategy around mental accounting (or, as in my own case, write a behavioral finance article on the subject), the null hypothesis of no underperformance cannot be rejected.

This isn’t to say that Iraqi investors never assign bonus and rights shares to separate mental accounts from the rest of their holdings. If they do, however, it remains unclear whether or not this has any systematic effects on the market as a whole.

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In State Banks We Trust

By Mark DeWeaver.

2013 was another strong year for deposit growth at the ISX-listed banks. Deposits at the 19 names that have so far reported year-end financials were up 17% year-on-year as of December 31. (Only BDFD and BELF, which together accounted for 8% of 2012 listed-bank deposits, have yet to report.)

While their deposit growth slowed from 32% in 2012, these 19 banks nonetheless continued to outpace the rest of the sector, where deposits rose by only 10%. As a result, their share in the deposits component of Iraq’s M2 money supply rose for a second year to reach 13%. (Click here for full-sized chart.)

This is the highest share in at least six years. Nevertheless, it represents only a modest improvement from the 10% low in 2011.

Clearly the playing field remains steeply tilted in favor of the state-owned banks. These lenders not only enjoy a virtual monopoly on government deposits but also accounted for 60% of private sector deposits as of year-end 2012. They held about 85% of total deposits, despite having only a fifth of total bank-sector capital and somewhat fewer branches—479 versus the private banks’ 515. (See pages 27 and 112 of the central bank’s 2012 bulletin.)

From the depositor’s point of view, the state-owned banks’ obvious advantage is their lack of bankruptcy risk. While private banks have been allowed to go under, it is highly unlikely that state-owned institutions would be permitted to suffer a similar fate. The central bank can always be counted on to rescue them in a crisis.

This means that the private banks’ deposit share is likely to remain low for the foreseeable future. In the absence of deposit insurance or any effective mechanism for dealing with bank failures, depositors can hardly be blamed for continuing to view the state banks as their safest bet.

Posted in Investment, Mark DeWeaver on Investments and FinanceComments (4)

A Vote of Confidence for BDSI

By Mark DeWeaver.

So far this has been a bad year for shareholders of Dar Es Salaam Bank (BDSI). Adjusting for July’s 23.2% rights and 18.5% bonus issues, the shares are down 36% year-to-date (as of September 10). This compares to a ytd return of -5% for the ISX index and +6% for Rabee Securities RSISX index.

This dismal performance is mainly due to the decision of majority shareholder HSBC to exit its position. The British bank announced in June that it was looking for a buyer for its 70.1% (pre-rights issue) stake and that it would not be subscribing to BDSI’s rights issue. (See this story.) Indeed, getting rid of BDSI now seems to be quite high on the HSBC “to do” list. At one point it even offered to give away its stake for nothing! (This offer was blocked by the Iraqi regulators, however.)

Without HSBC as a shareholder, BDSI could conceivably lose a sizable share of its current business. But this does not necessarily mean that earnings growth will suffer. There is likely to be considerable room for the bank to expand into new areas.

Lending is the most obvious example. As of the end of June, BDSI’s loan/deposit ratio was a mere 2%, the second lowest among the listed banks. The average for the sector is 40%. HSBC’s approach to risk management in Iraq has clearly been unduly cautious. With a new majority shareholder, BDSI may be in a position to grow its loan book considerably, thereby replacing lost fee and commission revenue with interest income.

It is also encouraging that the bank recently increased its capital from IQD 105.8 to IQD 150 billion. Following HSBC’s decision not to take up its rights, its rights shares were offered to the public and were reportedly oversubscribed. The biggest subscriber is said to have been one of the local investors in last February’s Asiacell IPO.

This vote of confidence had an immediate effect on the share price. Since closing at a multi-year low of IQD 1.07 on August 28, the last day of the subscription period, as of September 10 BDSI is up 26%.

Life without HSBC might not be so bad after all.

Posted in Investment, Mark DeWeaver on Investments and FinanceComments (5)

Stock Exchange Upgrades to NASDAQ Technology

The NASDAQ OMX Group has entered an agreement with the Iraq Stock Exchange (ISX) to upgrade its current trading platform. Under the terms of the agreement, ISX will replace its existing NASDAQ OMX platform (Horizon) with one powered by the renowned X-stream technology. The upgrade is expected to be rolled out by mid-year 2014.

“We are committed to becoming one of the most innovative and groundbreaking exchanges, in the Middle East and across the world,” said Taha A. Abdulsalam, CEO, Iraq Stock Exchange. “Upgrading our trading technology and continuing our partnership with NASDAQ OMX is a clear indication to investors, regulators and other exchanges that Iraq will continue to become a financial center for more regional and global businesses.”

The upgrade to X-stream will provide ISX with a widely deployed high-end, multi-asset trading platform that complies with international standards. The migration to X-stream is a step in ISX’s ambition to become a Middle Eastern hub, able to host and facilitate other regional markets. NASDAQ OMX has delivered trading technology to ISX since 2007.

“We congratulate the Iraq Stock Exchange on their commitment to a trading platform that is certain to put them at the technology forefront of exchanges in the Middle East,” Lars Ottersgard (pictured), Senior Vice President, Market Technology, NASDAQ OMX. “The upgrade to X-stream technology will equip ISX with a sophisticated and robust trading platform that increases investor involvement both in the Middle East and internationally.”

In less than a decade, traded shares in ISX increased almost 10-fold, to more than 1.2 billion traded shares expected in 2013, while market capitalization increased more than seven times over the same period to over $12,170 billion USD in the first six months of 2013 alone.

“We are extremely proud to support ISX’s positive development and their vision to provide a well-recognized marketplace in the region,” said Michèle Carlsson, Head of Business Development, Middle East and Africa, NASDAQ OMX. “ISX recently implemented one of the most successful IPOs in the Middle East and by upgrading to our X-stream technology, ISX will be running a resilient market place that will attract both Iraqi and international investors.”

(Source: NASDAQ OMX)

Posted in Banking & Finance, InvestmentComments (1)

Capital Increase Déjà Vu

By Mark DeWeaver.

A year ago I wrote a post called “Will the Banks Get More Time,” in which I argued that most of the ISX-listed banks weren’t going to make the central bank’s deadline of June 30, 2012 to reach IQD 150 bn in paid-up capital. I posted pretty much the same thing back in May, 2011 (see this post), when the banks were having trouble meeting the June 2011 target of IQD 100 bn.

Today it’s looking like “déjà vu all over again.” This time the deadline is June 30, 2013 and the CBI’s final target of IQD 250 bn is fast approaching.

Rabee Securities’ most recent bank-sector report found that as of May 23 only 5 of the 21 listed banks had either reached the target or would reach it once ongoing capital increase procedures were completed. (The five were BKUI, BMFI, BMNS, BNOR, and BUND.) Two banks—BDFD and HSBC-subsidiary BDSI—have yet to reach even last June’s IQD 150 bn target. In aggregate the banks still need to increase paid-up capital by a further IQD 1.6 trillion from the current total of IQD 3.5 trillion.

The CBI now has the same three options it had last time. It can (1) give the banks more time, (2) force some of them to merge, or (3) shut down those that miss the deadline. I think (2) and (3) are quite unlikely, simply because none of the banks appears to be at risk of failure. Most are already more than adequately capitalized for the amount of lending they do.

Giving the banks more time is clearly the most sensible option. This is also what the CBI did in 2011 and 2012. In both cases the deadline was extended by six months.

Once again I find myself asking “why should this time be different?”

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