By Mark DeWeaver.

I thought Sansar Capital’s recent report on the Iraqi banks was excellent. But I was surprised by its somewhat negative take on North Bank (BNOR). In particular, I found myself not entirely convinced by the following three points, which form the basis for their bearish case:

1. Insufficient collateral for overdraft lending is a significant risk. Actually, this is only true if the bank has no ability to assess the cashflow situation of its customers. This is unlikely to be true of BNOR’s corporate overdraft clients, which include large cash-rich companies such as Asiacell.
2. The new Central Bank of Iraq (CBI) auction rules threaten the growth of BNOR’s forex business. This will only be true if the bank’s customers are unable to find a way around the rules. But in fact they have in the past displayed considerable ingenuity in adapting to the CBI’s ever-changing forex policies. It’s not clear why this time should be different.
3. The absence of auditors’ qualifications in the English translation of the 2011 annual report implies an effort to mislead foreign investors. Maybe. But in the bank’s favor, it’s worth pointing out that (1) these qualifications did not appear in the Arabic version of the 2012 annual report, (2) unlike most of the other banks, BNOR has at least gone to the trouble of having its annual report translated, and (3) when meeting with the bank’s management in person I have always found them to be extraordinarily candid.

In addition to this, the bank is one of Iraq’s best capitalized, being one of only three to have reached the CBI’s IQD 250 bn share capital target. It has also been one of the top performing names in the Iraqi market. Adjusted for capital increases, the shares have risen by over 250% since 2009.

What’s not to like?

The security situation in Iraq hasn’t looked this bad in quite a while. Following the killing of at least 36 Sunni protestors in Hawijah on April 23, people are now even talking about a possible partition of the country. “It is wrong to say we are getting close to a civil war,” one Iraqi politician told the Guardian. “The civil war has already started.” (See this story.)

Yet Iraq Stock Exchange (ISX) investors don’t seem to have noticed. If a return to the sectarian conflict of 2006-2007 were imminent, Iraqi stocks would have crashed. Yet since the Hawijah massacre the Rabee Securities RSISX index has risen 2.8% (as of May 9). It’s up 11.6% year to date.

The market seems to agree with Joel Wing’s assessment in a recent piece for Foreign Policy. He argues that “growing support for the wider insurgency does not mean that Iraq is heading towards a new civil war” because:

(1) “Most operations by militants are in specific cities, and even then only affect a small percentage of the population” and

(2) “So far, the Shiite community is relying upon the government to take care of security rather than taking matters into their own hands.”

As long as these two points are correct, it’s easy to see why ISX investors should be unfazed. Sporadic terrorist bombings and gun battles between the Iraqi army and insurgents in particular neighborhoods result in tragic loss of life but don’t add up to a ‘civil war’. And as long as most Iraqis remain unaffected, increased levels of violence just aren’t going to have any material effect on GDP growth and the earnings of the listed companies.

By Mark DeWeaver.

On March 3, the ISX posted the following notification on its website:

“No institution or competent body has requested a license to act as custodian pursuant to Decree No. 17 of 2012.

“Therefore, the Depository Centre remains the sole body conducting the transfer of securities from the account of the investor [registered] with the Centre to the account of the investor [registered] with the broker and vice versa in accordance with the procedures and applications of electronic trading on the Iraqi Stock Exchange.

“Please be advised of the above and [of the fact that] the Board of Governors has a plan to encourage Iraqi and non-Iraqi financial and banking institutions who wish to provide this service.”

(The original Arabic version is available here. Hat tip Ali Albazzaz for this excellent translation.)

This took me a bit by surprise. As I wrote in my last post, National Bank of Kuwait (NBK) seems to be all set to start custodying Iraqi shares. Fellow Iraq fund manager Ali Albazzaz and I also coauthored two articles that mentioned NBK’s custody breakthrough–one for the Financial Times “Beyond Brics” blog, the other for the Emirates leading English-language paper, the National.

Has the ISX contradicted our story? Well, not really. We were wrong about NBK’s subsidiary Credit Bank of Iraq (BROI) having a custody license. They actually have a letter of authorization from the ISX Board of Governors. Thus, BROI’s authorization comes from the ISX rather than the Iraq Securities Commission, which issues licenses.

But does this make any difference to the foreign investor?

Given that custodians do not usually take over the functions of depository centers, it is also unclear what the second point in the notification signifies. Presumably the Iraq Depository Center (IDC) would transfer shares among depository center accounts in any case. Is the ISX simply making sure everyone understands that NBK will not be replacing the IDC?

Finally, what is the Board of Governors’ plan to encourage those who wish to provide this service? Will the ISX be using Letters of Authorization as a means to do this, as the case of NBK might suggest?

Given the importance of the custody issue to foreign investors, it would be helpful to have a bit more clarity on what the ISX is trying to tell us.

By Mark DeWeaver.

In a move that is likely to mark the start of a new era for the Iraq Stock Exchange (ISX), National Bank of Kuwait (NBK) has begun offering custody support services for ISX-listed shares through its 80%-held subsidiary Credit Bank of Iraq. This is arguably the most important step forward for the ISX since the implementation of electronic trading in 2009. At last the door is open for large institutional investors to enter the Iraqi market. (See this post for more on the significance of the custody issue.)

Credit Bank of Iraq received a letter of authorization to offer custody support services at the end of last year and just “went live” in January. So far the business has focused on custodying shares from the Asiacell IPO but they are now set up to custody all the existing names as well.

NBK will be an acceptable counterparty both for institutional investors and (as a subcustodian) for global custodians. With about US$ 58 billion in assets, it is Kuwait’s largest bank and also one of the largest in the Middle East. It has also been on Global Finance magazine’s list of the world’s fifty safest banks for the past six years and is the top rated bank in the region. In addition, NBK’s custody services now cover not only Iraq but also the GCC and Egyptian markets—an important consideration for institutions looking for a “one-stop shop.”

With a custodian of this caliber on board, the ISX is now in a position to mobilize significant amounts of foreign capital. This is important not only because the listed companies will have greater access to financing but also because increased participation by international investors will incentivize the introduction of best practices at local financial institutions. NBK’s custody breakthrough is thus a breakthrough not only for the Kuwaiti bank and its clients but for Iraq’s capital markets as well.

John Lee.

Zain Iraq‘s Chief Financial Officer, Wael Ghanayem (pictured), has told Bloomberg that the company plans to list 25 percent of its shares on the Iraq Stock Exchange  (ISX) by the end of June.

But Geoffrey Batt, managing director of the $44 million Euphrates Iraq Fund, told the news agency:

“A more realistic estimate is Zain will be positioned to list about six months after they convert to a joint stock company … At the moment, they need to overcome too many procedural hurdles to list by June 30.”

The share sale plan follows the successful IPO of rival Asiacell, which started trading in Baghdad earlier this month.

Zain Iraq is in the final stages of converting into a shareholding company, and has hired Citigroup, National Bank of Kuwait and BNP Paribas as advisers for the offering. The company’s profit climbed 6 percent in 2012 to $369 million and it expects “double-digit” growth this year, Ghanayem said.

Korek Telecom, part-owned by France Telecom, must also sell 25 percent of its shares on the bourse to comply with it license requirement.

(Source: Bloomberg)

By Mark DeWeaver.

I’ve often thought there should be a Nobel prize for corporate finance. It would go to the broker or investment bank that managed to place the largest IPO under the most unpromising circumstances. If there were such an award, I think Rabee Securities and its affiliate Melak Iraq would easily win this year after single handedly placing over US$ 1.25 billion worth of Asiacell shares. (There’s more on the Asiacell IPO here and here.)

This IPO presented a number of extraordinary challenges. Consider the enormous size of the offering, which was equivalent to almost a quarter of the entire ISX market cap. It never seemed possible that a block of shares this large could be entirely absorbed by local investors. Yet foreign investment banks decided to pass on the deal, which also made it seem unlikely that the shares could be placed abroad.

In the absence of a securities law, the IPO also had to be done without an underwriter. There was no guarantee that the entire offer would be taken up, nor could a single price be set for the shares based on investors’ bids. Instead, a minimum price was set (IQD 22) and the bids were simply fed into the exchange’s normal order-matching system. Investors had relatively little assurance that the price they paid would turn out to be a real market clearing price.

Yet despite these difficulties, Rabee and Melak have managed to pull off the largest IPO in the MENA region in the last five years. Congratulations to both for a job well done!

By John Lee.

Writing in the Financial Times, a partner at a London-based financial advisory business suggests Iraq as a true frontier market investment.

Citing precedents such as Japan in the early 1960s and Russia in 1995, Richard Greer, a partner at Laurel Capital Kingsway LLP, says:

“The greatest opportunities for emerging market investors have always come when political chaos coincides with a dire media consensus, and a major underlying economic improvement is thereby ignored. Iraq stands firmly in this tradition of missed investor opportunities.“

He says that despite the political tensions, many listed Iraqi companies achieved record profits in 2012, there is the beginnings of some sense of civil order, the accumulation and investment of corporate cash, and a widening economic growth.

While energy companies such as Genel Energy, Sterling Energy, and Gulf Keystone Petroleum (GKP) have been investors favourites, Greer says the domestic companies on the Iraq Stock Exchange (ISX) are still waiting to be discovered by international investors.

You can find our latest weekly stock market report here.

By Mark DeWeaver.

On December 13 the ISX amended the Iraq Depository Center (IDC) bylaws to prohibit investors from owning the same names in accounts at different brokers. The new rule, which went into effect on January 7, requires anyone holding stocks in the same company through different brokerage accounts to transfer all of their shares to just one of them. The ISX may penalize those who don’t comply by barring them from trading.

This change is evidently intended to crack down on share price manipulation. Ramping share prices is easy to do if you can sell shares back and forth between two accounts. You simply sell the shares to yourself multiple times at higher and higher prices. Then, once ordinary investors start to jump on the bandwagon, you gradually sell off your holding to them and get out at a profit.

It’s easy to see why the ISX should be cracking down on such behavior at this point. With the Asiacell IPO starting this month, ISX officias are understandably focused on maintaining an orderly market. There were also a few names that had been limit up for several days prior to the announcement and fell sharply immediately afterward. In hindsight, these cases look more than a little suspicious.

This rule change won’t end share price manipulation for long, however. In the very short term, speculators may have been caught off balance because they will no longer be able to use some of their brokerage accounts. But it won’t take them long to set up new accounts in different names. Then they will quickly get back to business as usual.