Islamic investment firm Arcapita Bank recently reported a turnaround to profit in its financial year ended the 30th June 2011, following two straight years of losses as a result of the tough operating environment brought on by the global financial crisis.
Due in part to operational efficiencies, Arcapita’s better performance is also attributed to the improvement in world economies and market conditions in the 12 months to June this year.
However, with financial markets once again in a state of fragility, Arcapita, which is involved in private equity, real estate and infrastructure investing, venture capital and investment placement, will need to continue solidifying its position or risk seeing its return to the black short-lived.
A good year
The bank’s return to profitability, which saw it report a net income of US$50.16 million against a net loss of US$559.39 million last year, was contributed not just by higher recurring and other income and management fees, but by a turnaround in investment banking income, fair value adjustments and foreign exchange gains, amounting to US$194.79 million. Last year, Arcapita reported a combined US$401.48 million in mark-to-market, foreign exchange and investment banking losses.
In addition, better market conditions afforded a more favorable environment for Arcapita’s core private equity business and opening up more opportunities for it to exit its investments. It completed seven full and partial divestments from its portfolio which returned US$1 billion to the bank and its shareholders in the 2011 financial year, compared to just three exits in 2010,.
“Based on generally improving sentiment, our expectation at the beginning of the financial year was for a return to growth and economic stability,” said Atif Abdulmalik, CEO of Arcapita in a statement accompanying its financial results.
He added that: “Market fundamentals have remained volatile, but by focusing on the areas within our control, protecting the bank’s investment portfolio, delivering exits where appropriate, operation efficiency and close management of the balance sheet…we have made our income target for the year. We also continue to make progress in adapting our business to the changed market fundamentals and the evolving needs of our investors.”
Nonetheless, the bank’s income statements continue to show some shortcomings, namely in its vulnerability to movements in asset valuations and higher allowances for doubtful receivables, which grew to US$100.99 million in 2011 from US$68.23 million last year.
Out of the frying pan, into the fire?
Even as Arcapita comes out of one challenging period, it seems it is again seeing trying times, thanks to the current uncertainty in global economies and markets in addition to political uncertainty brought upon by the Arab Spring.
“The board’s view is that over the short term, the global macro environment will remain constrained by slow growth and continued sovereign debt problems. Against this background, we expect that Arcapita will continue its focus on strengthening the balance sheet and leveraging its global investment platform to deliver steady growth targets for next year,” said Mohammed Abdulaziz AlJomaih, the chairman of Arcapita’s board of directors in the bank’s financial results statement.
Its balance sheet strengthening has been in progress since its 2010 fiscal year, when it eliminated all of its short term interbank liabilities, and has continued in its just-concluded financial year.
With expectations that markets may again take a turn for the worse in the coming months, building up its balance sheet further may be one of Arcapita’s best bets to buffer any future downside.
It will also have to continue diversifying its sources of recurring and other income and management fees, given that a large chunk of its total income is vulnerable to the asset price fluctuations.
In addition, the private equity market in the Middle East has been dealt a blow by political upheaval in the region, causing fund raising levels to slump and investor confidence to dive. “We as private equity firms would like to forget about 2011 and pretend it never existed,” Emad Mansour, CEO of Qatar First Investment Bank, was recently quoted as saying, while Mustafa Abdel-Wadood, CEO of private equity firm Abraaj Capital, said that the Arab Spring created short-term volatility and a challenging environment in which to secure funding for investments.
Diversifying income
To its credit, Arcapita began taking measures to diversify its business in 2010. Following a review of its business conducted last year, it has since identified the funds business as a new area on which it can rely to help take it to its next growth phase.
“Alongside its core business of deal-by-deal investments, Arcapita has made good progress in building its funds product offering, building on its track record in the industrial warehousing sector to develop several funds during the year, in Asia, Europe and the Middle East. The bank has also built out its infrastructure team in preparation for similar product expansion within this asset class,” it said.
The development of its funds business continues from efforts it put into the division last year, when it moved to offer funds for investment by international institutional investors.
“We expect that funds will produce predictable, recurring revenue streams to balance the transaction-based revenues from our deal-by-deal model,” it said, adding that the addition of the funds business comprised a strategically important addition to its overall operations. Its first fund launched under this new initiative was the ARC Real Estate Income Fund, set up with Al Rajhi Capital.
With global financial markets behaving like a ticking bomb, Arcapita has little choice but to brace itself for a repeat of the recent drought, despite having just turned over a new leaf this year. As the challenging operating environment continues, the bank may need to pin its hopes onto a more diverse income stream to get through what may be another tough year ahead.