Mixed results for Kuwaiti banks

Kuwait’s financial system adequately mirrors that of the entire Middle East. While some areas have shown resilience, others remain weak and risk weighing down their countries' banking systems as a result. However, in Kuwait positive signs such as a government-approved $100bn development plan are providing respite for a sector that is still reeling from the global crisis.

Although Kuwaiti banks were profitable in the first half of 2010, performances for the whole of 2010 varied widely. While some banks reported robust profits and adequate asset quality ratios, others reported continued low profitability due to high non-performing loan (NPL) rates and weak asset quality.

NBK dominance

National Bank of Kuwait (NBK) dominates the country’s banking sector. It is Kuwait's largest bank in asset terms, with assets up 2.2% in 2010 to Kd12.9bn ($46bn), and reported net profits of Kd301.7m, almost 14% up on the Kd265.2 achieved in 2009. Other profitability indicators for 2010 remained strong by regional and international standards; NBK's return on assets was 2.4%, while its return on equity was a sizeable 17.7% for the year.

Although operating income was down 9% year on year, due to lower net interest income, operating expenses decreased 12% due to lower administrative expenses.

Ultimately NBK’s asset quality and profitability proved extremely resilient to the economic slowdown. Ibrahim Dabdoub, CEO of NBK, says: “We have over the years maintained the highest asset quality indicators by regional and international standards, despite the ongoing economic challenges.”

NBK is one of many Kuwaiti banks looking to gain from the government-approved development plan. Mr Dabdoub says: “By the end of the first quarter, [NBK] will have at least one or two more contracts. The economic activity of the country depends upon government expenditure. The budget is there so we hope to see better economic activity this year.” 

He adds: “Our strategy in Kuwait and the Middle East and north Africa region was complemented in 2010 by receiving a licence to start operations in Syria, another large market with significant potential. In addition, we increased our stake in Boubyan Bank to 47%, strengthening our market position in the Islamic banking segment in Kuwait.” NBK’s operations outside Kuwait remained very strong in 2010, contributing more than 20% of the bank’s profits.

KFH's mixed year

In the case of Kuwait Finance House (KFH), the country’s largest Islamic bank and largest bank in Tier 1 capital terms, net income declined by about 9.3% in 2010 to Kd105.9m, from Kd116.7m the previous year. KFH was still the second most profitable bank in Kuwait, due to its large Islamic banking franchise and the wider margins it is able to earn. Although asset quality suffered from the bank’s high exposure to investment companies and the real estate sector, ratings agency Fitch considers the bank's “profitability and capital [to be] sufficient to absorb any potential losses”.

Fourth-quarter profit at KFH, the biggest Islamic lender within the whole of the Gulf, fell 29.2% in 2010. The bank made Kd8.7m in the three months to December 31, compared with Kd12.3m in the prior-year period, according to data from Reuters. Two analysts polled by Reuters had estimated an average fourth-quarter profit for KFH of Kd36.4m.

Risk issues

According to local analysts, both the financial crisis and economic slowdown in Kuwait exposed the weakness of some banks’ risk management practices. It also uncovered the risky nature of their lending methods in a market with limited opportunities for sound lending.

Elham Yousry Mahfouz, acting CEO of Commercial Bank of Kuwait (CBK), says this has been one of the lessons learned. “We took growth for granted and were aggressively chasing profit and not necessarily studying balance sheets and weighing up the pluses and the minuses,” she says, adding that Kuwait's banks are now looking more thoroughly at the quality of their assets.

CBK's improvement

CBK’s profitability in 2010 certainly showed some improvement, rising to Kd40.5m from a mere Kd146,000 in 2009. Other performance indicators showed a return to profitable growth, with a return on assets of 1.12% and a return on equity of 8.95% (in 2009 it was only 0.03%). The charge for impairment and other provisions for credit facilities and investments was Kd51.2m for 2010, a significant reduction compared with the Kd130.8m of 2009. Asset quality indicators showed improvement, although the bank has one of the highest NPL ratios in the region.
 
CBK’s total assets at the end of December 2010 reached Kd3.62bn (up slightly from 2009's Kd3.59bn) with shareholder equity of Kd465.9m (up on 2009's Kd439.9m). Its capital adequacy ratio at the end of December 2010 was19.96% (at the end of 2009 it was 18.22%), which exceeds the minimum 12% required by the Central Bank of Kuwait. The bank continues to have a strong capital base with more than twice the international ratio required by Basel II. 

Risk management and lending practices have improved in Kuwait, with industry players all pointing to the changes in management across the country's banking system as well as a more thorough approach to lending practices. David Thorpe, general manager at CBK explains the rigorous process clients have to go through in order to apply for a bank loan today. “Whether they are from well-known wealthy families or not, the clearing process will be the same,” he says.

Gulf Bank profits

Gulf Bank, Kuwait’s second largest commercial lender, reported a net profit of Kd19.1m for 2010, compared with a loss of Kd28.1 m in 2009. In line with its conservative policy; however, the bank retained the largest portion of the profit to increase specific and excess general loan provisions. Gulf Bank lost about $1.3bn in derivatives trading in 2008.

Ali Al-Rashaid Al-Bader, chairman of Gulf Bank, explains this improvement as “the outcome of applying a new strategy of focusing on core banking activities, the growth in the bank’s credit facilities to productive economic sectors, as well as the expansion in banking services in general”.

“These results also reflect the bank’s conservative policy of building excess internal reserves, enabling it to enhance its capabilities of growth and expansion,” he adds. Mr Al-Bader also points to the general improvement in the country’s economic conditions, as well as the five-year development plan projects which “had an obvious effect on attaining these results”. In February, Kuwait’s parliament approved an investment plan involving oil and gas production, the construction of a rail network and metro, airport expansion, new cities, hospitals, roads and a port on Boubyan Island.

Burgan's stellar year

Meanwhile, medium-sized Burgan Bank announced significantly improved financial results in 2010 with net profits rising to Kd4.7m.The bank has reported operating profit of Kd99m for the year. A reduction in NPLs and credit losses reflects a decreasing trend in provisioning. Burgan's regional subsidiaries have also recorded profits.
 
Commenting on the bank's results, Burgan chairman Majed Essa Al-Ajeel says: "Our latest financial results reflect a positive turnaround in profitability. The second half of the year was a turning point in the bank's operations, whereby our regional diversification strategy has helped to place us on very solid ground to meet the opportunities ahead. The results, which also include the bank's consolidated share of income from our regional banking subsidiaries – Bank of Baghdad, Gulf Bank Algeria, Jordan Kuwait Bank and Tunis International Bank – continue to record increasing growth trends."

Best of the rest
 
Looking at other banks, Al Ahli Bank of Kuwait saw a significant 35.7% rise in net profits for 2010 to Kd53.2m from Kd39.2m the previous year. And the smaller Islamic outfit, Boubyan Bank, which is now 47% owned by NBK, recorded net profits of Kd6.1m in 2010 compared with a net loss of Kd51.7m in 2009.

Within the Islamic banking sector, Kuwait International Bank (KIB) reported net income of Kd16.8m in 2010 compared with a Kd8.2m loss in 2009. Since it converted into an Islamic Bank in 2007, it has seen its revenues improve and is expected to capitalise on the increased popularity of sharia-compliant products in Kuwait. Analysts predict KIB will continue to post solid results over the next few years. According to Fitch, the bank is expected to “derive benefits from its conversion into an Islamic bank and future expansion”.

NBK rating worry

In a surprise development in early March, Moody’s has placed NBK’s C+ standalone financial strength and Aa2 long-term global local currency and foreign currency deposit ratings on review for possible downgrade. Moody's decision to place NBK on review was prompted by expected pressure on asset quality arising from the bank's regional operations (particularly in Egypt), both in terms of lending as well as in investments in now lower-rated regional sovereigns; the subdued prospects for credit conditions domestically – at least for the first half of 2011 given that the implementation of the Kuwaiti government's increased spending plans appears to have stalled – which, combined with an uptick in problem loans, will affect bottom-line performance; and latent credit risk in the system arising from unresolved systemic problems in the Kuwaiti investment companies sector and an unconvincing recovery in the Kuwaiti real-estate sector (particularly commercial real estate).
 
Nevertheless, NBK's financial performance remains strong and supports its standalone baseline credit assessment within the A rating range. The bank's reported asset quality (with NPLs at a low 1.65%) has exhibited resilience amid adverse operating conditions in 2009 and 2010, thereby outperforming its domestic competitors. Concurrently, NBK's strong capitalisation (its Tier 1 capital adequacy ratio is 18.2%) underpins its loss-absorption capacity and places the bank in a preferential position to grow by seizing opportunities that may arise once increased government spending materialises.

Kuwait's investment trouble

Investment companies in Kuwait grew rapidly until 2008, driven by abundant liquidity and low barriers to entry. Today the sector boasts at least 100 investment companies engaged in investment activities as well as consumer finance companies with total assets in excess of Kd14bn (equivalent to about 34% of Kuwait's banking system assets). While some performed well throughout the crisis, others defaulted on their debt. Kipco posted net income of $76.72m in 2010, up from $75.3m in the previous year. Global Finance House (GFH), however, defaulted on the majority of its $3bn debt.

For the CEO of GFH, Maha Al Ghunaim, this forced the group to be more cautious. “We are no longer interested in taking risk on balance sheet assets and are more focused on fee-generating activities and traditional banking,” she says. Since then, GFH has managed to reach a restructuring agreement with 54 banks, supported by the Central Bank of Kuwait. According to an IMF report published in 2010 “the key terms of the restructuring include the full repayment of outstanding debt and an overhaul of the business model to ensure long-term viability.”

Asset price correction

Following the sharp correction in global financial asset prices, the total assets of Kuwaiti investment companies contracted, declining 9% in 2009 and a further 8% in 2010. Ms Al Ghunaim points to oil prices, which are proving "comforting" for Kuwait's economy, which was badly hit during the global financial crisis. She adds that high levels of liquidity, amassed in recent months from oil revenue, have provided financial institutions with a steady stream of investment opportunities.

Global Investment House, which reported an income of Kd12.3m in 2009, hopes to be at the forefront of the recovery process and move on from the troubles of the past few years. “We are excited about the future and the possibilities that are opening up, especially in Saudi Arabia,” says Ms Al Ghunaim. The investment company, which is involved in wealth management across the Gulf Co-operation Council markets, hopes to capitalise on the increased liquidity available across regional economies and is looking to invest in the healthcare sector as well as the government-sponsored $100bn plan.

Knock-on effect

With large proportions of their assets invested in long-term, volatile investments and financed by short-term borrowings, investment companies suffered many serious blows during the global economic crisis. Their business model was highly reliant on foreign funding, and as such funding declined throughout the crisis, so did their profits. Many investment companies turned to local banks, which in turn caused them to bear the brunt of the fall and added to their troubles.

The exposure of Kuwaiti banks to troubled investment companies was a concern to local bankers, and CBK's Ms Mahfouz expressed surprise at the continued existence of some investment companies considering their overall performance. Investment companies lost more than $5bn during the recession in Kuwait, and continued to post losses of $200m in 2010. The Investment Company Index on the Kuwaiti stock exchange has lost more than 70% of its value since the beginning of 2008.

Responding to the high leverage, low liquidity and heavy reliance on foreign funding that dominate the investment companies operating model, the Central Bank of Kuwait issued a new set of regulations in 2010. A company’s leverage ratio (total liabilities/equity) cannot exceed 2:1 under the new regulations, which have to be implemented by 2012. Investment companies have to have a minimum capital ratio of 10%, defined as: cash and equivalents plus government and other sovereign debt/total liabilities. And finally foreign borrowings must be limited to 50% of total equity or 25% of total liabilities. According to a report published by the Central Bank of Kuwait, only 49 out of 100 investment companies meet all three criteria today.