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Middle EastApril 1 2016

A cautious optimism: Kuwait's banks stay ahead of the game

There is a positive mood in Kuwait's banking sector, thanks in no small part to the government's healthy balance sheet and its commitment to project spending. However, the low oil price environment and cooling real estate market loom large on the horizon.
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A cautious optimism in Kuwait

Though Kuwait’s near-term economic outlook may have been affected by slumping commodity prices, the country’s banking sector is yet to show any signs of strain. By most indicators, 2015 was a successful year for Kuwaiti banks as they benefited from supportive government project spending and strong growth in the non-oil sector.

According to data from the Kuwait Banking Association, this translated into asset growth of 5.6% for the year, with total assets reaching Kd58.6bn ($194.7bn), up from Kd55.5bn at the end of 2014. Gross private sector credit also grew from Kd32.7bn to Kd35.1bn over the same period. 

Most encouragingly, the banking sector also accounted for the majority of profits of listed companies on the Kuwait Stock Exchange in 2015. Total profits grew by Kd700m, or about 6% more than in the previous year. With the government now focused on the roll out of its Kuwait National Development Plan 2015-2019, the outlook for Kuwait’s lenders in 2016 is expected to be positive.

Mixed picture 

“The economic situation is still stable, and I hope that the government will continue its expenditure on development projects. Infrastructure investment will ultimately boost the non-oil sector over the medium term,” says Mazin Al-Nahedh, chief executive of Kuwait Finance House (KFH). 

This is not to say that the country’s banks will have an easy time of it while oil prices remain depressed. Exposure to a cooling real estate market is one risk on the horizon, while growing liquidity pressures are expected to diminish operating revenues over the coming year. Meanwhile, ratings agency Standard & Poor’s anticipates growing non-performing loans (NPLs) between 2016 and 2018, which in turn is expected to increase credit losses in the sector. 

“The main source of risk today is perhaps weakening real estate prices in Kuwait. However, weakening prices are only emerging in the commercial and investment segments, while the residential sector remains strong,” says Hamad Al-Hasawi, secretary-general of the Kuwait Banking Association. 

“As for other risks, since 2008 Kuwaiti banks have been able to clean their books of poisoned assets and improve their balance sheets. More important is the fact that banks are now holding large amounts of provisions in excess of their NPLs,” he adds. 

Kuwait’s banks boasted an NPL coverage ratio of 167% as of the third quarter of 2015, according to the country's central bank. In addition, most lenders are still pursuing a cautious approach to their provisioning. “If a customer is having problems repaying a loan, we take provisions on the spot. Although this is expensive, it is better to deal with the problem immediately. We want to keep NPLs below 1% of our total assets,” says Elham Mahfouz, chief executive of the Commercial Bank of Kuwait.  

Similarly, under the auspices of the Central Bank of Kuwait (CBK), Kuwaiti lenders are now under Basel III regulations for capital, as well as specific frameworks for domestic systemically important banks, liquidity and leverage. Figures from the CBK reveal that the capital adequacy ratio of the country’s banks was at 16.5% as of the third quarter of 2015. The Tier 1 capital to capital base ratio was 92.4%.

Capital boost 

Despite this strength, Kuwaiti lenders are looking to boost, as well as optimise, their capital structures. In 2015, the National Bank of Kuwait (NBK) issued $700m in Tier 1 perpetual capital securities, the first rated perpetual security offering in the Middle East. This was followed by a Kd125m issuance of subordinated Tier 2 bonds, which became the largest local currency bond issuance in Kuwait. Meanwhile, in March 2016, local press reports indicated that Gulf Bank, the country’s fourth largest lender by total assets, had received CBK approval for a subordinated Tier 2 bond issuance. 

From this strong base, most Kuwaiti banks are looking to capitalise on the country’s booming project market. In 2014, more than Kd7.4bn-worth of projects was awarded in the country, followed by Kd9.7bn in 2015. The next 12 months should offer even greater opportunities, with the government expected to sign about Kd16.7bn-worth of project agreements before the end of 2016. 

“The government is definitely committed to project spending. When oil prices drop it is typically cheaper to invest in major projects, so it’s better for the government to commit to these projects in the current environment. This is largely because material costs are lower and international contractors can quote lower prices than their regional peers,” says Ahmed Zulficar, deputy chief executive of Ahli United Bank Kuwait. 

The dominant opportunities will emerge in the country’s oil and gas sector, although construction, housing, transportation and utilities will also feature heavily. For NBK, which has a market share of about 33% of the banking sector’s total assets, the outlook in this space is particularly promising. 

“Our strategy centres around being at the forefront of large-scale Kuwaiti government projects, as our large capital base, high credit ratings and international presence provide us with an advantage over other Kuwaiti banks when competing for these projects,” says Shaikha Al Bahar, deputy group chief executive of NBK. 

This positive outlook follows a strong 2015 for NBK according to most performance metrics, in which net profits increased by 7.8% while operating income grew by 10% for the year. “The pick up in private sector sentiment reflected positively on business volumes, leading to loan growth at the group level reaching about 14% year-on-year ahead of all peers. Customer deposits reached $39.7bn growing by 7.1% year on year,” says Ms Al Bahar.

Retail hopes 

Beyond the project market, a number of lenders are banking on growth in Kuwait's retail sector. Regulatory changes introduced by the central bank in 2015 now allow Kuwaiti banks to buy out a customer’s loan from a competing entity. This has led to intensified competition and a scramble to gain market share between lenders who are prioritising consumer finance for their growth. “Most lenders in Kuwait are now attempting to gain market share through this mechanism,” says Ms Mahfouz. 

Meanwhile, the ongoing drive into digital banking is producing tangible benefits for Kuwait’s consumers. Al Ahli Bank Kuwait (ABK), the country’s fourth largest lender by Tier 1 capital, has worked hard to improve its digital and mobile banking offerings with the introduction of its ‘One Tap Touch ID Sign-in’ for the bank’s mobile application. This eliminates the need for multi-factor verification for its customers. Similar progress has been made on the bank’s payment offerings. 

"Some of the things we have launched – such as to tap to pay on your card, a service that we will eventually provide to customer's phones – ultimately reflect our strategy of making the customer experience more simple," says Michel Accad, chief executive of ABK.

Hurdles ahead 

While growth opportunities appear to be abundant, a number of difficulties are expected to hit Kuwait’s banks in the coming year. For one, adverse sentiment in the wider economy has been attributed to a decline in real estate sales. According to a research note published by ratings agency Moody’s, by November 2015 every real estate segment in Kuwait experienced a fall in sales for the year, following a sustained multi-year period of growth. Moody’s notes that between 2008 and 2014, the compound annual growth rate of real estate instalment loans in Kuwait was 8.1%, compared with just 4.5% for total domestic loans. 

With CBK data indicating that about 25% of the banking sector’s domestic loans are geared towards the real estate sector, there is some scope for concern. Yet, by early 2016 a more mixed outlook for real estate prices had emerged, with gains posted across some sub-sectors. For instance, although the residential home price index was 4.2% lower year on year in January, the residential land price index was up 2.6%. The investment building index was just 0.9% lower year on year, according to the NBK. 

“Activity in the real estate market cooled significantly in 2015, but the impact on prices has been relatively limited. To be sure, price growth eased, but this came on the heels of a very strong year in 2014. While prices in some segments may have seen some decline, overall prices held up relatively well; and we expect downward pressures to recede in 2016,” says Ms Al Bahar. 

Pressure on liquidity conditions also emerged in 2015 for reasons that mirror similar processes elsewhere in the Middle East; slower economic growth and a rise in official interest rates, among other factors. The banking sector’s total liquid reserves in December 2015 were Kd5bn, or about 8.5% of total assets. This figure marks a reduction from about 11% before mid-2015, according to NBK. The result has been a spike in the three-month Kuwait Interbank Offered Rate, which increased by 57 basis points in 2015. 

Nevertheless, few bankers on the ground harbour any concerns for the remainder of 2016. “With regards to liquidity, the liquidity risk in banks is very low, as Kuwaiti banks enjoy high levels of liquidity. Stress tests conducted by the CBK revealed that KFH enjoys high levels of resilience and its position is safe,” says Mr Al Nahedh.

An extended reach 

Beyond the domestic market, some Kuwaiti lenders are adopting an increasingly regional outlook for their growth strategies, just as more established international Kuwaiti players look to develop their already extensive positions. 

In October 2015, ABK completed the acquisition of a 98.5% stake in Piraeus Bank Egypt, a subsidiary of Greece’s Piraeus Bank. The deal was completed for $150m with an extraordinary one-off gain of $27m, which was allocated towards precautionary provisions. This transaction was notable in that ABK worked with Egyptian regulators to close the deal in six months, when typical deals of this nature have taken about one year to finalise, according to the bank. 

"Traditionally we have been a Kuwait-focused bank with a small presence in the United Arab Emirates, accounting for about 5% of our business. Following our Egypt acquisition, ABK will be split closer to 85% domestic and 15% international in terms of the overall business, with an appetite to push towards a 75% to 25% split," says Mr Accad. 

ABK’s move into Egypt follows a number of other regional banks that have made a push into the market. With Egypt’s banking penetration rate of about 10%, the scope for growth is huge. "In Egypt, the competitive landscape is not that broad, but more importantly it is a market that is significantly under-banked and we don’t have to gain market share from the competition. [In addition] Egyptians constitute one of the largest expatriate communities in Kuwait and there are many products and services that we can cross-sell thanks to their presence in the country," says Mr Accad. 

The NBK, which boasts a significant footprint across the Middle East and north Africa (MENA) and beyond, also benefited from its international activities in 2015. The bank has identified the MENA region as the core of its’ growth strategy outside of Kuwait with an emphasis on the Gulf Co-operation Council, where it offers corporate clients and high-net-worth individuals a range of conventional and sharia-compliant treasury and wholesale banking credit solutions. 

“We generated 27% of 2015 profits from outside Kuwait despite the challenges facing global capital markets, the continuous decline in oil prices and the uncertainty around the economic outlook. NBK has been focusing on a cross-selling strategy that aims at maximising the benefits of the group’s unrivalled international and regional network,” says Ms Al Bahar.

A happy medium 

For now, Kuwait’s banks look set to maintain their positive growth trajectory despite the challenges emerging in the home market and across the wider region. While much of this potential can be attributed to the government’s healthy balance sheet and commitment to project spending, equal credit should be offered to the prudent management of the banking sector itself. With most lenders well capitalised and well provisioned, the sector as a whole looks ready to ride out any turbulence linked to lower oil prices. 

“Despite what may seem to be a difficult year in economic terms, it is clear that the government is trying to mitigate the impact of falling oil prices on the economy by keeping public spending unaffected. We do not expect a significant drop in aggregate demand in the economy, helped by the high capital spending of the state. As a consequence, the key indicators of the banking sector are encouraging,” says Mr Al-Hasawi.

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