Kuwait’s finance sector was hit hard by the global financial crisis. The heavy losses it suffered forced the country's government to guarantee local bank deposits in late 2008 and implement a financial stability programme to try and restore confidence in the sector. But these efforts have had a limited impact.
What has followed has been a torrid few years, which have seen Kuwait become synonymous with some high-profile debt restructurings in the investment sector. Several of the country’s investment companies defaulted amid the credit crisis after the value of their assets plunged and frozen debt markets prevented them from raising new loans. Global Investment House underwent a debt restructuring of $1.73bn in 2009, while Investment Dar was forced to alter the terms on $5bn-worth of loans after defaulting in 2009. In total, the investment sector lost more than $2bn in 2009, following a loss of upwards of $3bn in 2008.
In turn, Kuwait's banks have been hurt by high credit exposures to the investment sector as well as to the property market. Total credit extended to investment companies and the real estate and construction segment stood at 11% and 25%, respectively. Both have been plagued by substantial impairment losses.
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Return to profit
However, 2010 saw the country's banking sector roar back to profitability, with aggregate net profits surging by 62.5% to Kd583m ($2.12bn) from Kd359m a year earlier. The majority of banks posted profit growth in excess of 50%, with only two banks reporting a fall in profits. However, these headline profit figures mask a more complicated reality – the uptick in profits resulting from a peak in provisioning rather than a significant improvement in the banks' performance.
In 2010, total asset growth rose by a disappointing 3.9%, while net interest income, which accounts for roughly 70% of bank revenues in Kuwait, fell nearly 1.2%.
The banks’ lending activity also experienced a slowdown. Total loans grew by 1.7% in 2010 and by 3.6% in the first quarter of 2011. Meanwhile, loans to the private sector and investments in bonds in Kuwait grew a mere 0.3% in the first six months of 2011, after a 1.9% increase in 2010, according to data from the Central Bank of Kuwait (CBK). Operating income for the sector dropped by more than 10% in the first quarter of 2011.
Net profits have come under pressure because of a lack of assets growth, which has largely been stagnant in the past two years due to the poor operating environment
National Bank of Kuwait (NBK), the country’s largest lender, reported a 4.5% decline in second-quarter profit, citing a “weak operating environment”. Meanwhile, Kuwait Finance House (KFH), the country’s largest Islamic bank, reported a 43% drop in profit for the same period.
“Net profits have come under pressure because of a lack of assets growth, which has largely been stagnant in the past two years due to the poor operating environment,” says Carlos Ribeiro, chief financial officer at Gulf Bank, the country’s second biggest lender. “Banks have plenty of liquidity and are willing to lend but there is no appetite to borrow. The private sector is very small while the key market players are mainly state-owned and do not need to borrow as they are cash-rich.”
Action plan
Much hope is being pinned on the government’s four-year $113bn Economic Development Plan (EDP). Approved in February 2010, the plan outlines 46 projects aimed at modernising and diversifying Kuwait’s oil-based economy. As the world’s fourth largest crude exporter, oil revenues account for more than 90% of state income.
Under this plan, Kuwait's government is expected to provide 50% equity, and analysts have speculated that the other half of the EDP will be financed by the banking sector. Fifteen projects are under development, comprising a total value of $13.4bn. Meanwhile, 23 projects have been announced and awarded with a combined value of $17.1bn.
Gulf Bank is already participating in financing four key projects – the Jaber Al Ahmed bridge with a project value of Kd1.04bn; the Sabah Al Ahmed Residential City, which will contain 70,000 to 80,000 houses at a value of Kd436m; the Jaber Al Ahmad Hospital (Kd303m); and a power plant.
“We are being very aggressive in participating in the development plan and want to get more than our fair share of projects,” says Gulf Bank's Mr Ribeiro. “While many banks are more international in their focus, we are very centred on the Kuwaiti market and we need to use this to drive balance sheet growth.”
Gulf Bank made headlines in October 2008 when the CBK halted its trading operations and stepped in to provide support after the bank was hit by steep derivatives trading losses amounting to Kd375m. The bank incurred losses from derivatives deals that it carried out on behalf of clients who defaulted.
On board
KFH, Kuwait’s oldest and largest Islamic bank, is also keen to benefit from the EDP. “KFH has taken part in financing several projects launched by Kuwaiti companies,” says Mohammed Al-Omar, chief executive of KFH. “In addition, some KFH subsidiaries have either won contracts or are competing to be awarded some of the floated projects.”
The lack of diversification in the country's economy has resulted in an over-reliance on the public sector. The EDP was designed to kick-start the economy; however, the plan is being dogged by repeated delays, which in turn are hampering the banks’ efforts to revive lending.
“Loan growth in Kuwait remains muted, with delays in the implementation of development projects,” said Goldman Sachs analyst Waleed Mohsin in a report published in July this year.
Political paralysis
While often lauded for having the Gulf's only fully elected parliament, it is Kuwait’s political system that is largely blamed for the slow progress in pushing through the EDP. There have been three dissolutions of parliament and six government resignations in the past five years. The inability to gain consensus on projects has resulted in the cancellation or delay of several contract awards and prevented many other schemes from leaving the drawing board.
The $77bn urban area Madinat al-Hareer (Silk City), located just off mainland Kuwait, is an obvious example of a large project that has failed to move forward due to political infighting. In January this year, Canadian firm Malone Given Parsons was brought in to re-draw the masterplan for the project, in association with the local GulfConsult. The $15bn Ras al-Zour refinery is another high-profile project that has been saddled with continuous delays at the planning stage.
All the ingredients are there [for Kuwait] to be successful... But parliament has ended up being more like a big labour union that spends time debating ideas rather than putting them into practice
“The political struggle between the parliament and government is damaging the country’s growth potential,” says Hisham Al–Razzuqi, chief executive officer of Gulf Investment Corporation. “All the ingredients are there to be successful. Kuwait has a small population of 3.5 million – of which only 1.3 million are nationals – and large reserves of oil. But parliament has ended up being more like a big labour union that spends time debating ideas rather than putting them into practice.”
Banking overflow
While Kuwaiti banks are queuing up to fund the schemes, they are increasingly aware that the EDP will undershoot targets. However, there is little else for them to lend to. Furthermore, the sector is highly saturated – Kuwait currently hosts 10 local banks and nine international banks. “Kuwaiti banks face fierce competition in a limited market, especially since foreign banks began operating in the market,” says KFH's Mr Al-Omar.
Consequently, banks are awash with liquidity and increasingly they are placing it back on deposit at the CBK despite the low interest rates. The loan-to-deposit ratio of the banking sector fell to about 85% by the end of the first quarter of 2011 from 98% at the end of 2009.
Kuwait’s three-month inter-bank interest rate has held firm at 0.8125% for most of the past three months – nearing its record lowest rate – according to Bloomberg data. The United Arab Emirates recorded the highest rate of 1.49625% among Gulf countries.
High concentrations
It was precisely the lack of investment opportunities that led Kuwait's banks to pile into the stock market and real estate. The reason NBK has fared better than its competitors is primarily because it has not been lending to the country’s investment sector.
“Kuwait still has too many investment companies,” says Mr Ribeiro. “Most banks have already taken heavy provisions against them but the underlying issues have not been completely addressed.”
In a report dated July 4, 2011, international ratings agency Fitch noted: “The relatively small nature of the Kuwaiti economy, with its limited private sector, translates into high concentrations and undiversified loan portfolios. Large exposures to higher-risk sectors – such as construction, real estate and investment companies – and speculative stock market lending are a common feature across the banks.”
However, the debt overhang at investment firms is ensuring banks steer clear of the investment sector. In late June, KFH announced that it would restructure $180m of debt to Gulf Investment House, in which it holds a stake along with Burgan Bank and Boubyan Bank.
Genuine need
Meanwhile, banks are showing little interest in the commercial property market, where asset values remain depressed due to oversupply. Nominal gross domestic product in the construction sector grew a meek 3.5% in 2010, reflecting this oversupply as well as the lack of investment in infrastructure. The performances of Middle Eastern stock markets have also been subdued due to the political unrest that has swept across the region this year and has come to be known as 'the Arab Spring'.
Aside from the multiplier effect that the EDP would have on banking activity, there is a genuine need for the projects that the plan outlines.
Kuwaiti banks face fierce competition in a limited market, especially since foreign banks began operating in the market
The rapid rise in Kuwait’s population is exerting considerable pressure on the country’s infrastructure, causing the country’s current housing crisis. Average population growth rate stands at 2.75% over the past few years and the number of people living in Kuwait is forecast to rise from 3.5 million in 2010, to 5.4 million by 2030. To be able to cater to this future demand, the country needs to expedite a number of infrastructure projects across the social, transport and power sectors.
“Kuwait needs a lot of investment and this is very overdue,” says Mr Ribeiro. “But there is now a willingness, and even realisation, that there is an urgency to implement this.”
Indeed, Kuwait’s central bank governor Salem Abdul-Aziz Al Sabah publicly acknowledged this in a televised interview with CNBC Arabia on July 19, 2011. “Without majorly improving the business environment, and urgent and quick capital spending on various state projects, there will be not be good growth,” he said. “Without providing good investment opportunities to the private sector to enable it to expand its local financial activities, the future outlook will be limited.”
The private sector’s role in the economy has become notably smaller. Private sector credit in Kuwait grew by a mere 2.4% year on year in June, after edging up 0.7% in May, but it is still far below the near 10% growth seen in 2009.
“The lack of the private sector’s involvement is one of the biggest constraining factors in the economy’s development,” says Mr Al Razzuqi. “The ministries can be very difficult to work with and there is a lot of bureaucracy which needs to be addressed.” While legislative changes to ease bureaucracy in the country will no take time, the CBK has used the hiatus to overhaul and tighten financial sector regulation.
Improved risk management
In light of the hefty losses sustained by the investment sector in Kuwait, in June 2010 the CBK issued tightened regulatory ratios of the sector through three criteria spanning liquidity and leverage.
First, a company’s leverage ratio (total liabilities/equity) cannot exceed 2:1. Second, all companies must have a minimum ‘quick ratio’ of 10%. This ratio measures a company’s ability to service short-term obligations, which is normally calculated by dividing quick assets (cash and equivalents, marketable securities and accounts receivable) by current liabilities. The CBK now mandates an even stricter calculation of the ratio by only allowing for the following to be included: cash and equivalents, and government and other sovereign debt (provided it is rated BBB or above). The third criteria is that foreign exposure (debt) must be limited to 50% of total equity.
The new regulation states a deadline of 2013, although the sector is expected to be fully compliant with the new measures by mid-2012. “I believe that risk management has improved significantly,” says Mr Al-Omar. “As far as I know, this coordination is on a daily basis and more efficient than before. But it still needs more effort and greater coordination with supervisory authorities that include the CBK.” The results can be seen in the increased capital adequacy ratio of the banking sector, from 16.7% at the end of 2009 to 18.8% at year-end 2010.
Faring differently
Non-performing loans (NPLs) are also declining, albeit at a steady pace. NPLs had soared by 153.97% during 2008 and by 84.38% during 2009, but declined by 14.24% during 2010. Banks’ systemwide NPLs stood at 7.4% at the end of 2010 and the CBK forecasts this will fall to 5% by the end of 2012.
Of course, the health of banks’ loan books varies significantly. At the better end of the scale, the NBK’s NPL ratio declined to 1.61% at the end of June 2011, from 1.81% a year earlier. Meanwhile, after peaking at 26% in March 2010, Gulf Bank’s NPL ratio fell to 15.6% by the end of 2010 and has fallen further to stand at 10.7% by June 2011.
Despite these declines, NPL stocks are still at high levels and will remain a top priority for banks during the next 12 to 18 months. And while the operating environment is improving, key systemic risks remain across the banking industry.
Banks' large exposures to higher-risk sectors – investment, real estate and the stock market – have been mitigated somewhat by improved capitalisation across the sector in 2010. However, investment companies are still challenged by a lack of liquid investments on their portfolio, and the slow recovery in the commercial property market also poses a threat.
The slow implementation of the EDP means credit growth in Kuwait will remain subdued for the rest of 2011 and profits depressed. The problems surrounding the country's bureaucratic political framework need to be urgently addressed if it is to usher through these projects and revive its stagnant banking market.
