Last year was a year of introspection for Kuwait. For the first time this century, the world's fourth largest exporter of oil recorded a decline, following eight years of consistent growth. While oil prices reached an all-time high of $147 a barrel in July 2008, they dropped dramatically by the end of that year, plummeting to $32 a barrel. Kuwait's oil export-dependent economy has been subject to the whims of the global market. Oil prices only seemed to recover by June 2009, when they crept above the $70 a barrel mark for the first time that year.
Those developments have had important implications on the Kuwaiti government's finances. The country's current account balance was estimated to have fallen to 25.4% of gross domestic product (GDP), from 41.2% of GDP in 2008. In addition, current and capital spending was said to have decelerated in response to oil prices. Last year was also marked by significant deflation, considerable underperformance of the Kuwait Stock Exchange and policy stagnation resulting in no new investment. Kuwait's saving grace was that it recorded its 11th consecutive annual surplus in the 2009/10 financial year, with $28.9bn of revenue in the first 11 months.
Banking difficulties
The banking sector's performance has mirrored Kuwait's economic woes in many ways. In the same way that the global financial crisis triggered an economic slowdown affecting oil prices, the same crisis has had implications on a number of key Kuwaiti banks. The most notable case concerns Gulf Bank, Kuwait's third largest bank, which had engaged in faulty derivatives transactions that led to the bank recording a Kd359.5m ($1.23bn) net loss in 2008. This was a particularly chastening experience; Kuwait's government via its central bank and its investment fund, Kuwait Investment Authority (KIA), supported Gulf Bank through its troubles.
Gulf Bank has managed to put itself back on a stronger footing as a result of raising Kd376m in a rights issue, to which KIA was a party, at the beginning of last year. The rights issue helped the bank to make an operating profit of Kd83m for 2009, but provisioning requirements meant that the bank still ended up making a net loss of Kd28m. Gulf Bank's performance so far this year suggests that its recovery could be sustainable. The bank's results for the first quarter of 2010 showed an operating profit of Kd44.3m, a remarkable improvement when compared with the figure for the corresponding period in 2009 of Kd15.6m. However, provisioning requirements meant that the bulk of the Kd44.3m had to be set aside, leaving the bank with a net profit of Kd524,000.
Global Investment House (GIH), Kuwait's premier investment banking institution, has also been a victim. GIH defaulted on a $200m loan in December 2008 that triggered cross-default provisions in the group's other obligations. The bank ended up posting a net loss of Kd257.6m for 2008. Speaking to The Banker last year, GIH's chairperson and managing director, Maha Al-Ghunaim, admitted that the bank bet "too much on decoupling and got hit hard".
However, since that nadir, GIH has reported more positive news on a number of fronts. In spite of posting a net loss of Kd148.8m, the bank's 2009 results show that its fee-based asset management, investment banking and brokerage business generated a profit of Kd12.3m. Furthermore, losses from investments and treasury activities fell by 61% compared with 2008. Credit impairment charges were also a fraction of what they were in 2008, amounting to Kd1.3m, compared with Kd22.1m in 2008. Perhaps more significantly, GIH announced that an agreement had been reached with its creditors over its loan repayments. The restructuring plan takes the form of three-year amortising facilities with each of the 53 lenders.
Institutional strength
While Gulf Bank and GIH have faced difficulties, other banks have been able to navigate through the financial crisis with relatively little difficulty. Chief among the strong performers has been Kuwait's renowned banking giant, National Bank of Kuwait (NBK). The bank posted a Kd265.2m net profit for last year, up 4% from 2008's figure of Kd255.3m.
NBK's profit was achieved in spite of the bank undertaking voluntary provisioning measures as a precaution. "Although NBK's asset quality remains among the highest in the region, precautionary provisioning put significant pressure on our profits in 2009; we expect this to change as we have demonstrated throughout the crisis that we have sound risk management practices,' says NBK group CEO Ibrahim Dabdoub. "We expect to continue on the positive performance trends throughout 2010 as the overall operating environment stabilises and business volumes return to normal levels."
NBK has already displayed its intention to strengthen its domestic and regional capabilities. In March, NBK received approval from the Central Bank of Kuwait to raise its stake in Boubyan Bank, a wholly sharia-compliant Kuwaiti institution, from 40% to 60% of the bank's capital. "Boubyan's strategic importance will feature highly in 2010 as we strive to build a strong Islamic banking franchise in the domestic market. Regionally, our priorities continue to focus on leveraging our fundamental strengths and capabilities to build a regional platform, and scale in growing key markets," says Mr Dabdoub.
Kuwait Finance House (KFH), one of the world's leading Islamic banks, has not been as fortunate on the level of profits but has recorded other positive indicators. In spite of profits falling by 46.3% from 2007 to 2008 and falling still further in 2009, KFH's total assets stood at Kd11.291bn for 2009, an increase of Kd747m from the previous year. Deposits rose by Kd650m to Kd7.262bn, an increase of 10% over the previous year. For the first quarter of this year, KFH's total assets and deposits continued to rise, recording 11% and 7% growth, respectively, compared with the same period in 2009.
Despite falling profits, KFH has undertaken significant transactions this year that suggest that its growth strategy will not be undermined. In early April, KFH announced a joint venture with Canadian real estate company Killam Properties to acquire up to C$450m ($436m) of multi-family residential properties in Canada, which builds on a similar venture undertaken in the US.
Confronting challenges
Even without considering the effects of the global financial crisis, Kuwait's banks have had to and continue to operate in a domestic economy that is the least diversified in the Middle East. This in itself poses a problem for lending activities. "A key problem that Kuwaiti banks face is the absence of a broad and balanced economy at home. This has the effect of reducing sound lending opportunities available to them; at present, real estate, investment companies and regional stock exchanges have been the main beneficiaries of domestic lending. Significant expansion of the domestic banking sector will depend on lending opportunities generated by government-sponsored infrastructure projects," says Philip Smith, senior director in the financial institutions team at Fitch Ratings.
Building on the theme of the limited lending opportunities at home, Naveed Ahmed, an analyst at GIH, suggests other areas of concern. "The key weaknesses in the local banking market include the absence of attractive lending opportunities; a minimal fiscal stimulus and absence of any major industrial/productive sector; a high delinquency rate; less favourable demographics; high barriers to entry; and the high systematic risk stemming from three banks possessing over 60% of the market's assets."
NBK group CEO, Ibrahim Dabdoub
Further issues
The financial crisis has thrown up a number of additional obstacles for the local banking market, according to Kuwait International Bank (KIB). A statement released to The Banker from KIB says: "The impact of the global financial crisis imposes some challenges on the local banking market, the most important of which are a slackening in demand for credit facilities being affected by the slow recovery mode of the overall domestic activity; shrinking market values of some mortgaged assets; and the probability of continued application of cautious financial provisioning policies." For its part, KIB, in spite of reporting a loss of Kd8.2m in 2009, intends to open eight new branches and introduce more advanced banking services in the domestic market over the course of 2010.
This begs the question of when the effects of the crisis are likely to pass. Senior bankers in Kuwait are still unsure. "It is still too early to assess how successful the Kuwaiti banks are in emerging from the crisis. Several banks had exposures to various types of asset classes that were severely hit during the crisis and these positions continue to translate into higher provisions," says NBK's Mr Dabdoub.
However, some bankers have identified a way of expediting a recovery. "Recovery can pick up pace if a timely implementation of mega infrastructure expenditure under the Kuwait Development Plan is carried out. A strong fiscal stimulus remains the need of the hour," says GIH's Mr Ahmed. The five-year, $128bn development plan was approved by the country's parliament in the early part of this year, but doubts remain as to whether the plan will come to fruition.
Regional developments
Recent regional developments, namely the Dubai World debt crisis and the defaults concerning Saudi Arabia's Saad and Ahmed Hamad Algosaibi & Brothers (AHAB) conglomerates, have also cast a shadow over the Gulf's banking sector. However, local bankers were keen to note that local banks were largely immune to those problems. "Kuwaiti banks have not yet reported any exposure to Dubai World, and the likelihood of such is remote as well," says Mr Ahmed. Mr Dabdoub adds: "The fallout from the Dubai World debt crisis and the default of Saad/AHAB groups had no effect on NBK as we had no exposure to either. NBK's management believes that establishing strong, long-term banking relationships with clients is key to a successful operational model. We have thus limited our exposure to only core banking activities and invested in businesses we understand."
Kuwait: Economic indicators
Future outlook
Current commentary on Kuwait's banking sector suggests that it will be another difficult year for the country's banks. In a report published in February of this year, Standard & Poor's (S&P) outlines its belief that Kuwait-based banks will suffer from the effects of unfavourable economic conditions on their profitability and asset quality.
However, KIB does not agree with S&P's prognosis. "For Dubai-based banks, such assumptions could be justifiable bearing in mind the adverse impact of the Dubai debt crisis on its local banking sector. But, for Kuwait's banking sector, we do not agree with such an assumption. The economic environment surrounding Kuwait's banking sector looks different. International Monetary Fund sources, as well as domestic official sources, anticipate a real growth rate of 4% to 5% for Kuwait's economy in 2010," it says in a statement.
A move that will go some way towards confounding worries about the health of Kuwait's banking sector is the introduction of the country's Financial Stability Law. Approved by Kuwait's cabinet in March 2009, the law entails a $5.2bn economic stimulus package to enable banks to lend about Kd4bn within two years, of which the government would guarantee up to 50% to encourage lending. The increase in liquidity is supplemented by a means to restructure operational companies with solid assets. In March of this year, the sharia-compliant investment house Investment Dar successfully filed to enter into the law so as to institute a restructuring plan that will allow the company to repay its financial obligations.
This particular development has been well received. "The fact that the Financial Stability Law has been passed is positive and has helped to reassure the market. There is still the question of the extent to which it will be used. The law further underlines the authorities' willingness to support the local economy, but not many banks are likely to take advantage of it, as the banks would in any case finance proposals from sound customers with appropriate collateral," says Fitch Ratings' Mr Smith.
Florence Eid, founder and CEO of Arabia Monitor, a London-based research and advisory firm specialising in the Middle East and north Africa region, agrees. "The slump in oil prices over the course of late 2008 and the first half of 2009 contributed to exposing firms that were overleveraged. When oil revenues fell, the problems of those firms were magnified. The new Financial Stability Law should go some way towards restoring investor confidence," she says.
Kuwait's banking sector is also helped by a strong regulatory environment, according to Mr Smith. "The central bank is a strong regulator and has cultivated that reputation since guiding the sector through the turbulence of the Iraqi invasion of Kuwait. It monitors the sector closely and is prepared to intervene, when necessary. Oversight has been stepped up in light of the global financial crisis and difficulties faced by some local banks, as demonstrated by the thorough review of banks' loan books and provisions before they are allowed to finalise their results."
