MARC has affirmed Kuwait Finance House (Malaysia) Berhad’s (KFHMB) long-term and short-term financial institution ratings at AA+/MARC-1. KFHMB’s ratings are based on MARC’s top-down approach in its assessment of KFHMB’s linkage with its parent, Kuwait Finance House K.S.C. (KFH) and the affirmation of KFH’s financial institution ratings at AAA/MARC-1. KFH’s ratings reflect its position as one of the leading global Islamic financial institutions with an extensive network and product offering as well as its strong capitalisation. At the same time, MARC has also revised KFH’s outlook to developing from stable to reflect the possibility of further deterioration on the quality of the bank’s credit portfolio given its exposure to many sectors which continue to be affected by its current challenging operating environment. MARC is concerned over the impact of higher-than-expected credit costs on KFH’s profitability and capital strength, although at this stage, KFH’s strong capitalisation appears sufficient to address the sharp weakening in its asset quality and earnings.

In common with its parent, KFHMB’s asset quality and earnings have also come under pressure in 1H2009 amid the difficult economic conditions. As KFHMB is rated on a top-down basis to reflect explicit liquidity support from KFH, any significant deterioration in KFH’s financial profile and a resulting revision of its assigned financial institution ratings or a weakening in its link with its parent will result in a revision of KFHMB’s ratings. Accordingly, KFHMB’s outlook has also been revised to developing from stable. The resolutions of the outlooks hinge on the ability of both KFH and KFHMB to successfully counter rising delinquencies as well as the progress made in addressing asset quality concerns. Failure to stem further erosion in their asset quality could lead to downward rating pressure.

KFH is the second largest bank in Kuwait in terms of assets and is also the second largest Islamic bank in the world. The government of Kuwait has a 44% stake in the bank. Despite reporting another year of strong growth in its financing portfolio, KFH’s non-performing financing facilities (NPFF) have been on the rise on account of credit exposures to the real estate and construction, and financial service sectors (mostly investment houses), which collectively accounted for 59.7% of its receivables at end-2008. With these sectors severely impacted by the credit crises and the subsequent economic slowdown, KFH’s NPFF ratio weakened sharply to 12.6% at end-2008 from 3.7% at end-2007.

KFH’s weakened asset quality also caused the bank to incur higher provision charges which accounted for 4.8% and 4.2% of its average receivables in 2008 and 1H2009 respectively, sharply higher from 1.1% of average receivables in 2007. This, together with a lower investment income and lower financing income, dragged down its post-tax ROA to 1.81% in 2008 and 1.06% in 1H2009 (annualised) from 4.31% in 2007. However, MARC notes that KFH’s capitalisation as reflected by its total capital ratio of 21.7% at end-2008 (2007: 22.8%) remains strong and well above the regulatory minimum of 12%.

KFHMB was set up in Malaysia in 2004 as a platform for KFH’s future growth in the Asia Pacific region. KFHMB’s gross financing portfolio expanded by 97.3% in 2008, supported by capital injections from its parent, before moderating to 8.2% in 1H2009. MARC notes that KFHMB’s exposure to many challenged sectors is a cause for some concern given that approximately 61% of its financing as of 1H2009 is accounted for by the financial services, manufacturing, and construction and real estate sectors, all of which were affected by the weak economic conditions. This, coupled with the seasoning of its financing portfolio, saw KFHMB’s gross NPFF ratio climb sharply to 5.48% at end-1H2009 from 0.92% at end-2008. MARC is informed that much of KFHMB’s new delinquencies relates to borrowers originating from Kuwait. As a result of the sharp increase in NPFF, its reserve coverage of NPFF declined to 69% at end-1H2009 from 329% at end-2008.

Although KFHMB’s post-tax ROA improved to 0.56% in 2008 (2007: 0.44%) it has since fallen to 0.25% on an annualised basis in 1H2009 due to higher credit costs, investment impairment losses and foreign exchange losses. Going forward, improvements in KFHMB’s profitability would depend on its success in resolving its NPFF portfolio, which currently exhibits vulnerability to additional credit costs.  That said, MARC believes that KFHMB’s reasonably strong capital levels as reflected by its Tier-1 and total capital ratios of 16.14% and 18.30% respectively at end-1H2009 (2008: 17.73% and 20.47% respectively) provide some buffer in the eventuality of further weakening in the bank’s asset quality. KFHMB’s capitalisation was boosted in 2008 by a capital injection of USD300 million from KFH, by way of ordinary share issuance. MARC will closely monitor KFHMB’s progress in resolving its problem assets.

Contacts:
Anandakumar Jegarasasingam, 03-2090 2250/ kumar@marc.com.my ;
Taufiq Kamal, 03-2090 2251/ taufiq@marc.com.my