MARC has affirmed Kuwait Finance House (Malaysia) Berhad’s (KFHMB) long- and short-term financial institution ratings at AA+/MARC-1. The affirmation of KFHMB’s ratings follows the affirmation of the long-term and short-term financial institution ratings of its parent, Kuwait Finance House K.S.C. at AAA/MARC-1. KFHMB is rated one notch below KFH to reflect the strategic importance of the subsidiary to the parent bank as well as the common-branding that exists between the two institutions. MARC notes that KFHMB’s dependence on parent support has risen as the bank’s intrinsic financial strength has been visibly affected by asset quality challenges. The near term impact of the bank’s weakened asset quality and operating performance on its capital adequacy was buffered by an injection of additional capital by KFH. Meanwhile, KFH’s affirmed ratings reflect its systemic importance to the Kuwaiti economy as the second largest bank in the country as well as indirect majority government ownership. In common with its subsidiary, KFH’s key financial metrics have weakened relative to pre-2008 levels. Accordingly, MARC has revised the outlook on KFH’s long-term rating to negative from developing. At the same time, KFHMB’s long-term rating outlook has also been revised to negative from developing to reflect that of its parent.

KFHMB’s asset quality metrics and operating performance have been significantly affected by the deterioration in its financing portfolio. Reported non-performing financing (NPF) rose to 18.6% of total financing at end-March 2010 from 0.9% at end-December 2008. This level of NPF is high by domestic Islamic banking standards, and reflects significant deterioration in asset quality after a period of rapid expansion as well as credit exposures at the riskier end of the financing spectrum. The increase in NPF has led to additional financing loss provisioning and a decrease in coverage levels to 43% as at end-2009. Although a degree of comfort is derived from enhanced credit procedures, in particular, strengthened monitoring and collection procedures, MARC is concerned that supplementary new provisioning may be required in absence of signs of stabilising asset quality. Furthermore, MARC believes that with KFHMB’s focus on quality credits going forward, this may result in slower growth in financing volumes and income. In MARC’s view, the foregoing will delay KFHMB’s return to profitability beyond the current year.

KFHMB’s stressed asset quality and reported after tax losses have been partially buffered by an equity capital injection of USD150 million (RM515 million) from its parent to enable the subsidiary to make further loss provisions as well as to afford it the capital to embark on a measured growth strategy. Following the capital injection, KFHMB’s total capital adequacy ratio improved to 23.3% at end-2009 from 20.5% at end-2008, before marginally declining to 21.8% as at end-March 2010 after reporting a net loss of RM56.1 million for the three-month period. However, MARC notes that KFHMB’s total capital adequacy ratio was well above the Malaysian Islamic banking sector average of 15.0% at end-March 2010.

Founded in 1977, KFH, the parent bank of KFHMB, is the second largest bank in Kuwait in terms of asset size and is also one of the largest Islamic banks in the world with an extensive reach across the Middle East and a presence in Southeast Asia through KFHMB. Kuwaiti government-linked institutions own a majority 48% stake in the bank. KFH also experienced asset quality deterioration amidst the global financial crisis with its NPF ratio weakening to 12.6% in FY2008 (FY2007: 3.8%) with bulk of the incremental NPF accounted for by credit exposure in the real estate and construction and financial services (mostly investment houses) sectors which were badly affected during the crisis. Although a marginal improvement in gross NPF was seen in FY2009, which resulted in a gross NPF ratio of 11.8%, MARC notes that this was largely a function of an enlarged financing book, as absolute NPF remained relatively unchanged during FY2009.

Meanwhile high loss allowances, coupled with lower financing and investment income, resulted in lower profitability with ROA declining to 0.66% in FY2009 from 1.81% in FY2008. At the same time, total capital ratio declined to 15.2% at end-2009 from 21.7% in the previous year. That said, MARC notes that KFH’s capital ratios remain within Kuwaiti banking standards and above minimum regulatory requirements. Noting the pressure on KFH’s stand-alone credit profile, MARC continues to draw comfort from the very high likelihood of sovereign support for the bank.

The absence of a sustained recovery in KFH’s financial performance or a weakening in support from the Kuwaiti government would trigger a downward revision of the parent bank’s ratings. At the same time, any weakening in support from KFH towards the subsidiary KFHMB may result in a downward revision of the latter’s ratings.

Contacts:
Anandakumar Jegarasasingam, 03-2090 2250/ kumar@marc.com.my;
Taufiq Kamal, 03-2090 2251/ taufiq@marc.com.my;
Lim Kok Seng, 03-2090 2272/ kokseng@marc.com.my