MARC has affirmed Kuwait Finance House (Malaysia) Berhad's (KFHMB) long-term and short-term financial institution ratings of AA+/MARC-1, following the rating agency’s affirmation of the long-term and short-term financial institution ratings of its parent, Kuwait Finance House K.S.C. (KFH) at AAA/MARC-1. The outlook on the ratings of both institutions is stable.

The long-term rating of KFHMB is notched down from KFH, reflecting MARC’s assessment that the creditworthiness of the former is highly correlated with the credit strength of KFH, taking into account KFH’s 100% ownership of KFHMB, the name sharing and MARC’s view that the Malaysian market represents an important geographic market for the group. The AA+ rating continues to incorporate a very high probability of parental support. Given the bank’s relatively small size and contribution to KFH’s consolidated revenues, MARC views KFHMB as a strategic subsidiary as opposed to a core subsidiary of KFH. The stable outlook on KFHMB’s rating is in line with the outlook on KFH’s rating. Any changes in KFHMB’s ratings are likely to be driven by changes in KFH’s rating and/or changes in expected support from its parent.

KFHMB’s credit metrics have weakened in recent periods; its capital cushion has been eroded by its significant reported loss of RM577.4 million for 2011 and its impaired loans ratio had surged to 23% as of end-2011 before settling at 15% as of end-June 2012 (1H2012). At the same time, MARC notes positively that KFHMB has taken decisive steps to address legacy problem exposures in its financing book and counter the drag on its profitability posed by the continuing recognition of credit impairment from these exposures. Gross impaired financing almost doubled as of end-2011 from its end-2010 level but the bank’s net impaired financing ratio saw a much slighter increase to 7.6% from 6.2% with the bank stepping up its provisioning against problematic exposures. Apart from the impairment of its legacy exposures, the bank appears to have accelerated write-offs during the first six months of 2012 (1H2012).

While MARC expects KFHMB’s asset quality to remain lower compared to other competitors, it acknowledges the bank’s improved financing loss reserves cushion and the prospect of credit impairments normalising at lower levels with the remaining risks from legacy problem credits somewhat reduced. The rating agency
expects the bank to report improved post-provisioning profitability and capital accretion, going forward. Financing loss provisions and problem financing formation are expected to trend lower following the major clean-up of its financing book and also as a consequence of KFHMB’s more disciplined lending in recent years. At the same time, MARC notes with concern the still high percentage of weak credits in KFHMB’s financing book, the majority of which are within its corporate financing portfolio. These could still expose the bank to a high level of credit impairments and credit losses in the context of tougher economic and operating conditions.

The affirmed rating on KFH, meanwhile, continues to incorporate a high probability of systemic support, reflecting its importance as the second largest bank in Kuwait by asset and the size of its credit portfolio and deposits, in addition to its stand-alone credit strength. The bank's indirect majority government ownership also provides assurance of state support if required. The support considerations provide a significant offset to negative credit drivers at the parent bank, in particular its stressed asset quality and continuing profitability challenges. Notwithstanding its mediocre asset quality and low returns on assets, KFH continues to possess some noteworthy credit strengths, including the resilience of its domestic retail banking franchise, its good geographic diversification and its strong funding base. The aforementioned strengths continue to provide flexibility for KFH to contend with its current challenges.

The parent bank, whose post-global financial crisis performance has been marked by periods of generally depressed earnings, has embarked on a five-year strategy and transformation programme that is aimed at bolstering the bank’s and group’s performance. The three-pronged strategy entails strengthening its performance in its home market, streamlining the group’s investment portfolio and increasing coordination across its international banking subsidiaries. KFH’s ability to execute its transformation programme could have potentially positive implications for its credit profile over the longer term in that its strategic initiatives could help to strengthen its global Islamic banking franchise and foster improved profitability. In the more immediate term, KFH’s ability to address key negative credit drivers such as its continued high level of non-performing finance facilities (NPF), provisioning for NPFs and pressure on its profitability would be a particularly important determinant of rating stability for both the parent and KFHMB.

Changes to KFHMB’s ratings and outlook will likely be triggered by any or a combination of the following: further deterioration in KFH’s credit metrics, a weakening in support from the Kuwait government and perceived or observed weakening in parental support from KFH.

Contacts:
Milly Leong, +603-2082 2288/ milly@marc.com.my;
Sharidan Salleh, +603-2082 2254/ sharidan@marc.com.my.