CAPITAL Intelligence (CI) has lowered the Financial Strength Rating (FSR) of Kuwait Finance House K.S.C. (KFH) to ‘BBB' from ‘BBB+'. The new rating is supported by KFH's dominance of the Islamic banking sector in Kuwait, as well as its large overall market share in both deposits and loans, and by the significantly improved equity base following the June 2013 rights issue. The rating is however constrained by an asset quality that continues to be less than satisfactory in terms of both headline non-performing financing (NPF) ratio (although a significant proportion of this is understood to be due to the inclusion of restructured debt) and loss reserve coverage, and by mediocre profitability at the net level. KFH remains Kuwait's largest Islamic bank, as well as being the second largest financial institution. KFH's Support Rating is raised to ‘1', reflecting both the Kuwait government's blanket guarantee of all customer deposits placed in Kuwait and the record of both the Central Bank and wider Kuwaiti government in supporting Kuwaiti banks in time of need. Moreover KFH's size as the second largest bank in the country (and its pivotal role in the Islamic banking segment) makes it very likely that strong official support would be forthcoming should it be required, especially in terms of liquidity. Notwithstanding the higher Support Level, CI also lowers the Long-Term Foreign Currency rating to ‘A', given the reduction in the FSR. The Short-Term Foreign Currency Rating is however maintained at ‘A1'. The Outlook on all ratings is maintained ‘Stable'. This Outlook however is in turn based on an assumption that 2015-16 will at last see a significant improvement in both asset quality and in profitability – at least at the operating level. If this does not happen, there could be further downward pressure on ratings in the medium term. For KFH, the crucial areas for improvement for 2015 are the same as those in 2014 − asset quality and profitability. As regards asset quality, the positives are that the problems now appear to have been largely identified (although the 2014 rise in money NPFs is a concern), and that the large portfolio of restructured debt is well secured and performing. The negatives are the still significant level of new accretions of problem debt and the still low level of cash loss reserves – although the collateral position adds some comfort. CI had expected much more progress in this area in 2014, but this was not the case. Near term progress is likely to come from the further successful restructuring of NPFs. While this may not in itself do anything to reduce the headline ratio, it should cut the level of exposure that is actually non-performing (and improve collateral coverage). As regards operating profitability, improvements here may be more difficult to achieve in the short term as costs have been rising faster than revenues (notwithstanding the encouraging performance on expenses in Q1 2015) – and a number of non-banking subsidiaries and associates still either add little to revenues or are actually loss-making. Improving operating profit is however vital as without this, the necessary additions to cash loss reserves cannot be made. KFH was incorporated in March 1977 as the first Islamic bank in Kuwait. Established as a public shareholding company and listed on the Kuwait Stock Exchange in 1983, KFH was originally regulated and supervised by the Ministries of Commerce and Finance. With the introduction of the Islamic Banking Law in 2003, KFH came under the regulatory supervision of the Central Bank of Kuwait in May 2004. The Bank's four largest current shareholders (47.9 per cent in aggregate) are quasi-governmental institutions. KFH has established banking subsidiaries in Bahrain (100 percent owned Kuwait Finance House BSC), Malaysia (100 per cent owned Kuwait Finance House [Malaysia] Berhad) and Turkey (62 per cent owned Kuwait Turkish Participation Bank). KFH also maintains a 100 per cent owned subsidiary in the Cayman Islands, KFH Private Equity Limited, which is active in Islamic investment. In addition, KFH controls several other Kuwaiti incorporated subsidiaries involved in Islamic finance and investments, real estate trading and investment, real estate management and aircraft leasing (ALAFCO). In the KSA, KFH has established the wholly owned subsidiaries Saudi Kuwaiti Finance House (an investment company) and Baitak Real Estate Investment Company SSC (real estate development and investment). KFH has also made direct or indirect investments in a number of associates active in Islamic banking and financial services including Kuwaiti-incorporated Gulf Investment House KSC (20 per cent), Ibdar Bank (40 per cent) and First Takaful Insurance Company KSC (28 per cent). Additional associates include 20 per cent owned UAE-based Sharjah Islamic Bank and five Bahrain-based real estate development companies. At end 2014, KFH had total assets of $58.7 billion, employed more than 9,000 staff worldwide and operated 390 branches and 740 ATMs. The domestic network in Kuwait comprised 65 branches. International operations contributed a majority of both operating revenues and net profit in 2014. — SG
