Fitch Ratings has affirmed Kuwait Finance House’s (KFH) Long-Term Issuer Default Rating (IDR) at ‘A+’ with a Stable Outlook. Fitch has also affirmed the bank’s Viability Rating (VR) at ‘bb+’.
KFH’s IDRs are driven by support from the Kuwaiti state. The Support Rating (SR) of ‘1’ and Support Rating Floor (SRF) of ‘A+’ reflect Fitch’s view of an extremely high probability of support being provided by the Kuwaiti authorities to all domestic banks if needed. KFH’s SRF is in line with Fitch’s domestic-systemically important bank SRF for Kuwait.
Fitch’s expectation of support from the authorities is underpinned by Kuwait’s strong ability to provide support to domestic banks, as reflected by the sovereign rating (AA/Stable) and a strong willingness to do so irrespective of the banks’ size, franchise, funding structure and level of government ownership.
The Central Bank of Kuwait (CBK) operates a strict regime with active monitoring to ensure the viability of the banks, and has acted swiftly in the past to provide support where needed. Contagion risk among domestic banks is high and we believe this is an added incentive for the state to provide support to any Kuwaiti bank if needed, to maintain market confidence and stability.
The Stable Outlook on KFH’s Long-Term IDR reflects that on the Kuwaiti sovereign rating.
KFH’s Short-Term IDR of ‘F1’ is the lower of two options mapping an ‘A+’ Long-Term IDR. This is because a significant proportion of the Kuwaiti banking sector funding is related to the government and a stress scenario for the banks is likely to come at a time when the sovereign itself is experiencing some form of stress.
Fitch judges this “wrong-way” risk to be high in Kuwait, but not likely to happen in the short- to medium-term.
The VR reflects the bank’s high risk appetite and weak asset quality, with significant operations in more challenging markets than Kuwait and only adequate capital ratios considering these risks. The VR also reflects KFH’s leading Islamic franchise in Kuwait, and strong funding and liquidity.
KFH is exposed to slower domestic economic growth and fewer financing opportunities. However, Kuwait is more resilient than its Gulf Cooperation Council (GCC) peers, mainly due to its exceptionally strong external balance sheet and the vast assets of the Kuwait Investment Authority (KIA – estimated at USD527 billion or 380% of GDP at end-1Q20).
This supports the government’s capital spending, albeit at a slower pace, and banks’ financial profiles. Fitch’s assessment of KFH’s operating environment takes into account the bank’s exposure to more challenging markets, including Turkey (28% of credit risk exposures at end-2019), Bahrain (11%) and Malaysia (4%).
KFH has a strong franchise as the largest Islamic bank in Kuwait and the country’s second-largest bank, with a market share of about 21% by assets at end-2019.
KFH’s asset quality remains somewhat stable, supported by the Kuwaiti sovereign that continues to fulfill its financial commitments. The bank’s impaired financing ratio increased only to 2.5% at end-1H20 from 2.2% at end-2019, mainly owing to impairments in the retail book and construction sector.
KFH’s concentration by economic sector and single borrower is below peers’ but remains high by international standards. Reserve coverage of impaired financing is high by international standards (203% at end-1H20) due to stringent and conservative requirements by the CBK but this is necessary for the bank’s significant exposure to more challenging markets outside Kuwait.
KFH’s net income decreased 40% year-on-year in 1H20, owing to higher impairment charges, as well as slowdown in financing and non-financing income from lower profit rates and business volumes.
KFH’s capital ratios declined in 1H20, due to higher risk weighted assets (RWA) driven by financing and investments growth. Capital ratios compare well with peers’, with a common equity tier 1 ratio of 14.6% at end-1H20 (15.7% at end-2019), but are only adequate considering pressures from volatile markets and high concentrations.
KFH’s expected mid-single digit financing growth in 2020 and continuous divestments of non-core banking assets will support capital metrics. The bank can also either raise capital if needed (although not expected) or retain dividends.
The trust certificate issuance programme’s ratings are driven solely by KFH’s IDRs of ‘A+’ and ‘F1’. This reflects Fitch’s view that default of these senior unsecured obligations would reflect the default of KFH in accordance with Fitch’s rating definitions.
The trust certificate issuance programme is housed under KFH Sukuk Company SPC Limited (KFH Sukuk, also trustee), a special purpose vehicle, incorporated in the Cayman Islands, solely to issue certificates (sukuk) under the programme.
The Long-Term IDR of KFH is linked to the Kuwaiti sovereign IDR. KFH Sukuk’s programme ratings are driven by KFH’s IDRs.
KFH has an ESG Score of ‘4’ for Governance Structure. Islamic banks need to ensure compliance of their entire operations and activities with sharia principles and rules. This entails additional costs, processes, disclosures, regulations, reporting and sharia audit.
This results in a Governance Structure relevance score of ‘4’ for KFH (in contrast to a typical ESG relevance score of ‘3’ for comparable conventional banks), which has a negative impact on the banks’ credit profiles in combination with other factors.
In addition Islamic banks have an Exposure to Social Impacts score of ‘3’ (in contrast to a typical ESG relevance score of ‘2’ for comparable conventional banks), which reflects that Islamic banks have certain sharia limitations imbedded in their operations and obligations, although this only has a minimal credit impact on the entities.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies).
Source Fitch Ratings