Standard & Poor’s Ratings Services said that it had affirmed its A-/A-2 long- and short-term counterparty credit ratings on Kuwait Finance House (KFH). The outlook remains negative.
The rating affirmation follows KFH’s recent announcement that it is launching a 20% rights offering, which we expect will be completed in the next few weeks. KFH expects to generate about Kuwaiti dinar 319.5 million (about $1.14 billion) from the offering and we expect the risk-adjusted capital (RAC) ratio before adjustments to improve to 7% by year-end 2013.
At the same time, we have revised our assessment of KFH’s stand-alone credit profile (SACP) to ‘bb’ from ‘bbb-‘. This partly reflects our revision of the anchor for KFH, the starting point for the long-term rating, to ‘bbb-‘ from ‘bbb’. The change stemmed from our opinion that some of the countries in which KFH increasingly operates exhibit higher economic risks than Kuwait, such as Turkey, where its lending business is expanding rapidly.
The change of the SACP also reflects the revision of our assessment of KFH’s risk position to “weak” from “moderate”. We expect the company’s credit losses to remain higher than those of peers with similar economic risk over the next 18–24 months. KFH allocates an important share of its balance sheet to nonbanking assets such as direct investments in real estate or equity stakes in nonbanking companies. Although the bank has a track record of generating high investment returns from some of these exposures, these activities are intrinsically riskier, more volatile, and less predictable than the core banking business. We believe KFH will continue to show some dependence on investment income over the next two years, despite a likely increase in revenues from its banking subsidiaries. However, we believe KFH’s recent efforts to strengthen its risk management framework and credit underwriting processes will result in visible improvements of the risk profile over time.
Our ratings on KFH now incorporate one notch of additional short-term support to reflect our expectation that management’s ongoing initiatives, including asset disposals, will reduce the risks on the bank’s balance sheet. If in addition to this, KFH were able to improve coverage of problematic assets, we would likely revise our assessment of its risk position to “moderate.” This also assumes that various credit quality metrics materially improve.
Strong government support in case of need gives the bank additional financial flexibility to absorb the cost of such an accelerated derisking strategy. Our view of the likelihood of this support reflects the bank’s “high” systemic importance in Kuwait, and our assessment of the government as “highly supportive” toward the banking sector. We factor an additional notch into our ratings in recognition of the government’s significant ownership stake in KFH, as well as economic trends that are strengthening KFH’s creditworthiness.
The negative outlook reflects our view that despite KFH’s more conservative stance on capital retention, and the expected capital increase, its capitalization will remain under pressure from its expanding balance sheet and relatively limited earnings generation. We expect the company’s RAC ratio before adjustments to exceed 7.0% in the next 12 months. However, if this does not occur, for example because of more rapid balance sheet growth than we anticipate, or inability to complete the scheduled rights offering, we would lower the ratings.
Additionally, if KFH’s transformation plan did not reduce its reliance on investment income, the overall risk control framework were unable to adequately cover the group’s complexity, or the credit underwriting process failed to prevent large swings in asset quality, we could remove the notch for short-term support from the rating, which would trigger a one-notch downgrade.
A revision of the outlook to stable would require significant improvements in the bank’s risk profile. This could for example happen through the reduction of nonbank assets and a stronger risk management framework.