More than a year after the global economic crisis reached the Gulf, Kuwait’s banks and the country’s wider economy are still suffering from the impact.

The Kuwaiti banks’ third-quarter figures are mostly in the red. In October, for example, Gulf Bank posted a 98 per cent drop in its third-quarter net profit, down to KD469,000 ($1.6m), compared with the same period in 2008, and ratings agencies have continued to issue gloomy assessments and downgrades about Kuwait’s banks.

The International Monetary Fund (IMF) expects Kuwait’s gross domestic product (GDP) to fall by 1.6 per cent this year, a more pessimistic forecast than the fund’s predictions for neighbouring Saudi Arabia and the UAE, whose GDPs it forecasts will decline by 0.9 per cent and 0.2 per cent respectively.

So when will the Kuwaiti banking industry recover its confidence? While most of the bad economic news in the region can be traced back to the global credit crunch of 2008-09, the Kuwaiti banking downturn has been exacerbated by four specific problems. First, Gulf Bank’s KD375m derivatives loss in 2008 has hit the second-largest Kuwaiti lender’s profitability throughout 2009.

Second, Kuwait’s major investment houses have suffered because of their exposure to real estate investments. Gulf Investment House reported its first-ever net loss in 2008, of KD257.6m, down from a profit of KD91.4m in 2007.

Third, Kuwaiti banks have increased their provisions for expected losses on their loans to troubled Saudi corporates Saad Group and Ahmad Hamad al-Gosaibi & Brothers.

And finally, the slide in domestic real estate prices has hit the value of banks’ assets.

The Kuwaiti banks’ recovery will be more complex and halting as a result of this set of problems. But the nature of Kuwaiti banks’ problems also offers hope that, one by one, individual institutions can pick their way out of trouble through an overhaul of their credit strategy, and in the specific case of Gulf Bank, a state bailout.

A Kuwait specialist at one leading ratings agency argues that the problems in Kuwait have attracted more attention than those in many other Gulf states because the local banks are expected to operate as independent, commercially viable institutions.

“Moody’s rating action reflects the weakening credit conditions in Kuwait over the past 12 months”

Stathis Kyriakides, analyst, Moody’s

The state authorities have provided only the support that was essential, forcing banks and investment firms to toughen their man-agement and accept the cost of their excesses or misjudgements.

By comparison, Qatar Central Bank has directly injected government money into the country’s banking system. Doha has undertaken a multi-pronged strategy to shore up its banks, marking it out as arguably the most interventionist government in the region. In February this year, the sovereign wealth fund Qatar Investment Authority injected $5.3bn of capital into the banking sector by acquiring 5 per cent stakes in seven of the nine Qatari banks listed on the Qatar Exchange.

But Kuwait’s central bank has not taken the same approach, instead approving an emergency ‘financial stability’ decree in December last year with the aim of securing local banks against major defaults. The law offers government guarantees against any drop in the value of the banks’ financial and real estate investment portfolios held as of 31 December 2008.

This less interventionist approach may have long-term advantages if the banks are forced to strengthen their risk-management strategies. But Kuwait still faces the fact that, almost a year after the initial crash, the financial sector continues to suffer and many institutions are struggling to get back on course.

Impairment charges

In August, ratings agency Moody’s Investors Service downgraded Burgan Bank’s rating from A1 to A2, and in September the agency downgraded the financial strength ratings of Commercial Bank of Kuwait from C to C-, and those of Al-Ahli Bank of Kuwait and Bank of Kuwait & the Middle East from C- to D+.

Commercial Bank’s long-term global local currency and long-term foreign currency ratings were also downgraded from A1 to Aa3, while those for Al-Ahli Bank of Kuwait were cut from A1 to A2, although the short-term global local currency and foreign currency grades for both banks were affirmed at Prime -1.

“Moody’s rating action reflects the weakening credit conditions in Kuwait over the past 12 months and the poor performance of the Kuwaiti stock exchange,” says Stathis Kyriakides, an analyst at Moody’s. “This has led to rising credit and securities impairment charges.”

In November, ratings agency Standard & Poor’s (S&P) lowered its long and short-term counterparty credit ratings – the ratings that determine a bank’s creditworthiness – on Gulf Bank to BBB-/A-3 from BBB+/A-2. It said at the time the outlook was ‘negative’ and that the deterioration in the bank’s assets had been greater than S&P had expected. The rating would have been worse but for the fact that Gulf Bank, as Kuwait’s second-largest lender, is systemically important to Kuwait’s economy and S&P expects the authorities will therefore intervene to provide the bank with extra support if needed.

But the news is not universally bad. In August, Moody’s affirmed a long-term deposit rating of Aa2 for National Bank of Kuwait (NBK), the country’s largest lender. Long-regarded as a paragon of conservative risk policy, NBK has reported profits of $263m for the third quarter of this year, 10 per cent up on the same period in 2008.

Making provisions

Operating income at NBK for January-September is also up, by $36m, and net profits for the nine-month period reached $703m. Chief executive officer Ibrahim Dabdoub says group earnings would have been $165m more but for several exceptional items: $33m in losses on the bank’s local investment portfolio, voluntary loan provisions of $66m, and a reimbursement of $66m to customers affected by the collapse of the investment scheme operated by US financier Bernard Madoff.

As one of the largest and strongest banks in the Middle East, NBK has been able to absorb these costs. But this year has been a lot less comfortable for many other Kuwaiti institutions. Commercial Bank of Kuwait (CBK), for example, has decided to allocate all of its 2009 operating profits to provisions.

“In terms of profitability, we were doing very well before the crisis,” says Abdulmajeed al-Shatti, chairman of CBK. “When the crisis hit, we decided that the situation was bad but that we really didn’t have enough information about what would happen in 2009 and whether our clients would be hit badly. We decided that whatever profits we made in 2009 we would set aside as provisions. This is basically just in case anything happens.”

On top of its existing provisions base, the bank set aside KD50m in the final quarter of 2008 and Al-Shatti expects it to have added about KD120m more this year, taking total provisions close to KD300m. He plans to return to the normal provisioning approach in the first or second quarter of 2010.

Setting aside provisions on this scale has left profits at a minimal level – a reported KD800,000 in the first half of this year.

Al-Shatti remains positive about the bank’s prospects. “Personally, I think the crisis is over,” he says. “What is happening now is that we are experiencing the aftershocks of the crisis.”

CBK’s careful approach with regard to provisioning is partly explained by the fact it is engaged in a court dispute with Kuwaiti investment house The Investment Dar. The bank has made sure it has comfortable reserves set aside to protect its position however the dispute turns out.

“To take all these provisions is not an arbitrary decision,” says Al-Shatti. “If anything happens, we don’t have to worry about it.”

“We decided that whatever profits we made in 2009 we would set aside as provisions”

Abdulmajeed al-Shatti, chairman, CBK

Meanwhile, the bank has been reworking its business strategy. In contrast to NBK – which shows no sign of retreating from its extensive international commitments – CBK has decided to focus on the home market, where it has a large branch network and a detailed understanding of market conditions.

Al-Shatti has been encouraged by the government’s efforts to draw up a long-term development plan for the state, which is currently under scrutiny in Kuwait’s National Assembly (parliament). At the same time, he points out that the traditionally heavy reliance on public sector employment provides extra security for the banking industry, because there is less risk of unemployment.

CBK’s traditional rival, Gulf Bank, is rebuilding after heavy losses on its derivatives business in 2008 forced Central Bank of Kuwait to step in with a rescue package and then ordered the institution to carry out a KD375m recapitalisation, helped by the Kuwait Investment Authority’s acquisition in January of a 16 per cent stake.

The bank sustained a net loss of only KD7.5m in the first half of this year, but its third-quarter results show a 98 per cent drop in earnings, compared with the third quarter of 2008, to KD469,000.

“The bank decided to take aggressive provisioning against its non-performing loans and credit facilities, particularly the regional portfolio, transferring all of its operating profit to the existing provisions,” Michel Accad, chief executive officer of Gulf Bank, announced in late October.

“Further precautionary provisions may be required if the general economic situation fails to improve. This may necessitate utilising our operating profits up to the first half of next year to cover our provisioning requirements.”

Accad’s veiled reference to problems in “the regional portfolio” is a reminder of the extent to which the financial problems of businesses in other GCC economies have hurt Kuwaiti institutions.

The Investment Dar, for example, has major property assets in Dubai, while Kuwaiti banks are thought to be among those hit by the debt crisis at Saad Group and Ahmad Hamad al-Gosaibi & Brothers in Saudi Arabia.

But Kuwait Finance House (KFH) – the world’s second-largest Islamic bank by assets  – has managed to stay in the black, reporting a net profit of KD34.3m for the third quarter of this year. This is 46 per cent down on July-September 2008 and is a slightly worse result than some analysts had expected.

But KFH says it does not have a large exposure to struggling local investment houses, some of which have been forced into debt restructuring over the past year.

Mohammad al-Omar, chief executive officer of KFH, points out that, faced with the tight central bank limits on lending by Kuwaiti institutions – Kuwaiti banks are not allowed to lend more than 80 per cent of their retail and government deposit base – the investment houses had turned abroad to raise extra credit, and this meant they were hit hard by the global liquidity squeeze and the sub-prime crisis. European and US banks have been hit the hardest by the credit crunch, affecting Kuwaiti banks that borrowed from them.

Although the lending constraints have protected KFH from the worst of the crisis, it has not been able to avoid some pain. But the bank still says its fundamental business strategy remains valid.

“Our strategy going forward is to do what we do best,” says Al-Omar. “We are asset-backed. We lend on the basis of assets in the real economy. We don’t do speculative business.”

In a region where the real estate boom of 2003-08 offered temptations for the big lenders, KFH has sought to maintain a balance in its activities.

“We are not only investing in real estate,” says Al-Omar. “We are supporting cross-border business between Kuwait and Iraq. Our customers are bringing in goods from abroad.

“We have customers who are involved in the oil business. We have customers who have real estate business. So we are diversified. We have a good share of the retail finance market.”

While some of Kuwait’s banks have grounds for optimism, the country’s investment houses continue to suffer badly from the effects of the economic crisis. The past year has been parti-cularly difficult for the private sector investment finance houses, which are a traditional strength of the Kuwaiti economy. Both The Investment Dar and Global Investment House (GIH) have been forced into debt restructuring talks with creditors.

On 17 September, The Investment Dar reached a standstill agreement with the co-ordinating committee of its banks and investors, and a chief restructuring officer, Mike Grant, has since been appointed. Hoping to reach a consensus deal with shareholders, The Investment Dar extended to 12 November the deadline for  shareholding parties to decide whether they wished to participate. This was primarily to allow investors who are represented by intermediaries, such as holders of sukuk (Islamic bonds), to reach a view on how to restructure.

GIH has already secured creditor endorsement of the proposals for restructuring its KD500m ($1.75bn) bank debt. Detailed planning talks with creditors continue. In the meantime, the group is working to slim down costs and rebuild its operating finances.

Recovery mode

A measure of the painful decisions that have had to be taken is the fact that personnel costs in the first nine months of this year were 49 per cent down on the same period in 2008, reflecting cutbacks made in GIH staff levels.

Despite such belt-tightening, GIH reported a net loss of KD104.2m in January-September this year, due to losses and expected losses on its principal investments and real estate holdings, and losses by associate businesses in which it has stakes.

But the latest figures suggest the worst may now be over. In July-September, the group lost only KD5.6m – 81 per cent less than it lost the preceding quarter.

At Kuwaiti finance house The International Investor, chairman Adnan al-Bahar takes a philosophical view of the crisis that has hit the industry. He says Kuwait does need the planned new capital markets regulator, the draft legislation for which is currently awaiting parliamentary approval, and one that is independent of the stock exchange. This will in his view help the country fulfil its ambitions to develop as a financial hub.

“But a better regulated capital market would not have prevented the crisis,” he says. “I believe that crises are in the nature of markets…No matter how well you regulate, how well you manage, it is impossible for us to avoid corrections.

“Part of the job of investment banks is to act as a bridge between the long-term investment needs of the economy and the fact that most of the money in the market is short term.”

From this perspective, the Kuwaiti banking industry could not have escaped the effects of the global liquidity squeeze, even if Kuwaiti bank lending rules had been more relaxed and the banks had been able to raise more of their funding locally.

Looking ahead to 2010, Kuwait’s banking sector will be in recovery mode, but this recovery will, for reasons unique to Kuwait, be slower than in neighbouring states.