Key fact

Profits of Kuwait’s nine listed full-service banks rose by nearly 60 per cent in 2010

Source: MEED

In many ways the past 18 months have seen a transformation in the Kuwaiti banking sector as profit levels have risen, provisioning declined and loan-to-deposit ratios improved.

During 2010, the combined profits of Kuwait’s nine listed full-service banks rose by nearly 60 per cent. Only two banks reported a fall in profits, with most posting profit growth in excess of 50 per cent as provisioning no longer weighed them down. In the first quarter, that upward trend continued with a nearly 20 per cent increase in overall profits for the sector.

Kuwait bank loans by sector
Real estate 25
Commercial 23
Other retail 23
Stock market lending 11
Non-bank financial institutions 11
Construction 7
Source: Central Bank of Kuwait

Enthusiasm for banks has recovered in the equity markets too. The banking sector index on the Kuwait Stock Exchange has recovered from its early 2009 lows, when it dipped to 7,500 points. It is now at around 12,000 points although still a long way off its peak in October 2008, when it nearly hit 17,000 points.

Provisioning eases

The recovery in profits has been driven more by the peak in provisioning than by a significant recovery in the operating environment. The operating income for the sector actually fell more than 10 per cent in the first quarter of 2011.

The combined figures also mask a patchy recovery, with some banks still struggling to increase profits and loan growth across the sector largely stagnant. During 2010, loans grew by just 1.86 per cent. In the first quarter, they rose by a lacklustre 3.6 per cent. Asset growth was also weak, rising by 3.9 per cent in 2010.

The EDP is much needed to stimulate the banking system, but the problem is the execution is poor

Naveed Ahmed, Global Investment House

More worryingly, net interest income, which accounts for about 70 per cent of bank revenues, fell nearly 1.2 per cent in 2010. The fall was driven by slow loan growth and weak margins, says Philip Smith, banking analyst at US rating agency Fitch Ratings.

“Most banks maintained their cautious stance towards lending,” says Smith. “Margin pressure follows 50 basis points of cuts in the Central Bank of Kuwait discount rate in 2010, to which most loans are linked and automatically reprice when it changes.”

Total operating income, 2010
Kuwait Finance House 31
National Bank of Kuwait 26
Gulf Bank 11
Burgan Bank 10
Commercial Bank of Kuwait 7
Al-Ahli Bank of Kuwait 6
Ahli United Bank 5
Kuwait International Bank 2
Boubyan Bank  2
Source: Kuwait Stock Exchange

With falling loan margins, banks have increasingly been chasing lower yielding deposits, but so far have had only limited success in offsetting the negative effects of lower margins and loan growth.

As interest rates start to rise, the margin on loans should start to improve quickly, and that should start to occur by mid-2012. Coupled with a generally improving economic picture which will benefit the banking sector, Fitch Ratings is predicting economic growth of more than 4 per cent for 2011 and 2012, a significant improvement on 2.9 per cent in 2010.

Demand for loans is expected to pick up in 2012, according to Elias Bikhazi, research director at the local National Bank of Kuwait. He says that consumer lending is already growing strongly and corporate demand should pick up by the end of the year. Bank profits should also start to improve as the government’s $125bn Economic Development Plan (EDP) is implemented, although many bankers are sceptical about how much will be implemented in the next 12-18 months.

Market share of assets, 2010
National Bank of Kuwait 28
Kuwait Finance House 28
Gulf Bank 10
Burgan Bank 9
Commercial Bank of Kuwait 8
Al-Ahli Bank of Kuwait 6
Ahli United Bank 5
Boubyan Bank 3
Kuwait International Bank 3
Source: Kuwait Stock Exchange

“There is a huge amount of enthusiasm for the EDP and banks are preparing to play a role in it, but there is also a concern that it may not end up happening as fast as we all hope,” says an investment banking head in Kuwait.

Slow credit growth

Most analysts say credit growth will be around 5-8 per cent in 2011, rising to about 10 per cent in 2012, reflecting a slow implementation of government spending plans. “The EDP is much needed to stimulate the banking system, but the problem is the execution is poor,” says Naveed Ahmed, senior financial analyst at the local Global Investment House. “We are very sceptical on the implementation and don’t expect to see any positives from it for the banking sector in 2011.”

While credit growth is lacklustre, the banks are very liquid, putting large amounts back on deposit with the central bank in low yielding assets. The loan-to-deposit ratio of the banking sector had fallen to about 85 per cent by the end of the first quarter, from 98 per cent at the end of 2009. Some analysts suggest the promise of government spending packages to come may even be deterring banks from lending now when they can wait and do more state-backed lending later.

The heavy provisioning and slow credit growth of the past few years has left most banks protecting their market share, rather than grabbing new customers. Between 2009 and 2010, there was very little change in market share in terms of both operating profits and assets. National Bank of Kuwait and Kuwait Finance House (KFH) remain the dominant lenders in Kuwait’s banking sector.

That is not to say that the past few years have been easy. Although NBK grew its profits in 2010 and is in a strong financial position, KFH faces a more challenging outlook and probably more provisions, says Ahmed.

KFH is having to restructure the debts of some of the investment houses it owns a stake in. In late June, KFH announced it would restructure $180m of debt to Gulf Investment House, in which it holds a stake along with Boubyan Bank and Burgan Bank. Commercial Bank of Kuwait (CBK) is also expected to continue provisioning during the rest of the year.

Non-performing loans

The ratio of non-performing loans to total loans shows that although system-wide the ratio is improving, several banks are still at very high levels. CBK, Gulf Bank and Kuwait International Bank (KIH) all have ratios of about 15 per cent or higher. In 2010, KIH was the only bank in Kuwait to have its non-performing loans-to-total loans ratio deteriorate, from 9.5 per cent in 2009 to 15.8 per cent in 2010.

The problems in the Kuwait banking sector are symptomatic of a wider concern for the country’s economy. A booming oil sector makes for great looking public finances, but the lack of diversification in the economy has resulted in an over-reliance on the state, or risky investments, such as the stock market and real estate.

The EDP is intended to rectify that, so its implementation needs to start as soon as possible. That would open up lending opportunities to the banking sector in state-backed projects in new sectors of the economy. It will also have massive benefits for the wider economy.

Unfortunately, the EDP is not expected to move forwards as fast as it should. Instead banks could be left waiting for a rise in interest rates as their best hope of increasing profits.

Investment: Banks make limited progress

Although the banking sector has largely managed to overcome the problems from the bursting of the regional real-estate and stock market bubbles, Kuwait’s investment companies are making limited progress at getting back on track.

The collapse in asset prices left many without a way of paying off the loans with which they had financed their investments.

Most of these companies have been forced into some kind of debt restructuring exercise, with varying degrees of success. So far, only Global Investment House has managed to secure an amicable solution with its creditors, after agreeing a $1.7bn debt deal in late 2009.

Since then, most other companies have moved slowly. In mid-June, the Kuwaiti courts outlined a debt restructuring for The Investment Dar (TID) under the terms of the Financial Stability Law, enacted by the government in order to protect distressed companies from their creditors, while they tried to work out a plan to pay off their debts. Privately, bankers in Kuwait are worried that more investment companies will default or be forced into seeking bankruptcy over the next 12 months. That will mean more long and potentially unfruitful battles in Kuwaiti courtrooms.

Although several creditors have reservations about the plan for TID, it does at least show signs of progress and that the Financial Stability Law can be used to come up with a largely sensible restructuring proposal. Banks worry that for a lot of other investment companies no progress is being made. As a result, an active secondary market is developing with distressed debt funds buying up loans in default, sometimes for as little as 10 cents on the dollar, in the hope that if they hold them long enough a solution will eventually see at least part of the debts paid off.

The poor state of the investment firms, many of which are still making a loss nearly three years after the onset of the financial crisis, is a big worry for the banks. A large part of their lending (around 11 per cent of total bank lending) was to these firms and some are owned by the banks. This put more indirect exposure to real estate and the stock market on banks’ balance sheets.

Although the Central Bank of Kuwait has now enforced stricter lending criteria to the investment companies, the lack of diversification in the Kuwait economy means the banks are likely to remain worryingly exposed to these firms over the next few years.