Fitch Ratings has affirmed Commercial Bank of Kuwait‘s (CBoK) Long-Term Issuer Default Rating (IDR) at ‘A+’ with a Stable Outlook.
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Fitch has also affirmed the bank’s Viability Rating (VR) at ‘bb’. A full list of rating actions is below.
KEY RATING DRIVERS
IDRS, SUPPORT RATING AND SUPPORT RATING FLOOR
CBoK’s IDRs are driven by support from the Kuwaiti sovereign. Its 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. CBoK’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 the level of government ownership. This view is reinforced by the authorities’ record of support for the domestic banking system in case of need.
The Central Bank of Kuwait (CBK) operates a strict regime with active monitoring to ensure the viability of banks, and has acted swiftly in the past to provide support where needed. Contagion risk among domestic banks is high (Kuwait is a small and an interconnected market) and we believe this is an added incentive to provide state support to any Kuwaiti bank if needed, to maintain market confidence and stability.
The Stable Outlook on CBoK’s Long-Term IDR reflects that on the Kuwaiti sovereign rating.
CBoK’s ‘F1’ Short-Term IDR is the lower of two options mapping to 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 of CBoK reflects its moderate franchise, heightened risk appetite considering high concentration of the loan book, volatile problem-loan generation, and weak profitability that is more sensitive to local economic conditions than its higher-rated peers’. The rating also reflects pressures on the domestic operating environment due to the coronavirus pandemic and lower oil prices. It also factors in CBoK’s adequate capitalisation, experienced management, sound liquidity.
The decline in oil prices has had adverse effects on Kuwait’s public finances and debt dynamics, external balances and economic growth and adds to the pressure on banks arising from the coronavirus fallout. CBoK 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.
CBoK’s franchise in Kuwait is only moderate but the bank has a good presence in corporate banking, particularly trade finance, well-known brand and reasonable branch network. The bank has an experienced management team and has consistently implemented the bank’s renewed and clearer strategy. However, the current crisis is likely to put pressure on the bank’s execution.
CBoK has the lowest impaired loans ratio in the local banking sector (1.1% at end-1H20; zero at end-2019 and end-2018) as the bank typically writes off loans as soon as they become impaired and swiftly initiates recovery efforts. This means that CBoK’s generation of potential problem loans is high (1.5% of average gross loans in 1H20; 4.7% in 2019; 3.4% in 2018) versus the peer weighted average (1.4% in 2019 and 1.3% in 2018). However, this write-off policy is likely to change should pre-impairment operating profits weaken. Given the challenging operating environment in Kuwait, potential further asset-quality deterioration cannot be ruled out. Reserve levels continue to be high (6.3% of gross loans and 572% of impaired loans at end-1H20; higher than peers’) due to the prudent actions of the CBK requiring the build-up of precautionary reserves. Fitch believes this is necessary for the bank’s significant concentration by sector and single obligor due to Kuwait’s narrow economy.
CBoK’s profitability is sensitive to a concentrated earning assets base, as illustrated in 2019 when loan impairment charges consumed 100% of pre-impairment operating profit; this percentage consistently exceeds local averages. Profitability is also highly sensitive to economic conditions and interest-rate cycles in Kuwait. The bank’s compression in its net interest margin in 2019 was mainly due to the higher cost of deposits following the increase in CBK’s bond/repo rates while the CBK discount rate, the benchmark for lending in Kuwait, was unchanged. In 1H20, similar to peers’, CBoK’s profitability was hit by lower interest rates via the CBK discount-rate cut and lower business volumes. The bank’s healthy non-interest income (fees and commissions represent 25% of operating income, which is above peers’) and good cost efficiency support pre-impairment profitability, although Fitch believes the write-off policy could lead to more profit volatility (operating profit-to-risk weighted assets ratio was only 0.1% in 1H20; zero in 2019 and 1.9% in 2018).
CBoK’s common equity tier 1 (16.7% at end-1H20) and tangible leverage (15.2%) ratios are higher than peers’. Expected low loan growth and an adequate pre-impairment operating profit (estimated at 3.5% of average gross loans in 1H20, annualised) will continue to support the bank’s capital. However, Fitch views CBoK’s capitalisation as only adequate given concentrations on both sides of the balance sheet, exposing CBoK to event risk, especially in the current deteriorating operating environment.
CBoK’s liquidity is well-managed and liquidity risk remains contained. Liquidity is underpinned by substantial Fitch-calculated net liquid assets at 21% of total assets and covering 32% of total customer deposits at end-2019. The Fitch-calculated gross loans/deposits ratio is constantly below 80% and the peer weighted average of 85%. Similar to peers’, CBoK’s high reliance on wholesale funding results in high deposit concentration. However, the deposit base has been stable, mitigating liquidity maturity mismatches.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A downgrade of CBoK’s Long-Term IDR would require a downward revision of the SRF.
Weaker ability to support, reflected in a sovereign downgrade, would lead to a downward revision in the SRF, but as the sovereign Long-Term IDR has a Stable Outlook, this is not our base case. A weaker propensity from the authorities to support the bank would also lead to a negative rating action, but this is unlikely in Fitch’s view given Kuwait’s strong record of supporting domestic banks.
A downgrade of the VR would arise from deterioration in asset quality and performance, which would negatively affect capitalisation metrics. This would likely come from a sustained deterioration in the domestic operating environment along with the weaker execution and risk controls.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The bank’s SRF is unlikely to be revised up in the near term given its already high level.
CBoK’s VR could be upgraded if the bank’s company profile continues to improve, including further diversification of the franchise and business model, a decrease in lending concentrations, which would reduce event risk. A slower generation of problem loans would also be positive for the VR.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579]
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