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Rating Action:

Moody's downgrades Kuwait Finance House long term ratings to A1, outlook negative

16 May 2013

Limassol, May 16, 2013 -- Moody's Investors Service has today downgraded Kuwait Finance House's (KFH) long term ratings by one notch to A1 from Aa3. Moody's also downgraded KFH's baseline credit assessment (BCA) and bank financial strength rating (BFSR) by two notches to ba1/D+ from baa2/C- respectively. The Prime-1 short term rating was confirmed. All ratings assigned to KFH carry a negative outlook.

The rating actions reflect (1) continued asset quality pressures (2) an increasing reliance on volatile investment income and (3) the current organisational complexity and overall risk profile inconsistent with global peers.

Today's rating action concludes the review for downgrade initiated for Kuwait Finance House on 7 November 2012.

RATINGS RATIONALE

---RATIONALE FOR DOWNGRADE

The first key driver for today's rating action is KFH's relatively weak asset quality. While the non-performing financing (NPF) ratio has improved from 8.8% as of year-end 2011 to 7.2% at year-end 2012 it still remains high when compared to local and global peers at the standalone baa2 level of 1.6% (note all calculations include Moody's adjustments). This weak asset quality is primarily driven by concentrated exposures to Kuwaiti non-banking financial institutions, real estate and underperforming investments. Despite an increase in general provisions, which led to improved coverage levels from YE 2010 to YE 2012, Moody's considers that the overall coverage level of provisions remain relatively low at approximately 75% when compared to KFH's local and global baa2 peers at 97% (Moody's does not include collateral values in this ratio). While current underwriting standards have significantly improved, legacy practices remain a source of future asset quality uncertainties.

The second driver of today's rating action is KFH's increasing reliance on investment income which is inherently volatile and less predictable, a feature not common with global peers at the baa2 standalone level. This is illustrated by its 25% contribution to total income in 2012 compared to 13% in 2010. Although net profit has substantially improved in 2012, it has been primarily achieved through this less stable income source.

The third key driver is the current organisational complexity of the institution. Moody's acknowledges KFH's extensive restructuring exercise aimed at improving efficiency, reporting and internal risk controls. Although management's recent efforts have already led to major improvements and cost reductions, the transformation plan includes a significant rationalisation of business lines and subsidiaries, as well as implementation of the technology infrastructure necessary to support a stronger and more consolidated risk management function. We anticipate it will take substantial time for the evolving management team to complete this process and reach a position of cohesion and stability for the firm. Given that this process also necessitates a major change in corporate culture, Moody's believes it will consume significant management time during a period when the market is becoming increasingly more competitive.

--- WEAKNESSES MODERATED BY STRONG AND DIVERSIFIED ISLAMIC FRANCHISE

Despite the weaknesses which in isolation are consistent with much lower rated peers, Moody's also takes into account KFH's strong global and local Islamic franchise which supports good top line revenue growth. KFH has around 20% local market share based on non-consolidated Kuwaiti assets and a good retail franchise that provides a stable anchor for the whole business. With a strong global brand KFH is the only Islamic bank with significant geographical diversification where currently around 48% of the bank's revenues are being generated outside Kuwait with markets like Turkey and Malaysia providing significant growth opportunities. Moody's rating action also takes into consideration the relatively low borrower concentration risk versus GCC peers (top 20 exposures are around 71% of Tier 1 versus peers often in the range 150-250%).

--- RATIONALE FOR NEGATIVE OUTLOOK

In addition to the asset quality pressures described above, Moody's views the bank's current capitalisation metrics as relatively weak, particularly in light of the large stock of equity and real estate investments and exposures held on the balance sheet that tend to be more volatile than retail assets. Although initiatives regarding risk-adjusted capital allocation should yield future benefits across all levels of the firm, KFH's consolidated Tier 1 ratio and loan loss coverage ratio of 13.6% and 75% currently compares unfavourably with Kuwaiti averages of 15.5% and 89% respectively, although it is expected that the firm will raise significant new capital before YE 2013 that should moderate this concern. This factor, in conjunction with the general uncertainties regarding the successful execution of such a transformation exercise, underpins the negative outlook.

---WHAT COULD MOVE THE RATINGS UP/DOWN

As indicated by the negative outlook, Moody's does not expect upward pressure on KFH's ratings over the near term.

The ratings could be downgraded as a result of (1) deterioration of asset quality metrics, (2) weakening of its retail franchise (3) weakening of capital position and (4) problems resulting from, or failure of, the restructuring exercise.

---SUPPORT ASSUMPTIONS

KFH's long term rating has been downgraded to A1 from Aa3 and now benefits from six notches of uplift from its BCA due to high likelihood of support from the Kuwaiti authorities in case of need. The uplift is a consequence of (1) KFH's leading market position in the Kuwaiti banking system with a market share of around 31% in terms of total assets (on a consolidated basis) (2) a 49% ownership by Kuwaiti government (Aa2) entities, in particular the Kuwaiti Investment Authority and (3) the Kuwaiti authorities long track record and transparency surrounding the provision of support to distressed financial institutions.

PRINCIPAL METHODOLOGY

The principal methodology used in this rating was "Moody's Consolidated Global Bank Rating Methodology", published in June 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

KFH is incorporated in Kuwait and reported consolidated total assets of KD14.7 billion (around US$ 51.7 billion) as of 31 December 2012.

The local market analyst for this rating is Khalid Howladar +971.4.237.9542

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Stathis A Kyriakides
Asst Vice President - Analyst
Financial Institutions Group
Moody's Investors Service Cyprus Ltd.
Kanika Business Centre
319 28th October Avenue
PO Box 53205
Limassol CY 3301
Cyprus
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Yves J Lemay
MD - Banking
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Cyprus Ltd.
Kanika Business Centre
319 28th October Avenue
PO Box 53205
Limassol CY 3301
Cyprus
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades Kuwait Finance House long term ratings to A1, outlook negative
No Related Data.
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