Short-term pain, ?long-term gain

The credit crisis waves of 2008 triggered a panic across the globe and to all types of sectors, irrelevant of their operating nature. The storm specially haunted the financial services sector, where the Kuwaiti banking sector was no exception to its regional and international counterparts. Crunching derivative loss at one of the prominent local bank, refraining ease financial flow to industries, hefty losses by debt ridden companies and consistent parliamentary blockages to Central Bank’s rescue package were primary causes for the humongous fall of the banking stocks. The market sentiments went extremely bad as banking stocks were out of favour and witnessed a huge selling pressure during Q1 2009. “Credit Facilities” and “Quality of Assets”, the two key functioning areas, remained under tremendous pressure during 2009, however, the Central Bank of Kuwait (CBK) acted swiftly and wisely to tackle and help out the industry of the crunch as it provided all needed support by issuing several verdicts of assurance for depositors and investors, as discussed in the later part.

Credit facilities
Banks are accustomed as a primary financial source for various sectors of economy, which in general lays a strong foundation for the GDP growth of the country. However in 2009, this economic pacer faced the toughest time of its history as inadequate earning opportunities, deteriorating asset valuations, tightening liquidity, increasing NPLs and affiliated soaring provisions mesmerised the whole sector. Such unwanted crisis put severe strains on the balance sheet of banks, especially on those, who borrowed externally and were heavily exposed to real estate and equity markets like what happened with UAE banks. Instigated by this, the Kuwaiti banks too, reported a huge drop in its gross loans and advances. From an annual growth of 21 percent + in the past four years, Gross Loans & Advances were subjected to a mere four percent growth in 2009 against 18 percent in 2008. The minimal positive growth could have been negative if NBK and KFIN, the two banking giants, would not have reported a growth in their respective loan portfolios. Collectively, total credit increased by $3.83bn, out of which NBK shared a whopping 78 percent of total expansion ($3.01bn) while KFIN shared 33.05 percent (1.27bn) after adjusting the negative growth for other banks.

Non-Performing Loans
Regardless of the recent economic rebound, the crisis has nonetheless exposed the need to strengthen the capital adequacy requirements (CAR) besides prudential norms and supervision, monitoring and surveillance. Non-Performing loans remain a key consideration for all the banks, and so the provision for the Gross Advances. Total provisions for the sector reached $6.93bn against Gross Loans and Advances of $105.88bn equals to 6.54 percent for the industry.

Individually, NBK and Islamic company KFIN had the least scale of provisioning while sharing a major chunk of Total Loans and Advances. NBK provided a mere 3.65 percent provision towards its prodigious Gross Advances whereas KFIN cushioned around 5.34 percent on a similar front. Such lower provisions clearly reflect the quality of their advances, however, on the provision coverage front; NBK remains unreachable among its peers, as it provided 90 percent coverage to declared NPLs as of December 2009.

In general, the banks are aiming to reduce NPL portion along with increasing provisions coverage. NBK, KFIN, Boubyan and KIB have already shown their intentions by increasing provisions for gross loans and advances, baring few other banks. NPL classification from September 2008 onwards, continued to stretch in 2009 as Gross NPLs reached a massive $10.46bn, witnessing a jump of 86.71 percent over FY 2008. Emphatically in response to growing NPLs, the banks also increased their provisions by 62 percent, from $2.85bn in 2008 to KWD 4.61bn in 2009, yet the growth remained far below from NPLs impetus. The growing gap between increasing NPLs and Provision instigated total provision coverage ratio to come down at 0.44 by December 2009, down by seven basis points from December 2008 (0.51).

In continuity, it is interesting to see that in a bid to limit risk through diversification, total group’s financial assets and off-balance sheet items distribution towards various sectors declined by four percent in 2009 and reached $176.61bn from $178.85bn, a year ago. Exposure to financial institutions, trading and manufacturing units, and government and other sectors were the key pullers as they reported a decline of 16.2 percent, 12 percent and 1.2 percent whereas the others reported a growth.

Despite ill-fate and depleting returns, “the real estate and construction sector”, continues to attract the banker’s attraction even in FY 2009. As shown in table 2, six banks increased their exposure to the sector, where KFH took a lead by increasing its exposure by around 50 percent. Such increasing confidence in the troubling sector is certainly buoyed by government’s serious attempts in implementing the new 5-year development plan, worth $104.90bn (KWD 30bn). The first ever 5-year mega plan includes the new Silk City worth $77bn, Al-Zour Refinery worth $15bn, Metro Rail project and improving infrastructure to various service sectors, which are certain to strengthen the sector in the long term.

Moreover, as per the latest monthly report by CBK, the construction and real estate sector together are utilising the extended credit facilities given by local banks to the tune of $28.55bn, which is almost 33 percent of total extended credit facilities amounting $87.29bn in July 2010.

Banking outlook
Definitely, the occurrence of the 2008 crisis, severely hammered the fundamentals, as the sector, once enjoyed a superior bottom line of $3.12bn (by September 2008), which plunged all the way down to report a net profit of just $1.08bn for FY 2009. Crippled by the storm, the freefall in net profit was mainly driven by the historical booking of provisions during all the quarters, post September 2008.

In such hard times, the CBK undertook all possible steps to immunise as well as strengthen the financial system. To encourage borrowings, the CBK made multiple cuts to bring the discount rate at its historical low level of 2.50 percent. It also increased the ratio of “Credit Facilities to Deposits” to 85 percent from 80 percent, lifting the allowed growth rates of credit portfolio by five percent and reducing the ratio of KD customer deposits in accordance to maturity ladder to 18 percent from previous 20 percent. Above all, the CBK showed its superiority in the region by approving a kind of financial stability law, which stamps 50 percent government guarantees on new loans, aimed to lend towards the productive sectors in Kuwait. Moreover, to safeguard and depositors investors interest, the CBK tightened the regulations to a minimum of 12 percent CAR as against eight percent recommendation by the Basel Committee. In a nutshell, the CBK aimed to prepare most-suited grounds for the banks to grow its business, in a bid to keep-on moving the economic wheel of the country.

Certainly, all the calculated measures as mentioned above worked positively as the lenders reported a consolidated net profit of $906m for the recent 6M-2010 ending June, up by 16.4 percent, from a year ago. The surge was mainly steered by declining provisions and operating expenses, reconfirming that the “worst is behind”. The halting provisions amid improving sentiments across the board have jointly put up a splendid show of profitability, which is poised to extend in remaining 2010. Looking ahead, the recovery of real estate and construction sector and rising consumption of commodities along with lower rates ? are all set to accelerate the pace of banking business in the remaining year of 2010 and 2011.

Shoyeb Ali is Vice President of Investment Research at Muthanna
Investment Company