: Foreign Currency Long and Short term ratings of ‘A+’ and ‘A1’, respectively, and Financial Strength Rating at ‘BBB+’. The Support level is maintained at ‘2’, reflecting the strong likelihood of support by either KFH’s government agency shareholders or by the government itself, given KFH’s systemic importance. The Outlook for all ratings remains ‘Stable’ at present, although ratings could come under pressure should there be a further deterioration in asset quality, or if provision coverage remains lower than at peer banks. Similarly, any further weakening of capital ratios could also put pressure on ratings.

The ratings are supported by KFH’s strong capital base, the Bank’s well established Islamic banking franchise and its diversified earnings streams. The major rating constraints are weaker financing asset quality, low returns from some investments in associate companies, weakened profitability and still tight liquidity.

KFH is a large and systemically important bank within the Kuwaiti banking sector. It also has significant banking operations elsewhere in the GCC and in the wider MENA region, as well as diverse investments in a series of non-banking businesses. While this breadth of activity has been an advantage in more buoyant times, KFH’s role as main banker to the Sharia’a compliant business sector in Kuwait has meant that it has suffered as a result of the downturn in that and other GCC economies. The impact has been seen in a sharp increase in non-performing financing receivables – including those outstanding from subsidiaries and associated companies, and in declines in the value of investment portfolios, and in the necessity to accept equity in return for debt in restructurings. The large level of investments in non-subsidiary associate banks and non-bank financial companies has also impacted the capital adequacy ratio although this remains adequate.

While liquidity ratios are a little on the tight side, there is little reliance on purchased funds and KFH has no difficulty in growing customer deposits when it so wishes. Efficient management of any resulting surplus liquidity can however be complicated given the restrictions on instruments in which it may invest. The weakening of asset quality has required heavy additions to financing loss reserves and this together with weakening profitability at the operating level has reduced returns – something that is unlikely to change until the asset quality issues have been resolved.

While H2 2011 may also be a difficult trading period for KFH, the business model is strong and the bank is well placed to benefit from economic recovery in Kuwait and Bahrain and from the continued positive performance of the economies of KSA and Turkey.