Moody’s affirms ratings of KFH and AUBK

Agency changes outlook to positive for Kuwait Finance House, Ahli United Bank remains stable

LIMASSOL, Jan 25: Moody’s Investors Service, (“Moody’s”) has affirmed the A1/ Prime-1 long and short-term domestic and foreign currency deposit ratings of Kuwait Finance House K.S.C.P. (KFH) and the A2/Prime-1 long and short-term domestic and foreign currency deposit ratings of Ahli United Bank K.S.C.P (AUBK) – which is majority owned by Ahli United Bank B.S.C. (AUB, unrated).

The rating agency has also affirmed KFH and AUBK’s Baseline Credit Assessments (BCA) and Adjusted BCAs at baa3. The outlook on AUBK’s long term ratings remains stable and the outlook on KFH’s long-term ratings has been changed to positive from stable.

Today’s rating action on KFH and AUBK follows KFH’s shareholders approving the acquisition of Ahli United Bank B.S.C. (AUB, unrated) – the largest bank based in Bahrain – on 20 January 2020. Upon completion of the acquisition, which is expected around April 2020, KFH will become the legal owner of all AUB shares.

KFH’s baa3 BCA affirmation reflects that this acquisition will, upon completion, create the largest bank in Kuwait by total assets (approximately around USD101 billion), with potential to strengthen and support growth in both KFH’s corporate and retail businesses. The affirmation of KFH’s baa3 BCA reflects the fact that the bank’s financial fundamentals will initially remain relatively unchanged and the rating agency’s expectation that KFH will maintain solid capital and liquidity buffers.

The change of outlook to positive from stable on KFH’s A1 long-term deposit ratings is driven by Moody’s view that, this transaction, despite the integration challenges associated with such cross-border transactions, is expected to support and enhance the ongoing improvement in the bank’s standalone credit risk profile. In addition, as a result of the acquisition, the bank’s systemic importance will increase as its consolidated market share will increase to around 35% from 23% in terms of total assets and it will become the largest Kuwaiti bank.

AUBK’s baa3 BCA affirmation reflects Moody’s view that until completion of the transaction the bank’s standalone profile is not expected to change significantly. At the same time, the stable outlook reflects Moody’s expectations that until the transaction is completed, the bank’s overall profile is not expected to change, while detail on any subsequent changes are at present limited.

Following the completion of the acquisition, KFH will become the largest Islamic bank, in terms of total assets with a combined USD101 billion of total assets as at 30 September 2019 (on a pro-forma basis), from USD 62 billion prior to the acquisition. This transaction will position KFH as a dominant bank in the Gulf Co-operation Council (GCC) as the addition of AUB’s solid corporate banking franchise complements its large and strong domestic retail customer base.

Moody’s believes that synergies from this larger Islamic franchise, after allowing for integration costs, has potential to drive stronger profitability. On a pro-forma basis for the first nine months of 2019, KFH and AUB’s combined net income to tangible assets was around 1.6% compared to KFH’s 1.4% on a standalone basis. The combined net profit margin (equivalent of net interest margin) and efficiency costs are expected to improve from KFH’s current standalone at 3% and 36% respectively for the first nine months of 2019. At the same time, the combined entity’s pro-forma provisioning costs accounted for 26% of pre-provision income for the first nine months of 2019, compared to KFH’s standalone 37% during the same time period.

Additionally, following the completion of the transaction, KFH’s exposure to complex investments (investments in joint ventures, associates and real estate) will proportionately reduce and consequently, the contribution of financing income to operating income is expected to increase. As per Moody’s estimates the combined entity’s net financing income would increase to around 70% of operating income for the first nine months of 2019 compared to KFH’s standalone at 64% for the same period.

The positive outlook also captures Moody’s view that the acquisition will enhance KFH’s geographic diversification and grow international operations, benefitting the bank’s asset risk profile. The bank’s non-Kuwaiti operations will increase to 50% of the consolidated assets from 40% of total assets for KFH on a standalone basis. Some of these operations are in relatively less riskier jurisdictions, like the United Kingdom, which is expected to improve the bank’s overall risk profile.

Although AUB’s large corporate banking business will expose KFH to higher concentration risks, Moody’s expects the bank’s financing book to remain relatively granular given the strong retail franchise of KFH in Kuwait.

The change of outlook to positive from stable on KFH’s A1 long-term deposit ratings is also driven by the fact that the acquisition will increase its market share and it will become the largest Kuwaiti bank. As a result, the bank’s systemic importance will increase and Moody’s will assess its government support which currently translates into five notches of uplift from its baa3 BCA.

Moody’s expects the credit profile of the combined entity to be broadly similar to the pre-acquisition positioning. Moody’s expects that the bank will maintain its asset quality and capital buffers. KFH’s NPF ratio (analogous to the nonperforming loan ratio) at 2.2% as of December 2018, is expected to remain broadly stable around the 2% level post-acquisition.

Following the acquisition, the combined entity is expected to have broadly stable capital buffers. On a proforma basis as of September 2019, the TCE ratio of the combined entity will be around 14%, similar to KFH’s standalone metrics.

Moody’s affirmation of KFH’s A1 deposit rating is based on continued very high government support assumptions for the bank, which translates into five notches of uplift from the bank’s baa3 BCA. Moody’s continues to assess the likelihood of government support for KFH as Very High.

The stable outlook assigned to AUBK’s long-term deposit ratings continues to reflect that capital, profitability and liquidity are expected to remain solid, although the bank’s asset quality and funding remain subject to concentration risks.

As per KFH’s disclosure, upon the completion of a legal merger between KFH and AUB which is expected around April 2020, AUBK (majority owned by AUB currently) is to be fully-acquired by KFH before being converted into a digital bank. Notwithstanding the rating affirmation, Moody’s notes that it will continue to monitor developments regarding the deal and the ultimate effects on AUBK’s consolidated asset quality, capitalisation and earnings.

AUBK’s BCA affirmation reflects Moody’s view that upon completion of the transaction the bank’s operations and standalone financial profile are not expected to change significantly. Until then, the bank’s baa3 BCA will continue to capture: (1) solid profitability, driven by its corporate banking franchise; combined with (2) sound capital adequacy and solid liquidity buffers; although moderated by (3) significant credit and funding concentrations.

Moody’s affirmation of AUBK’s A2 deposit ratings is also based on continued very high government support assumptions for the bank upon transaction completion, which translates into four notches of uplift from the bank’s baa3 BCA. This assessment reflects (1) the bank’s importance to the local banking system, with a market share of around 6% in terms of total assets in Kuwait; (2) the Kuwaiti government’s ownership stake in the bank (a 12.3% holding through the Public Institution For Social Security); and (3) the government’s strong track record of supporting financial institutions in times of stress.

Governance is highly relevant for both KFH and AUBK, as it is to all banks operating in the GCC. Although Moody’s does not have any particular governance concern for both banks, nonetheless, corporate governance remains a key credit consideration and requires ongoing monitoring.

Upward pressure on KFH’s ratings could develop from any combination of the following: (1) successful integration across various geographies without significant customer attrition or financial implication; (2) increase in profitability driven by stronger market positioning along with realization of synergies and no unexpected increase in one-time integration costs; and/or (3) increase in notches of uplift from government support.

Upward pressure on AUBK’s ratings could develop from a material reduction in its credit and funding concentrations and/or potential future parental support rating uplift coming from KFH upon completion of the transaction.

Although downward pressure on KFH’s ratings is not expected over the near term as indicated by the positive outlook, the outlook on KFH’s ratings would be revised to stable at the current ratings level, if there were: (1) integration challenges negatively impacting profitability; or (2) unexpected changes in its asset risk profile as a result of significantly higher borrower or sector concentrations following the acquisition. In addition, KFH’s A1 deposit rating already benefits from five notches of uplift from its baa3 BCA against a Kuwaiti average of four notches of uplift. As such, Moody’s can stabilize the ratings if the BCA is affirmed and uplift is maintained at five notches.

Downward pressure on AUBK’s ratings could develop from a deterioration in its asset quality as well as capitalization and/or a material weakening in its liquidity. Also, upon completion of the transaction, significant downsizing of the bank’s balance sheet through the expected conversion into a digital bank could exert downward pressure on the bank’s ratings.