Burgan Bank's KWD100 million subordinated bond rating affirmed
International credit rating agency, Capital Intelligence Ratings (CI Ratings or CI), has affirmed the ‘BBB’ Rating for Burgan Bank’s (BB) KWD100mn Subordinated Bond (Basel III compliant), maintaining the ‘Stable’ outlook for the Bond.
The terms and conditions applying to the issue include a non-viability clause, which essentially allows the Central Bank of Kuwait (CBK)—at its sole discretion—to require the Bond to be written off in its entirety. While there have been no formal guidelines issued as to what financial metrics or conditions would trigger this course of action, it has been assumed that such a trigger would not be activated as long as the capital adequacy ratio (CAR) of the Bank remains above the CBK’s minimum—with this calculation being made after the Bank has complied with mandatory provisioning requirements.
Moreover, it is clear from the wording of the issue prospectus that either action would be expected to precede any government support being made available. Therefore, given the specific features of the bond issue including its subordination, together with CI Ratings’ view on how the CBK is expected to resolve a distressed bank, the assigned rating of this Subordinated Bond is set one notch below the Bank’s Financial Strength Rating of ‘BBB+’.
The Subordinated Bond’s Rating is supported by the additional AT1 capital increase in 2016 and satisfactory loan asset quality, including strong loan-loss reserve (LLR) cover for non-performing loans (NPLs). Also supporting the rating is BB’s comfortable liquidity underpinned by a high level of customer deposit funding and good access to the capital markets. The general improvement in recurring profitability, notwithstanding the decline seen in 2016, as well as the established business franchise and geographically diversified asset base and revenue streams are also supporting factors to some degree. The rating is constrained by BB’s high exposure to non-investment grade sovereigns through operating subsidiary banks, considerable exposure to related parties, and by high customer concentrations in deposits and, to a lesser extent, in loans—although this is to a large degree systemic. Also constraining the rating is the still challenging operating environment and elevated credit risk, notably in Turkey, and to a lesser extent in the wider region.
BB, currently Kuwait’s second largest conventional commercial bank by consolidated assets, is majority owned by the prominent Kuwait Projects Company Holding K.S.C.P. (KIPCO), which has held an effective controlling interest in the Bank for two decades. BB’s risk profile was significantly modified over the past after it acquired (and integrated) four MENA regional banks from Bahrain-based United Gulf Bank (UGB), a KIPCO group sister company. The subsequent–and final−acquisition of what became Burgan Bank Turkey (in 2012) completed the Bank’s regional expansion drive. The takeover and consolidation of subsidiary banks significantly increased BB’s risk exposure to low rated sovereigns from an earlier negligible level. The economies and operating environments in these countries remain challenging. That said, it is worth mentioning that these banks are managed by BB, with business strategy and credit policy also set by the Bank.
Although impaired credits grew further in Q1-Q3 2017 following an increase in the previous year, the NPL to gross loans ratio remained at a satisfactory level – albeit higher than the peer group average – while LLRs continued to provide more than full cover. This, together with a sound capital base, means that the effective coverage ratio is also sound. However, credit and political risks in BB’s regional markets remain high, although to a much lesser degree in Kuwait itself. In the event that economic conditions deteriorate, BB as a corporate bank would be vulnerable to weaker asset quality given its high borrower concentration. The rapid credit expansion seen in Turkey over the last few years could become a source of new impaired loans if economic growth slows significantly or political conditions deteriorate.
Liquidity as measured by key indicators remains good, reflecting BB’s moderate share of loans in total assets. CI, however, notes that a significant proportion of liquidity is at the subsidiary banks’ level in the form of bank placements and cash and, to a lesser extent, government securities. BB’s funding is sourced predominantly from customer deposits, with a significant retail component. That said, expensive time deposits continued to dominate customer deposit funding, with their share in total having increased in the recent past. Customer deposit concentrations remain very high – as is the case with other Kuwaiti banks – although these deposits largely relate to government and semi-government entities. Despite the sharp fall in oil prices, these depositors increased their balances in 2016 (in contrast to some other GCC governments), although some of these time deposits were retired in the first nine months of 2017 given the increased cost of funding. Mitigating the high funding concentration risk is BB’s demonstrated and ready access to the debt capital markets.
BB’s balance sheet is currently well capitalised, following an additional Tier 2 issue in 2016 and a successful rights issue two years earlier. These have helped lift the Bank’s total CAR and CET 1 ratio to a sound level, notwithstanding a significant Tier 2 component in total CAR. Management anticipates that capital ratios will have improved at end 2017 from retained profit. BB’s capital base continues to provide a comfortable risk buffer. Balance sheet leverage was maintained at a moderate level.
The Bank’s gross income generation capability remains good, supported by diversified sources of net interest income and non-interest income (NII). Following a moderate decline in 2016, gross income rebounded in Q1-Q3 2017, compared to the same period in 2016, on the back of higher net interest income and NII. Although the latter was driven by recovery in fees and commissions and significantly higher other income, performance of NII has been rather volatile over the last few years due to one-off items. Operating profitability is nonetheless satisfactory and continues to provide the flexibility to step up provisioning as and when necessary. The return on average assets fell to a modest level 2016 but improved in Q1-Q3 2017 lifted by higher operating profitability. Returns remained broadly in line with the average for the Kuwaiti banking sector.