S&P: National Bank of Kuwait Outlook Revised To Negative On Weakening Operating Conditions;'A+/A-1' Ratings Affirmed

Rationale
On Feb. 16, 2009, Standard & Poor's Ratings Services revised its outlook on National Bank of Kuwait S.A.K. (NBK) to negative from stable. At the same time, the 'A+/A-1' long- and short-term counterparty credit ratings on the bank were affirmed.

The outlook revision reflects the weakening environment in which NBK operates, which is expected to put pressure on the bank's asset quality, financial performance, and ultimately on its stand-alone credit profile.

Although NBK has less exposure to problematic Kuwaiti investment
companies than its domestic peers (see article "Various Kuwaiti Banks Placed On CreditWatch Negative On Large Exposure To Investment Companies," published today on RatingsDirect), we believe that this could increase pressure on its asset quality and profitability. In addition, oil prices and the domestic stock market have declined dramatically, and the global slowdown has had a negative impact on domestic economic growth (1.4% expected in 2009) and credit markets. The long-term rating on NBK, which we consider a government-related entity (GRE), is one notch higher than its stand-alone credit profile to reflect our expectation of extraordinary support from the government
(classified as interventionist toward its banking sector) in case of need.

NBK is the largest bank in the State of Kuwait (AA-/Stable/A-1+), with total consolidated assets of $41.3 billion at year-end 2008. The bank has a consistent track record of leading domestic market share. It recently undertook a rapid overseas expansion to offset the major challenge of operating in an essentially mono-industrial country that is highly sensitive to oil-price fluctuations. We believe that the bank's rapid expansion strategy--notably in Turkey and Egypt--carries potential risks, especially at a time of global economic downturn.

NBK's funding profile has weakened over the past two years. The share of core deposits in its funding has steadily reduced, while loan growth has been significant. The loans-to-core (nonbank) customer deposits ratio reached 130% at year-end 2008 (albeit still within the 85% regulatory limit set by the Central Bank of Kuwait). As with other Kuwaiti banks, NBK benefits from the injection of deposits by GREs, and is expecting its international network to gradually raise more core customer deposits. We will therefore monitor the bank's ability to strengthen its deposit base.

NBK's exposure to local investment companies appears manageable and, in
our opinion, does not pose a threat to the bank's stand-alone credit profile. Its gross exposure is relatively limited, at about 12% of adjusted total equity (ATE). Nevertheless, the impact of the economic slowdown on the local corporate segment and some sectors such as real estate and construction (20% of NBK's lending at year-end 2008) is expected to lead to a deterioration in asset quality and profitability.

The bank's ratio of nonperforming loans (NPLs) remained sound at 2.0% of gross loans at Dec. 31, 2008. NBK allocated significant provisions during the fourth quarter of 2008, anticipating some asset quality deterioration, thereby strengthening its NPL coverage by loan loss reserves to a conservative 1.8x.  We take comfort from NBK's adequate underwriting policy and the low-risk profile of its personal loans that account for almost one third of its total loan portfolio. The bank's financial performance demonstrates a long and consistent track record of strength. Nevertheless, we consider that a repeat of this robust financial performance is unlikely, at least in the near term, as further provisioning may be required and lending remains subdued.

NBK's capitalization remains high--with ATE at 12.5% of adjusted assets at year-end 2008-and underpins its current financial profile. Capital ratios compare favorably with those of large international and regional banks and are expected to remain a key strength.

Outlook
The negative outlook reflects our expectation that the bank's stand-alone credit profile will be pressured by the weakening operating environment. The ratings on the bank could be lowered if asset quality and profitability were to deteriorate materially over the coming quarters, or in the event that its funding profile weakens. Further overseas expansion that could increase the bank's risk profile or weaken its capitalization would also be considered a negative rating factor. We would revise the outlook back to stable if the bank were to demonstrate sufficient profitability and asset quality resilience through the economic downturn and if it is able to improve its funding profile.