Moody's downgrades Gulf Bank to A1/C-; review maintained

These ratings remain on review for possible further downgrade.

The Prime-1 short-term ratings were affirmed.

The ratings were originally placed on review on 28 October following Gulf Bank's announcement that it had incurred potentially sizeable losses.


Although the bank has not yet clarified the extent and circumstances of these losses, today's downgrades reflect Moody's view that the bank's C BFSR is no longer sustainable.

The as-yet-undisclosed losses relate to the bank's exposures to complex foreign exchange derivative instruments marketed to a very small number of its customers, reportedly for hedging purposes.

Moody's understands that Gulf Bank conducted the transactions on a back-to-back basis --maintaining a hedged position -- but that the failure of one of its customers to meet a margin call revealed the level of counterparty risk
borne.

Losses were realised when Kuwait's central bank instructed the bank to close its positions to the counterparties selling these derivatives, regardless of whether the corresponding customers were performing.

Given that positions with performing customers remain open, the bank is no longer hedged and now bears not only elevated customer
credit risk but also additional market risk.



"The announcement of potentially material losses triggered a small run on the bank, which prompted the central bank to extend a blanket guarantee on all customer deposits at banks in Kuwait and to provide Gulf Bank with liquidity support.

Although the flight of customer deposits appears to have been halted, recent events may have a longer-term impact on the bank's franchise," explains Stathis Kyriakides, lead analyst at Moody's for the bank.

Gulf Bank is one of the largest retail banks in the country, behind National Bank of Kuwait and Kuwait Finance House.

"These events have brought to light weaknesses in the bank's controls and risk management practices and have raised questions regarding its capacity to identify and manage risks," the analyst adds.

Moody's believes that it is becoming increasingly probable that Gulf Bank will need to raise fresh equity to meet regulatory requirements, with both the authorities and the largest shareholders announcing that they would be prepared to inject capital as needed.

It is not yet clear what form the recapitalisation will take or what the state's and existing shareholders' participation will be, thus the bank may emerge with an altered ownership structure after rehabilitation.

Until the aforementioned problems came to light (notwithstanding the subsequent potential impact), Gulf Bank's underlying core business was performing well.

In particular, the bank had consistently generated strong levels of profitability, driven by good net interest margins, good cost controls, as well as high fee-generating capacity, although it is unclear how much of this relates to its high-risk derivative operations.

Moody's further review of Gulf Bank's ratings will consider: (i) the extent of the sustained losses; (ii) the extent of capital erosion and
the promptness and adequacy of capital replenishment, particularly as this relates to the bank's capacity to pursue its strategic objectives; (iii) the nature of the transactions that brought about these losses and what this indicates in terms of the bank's controls and risk management processes and capabilities; (iv) the level of additional exposure to customers involved in the high-risk derivative transactions and the potential for additional losses; and (v) the extent of a potential impact on the bank's franchise (including the impact on its market share and medium-term earnings power).