Moody's extends review on Burgan Bank, now for possible downgrade

The ratings were first placed on review on 12 May 2008 following the announcement by the bank that it had agreed to purchase from Bahrain's United Gulf Bank (rated Baa3/Prime-3/D+) the latter's stakes in four commercial banking subsidiaries and associates: Algeria Gulf Bank (60%), Bank of Baghdad (45%), Jordan Kuwait Bank (45%) and Tunis International Bank (77%). Upon the conclusion of the transaction, Burgan Bank is expected to have controlling stakes in the aforementioned banks and to potentially raise these stakes further as needed.

Moody's understands that the acquisitions are to be financed through the issuance of 200 million new shares (raising just over $725m -- the purchase price), which will be fully subscribed by United Gulf Bank. This means that the money paid to United Gulf Bank for the acquisitions will be returned to Burgan in the form of capital, with United Gulf Bank acquiring a 20% stake in Burgan. The deal can be viewed as an asset swap and, given that both Burgan and United Gulf Bank are controlled by the KIPCO group, the transaction represents a reorganisation of the group, bringing KIPCO's commercial banking activities under the umbrella of Burgan Bank.

Since May, Burgan Bank has completed the acquisition of Jordan Kuwait Bank (the largest of the four banks to be acquired at a cost of KD120m) but has yet to complete its capital increase. Burgan was established by Emiri decree and, for this reason, requires special government approval to proceed with the capital increase. As a result, following its acquisition of Jordan Kuwait Bank (and due to the higher risk-weighting on real estate and personal loans introduced by the Kuwaiti central bank earlier in the year), Burgan Bank's capital adequacy ratio declined from around 16% at the end of 2007 to just over the 12% minimum required by the Kuwaiti regulator. The bank expects that both the capital increase and the acquisitions will be completed before the end of 2008 and is currently in discussions with international auditing firms to determine how the transaction will be reflected in its 2008 financial statements.

During the review period, Moody's will focus on: (i) the scale of the immediate impact (if any) on Burgan's asset quality and overall risk profile following the acquisition; (ii) the bank's strategy and timetable in addressing integration challenges; (iii) the effect on revenue streams (in terms of both the enhancement to its diversification and the impact on its volatility); as well as (iv) developments in the bank's own domestic operations.

Moody's noted in May 2008, when first placing the bank's ratings on review, that the transaction has a low probability of having either a negative or a positive rating impact. However, the upside potential has in recent months been constrained even further by developments in the bank's domestic operating environment, prompting Moody's to change the direction of the review from direction uncertain to possible downgrade.

During the review, Moody's will also consider developments in the bank's domestic operations including the level of on-balance-sheet concentrations, particularly to Kuwait's real estate sector and the extent of lending for securities purchasing. The declines on both the Kuwaiti and regional stock exchanges as well as the events of October and November 2008 -- which have revealed problems in Kuwaiti investment companies -- raise concerns over a possible deterioration in asset quality in Kuwaiti banks (although systemic support has been exhibited).

Moody's assesses that given recent events the likelihood of rating upgrades of Kuwaiti banks, in general, is limited over the foreseeable future. Overall, Moody's believes that the ability of banks' managements to navigate their institutions amid a period of heightened market volatility and uncertainty and potentially, to seize likely opportunities to expand their franchises, would be key drivers for the banks' ratings going forward.

Burgan Bank is headquartered in Safat, Kuwait, and had total assets of $14.2bn at the end of September 2008.