Fitch affirms the Bank of Kuwait and the Middle East at 'A-'; outlook stable

BKME's IDRs and Support Rating reflect the extremely high probability of support from the Kuwaiti authorities, in case of need.

The bank's Individual Rating reflects adequate, albeit deteriorating, asset quality and profitability, but also its relatively small franchise and the impact of the slowdown in Kuwait's economic growth on BKME's future prospects.

Upward potential to the Individual Rating is currently limited due to the weaker operating environment in Kuwait.

Downside risk to the Individual Rating could arise if the bank's exposure to real estate, investment companies or lending for the purchase of securities leads to a marked deterioration in asset quality and profitability, or if capitalisation comes under pressure.

BKME's net income fell 3.5% yoy in 2008, primarily as a result of higher impairment charges for both loans and investments. Net income declined a further 71% yoy in H109 as a result of higher loan impairment charges (mainly general) and lower realised gains on investments. BKME's comprehensive income was also substantially lower, due to the fall in the value of available for sale investments, reflecting the weaker performance of the Kuwaiti stock market.

The impaired loans/total loans ratio worsened to 4.5% in H109, but impairment reserve coverage was sound at 102%. Loan growth slowed considerably in H109 as the bank has taken a cautious approach to lending in weaker economic conditions.

BKME has some concentration in real estate lending and share-financing, as well as by borrower, although this is not unusual in Kuwait.

Market risk is limited and mainly relates to the bank's portfolio of equity investments. Funding consists largely of customer deposits, where there is some concentration but they have proved stable. Liquidity is supported by a portfolio of Kuwaiti government bonds and interbank placements, as well as facilities with group entities and other banks. At end-June 2009, BKME's Tier 1 and total capital ratios were an adequate 13.3% and 15.1% respectively.

BKME is a medium-sized Kuwaiti commercial bank, providing a broad range of retail, corporate, treasury and investment management services. The bank is 75%-owned by Bahrain based Ahli United Bank (AUB, rated 'A-'/ Outlook Stable). The Public Institution for Social Security in Kuwait is the largest shareholder in AUB (19.3%) and holds 12% of BKME. In June 2008 the Central Bank of Kuwait granted in-principle approval for BKME to convert to an Islamic bank. The bank expects to begin operations as an Islamic bank from January 2010, upon the issuance of an Amiri decree.

In Fitch's rating criteria, a bank's standalone risk is reflected in Fitch's Individual ratings and the prospect of external support is reflected in Fitch's Support ratings. Collectively these ratings drive Fitch's Long- and Short-term IDRs.