The affirmed ratings are based on MARC's assessment on the probability of parental support from Kuwait Finance House KSC (KFH) to its wholly-owned subsidiary KFH Malaysia which is deemed as high. Accordingly, KFH Malaysia's long-term FI rating of AA+ is notched down from parent KFH's FI rating of AAA, which MARC has affirmed with a stable outlook. KFH's FI rating continues to reflect a very high likelihood of Kuwaiti government support due to the bank's high systemic importance as the second-largest bank in the country. KFH's rating is based on publicly available information.
KFH Malaysia's asset size remains modest at RM10.4 billion, representing 1.7% of the Malaysian Islamic banking system's total assets as at end-June 2017. Its past performance has been hampered by relatively high impaired financing. MARC notes that KFH Malaysia has continued to undertake initiatives to bring about a meaningful turnaround in the bank's performance. In this regard, commitment from its parent KFH has been evident in the form of providing strategic guidance and management expertise to KFH Malaysia. Among the initiatives being undertaken are a rebalancing of the bank's financing portfolios and enhancing its digital banking platform to strengthen its retail banking operations.
For the first half of financial year ending December 31, 2017 (1H2017), KFH Malaysia's household financing portfolio grew by 4.3% from end-2016 but a contraction in most of its other business financing portfolios led to an overall 1.9% decline in gross financing to RM6.7 billion as at end-June 2017. Notwithstanding the growth of its household financing segment, which was driven by mortgage and auto financing, the bank's overall financing growth prospects would continue to be challenging given the prevailing stiff competition in the domestic Islamic banking industry. The bank has continued with its restructuring efforts, which are expected to improve its asset quality metrics over the intermediate term. KFH Malaysia's gross impaired financing ratio declined further to 6.6% as at end-June 2017 (2016: 7.0%), however, it has remained higher than the domestic Islamic banking industry average of 1.4%. Financing loss coverage remained relatively stable at 77.6%. Its strong capitalisation with a Common Equity Tier 1 (CET1) capital ratio of 20.7% as at end-June 2017, above the Islamic banking industry average of 13.1%, provides a buffer against asset quality weakness.
For 1H2017, KFH Malaysia's net financing income declined by 11.3% y-o-y to RM80.6 million as gross financing contracted, compounded by a decrease in net financing margin to 1.63% from 1.85% in 1H2016. In addition, an impairment charge on securities of RM9.4 million contributed to the bank registering a lower net profit of RM27.3 million (1H2016: RM29.7 million). KFH Malaysia's funding base largely comprised wholesale deposits which accounted for about 90.9% of total funding as at end-June 2017. The high reliance on wholesale funding poses some liquidity risk to the bank, although this risk is mitigated by a liquidity coverage ratio (LCR) of 112.6% as at end-June 2017, higher than Bank Negara Malaysia's minimum requirement of 80% for 2017.
KFH Malaysia's ratings and stable outlook reflect MARC's expectations that KFH will maintain its ownership in the bank and provide parental support. Any perceived weakening in parental support from KFH and/or dilution in its ownership in KFH Malaysia would trigger a rating action to lower KFH Malaysia's ratings.