Yesterday KFH published its full year 2018 financial statements. FY18 net income of KWD227mn increased 23% Y-o-Y, and came in 4% ahead of our estimate of KWD220mn, because of lower-than-expected provisioning costs, and despite pre-provisioning earnings missing our estimate by 5%.  Y-o-Y earnings growth was mainly driven by net interest income (+19% Y-o-Y), lower operating expenses (-5% Y-o-Y) and broadly flat provisioning costs. It is worth noting that the Y-o-Y comparison of 2018 results is distorted by the impact of the depreciation of the Turkish Lira during 2018. 
 
4Q18 earnings of KWD58.3mn increased 26% Y-o-Y (4Q17 was a low base), but fell 21% Q-o-Q and came in 16% ahead of our estimate of KWD50.4mn, as both operating expenses and provisioning costs came below our forecast. The Q-o-Q earnings decline was driven by a 22% Q-o-Q fall in revenue (both net interest and non-interest income fell vs 3Q18) and higher operating expenses (+5% Q-o-Q). 
 
Results highlights: while we saw a Q-o-Q pickup in the growth of financing assets, KFH ended the year at lower growth vs the sector. Financing assets and deposit growth both increased by 2% Q-o-Q, following a 4% Q-o-Q drop for both in 3Q18. Growth in financing assets in 20148 was 2% Y-o-Y, a low figure compared to other Kuwait banks (6% for NBK, 5% for Gulf Bank) because of the impact of the depreciation of the Turkish Lira.
 
Strong increase in spreads in 2018; contraction in 4Q18 on higher funding costs. KFH’s spreads increased c60bps during 2018 (this is ahead of most banks in Kuwait, for which the increase has ranged from 10 to 25bps). Most of the increase in spreads happened in 1H18, and management had attributed this to maturing sukuks which were replaced with instruments at higher yields. FY18 net interest income was strong, up 19% vs 2017. Spreads in 4Q18 fell by 15bps vs 3Q18 due to higher funding costs. Fee income was weak and fell by 11% Y-o-Y in FY18 and by 19% Y-o-Y in 4Q18. 
 
Flat Y-o-Y provisioning expenses in 2018; excess provisions over IFRS9 at 0.4% of financing assets: Provisioning costs of KWD163mn in FY18 were broadly unchanged vs FY17, both in terms of provisions for financing assets and also in terms of other provisions. Loan loss provisions increased Q-o-Q in 4Q18 after a reversal in 3Q18. As for other provisions, there was a reversal in 4Q18 after large charges earlier in the year (provisions for legacy real estate portfolio in Saudi Arabia). KFH’s NPL ratio fell to 2.0% in 2018, down from 2.5% in 2017, while NPL coverage increased to 172% in 2018, from 161% in 2017. KFH noted in its financial statements that its current provisions of KWD416mn were higher than IFRS9 Expected Credit Loss of KWD373mn; the excess provision over IFRS9 requirement represents 0.4% of the financing assets book. We note that the Central Bank asked banks to take the higher of current provisions and ECL, and hence there has been no change to the 2018 financial statements as a result of IFRS9.
 
Surprisingly strong earnings contribution from Turkey: KFH discloses only on an annual basis some financial figures for the main subsidiaries. KFH Turkey contribution to earnings was KWD65mn in 2018, up strongly from KWD36mn in 2017 (the ownership was constant Y-o-Y at 62%). The strong earnings increase comes after a strong rise in revenues (there are no details about potential one-offs). The asset contribution of Turkey to the group fell to 24% in 2018 from 26% in 2017, while the earnings contribution increased to 29% in 2018 from 20% in 2017. (Elena Sanchez-Cabezudo, CFA, Ahmed El-Shazly, Company)
 
Kuwait Finance House: KWD0.62 as of 10 Feb. 2019, Rating: Neutral, TP: KWD0.63/share, MCap: USD13,171mn, KFH KK/KFH.KW