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Kuwait: Selected Issues

Author(s):
International Monetary Fund
Published Date:
August 2011
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III. Kuwait: Nonfinancial Corporate Sector Performance1

1. Kuwait’s corporate sector performance analysis for 2010 is conducted on 132 listed companies, compared to 110 in 2009, covering four sectors; Food, Industrial, Real Estate and Services.

A. Profitability

2. The financial performance of the corporate sector appears to have improved in 2010, notwithstanding the continued drag by the real estate sector (Table 7). The size of the listed nonfinancial corporate sector in Kuwait is large with assets of $68 billion at end 2010 (43 percent of bank assets) and a total debt of $12.4 billion (19 percent of bank loans).2 Debt to equity ratios remain within reasonable levels, averaging around 1. At the end of 2010, net profits of the nonfinancial corporate sector were higher than profits observed in 2009, largely on account of around 150 percent increase in the profits of the Industrial and Services sectors.

Table 7.Corporate Performance, 2008-10(In U.S. dollar billions)
Net Profit 1Total AssetsTotal Debt
Number of Firms201020092008201020092008201020092008
Food90.190.170.122.832.742.760.400.520.68
Industrial210.290.11−0.185.795.295.421.895.166.16
Real Estate49−0.35−0.39−0.2522.0224.0725.115.014.393.88
Services533.991.621.3537.4644.4844.835.0912.0912.11
Total1324.121.521.0468.1176.5978.1212.3922.1722.83

Net profit after unusual items

Source: Staff calculations based on Zawya balance sheets.

Net profit after unusual items

Source: Staff calculations based on Zawya balance sheets.

B. Corporate Sector Stress Testing

3. In this paper, we explore corporate sector vulnerabilities to short term interest rate and income shocks and implications for bank credit. For this purpose, the interest-paying capacity of the corporates was stressed by increasing short term interest rates by 200 points and 500 basis points from current levels, and by assuming a negative income shock of 25 percent. Following the standard definition in the literature, firms with interest coverage ratio (ICR) below 1 are unable to generate enough income to cover the interest payments and their debt is classified as distressed. For the purpose of this exercise it is assumed that if corporates are unable to generate funds to pay interest, loans to these corporates would eventually have to be classified as nonperforming loans on banks’ balance sheets. The exercise was conducted only on listed nonfinancial corporates, within which the Food sector represents 3 percent of total debt; the Industrial sector represents 15 percent of total debt; the Real Estate sector 40 percent of total debt; and the Services sector 41 percent of total debt.

4. The resilience of the sector appears to have improved in 2010. On an aggregate level, the ICR for 2010 for the sector was at 3.2 at end 2010, compared with 2.6 in 2009 (Table 8 and 9). Additionally, corporate sector leverage has improved on account of a decrease of 44 percent in total debt and 9 percent in total assets in 2010. This decrease in total debt was not observed in the weaker segments where the level of debt of the companies with ICRs<1 has increased. By sector, 37 companies—4 Industrial (5 percent of total debt), 19 Real Estate (29 percent of total debt), and 14 Services (17 percent of total debt)—out of the 132 listed companies had ICRs<1 or operating losses, compared to 31 companies in 2009. These companies accounted for 51 percent of the total debt of the listed companies in 2010 as opposed to a share of 39 percent of total debt in 2009.3 When further examining ICRs while taking into account cash cushions, the overall corporate sector performance improves substantially. By sector, 17 companies—1 Industrial (0.1 percent of total debt), 9 Real Estate (9.7 percent of total debt), and 7 Services (2.7 percent of total debt)—out of the 132 listed companies had ICRs<1 or operating losses, compared to 15 companies in 2009. These companies accounted for 12.5 percent of the total debt of the listed companies as opposed to a share of 7 percent of total debt in 2009.4

Table 8.Interest Coverage Ratio, 2010
Number of FirmsTotal AssetsCash ReservesTotal LiabilitiesShort-term DebtTotal debtICRICR with CashAverage rate 1
Food92.80.20.80.20.45.512.28.8
Industrial215.80.42.30.51.92.68.13.5
Real Estate4922.00.711.20.95.00.73.06.6
Services5337.54.514.61.85.14.814.19.6
Total13268.15.929.03.512.43.29.67.4
Source: Staff calculations based on Zawya balance sheets.

Average (interest) rate = Interest Expense/Total Debt*100.

Source: Staff calculations based on Zawya balance sheets.

Average (interest) rate = Interest Expense/Total Debt*100.

Table 9.ICRs by Sector, 2009–10
20102009
ICRICR w/cashICRICR w/cash
Food5.512.24.18.5
Industrial2.68.10.64.3
Real estate0.73.01.33.6
Services4.814.13.77.5
Total3.29.62.66.1
Source: Staff calculations based on Zawya balance sheets.
Source: Staff calculations based on Zawya balance sheets.

5. Similarly, the corporate sector maintains on average an adequate ICR (above 1) under an interest rate increase scenario of 500 bps, but the tests indicate some vulnerabilities on a sectoral level (Tables 10 and 11).

  • For the Industrial sector an increase of 500 bps will cause 2 additional companies (accounting for an additional 7 percent of total debt) to have an ICR<1.
  • For the Real Estate sector an increase of 500 bps will cause 2 additional companies (accounting for an additional 3 percent of total debt) to have an ICR<1.
  • For the Services sector an increase of 500 bps will cause 6 additional companies (accounting for an additional 4 percent of total debt) to have ICRs<1.
Table 10.ICR Performance Under an Interest Rate Shock, 2009–10
20102009
200 bpts500 bpts200 bpts500 bpts
ICRICR w/cashICRICR w/cashICRICR w/cashICRICR w/cash
Food4.59.93.57.83.47.02.75.5
Industrial1.65.21.13.40.53.20.32.2
Real estate0.62.30.41.71.02.70.72.0
Services4.011.63.29.32.85.82.14.3
Total2.57.61.95.72.04.71.53.4
Source: Staff calculations based on Zawya balance sheets.
Source: Staff calculations based on Zawya balance sheets.
Table 11.Number of Companies with ICR<1 After Shock, 2009–10
20102009
200 bpts500 bpts200 bpts500 bpts
Food2212
Industrial661010
Real estate20211012
Services16201216
Total44493340
Source: Staff calculations based on Zawya balance sheets.
Source: Staff calculations based on Zawya balance sheets.

6. While the performance of the corporate sector on average is adequate, attention should be given to those companies that comprise a substantial amount of the total debt of listed corporate, in order to avoid any spillover risks.

7. The stress testing also included an examination of the effect of income shocks, which indicated improved results compared to 2009 (Table 12).

Table 12.ICRs After Income Shocks, 2009–10(25 percent decline/increase)
20102009
ICRICR w/cashICRICR w/cash
Food4.19.13.06.4
Industrial1.96.10.53.2
Real estate0.62.21.02.7
Services3.610.52.75.6
Total2.47.22.04.6
Source: Staff calculations based on Zawya balance sheets.
Source: Staff calculations based on Zawya balance sheets.

C. Distance to Default

8. Distance-to-default (DD) measures the extent to which a firm’s total assets (at market value) need to fall for a firm to default within a year, given its current balance sheet position.5 For an individual firm, default occurs when the value of equity reaches zero. According to the methodology used in this analysis, a firm defaults when the market value of its assets falls short of its debt liability, or alternatively the market value of its equity falls to zero.6 The Distance to Default calculation is derived from “inverting” the Black Scholes Merton (BSM) model. The BSM model is most often used to price a derivative asset (e.g. a call option) as a function of the probability of events.7

9. DD indicators were calculated for the banking sector and the corporate sector comprising food, industry, real estate and services companies (figure 5). The results indicate that even though these sectors were affected by the global crisis, their default risk is low; signifying that Kuwaiti banks and corporates are well cushioned to withstand shocks. The graphs show the direct correlation between the DD and the movement of equity in the market. As is expected, they move together (a high value of equity means that markets are assigning a strong probability that the future value of assets exceed its debt).

Figure 5.Kuwait: Distrance to Default of Banks and Non-financial Corporates, Aug. 2008–Dec. 2010

Source: Bloomberg, EMED, RATS and Fund staff calcuations.

1Prepared by Renas Sidahmed.
2Total debt in 2009 was 43 percent of bank loans.
3In 2009, 30 out of 110 companies had ICRs<1 or operating losses; 8 Industrial (18 percent of total debt), 10 Real Estate (12 percent of total debt), and 12 Services (8 percent of total debt).
4Taking into account cash cushions, in 2009, 15 out of 110 companies had ICRs<1 or operating losses; 4 Industrial (1percent of total debt), 2 Real Estate (2 percent of total debt), and 9 Services (4 percent of total debt).
5
A = assets, B = debt, σA = standard deviation of asset return, μ = expected return
6Total liabilities have been used for the purpose of this analysis.
7To calculate probabilities of default, Merton (1974) On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, Journal of Finance, 29, no. 2 assumed that a company’s equity is a call option on its assets (the equity has value only if the value of assets exceeds that of debt) and provided the formula needed to back up the probability of default from the value of equity and the volatility of the equity price.

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