Economic growth supports Saudi lenders

The Saudi banking sector performed strongly in 2012, with this trend set to continue this year thanks to high oil prices and government spending. Published in MEED, 25 April 2013

The Saudi economy is performing strongly these days, helped along by historically high oil prices and equally high levels of government spending. The country’s gross domestic product grew by about 6 per cent last year, according to the IMF, and the Washington-based organisation is predicting a further rise of 4.2 per cent for this year.

This is good news for Saudi banks, with more deposits to be gathered and more businesses wanting to borrow money to finance their expansion. Over the past year, banking sector assets, customer deposits, loans and profits have all risen at a healthy pace, although provisions for bad debts are on their way up again.

Overall, the banking sector’s combined assets increased by 14 per cent in 2012, to reach SR1.7 trillion ($457bn) by the end of December, while loans and other advances were up by an even stronger 17 per cent to SR835.9bn. All that fed into a healthy rise in operating profits, which were up 10 per cent to SR64.5bn, and net profits, which rose 11 per cent to SR35.1bn.

Rising deposits

Underpinning all that has been the strong performance of customer deposits, which rose in value by 15 per cent in 2012 to stand at SR1.3 trillion by the end of the year. Those deposits are a key strength for Saudi banks, which pay little or nothing to customers with deposits.

“Customers tend to place a large portion of deposits on demand due to the lack of alternative attractive placements and the low interest rate environment,” says Nicolas Hardy, an analyst at US credit ratings agency Standard & Poor’s (S&P). “Those deposits are barely remunerated and tend to remain stable. So the funding costs for Saudi banks are low and this, in turn, supports profitability.”

Amid all the good news there are, however, a few clouds on the horizon. One issue of note is the rise in provisions that banks made last year to cover potential credit losses. Having lowered their provisions by 39 per cent in 2011, banks have once again started to set aside more for bad debts and the figure rose by 29 per cent in 2012 to reach SR7.6bn.

In part, this increase is simply an indication of the caution of the Saudi regulator at a time of overall growth. The central bank, the Saudi Arabian Monetary Agency (Sama), likes to maintain a range of counter-cyclical buffers, including high capital adequacy ratios and 130-150 per cent coverage for bad loans at any time.

“We expect Saudi banks to continue to display excess provision for bad loans,” says Hardy. “Any time there is even a slight increase in non-performing loans, they will likely post the corresponding amount of provision to keep the coverage ratio at the same level. They have the earnings capacity to do so. In our view, there is little risk of a general deterioration of asset quality as long as the local economy benefits from high oil prices. But banks do face concentration risk in their corporate loan book, and an unexpected credit event caused by mismanagement or fraud at a large corporate group could potentially harm bottom-line profits severely.”

Cautious stance

A cautious approach by Saudi banks is understandable given their recent experiences with two local conglomerates, AH al-Gosaibi & Brothers and Saad Group, which defaulted on billions of riyals in debt in 2009. But Murad Ansari, Riyadh-based director of equity research for Egyptian bank EFG Hermes, says there is little reason for concern for now.

“Last year, there was an effort to improve non-performing loan recovery ratios for a couple of names,” he says. “Now, banks are more or less where they should be operating at in terms of provisions. On the asset quality front, there is generally nothing out there causing concern.”

In absolute numbers, the largest provisions made in 2012 were by Al-Rajhi Bank, with SR2.3bn, followed by National Commercial Bank (NCB) with SR1.5bn. Those two banks are the largest in the Saudi market by most measures, with NCB leading the way in terms of assets and deposits and loans, while Al-Rajhi is the best performing in terms of operating profit and net profit. They are followed by Samba Financial Group, Riyad Bank, Bank Saudi Fransi and Sabb. Between them, the six institutions account for 77 per cent of all bank assets.

Another area of note is the amount of cash banks are holding. The value of cash in hand and at Sama rose by 26 per cent last year to reach SR214 trillion by the end of December. That suggests banks are struggling to find ways to put their assets to work in the economy.

That is, again, partly, because of caution from the regulator. Sama insists loan-to-deposit ratios are capped at 85 per cent, for instance, but there are also a limited number of suitable borrowers in the private sector and the government has not issued any bonds in recent years.

“What is difficult for Saudi banks is to find good opportunities to lend, vis-a-vis risk concentration limits,” says one banking analyst. “There are a limited number of very large corporates; when you reach the limits, you can’t go beyond them. The government is not issuing much debt either, so there are a lack of acceptable lending opportunities.”

Mortgage market

The lending that does occur in Saudi Arabia is often fairly low-risk. Repayments of retail loans tend to come directly from borrowers’ salaries, while most, if not all, large projects in the country are backed by government entities. However, as the rise in loans and other advances last year indicates, there is at least some appetite for risk.

“Having gone through a very tough credit cycle in 2009/10, the banks were generally concentrating on very high-quality names,” says Ansari. “A large part of incremental lending was concentrated in the contracting sector or anything related to government spending, but we’ve seen a slight broadening of that over the past six months and now it is not just the contracting companies. Industrial companies and [businesses in the] other services sectors are gradually expanding and requiring more financing to fund their expansion.”

One route to more lending activity in future is the mortgage market, following the approval of a long-awaited series of laws regulating this area in July last year. The impact of the law, however, is likely to be gradual and could take several years before a real market difference is felt.

S&P estimates home financing currently represents about 5 per cent of banks’ loan books and suggests this is unlikely to rise by much until the new law is fully implemented and tested. Until then, most home finance will continue to be provided by the state-owned Real Estate Development Fund.

To take full advantage of the opportunity, banks will have to find a way to match the long-term nature of mortgage lending with their current short-term funding profile based around customer deposits. There have been suggestions in the Saudi press about Sama setting up a real estate refinancing company that would be able to buy up mortgage loans made by the banks, which would help to solve this issue. The new body may be part of the Public Investment Fund, although no details have yet been confirmed by the authorities in Riyadh.

As well as offering a new line of bank lending, the mortgage law could also provide an indirect boost by providing a pool of business for the insurance arms of the country’s banks.

Easing growth

While they wait for that market to develop, some local banks say they expect credit growth to ease off this year. Samba, for example, said in a research note released in April that domestic credit growth has been strong in the kingdom over the past year. It did, however, predict that this will ease in 2013-15, as a gradual softening in oil prices feeds into private confidence and public investment levels. Rival bank, Jeddah-based NCB, also suggests credit growth to the private sector could grow less this year, as banks try not to overheat their balance sheets.

Even if there is an easing of growth, it seems unlikely there will be any sort of meaningful slowdown. Recent business surveys suggest a sense of optimism in the country. The most recent purchasing managers index data compiled by Markit and UK bank HSBC, for example, was at 58.9 points in March. NCB’s business optimism index was at 55 for the non-hydrocarbons sector in the first quarter of 2013, up from 47 at the end of last year. In both cases any score above 50 indicates growth.

Confidence is strong due to a mixture of high oil prices and the government’s continued investment in infrastructure and other projects which, in turn, helps to create opportunities for private sector firms. Along with the evidence from the first-quarter results, in which profits rose in most cases compared with last year, this suggests Saudi Arabia’s banks can expect another healthy year in 2013.