On the face of it, Saudi Arabias bank chiefs have little reason for worry as they prepare for a new year.
Compared to their embattled counterparts in financially challenged parts of the world, the kingdoms banks are in robust shape: highly liquid with deposits at the central bank in excess of the regulatory requirement to the tune of over SR68 billion ($18 billion) in October they are also well capitalised, and operating in a healthy economy where government spending is driving a wealth of new lending opportunities in infrastructure and housing projects. Asset quality is among the strongest in the region, with relatively few problem loans spooking the balance sheets.
Most Saudi institutions have now completed the process of provisioning against bad loans, triggered by the financial crisis and the debt problems associated with two financially troubled family conglomerates, AH Al Gosaibi and Brothers and the Saad Group, which came to the fore in 2009.
Healthy profitability is another cause for cheer. High non-interest-bearing deposits, which account for 60 per cent of system deposits and strong operational efficiency, will continue to support Saudi banks high profitability levels, predicts Moodys ratings agency.
The 12 listed banks saw net income rise by SR2 billion in the first nine months of 2012, to SR27 billion. Pre-provision profitability for its rated banks stood at 2.8 per cent of average assets during the first half of 2012.
With the benefits of the governments expansionary fiscal policies filtering through, and swelling corporate loan demand, banks are primed for a sustained growth in profits; investment bank Credit Suisse predicts Saudi banks should deliver double-digit earnings growth for the next three years thanks to higher credit volumes.
Third-quarter 2012 results saw some banks post profits in double-digits. National Commercial Bank the strongest performer announced a 12.7 per cent increase in net income for the nine months of 2012 to SR5.04 billion. Arab National Banks net profit for the third quarter rose 10.3 per cent to SR573 million.
Thanks to the strong profitability, Saudi banks are in a good position to build up their capital buffers and they are clearly in a position to absorb losses without doing material damage to the capital base.
However, it is not a uniformly positive picture. Saudi Arabias largest listed bank, Al Rajhi Bank, saw third-quarter net income decline from SR1.94 billion in 2011 to SR1.87 billion blamed on higher operating expenses while Banque Saudi Fransis third quarter net income fell 12.9 per cent to SR662 million.
The weaker third quarter figures at some Saudi banks may also reflect pressure on the bottom line due to higher than expected loan-loss provisions, a concern for those institutions exposed to the financially troubled construction company Mohammed al Mojil Group (MMG). The contractor announced in September 2012 that its liabilities exceeded its assets, leaving a deficit of SR279.8 million, having run into problems on some large contracts.
With key corporates still experiencing problems, clearly not all is rosy in the kingdoms garden. Banks will not be immune. As Moodys noted in its Saudi banking outlook published in October 2012, banks remain exposed to event risks, owing to continued high, albeit declining, single-party exposures in the banks loan books. Vulnerabilities in the corporate sector, including the relatively low transparency of family-owned conglomerates and the frequent intermingling of risky investment activities with more stable operating activities, remain threats.
Moodys notes that around 100 to 150 basis points of the existing problem loan ratio is driven by AH Algosaibi & Brothers and the Saad Group, and doesnt expect any resolution or write-off of these legacy impairments over the outlook period.
Although we have seen some improvements over the past two to three years there are still conglomerates around who have weak reporting structures. So although there has been some improvements the Capital Market Authority has strictly enforced structural guidelines for example I think that some of the companies still have a way to go in this regard, says Moodys Saudi banking analyst Christos Theofilou.
Overall asset quality will be supported by benign operating conditions, which may offset some of the event risk related to high concentrations evident at Saudi banks.
And compared with other Gulf banks, Saudi institutions have smaller low problem loan ratios. Problem loans as a percentage of gross loans in Saudi Arabia are similar to those in Oman and only lag the levels reported in Qatar, says Moodys. It expects problem loan levels for the rated banks to improve slightly to around 2.5 per cent of gross loans over the outlook period, compared to 3.0 per cent at the end of December 2011 and 3.6 per cent at the end of 2010.
A greater concern for the government is that banks participate more fully in the long-term overhaul of the Saudi financial system, which remains undeveloped. Key segments of the financial system, such as bonds, SME financing, and mortgage lending, remain underdeveloped, warns the IMF. The share of bank loans going to small and medium-sized enterprises, though increasing, is below other countries.
This could change and bank credit to the private sector was expanding at a healthy rate in late 2012. Jadwa Investment notes a strong expansion in medium-term credit which reflects the banks participation in financing infrastructure and housing projects. Bank credit to the private sector expanded by 1.5 per cent month-on-month to October 2012, pushing the annual growth to 14.7 per cent.
Says Fitch Ratings analyst Paul Gamble: This is basically a continuation of what weve seen in year-on-year terms about 15 per cent loan growth, and were looking for another 15 to 20 per cent in 2013. The macro outlook is good; banks and borrowers are comfortable with this environment and that suggests credit growth will be healthy and will support the private sector.
Other analysts suggest a note of caution, however. I think Saudi bank lending to the private sector will probably grow by around 16 per cent next year, down a touch on the likely rate this year, says James Reeve, deputy chief economist at Samba Financial Group: There are plenty of projects that need financing, thats for sure, but is the pricing good enough to attract the banks? Thats the question.
In terms of retail loans, says Reeve, there is not a lot of scope given statutory caps on personal loans. Mortgages are exempt from these caps, and there might be scope to increase them, but I think banks will remain cautious, he says.
The kingdoms banks loan-deposit ratio is among the strongest in the region, with deposits on the increase. Commercial bank deposits increased by 13 per cent year-on-year in October, notes Jadwa in its monthly Saudi chartbook. With deposits rising at a faster monthly rate than lending, the loan-to-deposit (L/D) ratio slipped to 81.5 per cent.
There is scope for Saudi banks to grow their loan book going forward. Though the Saudi Arabian Monetary Agency (SAMA) - the central bank - has a recommendation of keeping the L/D ratio below 85 per cent, the banks still have a buffer to further growth of their loan book before there is more competition on deposits.
Excess bank deposits at SAMA provide scope for further lending growth, says Reeve:
The loan-to-deposit ratio rose a bit, yes, but it has since fallen back and is now just below the regulatory limit of 85 thanks largely to a pick up in government deposits.
Few are getting hung up about these movements: the L/D ratio is still comfortably below Gulf peers and banks have decent amounts of capital. There is also a ready market (domestic and foreign) for new rights or bond issues should banks feel the need to raise additional capital, says Reeve.
There is the option of more government deposits going into the bank sector that is not going to prove a constraint even with interbank rates going up. Absolute borrowing rates are still very low which is a positive sign for the economy.
Looking forward, the benign operating environment and the robust pipeline of projects should provide ample opportunities to growth loans. The advent of housing loans is another boon, enabling banks to develop their retail portfolios more successfully. This wont be viable in the medium term, as the mortgage legislation needs to be fine tuned, but housing loans will clearly figure more prominently in banks activities in coming years.
That wont improve banks prospects for participating in large project financings. Asset and liability maturity mismatches will remain a structural challenge, undermining Saudi banks capacity to lend to massive ventures like the Sadara Chemical project, a $20 billion scheme sponsored by Saudi Aramco and the US Dow Chemical.
For major project financings of this scale, Saudi banks have not been able to adequately replace the Western financial institutions that scaled back their project lending exposure to the Middle East more than four years ago. As a result, project sponsors are tapping non-bank institution for lending capacity, notably the export credit agencies.
All this is unlikely to concern Saudi bank chiefs. With a rising tide of corporate activity to lend to, and developing retail franchises, they are well placed to continue their solid progress of the last three years.
According to Moodys Theofilou, Saudi loan books are going to be driven on the one hand by the corporate sector and on the other by spending by the government on infrastructure and other development projects. Theres a lot of trickle-down effect through these projects and the non-oil private sector corporates will benefit from the spending. In turn, the banks will lend to the corporates in order to finance the projects.
A period of stability and calm will serve Saudi banks well after some of the turbulent experiences of recent years. Quietly building up loan books while posting strong earnings looks a viable strategy for 2013.
