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Middle EastAugust 1 2004

Oil wealth offers new opportunity

As Saudi Arabia remains flush from booming oil prices, and opens its banking sector up to competition, the kingdom’s institutions are making aggressive plays for the consumer market and other new business. James Gavin, Jon Marks and Paul Melly report .With international banks set to enter Saudi Arabia’s previously guarded markets, as the long-awaited capital market law comes into effect, the threat of increased competition is looming on the horizon for the country’s banks.
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At the same time, one of Saudi banks’ main sources of income – the issuance of government paper – is slowly drying up. Despite this, Saudi institutions can look forward to a bright future of growing lending opportunities and robust profitability. The deterioration in the kingdom’s internal security situation has had little immediate impact on the 10 Saudi-owned banks. On the contrary, as consumers embark on an oil-driven spending spree, the local market is as buoyant as it has been for many years.

Half-year 2004 results look set to continue the rising profitability trend of 2003, when average net profits grew by 16.4%. Of the early reporting banks, Arab National Bank (ANB) showed a dramatic 53% increase in first-half net income to SR576m ($153.6m) – founded on a 78% increase in fee income and 21% increase in net interest income. First quarter net profits of the 10 local players were up an average 27% amid strong oil revenues, healthy liquidity and rising confidence from both local consumers and, increasingly, the corporate sector.

The increase in oil prices to over $40 a barrel in the second quarter has helped to generate excess liquidity in the market, while unsated demand among Saudis for credit is providing banks with opportunities for expanding their consumer credit exposure.

The capital market law, so long talked about yet frustratingly unimplemented, is finally making progress, with the appointment of a five-member executive to the Capital Markets Authority (CMA) in early July, headed by Jammaz Al-Suhaimi, the well-respected deputy governor of the Saudi Arabian Monetary Agency (SAMA).

Welcome development

Whether or not the new capital market boosts the bottom line in the short term, Saudi banks are looking forward to the new trading environment. “It’s a welcome development as it will give us a lot more credibility, with a structure behind the capital market,” says Nemeh Sabbagh, managing director of ANB.

While the new financial regime will pose greater competition challenges for Saudi banks, as they lose their monopoly on local investment banking activities – and the nice line in fee and commission income that goes with it – the net effect is likely to be to their advantage. If their share of the pie is getting smaller, at least the pie itself is slated to get much bigger.

“There will be more IPOs, more privatisations and there will be more opportunities for Saudi banks – the competition will also be healthy for them, pushing them to adopt more modern systems and processes,” says Said al-Shaikh, chief economist at National Commercial Bank (NCB), the kingdom’s largest institution.

Healthy competition

Most Saudi bankers are sanguine about the impact of the mooted regulatory changes on the bottom line and this view is shared by ratings agencies, which see local banks as robust enough to see off the competition.

That competition is slowly getting bigger, with the issue of licenses to large international banks and the putative emergence of a small new Saudi-owned institution, Al-Watan Bank. The traffic is not unidirectional though – Citigroup finally announced its exit from Samba Financial Group (the former Saudi American Bank, known as Samba) in late May, with its remaining 20% stake taken up by the Finance Ministry’s Public Investment Fund (PIF).

But any pain to be endured by the removal of local banks’ monopoly privileges through the capital market law is likely to be limited and relatively short-lived. “The most important thing for every bank is that one-third of their customer deposits do not incur any cost. So losing 1% or 2% from gross revenues from lower fee and commissions income is not something they will lose much sleep over,” says Mardig Haladjian, Saudi bank analyst at Moody’s Investors Service.

Consumer boom

Consumer lending shows no signs of abating and margins remain fat – enough to compensate for a tailing off in the issuance of government debt. “Saudi banks have an attractive alternative to investing in government paper; they are lending to retail customers at better rates, and as long as the quality of lending remains good, that will be good for the overall margins that banks have,” says Mr Haladjian.

With Saudi Arabia pumping out more than nine million barrels of crude at oil prices above $35 per barrel, the government is overflowing with liquidity. As a result, the need to issue paper to raise finance has subsided, diminishing the stock of debt available to the banks – though it is still sufficient to maintain a healthy volume in the secondary market before it fully drains away. According to Mr Sabbagh, business is tailing off: “We might start feeling the impact of that next year, but we’ve still got a substantial portfolio and we are diversifying.”

The trend away from general debt issuance towards more selective issues gained traction in March, when SAMA announced a change in the way it issues government securities. The central bank introduced “Dutch auctions”, with selected banks invited to invest.

Corporate growth

These trends will prompt long-term changes in balance sheets, forcing Saudi banks to look outside the public sector for lending opportunities. The onus on diversification will prompt some into structuring increasing volumes of local corporate bond issues.

A revival in corporate lending could help redress the looming shortfall in the banks’ traditional bread and butter income of living off government debt. Energy-based infrastructure projects, many with private sector backing, are coming to market and the impact on construction-related borrowing could be significant.

Banque Saudi Fransi (BSF), which reported a 17% rise in net profits last year, says diversified revenue streams have contributed to its strong income growth. BSF is one of the lead arrangers on a $500m debt package for four power plant projects sponsored by state energy company Saudi Aramco.

“Corporate lending growth has taken off in the past six months and is looking pretty robust,” says Mr Sabbagh. “Corporate earnings are pretty strong – overall it’s a healthy environment.”

But for now, corporate lending is unlikely to enjoy the rapid growth rates racked up by the consumer market in the past year. Soundings suggest Saudi corporates are still sufficiently liquid not to need to tap the domestic bank debt market yet.

Most of the running, say Saudi bankers, will continue to be made by the retail market.

Emerging markets

The record profitability enjoyed by Saudi banks is largely based on rampant growth in the consumer banking market (see box).

But banks can look forward to other fee earning opportunities emerging over the next year. Increased corporate bond issuance is one avenue to go down, once the capital market law is finally on the statute book.

This will have positive spin-offs in other areas. Saudi banks have traditionally been constrained from increasing exposure to the booming project finance market by the relatively immaturity of their asset bases. “Saudi banks could issue bonds to increase the maturity of their assets and enable them to participate in long-term financings,” says Mr al-Shaikh.

The gradual opening to international banks poses new questions, with the capital markets law allowing foreign institutions to set up investment banking operations. Ahead of final approval for this move, the authorities confirmed their intention to promote foreign participation when SAMA awarded universal banking licences to BNP Paribas, JP Morgan and Deutsche Bank.

According to Mohammed bin Sulaiman al-Jasser, deputy governor of SAMA, the new arrivals will help to diversify the range of products on offer to Saudi business – notably corporate bonds and other project financing tools.

While several major western banks have long been involved in joint ventures – such as Samba, HSBC’s Saudi British Bank and the Crédit Agricole Indosuez-affiliated BSF – the universal licence awards marked another important step towards market liberalisation. Only in the last four years have banks from other Gulf Co-operation Council member states been allowed to operate in the kingdom, under a GCC agreement to open up the regional financial market. Bahrain-based Gulf International Bank (GIB) was the first to secure a licence, followed by Dubai-based Emirates Bank International, National Bank of Kuwait and National Bank of Bahrain.

Deutsche has said it will initially focus on wholesale business. But incomers may also be looking to cultivate the private banking business of Saudi clients who are looking for alternatives to the US for their assets. Deutsche has a taste for this investment business, in 2002 launching the “equity builder” investment products for Islamic investors, in partnership with NCB.

BNP Paribas was initially licensed only for one branch, but the French bank also plans Al-Khobar and Jeddah branches, as part of its wider growth in the GCC region.

It is not all good news, however. Many western institutions are clearly concerned for their personnel during the ongoing terrorist assault on foreign and ruling Al-Saud targets. “Officially it’s business as usual, but that business is being transacted by our local staff – we’ve pulled out the expats without making any noise about it,” says one area manager of a major international bank.

Samba restructuring

It was business, rather than politics, that drove Citigroup’s move – after months of speculation – to sell its 20% holding in Samba for $760m. This represents a $0.15 a share gain and 25% premium above the market value.

The Samba stake had been under review since last October, when the long-standing management contract with Samba came to an end. While Citigroup retains a strong Middle Eastern presence – with 2300 staff in eight Arab countries besides Saudi Arabia – the Samba contract was the only arrangement where the US group had management responsibility for a bank in which it lacked a controlling stake. Prior to the final disposal, Citigroup had reduced its Samba holding on three previous occasions – in 1991, 1999 and 2003.

The buyer is the state-owned Public Investment Fund (PIF), with bankers suggesting that Samba shares could be marketed to local private investors at a later stage.

Citigroup is anxious to say it is not abandoning such an important market. “Citigroup has been doing business in the Middle East for nearly 50 years and we remain committed to our clients throughout the region,” says group spokesperson Andrea Hurst. “We continue to see potential for new business opportunities in Saudi Arabia and we are actively exploring these opportunities.”

Consumer market growth The key players in Saudi Arabia’s increasingly crowded consumer market have all developed highly effective and increasingly sophisticated retail franchises. All banks are fighting aggressively for market share, particularly in the emerging Islamic (or Shariah-compliant) retail segment, in the knowledge that income flows are being beefed up by Saudis’ willingness to pay over the odds for neatly tailored products. Some banks report that the bulk of their retail products are now tailored for the Islamic market. Most Saudi players now offer Islamically structured versions of retail products alongside the conventional ones.

“Consumers do not seem to be pushing for a reduction in borrowing rates just yet, and the shift to Islamic-based consumer finance continues, says Mardig Haladjian, Saudi bank analyst at Moody’s Investors Service. “People now prefer to borrow based on Shariah structures, rather than conventional methods.”

New products range from car loans to Islamic debit cards, such as that offered by Riyad Bank, to quasi-mortgage housing finance products from Al-Rajhi Banking & Investment Corporation and Saudi British Bank, designed to test the water ahead of the anticipated introduction of mortgages in the kingdom. “The housing market has a huge financing requirement given the strong pent-up demand for mortgages from consumers,” says Said al-Shaikh, chief economist at National Commercial Bank (NCB).

Saudi banks’ growing interest in the Islamic retail sector comes amid rising speculation that NCB is preparing to take the plunge and convert fully to Shariah principles – a move that the bank has officially denied.

The rapid growth of consumer banking has not led to any noticeable deterioration in asset quality, while delinquency rates in the Saudi banking sector remain low, at an estimated average of just 3%. A substantial proportion of loans to individuals are based on salaries, which helps reduce the risk. A recently-established credit bureau will help scrutinise individuals’ credit records and assure confidence in light of the retail sector’s startling growth.

The existence of a credit bureau might tempt banks to look beyond salary-based lending criteria. However, such a bold move could still be some way off. SAMA retains a firm regulatory hand and is discouraging local banks from allowing consumer lending to exceed 30% of their overall loan portfolios, although analysts say that these measures alone are unlikely to take the heat out of the retail market in its current state.

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