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Country reportsMay 1 2013

Saudi's banks enjoy an enviable position

Government spending has kept the Saudi Arabian economy buoyant over the past few years, allowing the country's banks to maintain a healthy profit level in 2012. And their prosperity is showing no signs of waning, with an ambitious home ownership target spurring growth in the mortgage market and momentum building in the small and medium-sized enterprise space.
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Saudi's banks enjoy an enviable position

The stellar performance of Saudi Arabia’s banks must appear to be a mirage to the banking sectors of many other countries in the world. Its figures are enviable on every front – from its healthy profits to its strong liquidity ratios to its negligible non-performing loans (NPL) ratios. 

Last year represented the country's second best ever when it came to banking profitability, with its 12 commercial banks posting profits of SR33.5bn ($8.93bn) – only marginally lower than the record of SR34.6bn recorded in 2006. This was nearly 8.4% higher than the 2011 net earnings of SR30.9bn, although the profit growth in 2012 was much slower than in 2011, when it stood at about 18.3%.

The high earnings are a result of a surge in domestic credit in Saudi Arabia, as banks are scaling back their provisioning and taking advantage of an upswing in public sector projects and the domestic economy. As a result, lending continued on an upward trend, especially to the private sector.

Total bank credit at the end of 2012 reached SR999bn, with net new credit issued in 2012 standing at SR140.8bn, meaning once again the growth in lending in Saudi Arabia has outpaced deposits, which contributed to a rise in the country's loan-to-deposit ratio to 82.7% at the end of November. 

State spending

The increase in profits among Saudi Arabia's banks over the past couple of years followed muted credit growth and negative profit figures between 2008 and 2010, in the wake of the onset of the global financial crisis.

“The global financial crisis didn’t have a very material impact on the banking sector – it was more a sentimental impact and the banks have recovered from that,” says Fahad Alturki, senior economist at Jadwa Investment. “Since the end of 2011, banks have started extending more credit, both on the corporate and consumer side, and this has maintained a positive trend since then. A key driver of this was the government fiscal packages that comprised 24% of gross domestic product [GDP]. Once these were channelled into the market, the banking sector felt more comfortable about easing their risk aversion and expanding credit.”    

Indeed, the Saudi government dramatically increased its domestic spending in 2011 in order to quell popular discontent brewing among its Shi’ite minority and those demanding better job prospects and wages in light of the Arab Spring uprisings. Only days after the collapse of former Egyptian president Hosni Mubarak’s regime in February 2011, Saudi Arabia’s King Abdullah bin Abdulaziz Al Saud announced a social welfare package for its citizens worth $10.7bn, featuring 15% salary increases for state employees, as well as extra funds for jobs, housing, studying abroad and social security. It included a subsidies programme called Hafiz, which pays unemployed Saudis SR2000 a month for a maximum of one year. 

By the end of February, the transfers had risen to $37bn. The trend continued in March with the government heralding an additional $93bn in social spending.

Credit growth

This hike in social spending combined with the huge government expenditure programmes has had a trickle-down effect, leading to greater domestic consumption, making the retail segment an increasingly attractive area for banks to move into. It has also boosted confidence among the banks to increase their lending to the private sector, which played a pivotal role in driving the country's economy forward – credit to the private sector witnessed a 15.2% year-on-year gain during November, while credit to the public sector contracted by 2% annually.

“Bank credit to the private sector grew by 16.4% in 2012,” says Abdulrahman Al-Hamidy, vice-governor of the Saudi Arabian Monetary Agency (SAMA), the Saudi central bank. “And this growth was entirely justified by economic activities as today there is a real demand from the private sector to expand.”

Credit growth stood at about 10.7% in 2011 and only 5.5% in 2010, while recording negative growth in 2009.

“The incremental increase in the banking sector’s loans to the private sector in 2012 reached the second highest level in the banking sector’s history,” says Mr Alturki. “Two-thousand and eight was the record high. The private sector grew by 7.5% in 2012, outgrowing non-oil GDP, which grew by 7.2%, and the overall economy’s growth of 7.2%.”  

Dealt a blow

According to Mr Alturki, another factor behind the rise in profits in 2012 is that provisions for bad debt were much lower than in the previous few years.

In 2009, the banking sector wobbled when two of the country’s largest and oldest business conglomerates – Ahmad Hamad Al Gosaibi and Brothers and Maan al-Sanea’s Saad Group – defaulted on a series of bank debts amounting to $22bn, prompting the biggest corporate meltdown in the country’s history.

“This experience impacted the banks but to a limited degree and they have learnt from it,” says SAMA's Mr Al-Hamidy. Bankers are keen to stress that banks were barely scathed by the debt default, but the fact remains that there are still billions of dollars worth in unpaid loans.

A group of nine Saudi banks continue to claim at least $2.4bn in unpaid loans to the Al Gosaibi holding company. They include some of the country’s largest banks such as National Commercial Bank (NCB), Al Rajhi Bank and Saudi Investment Bank. And the debt extends beyond the local banks, with more than 100 international banks making claims amounting to $12bn.

The two corporates remain in protracted negotiations with the banks, with the dispute now a bitterly fought legal affair that is being thrashed out in courtrooms across New York, London, Switzerland, the Cayman Islands, the United Arab Emirates and Bahrain.

Pastures new

While the future course these proceedings will take remains unclear, Saudi bankers are quick to point to the many exciting opportunities offered by untapped areas of growth. If there is one buzzword that is being bandied around the capital Riyadh today, it’s ‘mortgages’.  

After being debated for more than 10 years, the country’s first mortgage law was approved in July 2012 – hailed as a landmark achievement that will transform home financing in Saudi Arabia from the current practice of extending loans based on a multiple of salaries to property-secured lending.

Saudi banks have traditionally offered home-buying loans, and not mortgages, because home-buying loans are not fully secured by the properties being acquired, but instead primarily secured by banks' automatic deduction of loan repayments from borrowers' salaries.

It is hoped that the new law will help to tackle one of the most pressing social issues facing Saudi Arabia. It is currently estimated that 37% of the population has ownership of their homes, with the government having set itself the target of 80% home ownership by 2024, according to an NCB report published at the end of 2012.

With at least half of the population now under the age of 21, the Saudi population is growing rapidly at an annual growth rate of 3.3% between 2007 and 2011. Some 200,000 new homes a year are needed, according to real estate property service company Jones Lang LaSalle, so the demand for loans is likely to be high. 

Property ladder

Although housing finance has been available for some time, generally lenders have maintained a conservative stance given the legal uncertainty over foreclosure. Consequently, mortgage penetration is low – accounting for about 2% of GDP in the country, compared with more than 70% in the UK and the US.  

The mortgage law has already encouraged banks in Saudi Arabia to take more risk, as evidenced by the growth registered in home lending. Indeed, home lending grew at its fastest pace in at least four years in the second quarter of 2012, according to data from SAMA; with real estate financing increasing 83% to a record of $12.8bn from the same period a year earlier. Meanwhile, retail real estate financing stood at about 18% of consumer financing as of the end of June 2012, versus 8% in 2008.

The changes could boost residential lending to about $32bn annually, according to estimates by Capitas Group International, a Saudi company focused on Islamic finance.

“We are already offering home loans so we gave SAMA our advice on the creation of the mortgage law,” says Suliman bin Abdulaziz Azzabin, chief executive of Al Rajhi Bank. “There’s going to be huge competition in price and tenor for mortgage products.”

Saudi British Bank was "the first bank to provide a home loan in 2005”, according to its managing director, David Dew. “We worked hard to develop that and today we are the number two home loans provider in the country," he says. "The key risk is the interest rate. Interest rates are at all-time lows today, which needs to be considered when you’re providing long-term products that stretch out as far as 15 to 20 years. There needs to be some provision for securitisation so that banks can take the loans off their balance sheets.”

According to insiders, the law will provide for the creation of institutions that can buy mortgages from lenders and then securitise them so that they can be sold to investors.

“I think there will be healthy growth in this area as there’s a genuine need for housing,” says Mr Al-Hamidy. “Our banks provided mortgages before the law so most of them have experience in this. There are already three mortgage companies in existence and all have banks as shareholders. But at the same time that the mortgage law was approved, we established a General Department for Finance Companies Supervision to supervise mortgage and finance companies.

"However, we’re still waiting for final approval on some of the by-laws but they’re almost ready – I’m optimistic that they’ll be enacted before the summer [mid-2013]. They’ll provide legal support and the framework that’s needed.”

Spanner in the works

Saudi Arabia has issued final regulations on three of the five laws that comprise the mortgage law – real estate financing, leasing and the supervision of financial companies – but rules on the enforcement of foreclosures and mortgage registrations have yet to be completed. It is the enforcement of foreclosures that the financial industry is most concerned about.

“Foreclosure is the key issue – whether in reality they can act on the foreclosure law,” says Mr Alturki. “Therefore, I think it is unlikely that the mortgage law will have an impact straight away. More likely that mortgage companies and banks will experiment with the law for three to five years.”

The same issue has also been highlighted by ratings agency Standard & Poor’s, in a February 2013 report. "The legal uncertainty surrounding foreclosure after a borrower's default has been the primary stumbling block," it says.

However, if the mortgage law codifies the foreclosure process – stating that in the event of a bankruptcy, the mortgage is senior to all other loans – this will give banks and home finance companies the confidence to lend.

“Against the current gradual recovery in corporate loans, we consider that retail lending is particularly vital for Saudi banks to protect overall bottom-line results in a low-interest environment,” notes the S&P report, estimating that rated Saudi banks' net interest margins contracted to 2.9% at the end of the third quarter of 2012, from 4% in 2007. “We believe Saudi banks have spotted a good opportunity in home financing as a means to sustain the current lending revival to retail customers,” it continues. 

The rise of SMEs

Another area that is helping to sustain the uptick in lending is the rise of the small and medium-size enterprise (SME) sector as a viable investment opportunity.

In 2006, the Saudi Industrial Development Fund, an affiliate of the country's ministry of finance, set up the Kafala programme, in coordination with a group of Saudi banks to fund SME projects. The programme guarantees financing banks 80% of existing projects’ finance and future projects’ finance value.

Kafala means ‘guarantee’ – we guarantee 80% of the loan,” says Mr Al-Hamidy. “The NPL ratio of this programme is less than 5% because banks study it in a very professional way. It has been a huge success.”

Since its launch until the end of 2012, the programme has approved 765 guarantees for 909 SMEs valued at SR2.3bn, where banks and other financing institutions provided funding facilities worth SR4.83bn.

In 2012, 918 firms benefited from the programme, compared to 742 in 2011, an increase of 24%, with the programme approving 670 guarantees for SMEs in 2012 valued at SR4.8bn. The volume of funding offered by the participating banks in the programme stood at SR1.78bn in 2012 compared to SR1.28bn in 2011, an increase of 38%.

“Today, there is a real focus on SMEs – we have encouraged banks to establish departments specialised in financing SMEs and a good number of our banks have done so,” says Mr Al-Hamidy. “We anticipate it will be a key growth area over the next five to 10 years.”

Solid growth

To date, NCB has established more than 15 centres, while Saudi Hollandi Bank has opened more than three.

“The two key challenges for the Saudi economy are the shortage of housing and SMEs,” says Saudi British Bank's Mr Dew. “We are looking to develop business banking. We have launched some new packages within business banking for SMEs.”

Al Rajhi Bank is another bank considering entering the market. “SMEs will become more important," says Mr Azzabin. "Saudi Arabia is home to about 670,000 SMEs, with the majority of these companies being in the small business segment. The distribution of SMEs is skewed towards the trade and construction sectors, with the majority of companies in three provinces.

“Going forward, the solid performance of corporates is expected, with the SME and mid-corporate segments outgrowing large corporates in revenues and profits. To benefit from the strong growth prospects of SMEs, banks need to develop industry-specific product and service propositions.”

Remaining upbeat

While the leading Saudi banks are among the strongest in the Middle East and bankers remain upbeat about growth opportunities, they are also quick to point out that competition is fast intensifying.

“Competition today is fierce,” says Dr Bernd van Linder, managing director of Saudi Hollandi Bank. “All Saudi banks are very liquid and it is a low-interest environment so the competition keeps getting fiercer and fiercer.”

Despite strong structured growth in the banking sector over the medium term, revenues and profits will be under pressure over the next two years due to low interest rates, a highly competitive market, and more demanding clients. Additionally, the regulatory landscape will continue to be conservative with an aim of balancing industry growth with stability. Increased sector loan-to-deposit ratios of about 76%, with many banks reaching the 85% ratio, is leading many of them to chase funding.

However, Saudi banks remain highly liquid, with substantial surplus liquidity placed with SAMA (and on the interbank market), which provides plenty of scope to fund further loan growth. They are also extremely well capitalised, with an average capital adequacy ratio of their banking sector standing at 17%.

The country has the largest and fastest growing population among the Gulf Co-operation Council countries. This, combined with increased government spending, a rising average income, its strong and stable economic growth – estimated at 4.2% in 2013 – underpinned by sustained progress in diversification and industrialisation, will ensure increasing demand for existing banking services and the expansion into untapped services as well.

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