Unlike many bankers across the globe, adversely affected by the subprime crisis and feeling the strain, the atmosphere among bankers in Saudi Arabia is strikingly different: they are revelling in the high oil prices and diversified economic opportunities, and are bullish about the robust prospects ahead. But, as the economy looks set to enter a new golden era, Saudi banks are also readjusting to a more sustainable level of growth.
“Gone is the euphoria of 2005-06,” says Robert Eid, chief executive of Arab National Bank (ANB), as banks return to a more sustainable expansion after the halcyon days of 2006, when stock market activity soared before the eventual crash.
Although consumer confidence took a battering in 2006 in the aftermath of the crash, most banks managed to avoid the fallout and still posted record profits with profit growth in excess of 25%. Results in 2007 were not quite the same, however. Talal Al-Qudaibi, chief executive of Riyad Bank, says: “2005-06 was an exceptional period with a lot of earnings coming from brokerage. Now, banks are back to more normal conditions where we will see more lending.”
John Coverdale, chief executive of Saudi British Bank (SABB), says: “2007 represented a retreat to core,” as banks worked their way through the stock market correction and adjusted to the changes in the economy and the government’s increased spending plans. Unlike in previous years when profit growth surged, there was an important shift in 2007. Although banks remain highly profitable, there was an overall decline in aggregate net income for Saudi banks.
Net income for banks in 2007 fell by 14.4% to SR30.3bn ($8.1bn) from SR35.4bn in 2006, according to aggregate statistics from the Saudi Arabian Monetary Agency (SAMA). The effect of the huge brokerage earnings in 2006 and their absence in 2007 can be seen in the shift in the non-interest income ratio, which fell from 55.6% in 2006 to 47.3% of total operating income in 2007. The switch has been made from fees to more traditional net interest income.
Profits down but strong
However, while total profits may be down, the Saudi banks’ profitability still remains strong at an aggregate 22.3% in 2007, down from 30.5% in 2006. In terms of return on assets, the aggregate ratio slipped to a healthy 2.82% in 2007 compared with 4.2% in 2006. Key to understanding the changes that have taken place in 2007 is analysing core balance sheet aggregates.
Although bankers may agree that 2007 was a transitional and not a terribly strong year, significant growth still took place, indicating positive trends. Total assets rose 27.4% to reach SR1073bn ($286.3bn) as banks expanded (net) loans by 21.9% to SR559bn and customer deposits rose 21.4% to SR762bn. Also, total aggregate shareholder funds grew steadily, expanding by 17.1% to SR135.7bn.
The stock market correction was expected to lead to increased provisions, and clearly aggregate provisions rose 4.6% to SR16.9bn in 2007 as non-performing loans rose 25.8% to SR11.8bn. But provision coverage remains healthy (at 142.9%) and rating agency Moody’s expects banks’ asset quality to be more resilient than in previous credit cycles. Also, the aggregate capital adequacy ratio remains strong and steady, staying virtually unchanged in 2007 at a conservative 20.6%, well above Basel II requirements.
In short, despite the 14.4% drop in net income in 2007, the core fundamentals in the Saudi banking system remain solid. Following the inevitable stock market crash as retail investors learnt the harsh realities of markets, the banking sector is arguably now in better shape for the future than at any time in its history.
Banks naturally dislike dips in earnings but, just as the consensus view was that the 2007 performance reflected to a large degree the market crash of 2006, the consensus going forward is that 2008 represents a new dawn and new opportunities.
Huge opportunities
Riyad Bank, Saudi Arabia’s fourth largest bank, achieved a profits rise of 3.5% to SR3011m in 2007. Chief executive Talal Al-Qudaibi believes that opportunities are huge in all sectors, especially in mortgages. “The new mortgage law is coming soon, in the next few months; there is big demand for housing, there will be much more activity in mortgages and we will be using an Islamic structure,” he says.
Riyad, which was the only bank to post improved profits, is keen to take advantage of the market mood and is planning a massive capital increase that will provide the potential to double the size of the bank. Mr Al-Qudaibi wants to increase paid-up capital from SR6250m to SR15,000 – a 140% increase – through a rights issue, hopefully in the second quarter of this year.
He says that the issue would increase the total net worth of the bank to SR28bn from its current SR12bn, enabling it to expand its business significantly. Lending at Riyad grew by almost 30% in 2007 to SR67bn and Mr Al-Qudaibi believes that there is buoyant growth in the commercial lending and project finance sectors, which the capital increase can take advantage of.
“Banks should focus on the basics,” he says. He plans to strengthen his retail network by increasing the number of branches by 20% from 200 to 240.
“We want to be number one in ATMs; we are the second largest network [to Al Rajhi], with 1562 ATMs at the end of 2007 and I plan to expand our network,” says Mr Al-Qudaibi. Riyad wants to build its core retail capability through more branches and ATMs and strengthen its asset management role through its new investment subsidiary, Riyad Capital. Riyad is the biggest asset management player in local equities and with its long-established partner, Fidelity, has a SR20bn portfolio of local equity market funds.
Trading fees fall
Al Rajhi Bank, the third largest bank, whose core business is retail, posted a net profit of SR6450m in 2007, down 11.7% on the previous year. Nevertheless, net income from investments in this sharia-compliant institution were up 13.1% to SR7721m, and the profit decline could be seen in the dramatic drop in fees from share trading services, which fell from SR1.5bn in 2006 to SR499m in 2007 as a result of the market crash.
Al Rajhi chief executive Abdullah Sulaiman Al-Rajhi told The Banker that the economy is continuing to boom. As well as retail, Al Rajhi plans to focus on more corporate and structured finance, he says – an area where he believes there will be considerable growth in the next few years. Adding to the most extensive branch network in the kingdom with more than 390 branches (including 107 ladies branches), Al Rajhi plans to open a further 140 branches in the next 18 months and expand its leading ATM network by 20% to 1900.
In a December report on the bank, rating agency Standard & Poor’s acknowledged that Al Rajhi is among the most profitable and best capitalised banks in the Gulf. “Plans in the corporate banking segment – an area in which Al Rajhi traditionally lagged behind peers – are ambitious. Growth is targeted mostly in the top-end and middle-market segments, with an emphasis on the kingdom’s infrastructure and residential development. We believe that Al Rajhi should benefit from its expertise in sharia-compliant products when attracting mid-size companies, generally more sensitive to Islamically structured products,” said the report.
Marking milestones
The core operating income of Samba Financial Group, the second largest banking operation, fell by 1% but the group posted strong growth in other major indicators. Like other banks, Samba’s return on equity in 2007 slipped but still remained strong, at 29.1%, with total assets up 24.5% to SR154bn, net loans up 20.2% to SR80.6bn and deposits rising by 22.1% to SR115.8bn. The bank also achieved two milestones in 2007: first, expansion into Pakistan through the acquisition of Crescent Commercial Bank; and second, the creation of investment subsidiary SambaCapital, which topped the regional league tables in the financial advisory category. Samba chief executive Eisa Al Eisa says: “The overall financial performance of the bank continues to be strong with significant growth in consumer, corporate and treasury businesses.”
SABB, the sixth largest in the kingdom, was the only bank to achieve profit growth in every quarter of 2007 but, like others, its profits (SR2.6bn) were 14% lower than in 2006 (SR3.0bn).
Nevertheless, Mr Coverdale believes the outlook is robust and ripe for growth and is planning, like Riyad Bank, a major capital expansion through a scrip dividend. Minority owned by HSBC, SABB has a 40% stake in investment company HSBC Saudi Arabia, which is active in a variety of investment banking and asset management activities, and also claims a 37% market share in local equity funds.
Consumer focus
ANB, which accounts for 9% of total banking assets, is one of the smaller banks that has fashioned a successful consumer-focused strategy. Mr Eid describes his approach as simple, very conservative, consumer-oriented with a minimum exposure to the stock market.
He highlights four strategic areas, housing finance, insurance, investment (through new investment subsidiary ANB Invest) and heavy equipment leasing, as critical growth areas for ANB, where the aim is to create ‘best of breed’ capabilities, such as the joint venture with global insurance giant AIG, along with quality implementation.
With help from consultants McKinsey, ANB has implemented a radical overhaul of its consumer operations in the past 18 months; by year-end it will have 150 branches (including 60 new and redesigned branches and 38 Islamic branches), up from 115 branches at the end of 2006. The bank has implemented a new market segmentation approach along with performance management in its new state-of-the art branches, and has used successful new techniques in its award-winning call centre and share- trading operations.
ANB has outperformed the overall Saudi banking sector in terms of lending growth and deposit accumulation in the past few years, according to analysts. ANB’s net loans and deposits grew by a compound annual rate of 33% and 22%, respectively, in the four years ending in 2006, compared with growth rates of 24% and 15% for the overall sector.
At the same time, ANB grew its net profit more rapidly than its peers did, logging a 48% compound annual rate in the three years ending in 2006, compared with 41% for its peers. Like others, ANB’s profits fell in 2007 by 1.7%.
Saudi’s biggest bank, Jeddah-based National Commercial Bank (NCB), was consistent with overall performance trends, posting a 3.7% fall in profits to SR6.0bn in 2007. It has established the largest investment company in the kingdom, NCB Capital, which has a paid-up capital of SR1bn. A key to NCB Capital’s future potential is that the world’s foremost investment bank, Goldman Sachs, is to become a minority partner, strengthening the venture’s investment banking capability.
Although the full details of Goldman’s role are not yet clear, the two banks had approved a deal by the end of February and were awaiting full regulatory approval. Some bankers are dubious about the deal and argue that Goldman’s appetite for large deals makes it difficult to create viable synergies in the joint venture; but NCB Capital is already becoming a force, with 12% market share in the brokerage sector and $12bn in funds under management.
New players on the block
Besides the entrance of Goldman Sachs and other Wall Street institutions, there are an increasing number of new players on the Saudi financial block. Sheikh Hamad Al Sayari, governor of SAMA, told The Banker that the expanding economy creates demand for more competition and a large new bank with a paid-up capital of SR15bn is due to floated in the first half of this year (see interview, p121).
The new giant, to be called Al Inma Bank, will be a universal sharia-compliant institution and is expected to be operational by year end. Along with the 83 investment companies licensed through the Capital Market Authority (CMA), Al Inma would bring the bank total to 12, on top of the 10 branches of international banks now operating in the kingdom.
Although many of the licensed investment houses have not yet begun operations, they are expected to add a new dimension to the Saudi financial sector and end the monopoly of the major Saudi banks, which have been required to split off their investment banking businesses into separate companies.
One of these new players is Falcom Financial Services, which launched its activities in February with a paid-up capital of SR1bn. “Falcom offers a broad array of sharia-compliant investments strategies, mutual funds, advice and planning across all major asset classes to a diverse group of institutions, high net worth individuals and retail investors,” says chief executive Adeeb Al-Sowailim. Like elsewhere in the Gulf, Falcom and other new players are adopting a sharia-compliant strategy.
In 2008, with the range of financial services providers strengthened, the oil price hitting $110 a barrel and a bonanza of projects in the pipeline, the outlook for banks is not only bright but sustainable in the medium term. It also appears that this Saudi boom will not be wasted.
