Further growth in retail mortgages will continue to underpin credit growth for banks as the economy improves. John Everington reports.

Having come through the darkest days of the coronavirus crisis largely unscathed, Saudi lenders are set for windfall years in 2022 and 2023. Surging oil prices and the ongoing strength of the country’s retail mortgage boom are set to underpin credit growth in the years to come.

While rising interest rates may take some of the shine off credit growth in the medium term, such increases are set to significantly boost banks’ profits further, given the high levels of floating loans on banks’ balance sheets. Such rate rises may herald the rise of a new generation of saving products, in line with government priorities.

The steady performance of the country’s banks has put to bed talk of further mergers in the sector, with credit profiles holding steady. Indeed, traditional lenders are set to be joined by a new generation of digital-only lenders, led by STC Bank, the country’s first tech ‘unicorn’ (a company valued at $1bn plus).

Position of strength

Saudi banks entered the Covid-19 era in a position of strength, enjoying strong profits and healthy capital buffers in 2019. In a sign of the perceived resilience of the sector, the Saudi central bank (SAMA) chose not to relax regulatory and macroprudential requirements for banks in the early days of the pandemic, unlike regulators in some other markets in the Gulf Co-operation Council.

Such an approach has been largely vindicated, with the Tier 1 capital adequacy ratio for the sector holding at or above the 18.1% level recorded in late 2019, according to data from Aljazira Research.

Lenders’ profitability has almost recovered pre-pandemic levels, with provisioning charges dropping by 44% year-on-year as the economy improves. According to Aljazira Research, the banking sector’s net profit for the fourth quarter rose 38.8% year-on-year to SAR2.76bn ($736m).

Non-performing loans (NPLs) rose from 1.9% in 2019 to 2.2% in 2020, according to SAMA data, with significant increases in problem loans in the commerce, manufacturing and construction sectors. Aljazira Research estimates that NPLs recovered to 1.8% at end-2021, with strong loan growth in the past year softening the impact of higher impairments on asset quality metrics.

Recovering operating conditions have prompted SAMA to end its deferred payment financing support programme, introduced at the beginning of the pandemic in mid-March 2020, at the end of March 2022.

“The decision to end the deferred payment scheme for the banking sector is a testimony to improved operating conditions for corporates and for small and medium-sized enterprises (SMEs) in particular,” says Amin Sakhri, director of banks for Europe, the Middle East and Africa at Fitch Ratings.

“We need to wait and see how banks’ asset quality metrics were actually impacted at end the first quarter of 2022, but our expectation is that the impact of the ending of the scheme is going to be very small overall for the sector.”

However, in April 2022, SAMA announced that it would extend its guaranteed financing programme for micro, small and medium-sized enterprises (MSMEs) — also introduced at the start of the pandemic — until March 2023.

The programme is one of several designed to boost the SME sector; the country’s ‘Vision 2030’ plan intends to increase SMEs contribution to gross domestic product from 20% in 2016 to 35%, and to raise the share for SME lending to 20% of the total lending portfolio. In February 2021, the state announced the approval of the establishment of the Bank of Small and Medium Enterprises, affiliated with the country’s National Development Fund.

Short-term funding requirements from local businesses, together with the booming retail mortgage market, saw credit growth surge by 14.8% in 2020, according to SAMA — nearly double the rate for the previous year. Credit grew by 15.4% in 2021, Aljazira Research reports.

Strong retail mortgage market

While an improving economy promises to lift credit demand across all sectors, in particular the rapidly expanding hospitality and leisure sectors, the retail mortgage market remains the gift that keeps on giving for Saudi lenders, thanks to the government’s Housing Vision Realisation programme.

The scheme, a key part of Saudi Arabia’s Vision 2030 social and economic transformation plan, aims to increase home ownership via a series of government subsidies and guarantees. Such support makes retail mortgages a critical part of banks’ offerings, with high margins enabled by the absence of caps on retail loan pricing.

“The market may moderate a bit, but we still expect strong growth in the years to come. The objective set by Vision 2030 was to increase homeownership to 70% of Saudi families, and we’re still a way away from that level,” says Tony Cripps, CEO of Saudi British Bank (SABB), the country’s fourth-largest lender by assets.

“Even the parts of the real estate market that are not supported by the government are likely to remain robust, given the overall strength of the economy.”

While the two largest banks in the country, Saudi National Bank (SNB) and Al-Rajhi Bank — which together account for around two-thirds of the overall retail mortgage market — will continue to be the main beneficiaries of the growth of the domestic real estate, opportunities still exist for other banks with tailored offerings.

“As funding costs begin to rise as interest rates increase, we could see other banks that cater to specific niches win business by enhancing customer experience and cross-selling to their existing clients, although we expect large franchises will continue to dominate this segment,” says Mr Sakhri.

Interest bites

While Saudi banks in the main expect credit to increase by 13–15% in 2022, S&P Ratings believes growth will be more muted at around 12%, as interest rate rises begin to bite.

Having raised interest rates already in March for the first time since 2018, SAMA is set to follow the US Federal Reserve (due to the peg between the Saudi riyal and the US dollar) in raising rates further in the coming months, with up to five extra rate rises predicted by S&P for 2022 alone, with further rises predicted for 2023.

“At some point, higher rates will gradually cool off lending growth,” said S&P in a mid-April briefing note. “Specifically, we believe that mortgage growth will start to moderate, even in nominal terms, in 2022 as the market becomes more saturated.”

Such a slowdown would, however, be moderated by an increase in contracts related to Vision 2030 projects, along with private-sector support programmes, which should boost demand for credit among corporates.

Despite the potential dampening effect of interest rate rises on overall credit growth, such increases by SAMA will provide a profitability windfall for lenders in the years ahead. S&P notes that a large portion of corporate loans (representing around 55% of total loan books in the country) are linked to a Saudi riyal benchmark rate, while around two-thirds of overall deposits — which rose by 8.3% in 2021 — are demand deposits with zero or very little funding costs.

S&P estimates that for every 100-basis point increase in rates, banks’ net income is likely to rise 13% and return-on-equity by an additional 1.5 percentage points. Alinma Bank, which has a more than 80% exposure to the corporate sector, is set to be the main beneficiary of rate rises in 2022/23, according to Aljazira Research.

The rise in interest rates may lead to a shift in retail deposits from demand products to time and savings accounts. Such a shift would be in line with Vision 2030 schemes to encourage greater levels of saving among the Saudi population, which include the (as yet unconfirmed) establishment of a newly created national savings scheme.

“Should this initiative be successful, Saudi banks may see a meaningful increase in longer-term domestic liabilities, which will be positive for the widening maturity mismatch arising from the recent expansion in long-term mortgage lending,” according to S&P.

Consolidation on hold

The onset of the Covid pandemic in early 2020 led to speculation among analysts about a new series of mergers and acquisitions in the banking sector across the Middle East, with smaller lenders in particular being obliged to team up to boost their credit profiles to be able to better compete with the region’s larger players.

The past five years in Saudi Arabia have witnessed the absorption of Alawwal Bank by SABB in 2019, and the merger of National Commercial Bank and Samba Financial Group to create SNB, the country’s largest lender by assets and the third-largest in the region behind Qatar National Bank and the UAE’s First Abu Dhabi Bank.

Yet the increasingly stable outlook for the Saudi economy has reduced the impetus among lenders to seek further tie-ups.

“One of the key drivers for consolidation in any market is when there’s a significant deterioration in banks’ credit profiles, but banks in Saudi Arabia generally held up well during the crisis,” says Mr Sakhri.

“The smaller banks … all have specific business models and targeted segments, and are still managing to perform fairly well as standalone banks.”

Digital growth

Indeed, the banking sector is set to welcome new players in the near future in the form of the country’s first digital banks. After publishing guidelines for digital-only banks in 2020, SAMA awarded licences to two such lenders: telco STC and a consortium led by local investment conglomerate Abdul Rahman bin Saad Al-Rashed and Sons in June 2021.

A third licence was awarded in February 2022 to D360, backed by sovereign wealth fund the Public Investment Fund. None of the new licensees have announced when they plan to launch banking services.

Digital wallet providers have been making significant waves in Saudi Arabia since the first players were licensed in early 2020, with a total of 17 providers licensed by SAMA at time of writing. Yet the impact of such companies on the banking sector as a whole is forecast to be minimal in the short term.

“In areas such as payments and remittances, the new digital players have been increasingly active,” says Mr Sakhri. “But competition on more traditional banking services, such as lending and consumer deposits offered by digital banks, is yet to be seen, in particular as most of these services still have to be approved by SAMA. Further to this, we expect it will take some time until Saudi customers transition from the traditional banking system, which they trust and are familiar with.”

New entrants are likely to compete hard on price to win new business, benefiting consumers, according to SABB’s Mr Cripps.

“The main impact is going to be an improvement in pricing for deposits as the new players look to attract funding, and also initially for unsecured lending. This is a phenomenon that we’ve seen in other markets such as the UK and Australia,” he says.

Key to the success of the new digital entrants will be their ability to go beyond banking and offer a wider lifestyle proposition for customers, he says.

“Pure standalone banks in other markets have been able to offer benefits to customers, but haven’t really achieved high market penetration. Those that have succeeded are able to develop a broader platform.”

Such an approach has been pioneered in the Middle East by the UAE’s Emirates NBD, via its digital-only standalone product Liv, in 2017. The bank upgraded its service suite with the launch of Liv Prime in March 2021, offering benefits including two-for-one cinema tickets, free deliveries on fast food-delivery app Deliveroo, and a free premium music subscription on streaming app Deezer, all for a monthly or annual subscription fee.

Liv has accrued more than 500,000 customers in the UAE and around 82,000 in Saudi Arabia since its launch in 2020.

Of the three digital banks licensed so far by SAMA, STC is perhaps the most eye-catching prospect. The operator launched its STC Pay payments service in 2018, which has subsequently grown to become one of the largest companies of its kind in the Middle East and north Africa, with a customer base of nearly eight million.

STC Pay became Saudi Arabia’s first tech unicorn — and the third in the Middle East — in November 2020, when Western Union acquired a 15% stake in the company in November 2020, valuing the company at $1.3bn.

“STC is a good example of starting out as a pure telco and then being able to build a platform that offers payments and remittances and now banking services,” says Mr Cripps. “It’s going to be interesting to see if they can build up a [big] banking customer base.”


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