Non-performing loans (NPLs) at Saudi banks are likely to peak by 2010-11 while the assets quality is expected to deteriorate further, according to a Bank of America-Merrill Lynch report.
NPLs at top three Saudi banks – Al Rajhi Bank, Arab National Bank (ANB) and Samba Financial Group – are projected to double from 1.1 per cent to 2.5 per cent by 2010 as the full extent of the poor macro economic feeds through.
In its coverage for top three Saudi banks, the report said Al Rajhi is better positioned in terms of NPL coverage after the bank spiked provisioning in 2008 when NPLs dropped; while ANB will see rise in NPLs from lows of 0.4 per cent to 1.1 per cent by 2010.
The Saudi banking sector will see deterioration in asset quality in line with the cyclical downturn but this will not be part of a systemic problem, the report said.
The bank expects little change in the asset allocation of Saudi banks but do see limited volume growth of seven per cent for 2009 before it picks up again into double digits by 2010.
It expects that the Saudi Government's stimulus package to kick start lending again halted as a result of asset quality concerns.
The banks' volume growth prospects in the short term will undoubtedly be affected by lingering concerns on asset quality while long-term trends will be driven by the extent of lending under-penetration and by regulatory reform. Given the strong funding position of the Saudi banks versus their Gulf peers, they look well positioned to return to growth while genuine demand is likely to arrive sooner.
"We expect provisioning to weigh the most on bank profitability but it will be manageable because of the already increased general provisioning. In addition, the banks have healthy top line support with limited impact on post provision net interest margins (NIMs) compared with their regional and global peers," it added.
Merrill expects interest income growth of Saudi banks to be sluggish in 2009 at between five per cent for Samba and eight per cent at ANB due to slowing balance sheet growth and contracting NIMs in the second half. Net interest margins will bottom out in 2010.
The report stated that the banks will struggle to maintain fee income growth at the Q1 level as seasonal factors come into play but the outlook for a healthy recovery in 2010 looks promising.
Al Rajhi is least reliant on capital market linked fees, which it was able to grow 10 per cent year-on-year in first quarter against a decline of 35 and 24 per cent at Samba and ANB, respectively.
Capital market linked fees – dominated by brokerage – remain highly relevant at Samba and ANB. The Saudi market has seen a significant fall in trading values during the global downturn. However, velocity remains high and with 92 per cent of trading linked to retail accounts the banks will continue to enjoy a dominant position despite the entrance of foreign and regional investment banks.
The report believes that the bulk of investment write downs by Saudi banks is behind as they have already made significant write-downs and generally de-risked their balance sheets. Al Rajhi, despite its high exposure to real estate, is at the least risk of further write-downs. Samba has shifted a greater proportion of its investment book to lower-risk exposures such as government debt while ANB increased its exposure to financial firms and corporates.
The report said Saudi banks were very well capitalised with 13.2 per cent equity to assets ratio for the whole system as of March 2009. In addition to their strong capital position, the lack of stress in the banking system and the strong profitability ratios are first line of defence. Sama's minimum Basel II capital adequacy ratio for the banks is eight per cent and it will be restricted to no more than 11 to 12 per cent.
Al Rajhi stands out with among the highest core Tier 1 capital adequacy ratio of Mena banks at 19 per cent. With such high capital ratios, the biggest risk to capital strength is likely to come from inorganic international expansion, particularly in the case of Samba and Al Rajhi because they have made international forays before.
The report believes that medium-term constraints on revenue growth are margin contraction from falling benchmark rates and the maturing of fixed rate securities; slower balance sheet growth particularly in corporate lending; fee income under pressure from falling trading values in the local exchange and reduced credit-linked fees.
The report expressed serious concerns with regard to banks' excessive exposure to the steel and cement producers, contracting firms and over-leveraged family firms which have been massively hit by the crisis as indicated by the recent Saad Group restructuring.
Saudi corporates have leveraged up in recent years with the ratio of corporate loans to non-oil GDP up from 48 per cent five years ago to 108 per cent in 2008, which is a major concern on asset quality. But Merrill Lynch draws some comfort from the still acceptable levels of absolute gearing and because the macro deterioration has not hit Saudi particularly hard.
Another positive for the Saudi banks is that the country's real estate and construction sector are less speculative than other regional countries because of the limited foreign ownership – restricted to one home per resident – and demographic driven demand.
The bank expects loan growth to pick up in the second half driven by government-backed project spending; the initial asset quality deterioration should by then be over. The Ministry of Finance recently reiterated its budget expansion plans and stated that it had doubled contract awards in first quarter this year against first quarter in 2008 to $10.8bn in total – equal to the expected 7.1 per cent of corporate loans for 2009 and that planned projects for the next five years remain at 128 per cent of GDP. Bank of America-Merrill Lynch expects Saudi corporates to concentrate on raising loans from banks rather than tapping the capital markets.
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