WORD IS BOND

Saudi Arabia 2017 | FINANCE | REVIEW: BANKING

Decisive action by Saudi Arabia's central bank helped place the banking sector on a stable footing heading into 2017, and industry leaders are confident the sector will emerge from the current down cycle stronger than before.

It is impossible to talk about the Saudi banking industry without talking about the oil industry. The fall in oil prices had a significant effect on the Kingdom's fiscal situation, and led to fiscal consolidation, uncertainty in the lending markets, and international concern over the state of Saudi banks. The Saudi Arabian Monetary Agency (SAMA), the Kingdom's central bank, has taken aggressive steps to stabilize the fiscal system; initiating a stimulus package to support lenders and extending policies designed to increase consumers' access to credit. The government has also entered global debt markets for the first time with a record-breaking bond issuance that helped boost the sector and reminded international participants of the Kingdom's unmatched potential. Going forward, continued careful management of the sector's loan rations and currency valuation will be needed to establish the conditions needed for economic success regardless of the price of oil.

SECTOR OVERVIEW

Saudi Arabia's commercial banking sector had 12 listed banks (four of which are sharia compliant) as of 4Q2016 and a total of SAR2.26 trillion (USD690 million) in total assets, up 2.2% from 4Q2015. Total deposits rose 0.8% YoY to SAR1.62 trillion (USD432 billion) in 4Q2016. The Kingdom's economic slowdown can be seen in the reduced growth rate of loans in the banking sector; the total volume of loans grew 2.9% over the same period in 2015, the lowest rate since the 2009 recession. Half of all new loans extended had maturities of less than a year, but the medium-term loan sector actually saw significant growth, with one-to-three-year loans rising 9.7% YoY. Loan activity in key sectors slowed compared to recent years but still grew at a moderate rate; corporate real estate loans grew by 14.3% YoY, solid but well below the 54.1% growth figure posted in 2015. Retail real estate loans grew 8.2% in the same period. Though the non-performing loan ratio rose from 1.13% in 3Q2015 to 1.24% in 4Q2016, the industry's overall coverage ratio went from 169% to 175%, a mark of the overall health of the sector. Despite the mixed performance in some areas, the banking sector overall posted a 3.8% increase in income. Most of this came from retail and treasury income, which increased by 7.9% and 1.2% YoY, respectively, and counteracted the 0.8% fall in corporate sector earnings and a 11.7% drop in investment services income.
The sector's strong indicators and stability even in the face of decreased economic performance combined with SAMA's actions have given the international financial community confidence in the sector's future. In March 2017, rating agency Moody's revised its outlook for the Saudi banking sector to stable from negative, reporting that it projected the Saudi economy to recover despite low oil prices. Government spending aimed at diversifying the economy and improving consumer confidence is expected to keep the banks in a stronger financial position than their regional peers despite continued economic stagnation in 2017.

SAUDI ARABIA MONETARY AGENCY

SAMA, the Kingdom's central bank and financial regulator, has taken active steps to support the banking sector in the midst of the current economic slowdown. 2016 saw the arrival of new lending rules and cash transfers from the government to commercial banks, to increase liquidity and stimulate economic activity in the market. Mid-2016 saw interbank rates—the exchange rate of short-term loans between banks—rise to their highest levels since the 2009 recession, a measure of the liquidity squeeze facing the sector. In February 2016, SAMA raised the percentage of deposits that Saudi banks could lend from 85% to 90% in an attempt to increase the flow of credit into the economy. The rate was raised again to 90.5% in July, as demand for credit increased, SAMA made USD5.3 billion available to the banking industry at a discounted rate while at the same time loosening its lending regulations. This came at a particularly important time for the Saudi economy; the government eliminated bonuses and cut salaries for civil workers, dramatically reducing the take-home pay for the majority of all working Saudis. In the face of this reduced consumer purchasing power, increasing liquidity in the credit market was crucial to the health of the Saudi economy.

By all metrics, SAMA's actions were successful. After stagnating in the first half of the year, the commercial banking sector saw deposits rise slightly YoY, as referenced above. The upgrading of the nation's outlook rating reflects global belief in the fundamental soundness of the sector and SAMA's ability to take further action as needed. Early 2017 has brought more good news for the sector's financial health. A recovery in the price of oil has increased revenues, putting more money into the Saudi economy by allowing the government to reverse some of its previous austerity cuts. In April 2017, King Salman reinstated the bonuses that were cut in late 2016 while maintaining the relaxed lending requirements instituted around the same time. A falling interbank ration and continued growth in lending rates served as additional positive indicators that the sector was moving in the right direction. There are still reasons for concern about the Kingdom's fiscal situation—the government deficit is expected to persist for the near future, and the price of oil remains a long-term concern—but the foundation appears to be stable.

FOREIGN BONDS

As part of its strategy to increase liquidity, SAMA issued its first sovereign bonds in October 2016. The issue marked the first time since the 1980s that the Saudi government looked to international sources to help finance its fiscal deficit, and was the first time it had issued sovereign bonds. It was a landmark entry—the Kingdom raised USD17.5 billion, the largest debut in history and more than USD1.5 billion beyond what Saudi officials expected to raise. The size and scale of the issue reflected global investor interest in Saudi debt and confidence in the Kingdom's economic future. Demand was high enough that the yields for the five-, 10-, and 30-year bonds offered actually ended below expectations, but it made no difference; the sale was an unqualified success that left both Saudi officials and global investors satisfied. Significantly, the Kingdom's debut on the global debt markets marks another step in the economy's larger move toward privatization. Improved global relationships with investors and adherence to international transparency standards have helped the sector become more structured, increased credibility, and increased the Kingdom's desirability in the eyes of global markets. The banking sector should gain new opportunities with the looming arrival of private firms into the energy, construction, and services industries, and the preexisting relationships in the global credit markets formed by this initial bond offering will undoubtedly be valuable as the Kingdom moves toward its long-term economic goals.

Encouraged by this first issue, SAMA and the Saudi government have made it clear that they will return to global debt markets to finance the fiscal deficit and bolster the banking sector's liquidity. In April 2017, the Saudi government launched its first sukuk, or Islamic bond, issue. Worth USD9 billion, sukuk bonds are a sharia-compliant alternative to traditional interest-bearing bonds that have become a popular financial tool in Islamic countries. As with the first issuance, the money raised will be used to finance the rapidly shrinking deficit and, in theory, allow the Kingdom to prevent burning through its foreign currency reserves. Yet despite the success of the April sukuk issuance, SAMA's report for May 2017 stated that Saudi Arabia's net foreign assets had fallen below USD500 billion for the first time in six years. The IMF's warning about the long-term financial health of the country after reserves began to fall in 2014 was one of the primary factors behind the government's austerity cuts, but this fall indicates that either an increase in the economic growth rate or further spending cuts may be needed to stabilize the Kingdom's financial situation. Global financial markets expect additional bond issuance within the next year, and the Kingdom is still well above the reserve levels where new currency policies would have to be implemented, but the rate at which Saudi Arabia is going through cash is still something markets will keep an eye on.

CURRENCY

The riyal's peg to the dollar has remained constant throughout the recent period of change in the sector, but concerns over the Kingdom's economic performance have led to speculation as to whether this policy might end. The riyal is fixed at SAR3.75 per dollar, and SAMA and government officials have publicly expressed confidence in the Saudi economy's ability to handle currency speculation, stating that they have no plans to de-peg. As the Kingdom's economy slowed in early 2016, some domestic traders began to bet on devaluation, but SAMA condemned the practice and launched a series of probes seeking to shut down this activity. The bond sales in late 2016 alleviated many immediate fears of devaluation, but concerns still persist. The Saudi Consumer Price Index fell 0.4% in January 2017, the first month of deflation since 2005. This came about in large part due to the growing strength of the dollar, which made the food imports that Saudi Arabia depends on more expensive. Deflation reached three consecutive months in May 2017 even in the face of slightly improved economic activity, but government officials remained positive about the long-term outlook of the riyal and the wider economy. Planned increases in prices by way of new value-added and “sin" taxes should help increase prices, and upcoming energy subsidy cuts should have the same effect. All indications are that the peg remains the surest move for the Saudi fiscal sector for the foreseeable future.

Omar Almajdouie
OMAR ALMAJDOUIE
Founding Partner, RAED Ventures
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