If Saudi banks were meant to be feeling the pain of lower oil prices, their first-quarter financial results do not appear to show it.

Two of the smaller lenders, Saudi Hollandi and Bank Aljazira, showed impressive increases in profit – 43 per cent and 30 per cent respectively. Overall, the kingdom’s banks recorded year-on-year profit growth of 5.4 per cent in the first quarter of 2015, following a generally positive 2014.

Only Al-Rajhi Bank, the large Islamic lender, bucked the trend, revealing a 11 per cent drop in first-quarter net profit to SR1.5bn ($400m). Generally, the bigger Saudi banks have reported solid, albeit unspectacular, bottom line growth, with National Commercial Bank’s 2.8 per cent increase and Sabb’s 3.2 per cent expansion confirming earnings growth in the low single figures.

Strong 2014

The kingdom’s 12 listed banks reported a healthy 2014, with combined profits rising by more than 10.2 per cent to SR41.6bn, thanks largely to increases in commission fees and revenues improving performance. Take out the underperformers from last year – Al-Rajhi and Bank Aljazira (which was hit by a large provisioning in the third quarter of 2014) – and the sector as a whole would have shown a net profit rise of more than 15 per cent.

But with weaker oil prices and subdued credit growth in 2015, Saudi lenders are expected to struggle to match that performance this year.

Growing loan books amid tepid confidence is a challenge. “There are a number of factors that are pushing down growth in credit to the private sector, and one of them is the negative sentiment in the private sector,” says Fahad Alturki, chief economist and head of research at the local Jadwa Investment. “There are worries that the government may not maintain higher government spending.”

Many Saudi businesses have long memories and are thinking back to the 1980-90s, when a period of lower oil prices forced projects to halt and, all too often, delayed payments. Analysts dismiss this comparison, however. “The picture is not comparable with the situation in the 1990s because the sovereign balance sheet is so much stronger now, with large reserves and low debt,” says Alturki.

That message has not yet sunk in, and banks’ loan book growth has been slowing as a consequence. Retail-oriented lenders such as Al-Rajhi have been particularly exposed to these worries, although banks are still rolling out new branches at a brisk pace, with a total of 25 added in the first quarter, according to the latest bulletin by Saudi Arabian Monetary Agency (Sama), the central bank. 

Saudi banks remain highly liquid. According to Jadwa Investment, deposits at Sama in excess of the regulatory requirement stayed over SR50bn, accounting for 40 per cent of total bank reserves in March. The strong growth in bank deposits meant the loan-to-deposit ratio fell to its lowest in almost a year, at 79.2 per cent. The deposit increase in part reflects the munificence of Saudi Arabia’s new monarch, King Salman bin Abdulaziz al-Saud, who announced a sizeable bonus for public sector workers on assuming the throne.

Retail banking

Banks are likely to find it a struggle to shed the excess liquidity, given the regulatory moves introduced late in 2014. Indeed, this reinforces the sense that the weaker confidence in the kingdom is not the only cause of the slower loan growth; Sama’s implementation of new consumer finance regulations, which came into effect in September 2014, imposed limits on earnings growth. These have had a dampening effect on those lenders whose portfolios are heavily weighted to the retail banking sector, notably Al-Rajhi.

According to a research note published by Aljazira Capital, the overall growth in retail loans was much slower than the 11.6 per cent year-on-year rise in total loans at the end of the third quarter of 2014. The fall in the market share for retail loans is negative for the sector given that they usually provide the highest net interest margins.

Sama also handed itself the power to cap retail lending at specific banks. In addition, in November 2014, a new mortgage law came into force as part of a wider, ongoing package of reforms in the real estate sector. A provision of the new regulations is that a loan-to-value cap of 70 per cent has been placed on Saudi banks.

“There’s been a number of regulations that have capped the fees and interest rates that banks can charge,” says Alturki. “For example, the regulations on mortgage loans have implications for long-term loans, and all this is combining to drive the credit slowdown.”

That leaves lending to the private sector lower than last year, but still increasing at a forecast rate of about 10 per cent. In the first quarter, banks showed an overall 10.4 per cent increase in loans and advances against the same period in 2014, to SR1.29 trillion.

Other challenges

The strong correlation between government spending and non-oil growth will have had an influence on bank asset quality. But according to a March assessment of the Saudi banking sector by the local Al-Bilad Capital, the impact will be mitigated by banks’ retention of high levels of preventive capital, small non-performing loans and high liquidity, which will combine to place the sector in a stronger position to meet the decrease in government spending.

That generally positive assessment chimes with other analysts’ views. “Although the low oil price environment will subdue confidence and credit growth, we still expect a reasonably robust level around the 12 per cent range,” Khalid Howladar, vice-president and senior credit officer at US-based Moody’s Financial Institutions Group, tells MEED.

Saudi banks have suffered no more than other GCC states from the low crude price climate, says Howladar. “The Saudi government is currently engaging in a counter-cyclical spending policy, thus supporting the operating environment for banks. So local banks – like most in the stronger GCC countries – still show solid credit metrics.”

Moody’s expects most financial indicators to remain resilient over 2015. “The only expected impact over the 2015/16 period is on the funding and liquidity side,” says Howladar. “The Saudi banking system has a moderate amount of government-related deposits, which is expected to decline over time as oil revenues fall. This will reduce system liquidity and ultimately push up the cost of funds.”

However, with a large stock of liquid assets (about 30 per cent, according to Howladar), Saudi banks have enough headroom to adjust to changes in the funding environment.

Overall, non-performing loan ratios seems to have stabilised, according to Aljazira Capital. It says the only concerns on this count are in the telecoms and transport sectors. Local telecoms operators Mobily and Zain have experienced cash flow issues, especially Zain, which on an operational level has been generating losses. Zain owes almost SR2.25bn to local banks, while Mobily has recorded a disappointing performance, with weak cash flows and a heavy burden of almost SR14bn to local banks.

US decision

The outlook for Saudi banks will hinge on decisions taken thousands of kilometres west of Riyadh. If the US Federal Reserve chooses to tighten monetary policy in the second half of 2015, this would affect credit growth in the kingdom.

Much of the margin compression experienced by Saudi banks reflects the general low interest rate climate that has persisted in light of the local currency’s peg to the dollar. The expectations are, however, that this pressure on margins will eventually dissipate.

Since the Saudi government appears fully committed to an expansionary fiscal policy approach, credit growth should nonetheless show some strength, even though the government may choose to fund its hefty public expenditure programme through debt financing, which could have the effect of crowding out retail loans.

One further cause for optimism is that Saudi Arabia’s banking system has a relatively low dependence on government deposits. According to Moody’s, 22.5 per cent of system deposits come from the state, whereas in Qatar, the equivalent figure is 38 per cent. The maintenance of a solid funding base, bolstered by a still cash-rich sovereign – albeit one that is also reducing its stock of reserves at an accelerated rate in the current low oil price climate – will provide confidence.

Perhaps the biggest challenge this year is the limited options for growing the bottom line. For Saudi banks with amplified exposure to the consumer market, the prospects for this year are not propitious. But generally, the picture is one of relatively solid health.