Saudi banking: Cause for consolidation

30 November 2007
Growing competition for a share of the burgeoning Saudi investment banking sector is set to spark a series of mergers

A few years ago, investment banking was virtually non-existent in Saudi Arabia. Now there are 78 bodies licensed by the Capital Market Authority (CMA) to undertake investment banking activities, ranging from Wall Street giants to two-room local organisations.

The kingdom’s banking sector, strictly ruled by the Saudi Arabian Monetary Agency (Sama) for 30 years, has been transformed due to a calculated government strategy to liberalise the market. To accelerate the process, Sama placed a moratorium on the extension of full commercial banking licences in December 2006, requiring commercial banks to spin off their investment banking operations to legally independent subsidiaries. That deadline expired on 31 July.

Since then, every one, from small investment banks to the largest and most profitable global institutions, has been moving into the market. Institutions which, only a few years ago, would scarcely have even considered entering the Saudi market, have broken with tradition. Some unlikely partnerships have emerged. These include Goldman Sachs teaming up with National Commercial Bank’s investment banking subsidiary, NCB Capital. This is perhaps the most intriguing - an unlikely partnership between one of Wall Street’s oldest Jewish-owned financial institutions and the Gulf’s largest lender and holder of a substantial Islamic franchise.

“The draw is the liquidity,” says Said al-Sheikh, chief economist at NCB. “Since 2002, it has been made very attractive for institutions to follow this liquidity.”

The logic behind the Saudi commercial banks’ decision to link up with the big Wall Street institutions is clear. Joining up with big foreign banks gives them access to a far wider range of products and expertise. It also works as a marketing exercise. NCB’s strategic co-operation agreement with Goldman’s in February 2007 was a way of announcing its entry into the market, harnessing NCB Capital’s local market knowledge with the US organisation’s sophisticated product platform.

But NCB’s model is not being followed by all players in the market. Morgan Stanley has entered a joint venture agreement with The Capital Group, a local investment bank, but another major US institution, Merrill Lynch, will operate independently under its own name.

The investment banking market can be divided into four categories. Apart from the major international banks, there are a growing number of regional institutions. These include Addax Investment Bank, Shuaa Capital and Rasmala Investments, which all entered the market in 2007, and domestic houses and commercial banks that have created separate entities. Early movers such as HSBC, the first to launch an investment-banking unit in the region, have had a lasting effect and attracted a large amount of business. Others may struggle to keep up.

Reducing volatility

Whatever route foreign banks chose, they will be competing across a narrow tier of asset classes. Yet the entry of new firms into the market will help to reduce volatility on the stock market and introduce greater expertise into the country’s corporate advisory, project finance and asset management classes.

Investment banks also offer a clear advantage for foreign investors considering opportunities in the kingdom. “The Saudi market is still a bit of a black box for foreign investors, so investment banks are logical places for foreign companies to turn to,” says Brad Bourland, head of research and chief economist at Jadwa Investment, one of Saudi Arabia’s new breed of investment companies.

In a few months of operation, Jadwa has recruited more than 100 staff and launched six mutual funds.

Bourland forecasts that Saudi Arabia’s financial services sector will grow by 10 per cent a year to 2010, considering the strong demand for advisory services from companies wanting to enter the market. The investment banking component should grow even faster. “It is a bit of a goldrush at the moment,” he says. “There is a lot of competition, so companies will have to grow hard to get market share.”

Equity and debt capital markets are poised to deliver robust growth, with the issuance of sukuk (Islamic bonds) and initial public offerings (IPOs) providing a steady flow of deals. Saudi blue chips are aggressively tapping into debt financing through the issuance of sukuk and medium-term notes. There is also a large volume of merger and acquisition work due, as the Saudi corporate environment restructures.

“This is an investment banking play for the next year,” says Basil al-Ghalayini, head of BMG Financial Advisors, which was granted its investment banking licence this year. “That is why every single regional or international name is trying to get licensed by the CMA.”

Relationship skills

New local organisations will be highly focused on clients, using their relationship skills to compete with the bigger commercial banks. More Saudi family businesses aim to go public, and will provide a large volume of transactions for niche players. “Before I got a licence it was a really hard sell convincing families to go public,” says Al-Ghalayini.

Jadwa, founded by the heads of some of the kingdom’s leading business families with SR500m ($135m) in paid-up capital, aims to become one of the most aggressive market movers in the increasingly crowded Saudi investment banking market. Its strong balance sheet has already been well used in snapping up proprietary investments, starting with the acquisition of a 30 per cent interest in Saudi Aramco Lubricating Oil Refining Company (Luberef). Like NCB’s high-profile partnership with Goldman’s, the deal was timed to generate maximum publicity.

Jadwa is also focusing on equity research - until now an underserved area of Saudi Arabia’s capital market. The firm regards it as a natural fit for an investment bank rather than a commercial bank. This may not prove to be a profit centre for Jadwa, but it could help to strengthen the firm’s position in the market, founded on Bourland’s long-term reputation in Saudi Arabia.

“A lot of firms are looking to in-depth research on the asset management side,” says Samir Arab, managing partner of regional investment firm MerchantBridge, which has teamed up with a local partner to set up the Development & Management House for Investments.

The profits may end up going to the largest banks. Those offering limited brokerage services are unlikely to raise a sufficient volume of business to compete with the large banks, which are able to offer a range of services from mergers and acquisitions through to sukuk and project finance.

Sceptics question the motivation of the big global banks’ move into the kingdom, suggesting the Saudi market is still too small to sustain their interest. Some say it is the corporate finance deals that are attracting them. But locals point out there are opportunities beyond the many corporate finance offerings. “Corporate finance may be the biggest draw, but asset management and wealth management are equally important,” says Al-Ghalayini.

Mutual funds only make up 5 per cent of Saudi market capitalisation, suggesting a major potential growth area for investment banks. Although investor confidence has yet to recover fully from the share price collapse of 2006 - the average daily volume of shares traded in the first three-quarters of 2007 was down by nearly 19 per cent on the same period in 2006 - bankers forecast a substantial number of new listings in the next two years, doubling the current 100 companies listed on the Tadawul All-Share Index (Tasi).

Subdued market sentiment has failed to quell Saudi demand for IPOs and there should be more than enough advisory work available. For example, NCB Capital expects 30-40 companies to undertake IPOs in 2008, with offerings worth up to $8bn - twice the level of 2007.

Despite the large number of investment companies licensed by the CMA, many still lack the capacity to fully absorb the booming level of business.

Inevitable consolidation

“We are having to turn business away every single week as we do not have enough people to work on it,” says one Saudi investment banker. “We have difficulty hiring and retaining talent. The market is becoming a jungle.”

Consolidation is inevitable, as some of the less scrupulous banks fail. “The market is saturated and there will be a lot of mergers,” predicts a Jeddah-based financier. “It might go down to just a handful of players.”

A few companies that have already had their licences revoked by the CMA are aiming to burnish its reputation as a tough regulator. These firms have proved incapable of fulfilling the requirements of their licences. “This is why we are focusing on execution, implementing what we have the license to do,” says a Riyadh-based investment banker.

Rise in job opportunities

Saudi Arabia’s financial services boom could help to resolve one of the country’s most difficult problems: the lack of job opportunities for young Saudis entering the labour market.

The financial services sector employs 33,000 Saudis, an increase of 3,400 since 2006. But experts say the proliferation of new institutions following market liberalisation will substantially increase job creation. Hamad al-Sayyari, chairman of the Saudi Arabian Monetary Agency, predicts that employment in the financial sector will double in the next five years.

“We have gone from 10 banks to 100 financial institutions, plus insurance as well. So if you are a young Saudi with an education in economics or finance and want a career in banking, the opportunities are there,” says Brad Bourland, head of research at Jadwa.

The biggest challenge is to improve the education sector so more Saudis will be suited to working in the financial sector, with the right skills. Some new initiatives will help in this regard. A financial academy is planned at the King Abdullah Financial District near Riyadh, which aims to raise skills levels and supply financial services firms with improved local talent. Saudi-based investment banks are also teaming up with business schools to hone Saudi talent specialising in investment banking.

Key fact

Saudi Arabia's financial sector is projected to grow by 10 per cent a year until 2010.

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