In early June, the Power & Water Utility Company for Jubail & Yanbu (Marafiq) secured a loan that would have been virtually impossible anywhere else in the world. The utility got a SR2.5bn ($667m) 15-year loan priced at just 85 basis points above the Saudi interbank offered rate (Sibor).

Last year the concern was credit and maintaining credit quality, now it has shifted to revenues

Investment banker

Saudi Arabia’s banks are in a unique position. They are sitting on a huge pile of cash and they are desperate to lend it. After making no new loans in 2009 and dramatic falls in the interest rate, they must start lending again to avoid another fall in their profit levels in 2010. The drive to lend is beginning to worry some bankers, who say loose lending practices will mean banks start lending too much too cheap.

“There is definitely a change in the rhetoric from management,” says an investment banker at a local lender. “Last year the concern was credit and maintaining credit quality, now it has shifted to revenues.”

“Risk managers ruled the roost, but they are now moving aside and helping deals get done,” he adds.

A senior executive at another local bank agrees. “Risk management was definitely the dominant function of 2009, and they are still significant, but their influence has been rebalanced,” he says.

Eyeing profit

Credit quality became the key mantra of 2009 after several multi-billion dollar defaults by key companies in Saudi Arabia. The most high-profile of these were the defaults on more than $20bn of debt by two large local corporates, the Saad Group and AH al-Gosaibi & Brothers. The defaults caused banks’ appetite for risk to disappear in 2009. The total bank loans in the kingdom fell in 2009 as the private sector continued to deleverage and banks avoided making new loans. That was in sharp contrast to 2004-2008, when credit growth averaged 23 per cent a year.

The situation is now beginning to change. In the first quarter of this year, the total profit made by Saudi banks fell by 24 per cent. Coupled with this is a fall in interest rates from more than four per cent to around 50 basis points, which means lending has become a much less profitable business. As a result, banks are desperate to book new assets in order to boost income.

“Banks are sitting on a substantial pile of cash which they have to deploy if they want to be more profitable than last year,” says John Sfakianakis, chief economist at Banque Saudi Fransi. By the end of the first quarter of 2010, Saudi banks were putting SR120bn on deposit with the Saudi Arabian Monetary Agency (Sama), rather than lend it out to the private sector. At the same time, the loan to deposit ratio fell to 62 per cent, well below the 85 per cent regulatory limit.

Sfakianakis says banks are starting to lend again. “In the second half there will be a more complete turnaround in credit to the private sector,” he adds. Credit growth of around 8-10 per cent is predicted by most economists in the kingdom for 2010.

Hasan al-Jabri, managing director of investment banking at NCB Capital, says most banks are concentrating on lending to the government, or state-owned companies, but that “lending to the private sector is starting to pick up, but still very selectively”.

Brad Bourland, chief economist at Riyadh-based Jadwa Investments, says, “Banks are willing to lend, but now they only really want to do it selectively or for their 10 best clients.”

How selective banks are will be key to whether the lending done in 2010 is a successful way of boosting revenue, or is storing up troubles for the future. Privately, some bankers describe the Marafiq deal as a return to the name lending practices that fell out of favour after the Saad and Al-Gosaibi defaults. This involved banks lending money based on the borrowers reputation alone, and without any measures for them to monitor how the loans were used.

Bankers working on the Marafiq deal say the description is wrong, pointing to the company’s lack of debt, state links, and strong cashflows. Either way, banks in the kingdom were not bothered, and competition to be involved in the deal was fierce. It was massively oversubscribed, with just three banks saying they could fund the whole loan deal. In the end, six banks funded the loan.

Several other deals have also experienced huge demand from the local banks, largely pushing out international competition. The Maaden aluminium smelter project financing, Jubail refinery financing, and a corporate loan for mall operator ACCL Arabian Centres, all faced a huge response from local banks desperate to book assets.

International banks faced constraints on these deals either because they could not compete with the low pricing that local banks were prepared to accept, or because of structural features that concerned them. “Liquidity is available in abundance and that is leading to healthy competition in terms of pricing, which is now at almost pre-crisis levels,” says Robert Eid, chief executive of local Arab National Bank.

Most of the loan deals completed in Saudi Arabia have been for state linked firms, or lending to private sector clients working on public sector projects.

“Most of the new opportunities to lend are good, sound credits,” says Eid. But as loan volume picks up, concerns about the quality of the deals being done will increase.

“There is a mad scramble whenever a quality asset presents itself,” says the head of investment banking at one local institution. This is mixed with muted appetite for anything outside the top tier of local corporates. He adds that so far banks have been able to protect their asset quality, but, “at some point people will realise they can’t keep putting money on deposit at the central bank and they will start lending aggressively”.

When that occurs, it will be harder to ensure that banks are not making bad decisions on lending. A local syndications head says, “There are a few banks that are clearly desperate to book deals and are putting down huge tickets at breathtakingly low prices. That competition to lend is not always healthy.”

Asset quality

Suliman al-Gwaiz, deputy chief executive of Riyad Bank, says: “It’s true that what is healthy for some banks is not always healthy for the others, but what I think we are seeing at the moment is banks trying to buy back market share after a slow 2009.” Because of this, he says the competition that is driving down pricing will not last beyond early 2011.

That should help protect asset quality, and so far loan growth is mainly being directed towards top tier clients. But practices such as name lending will take time to change.

“Banks are now lending more to the private sector than before and name lending is fading away, but it takes time to rectify that process,” says Sfakianakis.

At the moment, problem loans look more likely to come from refinancing than booking new assets. Local bankers say there are several large deals currently being refinanced because international banks, scared off by their exposures to Saad and Al-Gosaibi, want to just clean their hands of the transactions. Some are already in default because they were poorly structured when cash was easy to come by in the 2004-2008 boom.

As international banks exit, the additional layer of scrutiny they provided on structuring deals is removed. The local banks, who are taking the place of foreign banks, will have to avoid being swayed by borrowers with state links or existing relationships and ensure deals are well structured. That will prevent them falling into the trap of making loans to boost their profits now, which come back to haunt them in the years to come.