Saudi banks would not register any significant boost to their profitability in 2010 despite their strong characteristics and the economic environment in which they operate, Nomura Financial Services said in its Saudi bank industry overview this month. Saudi banks' profitability this year will continue to suffer from anemic lending growth of between 5 percent and 10 percent, it said, adding that top-line revenue growth is likely to remain weak amid sluggish volume growth and pressured margins. “We believe banks will continue to book high provisions, which is likely to penalize the bottom line. We expect an earnings recovery in 2011, and our investment case is geared towards net interest margin expansion through interest rates increases,” said Tarik El Mejjad, head of the team that prepared the report. “As we believe the market is generally forward looking, we think investors should start to position their portfolios for the rising rates that we expect,” he added. The perceived weak growth was due to a combination of: 1) a lack of demand from the private sector because the government is competing to finance directly large infrastructure projects; and 2) the banks' cautious stance because it may still be assessing their exposure levels. The report further said a slight margin contraction will add to the profitability pressure on the banks. The banks' ability to re-price their loan books is diminishing, the high-yielding government securities are maturing. “We do not believe the cost of funding will improve further. Moreover, we think asset quality is likely to continue to deteriorate, although at a slower pace, mainly originating from the corporate segment. We remain concerned about the financial health of some family conglomerates, especially in a still-challenging economic environment. We believe provisioning should remain high because the coverage ratio has dropped significantly for most of the banks we cover,” El Mejjad noted. However, 2011 will be a strong recovery year. A rise in interest rates, seen in 2011, should be a trigger for bank revenues. Owing to their high share of demand deposits and free funds, Saudi banks should see a boost to their interest margins. The report expects banks' lending activity to resume, supported by high liquidity positions and demand recovery. Yet, the planned mortgage-lending law will not contribute to mid-term loan growth, it noted. “We upgrade Samba to Buy from Neutral. We maintain our Buy ratings on Al Rajhi Bank and Riyad Bank. We downgrade SABB to Reduce from Neutral amid concerns over asset-quality deterioration,” the report indicated. Moreover, the latest Nomura industry report said asset quality deterioration should continue to hit banks' profitability. In 2009, with the exception of SABB, the banks' asset quality deterioration was in line with our forecasts. “We believe banks' NPLs should peak in 2010 at 2.0-5.0 percent and continue to originate mainly from the corporate sector. In our view, P&L provisions should remain high - at least equal to 2009 levels ranging between 0.75 percent and 2.5 percent of gross loans. In 2009, NPL coverage decreased significantly more than banks' three-year average run rates, suggesting a pickup in provisions in the coming quarters. Although SABB is likely to be the most negatively affected, with coverage reaching a historical low of 50 percent, Riyad Bank saw its coverage ratio stabilize. We expect seasonal effects to add pressure to the NPLs in 2010 owing to the sharp slowdown in lending growth after a few years of strong lending activity.” Besides, corporate asset quality deterioration should peak in 2010, the report said. In 2009, for most of the Saudi banks Nomura cover, the bulk of NPLs came from the ‘Commerce, Services and Other' loan categories. “We have very little visibility about the current financial situation of Saudi corporate and family conglomerates, but banks' managements suggest that the worst is behind them. In our view, asset quality should continue to deteriorate in 2010, but at slower pace.” Nomura remains cautious regarding banks' exposure to “name lending”. “In our view, banks such as Samba and SABB, with high shares of ‘Other' loans category should be the most exposed to ‘name lending' practices. In 2009, we estimate these exposures to 15 percent and 21 percent of total loans for Samba and SABB, respectively, of which 8.7 percent and 2.1 percent have already been impaired.” Saudi banks' retail portfolios should continue to perform well. In contrast to UAE, we remain confident about Saudi banks' exposure to the retail segment. The banks' retail loan book asset quality was strong in 2009. Moreover the amount of retail past due, but not impaired, loans decreased from 2008 to 2009, which suggests an asset-quality improvement in the sector. “We believe banks such as Al Rajhi with relatively high share of retail loans is a clear beneficiary of this benign environment. In our view, Saudi banks' superior position in terms of retail asset quality owes much to the following factors.” Saudi banks have among the lowest retail lending penetration within Nomura's EEMEA coverage universe. In 2009, it stood at 13 percent of GDP, down from 16 percent in 2005. With the exception of Al Rajhi Bank, Saudi banks have lower exposure to retail lending compared with their UAE peers. This is partially a consequence of regulatory action, as lending growth started to decline after SAMA enforced in 2006 a directive constraining consumer lending. Nomura noted that bank margins are under pressure as interest rates hikes in 2010 are less likely. In a stable interest rate environment, “we expect 2010 net interest margins to be slightly under pressure. We think the main source of NIMs weakness should come from the fading asset re-pricing power in 2009. We also see the maturity of the Saudi sovereign bonds as a source of potential margin pressure. On the liability side, we do not believe banks' cost of funding can improve further.” However, Saudi banks could create a positive surprise if interest rates rise in 2010. Owing to their high share of demand deposits and free funds, banks could see a boost to their profitability from the expansion of their net interest margins. “In that context, we continue to see Al Rajhi Bank as the key beneficiary in this area.” The report indicates Saudi banks are not in a position to mitigate margin pressure by proactively re-pricing their loan books - neither in newly originated loans nor back book loans. “We think it will be increasingly difficult for banks to justify to their customers the rationale for higher liquidity and risk premiums.” Compared with 2009, the banks' liquidity positions have materially improved, and concerns over asset quality worsening have reduced. “We expect competition for loans to resume progressively in 2H 2010, making loan re-pricing even more difficult. By the end of 2010, most of the high-yielding government securities should mature, adding pressure to Saudi banks NIMs. These government securities include Saudi Government Development Bonds, Floating Rates Notes and Treasury Bills. Banks have then to replace them with newly issued bonds that currently yield less than 1 percent. As we observed in 2009, banks tried to reduce this negative impact by investing in the sovereign debt of other GCC countries and/or US debt. Saudi banks' total foreign investments have jumped in the past 12 months by SR47 billion to SR112 billion, the highest in Saudi banking history. However, managing their risk exposures, we understand that there is a limit for investing in these foreign securities. “We think the cost of funding bottomed out in 4Q 09 and should remain stable in 2010. Generally, Saudi banks have the cheapest cost of funding in our EEMEA coverage universe owing to their high share of demand deposits and free funds.” In 2009, with the excess liquidity in banks' balance sheets and the sluggish lending growth, cost of funding has reached historical lows for most of the banks we cover. With loan/deposit ratios for the sector at only 78 percent, and low loan growth expectations, we do not see banks chasing expensive deposits in 2010. However, Nomura report believes there will be some sort of competition over core deposits. Saudi banks remain attractive in a rising interest rate environment, Nomura said. One of the key elements to our positive view on the sector is banks' ability to capitalize on the rising interest rate cycle. Given the currency peg between the SR and $, the Saudi rates have generally followed a similar path to the short-term interest rate of the US Fed, which we see as stable over 2010. “We would highlight that the structure of banks' balance sheets in our coverage has changed in the past six months because: 1) assets are re-pricing much quicker than deposits and 2) there has been a prolonged period of low interest rates, increasing the share of demand deposits over total assets materially compared with 2009.” These two elements both have a positive effect on NIMs in a rising interest rate environment, it noted.
