During the heights of the economic crisis, governments throughout the world rallied to design financial stimulus packages to keep their countries as insulated from negative economic pressures as possible. Standard & Poor's Ratings Services (S&P) sees Qatar and Saudi Arabia as two examples in the region of how proactive government support and spending have been instrumental in helping banks maintain relative stability compared to their GCC neighbors. The GCC banking sector as a whole faced a challenging year in 2009 with most countries facing limited or negative GDP growth, reduced liquidity, lower business volume, and a drop in asset values,representing a significant deterioration in banks' operating environments. This was coupled with a general slowdown in infrastructure and project investment, with the GCC witnessing a significant reduction in project finance of almost 50 percent to roughly $20 billion in 2009 from $40 billion the previous year. The value of IPOs, which banks benefited from significantly in 2006 and 2007, was also reduced by almost 90 percent in 2009, with only Saudi Arabia and Qatar continuing to float new offerings. Nonperforming loans (NPLs) have risen significantly in the past few quarters, with the ratio of NPLs to total loans reaching 5.4 percent on average after the first nine months of 2009 from 2.7 percent at year-end 2008. S&P expects NPL ratios to peak by midyear 2010 due to continuing pressure in the corporate sector, exposure to the Saad and Al Gosaibi defaults, and uncertainty surrounding the Dubai World restructuring. In S&P's analysis of the 31 banks it rates across the GCC, it noted a significant divergence in credit quality in Gulf banks due to a range of economic and political factors. In our observation, Saudi and Qatari banks in particular showed the strongest resilience, thanks in part to an increase in oil and gas exports, but also largely due to government capital injections into the banking sector and considerable financial investment in infrastructure and project development. We believe that while GCC countries across the board do tend to show an exceptional willingness to provide support to their banking sectors, their respective capacities to do so have remained sound, although with some variations between each country. Qatari banks have received what we consider to be the most direct and proactive support with the Qatar Investment Authority (QIA) injecting capital representing a 10 percent boost to the system into all banks with the exception of Qatar National Bank. The government also offered to purchase a number of banks' stakes in companies listed on the local stock market, leaving banks the option to repurchase these investments at the same price within a five year period. This was taken even further with the government purchase of a portion of the banking sector's real estate and other loans. The total support package was in excess of $6 billion and, in S&P's opinion, has been largely responsible for the strong resilience of the local banking sector. Saudi banks meanwhile benefit, in our view, from belonging to a relatively insulated and well-protected market with only 12 commercial banks operating within the largest economy in the GCC. While we see that Saudi Arabia generally benefits from a strong financial position, an increase in oil prices also helped support the government's fiscal surplus and increased investment in international assets. This led to a number of government-sponsored projects in the country and stimulated increased lending to government employees. More than $100 billion of contracts were awarded in 2009, with most in the non-oil sector. Compared to its peers in the GCC region, we see that Saudi banks also tend to benefit from a stronger liquidity position with access to large accumulated reserves and low funding costs, as a high proportion of deposits do not pay interest. As a result, we saw only a limited deterioration in Saudi banks' credit quality. While seeing tentative signs of recovery throughout the GCC, we expects banks will continue to operate in a challenging environment: the lagging effects of the economic slowdown, ongoing real estate correction, and limited economic and asset growth will likely continue to affect Gulf banks in the coming quarters. However, we also see a few positive factors for banks. The Gulf has avoided a massive liquidity crisis thanks to government support and significantly reduced loan growth. Gulf banks are also seen to continue to enjoy strong earnings capacity and high efficiency by international standards, and on average a lower cost to income ratio than their European or US peers. Economic indicators are another reason why we believe Qatar and Saudi Arabia are likely to lead the recovery in the GCC region in 2010. Qatar is considered likely to show strong economic growth this year due to increasing gas exports even while other important sectors, such as real estate, are likely to remain under pressure. In Saudi Arabia the continued sponsorship of a large number of projects is expected to steadily making room for the banking system to resume growth in the coming year. - The writers are S&P credit analysts __
