Saudis well placed after tough year

Despite the provisions set aside for exposure to the troubled Saad and Al Gosaibi conglomerates, Uta Harnischfeger reports The most recent results of Saudi Arabia's big banks bear testimony to a tumultuous year in which lenders set aside steep provisions for the large-scale defaults at the Saad Group and Ahmad Hamad Al Gosaibi and Brothers.

But despite declining fourth-quarter profits among most of the kingdom's major publicly traded lenders, the outlook for the sector this year may be better than the numbers suggest. Economists predict that Saudi Arabia, the Gulf's most populous country with its huge oil revenues, young population and pent-up housing demand, is set to resume growth, even if not at the level of the years leading to the financial crisis.

Most importantly, private-sector spending is expected to resume after a year dominated by government efforts to boost public spending to get the local economy back on track. Last year, the government spent almost US$150 billion (Dh550.95bn) to spur economic growth, the highest percentage of GDP among the Group of 20 leading and developing economies. The kingdom plans to spend between $400bn and $500bn on infrastructure in the next five years. Credit Suisse expects the country to grow 2.6 per cent this year and 4.7 per cent next year, while Banque Saudi Fransi estimates the economy will expand by 3.9 per cent this year, driven by higher oil prices and greater infrastructure spending.

"The private sector, encouraged by stimulatory public spending, is poised to make a comeback, albeit with less enthusiasm than in the years leading up to the global financial crisis," says John Sfakianakis, the chief economist at Banque Saudi Fransi. Strong global energy demand, many hope, should keep oil prices at about $80 a barrel, and government coffers replenished. Saudi Arabia has budgeted to spend $144bn this year.

But such grand plans need financing. Most immediately, banks must once again become more willing to lend. They must shed their extreme risk aversion and get their provisioning out of the way. Then, Saudi Arabia must nurture its equity and debt capital markets. The importance of infrastructure is such that it accounts for one third of the kingdom's total budgeted expenditure. Oil, petrochemicals and gas account for another third.

The UAE Government, by contrast, has set aside 15 per cent of its budget for infrastructure and 9 per cent for the oil and petrochemical sector. Some of Saudi Arabia's most prestigious infrastructure projects include the King Abdullah Economic City ($27bn), the new mining centre Ras al-Zour Resource City ($25bn), and airport, road and railway projects including the expansion of the King Abdel-Aziz Airport ($11.3bn), the Mecca-Medina rail link ($6bn) and the Saudi Landbridge ($5bn).

The Saudi Landbridge project is for a huge rail network linking Damman on the Arabian Gulf to Jeddah on the Red Sea, via the capital Riyadh. Banks are expected to chip in about $80bn of the overall infrastructure spend, while the government should account for about half and debt and equity capital markets for the remainder, says Mohammed Hawa, a research analyst at Credit Suisse. "It is extremely important that public spending continues [in 2010]. Most, but not full provisioning, happened in 2009," Mr Hawa says. "Once banks have their provisions behind them and reach a comfortable level, they will start lending again."

Mr Hawa estimates that Saudi banks have so far set aside about half of the provisions that will be necessary. Lenders in the kingdom could be owed as much as $7bn by the Saad and Al Gosaibi groups. While provisions among Saudi banks mounted last year, new lending contracted by about 5 per cent. "We believe the crisis of confidence is slowly easing and we anticipate an advancement in bank lending to the private sector this year," Mr Sfakianakis says.

"A primary reason for this will be necessity; if banks want to avoid a repeat of their lacklustre 2009 profit performance, they will have to energise the pace of credit expansion." Banque Saudi Fransi expects bank lending to grow 8 per cent this year, still far from the 30 per cent growth in 2008, but enough to spur growth. Once provisions, which eat into profits, are out of the way, Saudi banks have a lot going for them.

"We can see that their operating performance is really resilient," says Nicolas Hardy, a banking analyst at the ratings agency Standard & Poor's. "All is quite well apart from the Saad and Gosaibi episode that hurts overall." The Saad and Al Gosaibi cases are still being dealt with. Saudi banks still profit from ample, cheap deposits that allow them to generate good profit margins. As interest margins rise, the margins will increase further.

But in the past year, a decline in lending and mounting provisions have pulled profits down. Samba, the country's second-largest bank, said its loan portfolio dropped by 14 per cent, to 84bn riyals (Dh82.27bn) by the end of the year. Banque Saudi Fransi, the fifth-largest lender, said provisions pushed its fourth-quarter net profit 43 per cent lower compared with a year earlier. Saudi Hollandi Bank posted a loss of 440 million riyals in the fourth quarter, also due to provisions.

"I was pretty much shocked about the results," says Deepak Tolani, the banking analyst at Al Mal Capital. "The provisions seem extremely high. Saad and Gosaibi are throwing a big shadow on everybody." Mr Hawa says banks must use debt markets more because of an "alarming mismatch" of maturities. "Either banks need to issue long-term bonds or companies that are big enough need to do so themselves." So far, only the biggest companies such as Saudi Basic Industries Corporation (SABIC), the world's largest chemical maker, and Saudi Electricity have issued public bonds. Others, such as Saudi BinLadin Group or the bank SABB, have made private placements.

Most recently, debt troubles at Dubai World have further heightened the risk aversion of international investors. Last month, SABIC privately placed 10bn riyals. Analysts suggest this was cheaper than a public placement. "In this environment it makes sense to target a small group of investors who already know the issuing company a lot better," says Chavan Bhogaita, who heads credit research at the National Bank of Abu Dhabi. "It is a win-win situation for both. Some investors want exposure and the process is less onerous on the issuer."

But economists say it is only a matter of time until investor confidence and international appetite for the kingdom's debt markets return. "There is a huge demand for long-term and bigger buy-to-hold investments," says Mike Hughes, who heads Deutsche Bank's global transaction banking in the Middle East. "The effective returns are still good and I don't think that will change soon." Before the market can really take off, a few other boxes need to be ticked. Experts call for sovereign bond issues to create a feasible benchmark, and more market makers and central bank repurchase facilities to help the market work smoothly.

The secondary market needs to become more active and more rated companies must be willing to come to the market. "Saudi Arabia's capital market has evolved quite a bit, but more needs to be done," says Mr Sfakianakis. At the same time, some analysts take encouragement from the more measured pace of growth. "Saudi Arabia could have very significant capital-raising issues both in debt and equity which, ideally, would also be offered to international investors," says Mr Hughes. "But the clearing and settlement infrastructure needs to support the opening of the dam."

As its debt and equity markets slowly evolve, economists believe Saudi Arabia is best equipped to emerge strongly from the crisis. "Fundamentally, they [the Saudi government] are very experienced in the region. They have lived through crises before, set aside reserves for tough times and they didn't use too much leverage," says Mr Hawa. Saudi Arabia is the least geared economy in the Gulf. At about 225bn riyals, its sovereign debt is 60 per cent lower than in 2002 and stands at 15 per cent of its GDP. Its private sector debt accounts for a moderate 45 per cent of GDP.

Mr Hawa says the country's large population forces it to keep a lid on inflation, which is key to allowing public spending to accelerate. uharnischfeger@thenational.ae