Sunday 20, May 2018 by Jessica Combes

Lower interest and credit costs credit positive for Saudi banks


Riyad Bank (A2 stable, baa11) is the final Saudi Arabian domestic bank to submit its preliminary first-quarter 2018 financial results

In aggregate, Saudi banks reported a 7.5 per cent year-on-year increase (18 per cent quarter-on-quarter growth) in net profit for the first quarter, mainly because of lower interest expenses and provisioning charges, according to Moody’s Investor Services.

The results are credit positive for Saudi banks because the improvement occurred amid subdued economic activity that negatively affected credit demand—lending contracted by one per cent year on year as of March 2018—and banks’ revenue. Saudi banks’ interest expenses declined 12.5 per cent year on year and two per cent quarter on quarter, reflecting improving funding conditions in Saudi Arabia after significant tightening in 2016, when falling oil prices and large sovereign debt domestic issuance reduced funding available to Saudi banks and negatively affected their funding costs.

Saudi Arabia’s improving liquidity and funding conditions since 2017 have narrowed the Saudi Arabian Interbank Offered Rate’s (SAIBOR) spread against US dollar-denominated London Interbank Offered Rate, even reaching negative spreads in March 2018, despite a number of rate hikes by the US Federal Reserve. Since April 2018, the SAIBOR has risen to around 2.4 per cent, its highest level since 2009, following a decision by the Saudi Arabian Monetary Authority, the central bank, to increase its repo rate in response to a decline of Saudi money rates below US rates.

However, Moody’s does not expect that this increase will create immediate upward pressure on interest expenses, given limited credit growth and Saudi banks’ favourable funding profile—banks have an average net-loans-to-deposits ratio of 83 per cent and more than 60 per cent of their liabilities were in non- interest-bearing deposits as of March 2018. 

Lower interest expenses supported a seven per cent year-on-year increase in net interest income and offset the effects of three per cent growth in interest income. On a quarterly basis, however, both net interest income and interest income declined by one per cent, reflecting a contraction in net loans for the second consecutive quarter. Income generation is expected to remain challenged given subdued lending activity, somewhat balanced by higher returns on investment portfolios and the gradual re-pricing of variable-rate assets.

However, the positive trend in net interest income was partly offset by an eight per cent year-on-year reduction in non-interest income, leading to three per cent growth in operating income. Declining non- interest income arises from less demand, and thus fee-based income, for loans, credit cards, trade and foreign-exchange transactions. 

Higher operating revenue and flat operating expenses supported an increase in Saudi banks’ pre-provision income to 2.6 per cent of total assets in the first quarter, versus 2.5 per cent a year earlier. Another credit-positive development was a 21 per cent year-on-year decline in net impairment charges, and 47 per cent quarter on quarter.

Weak economic conditions, asset quality deterioration in lending books and banks’ preparation for the implementation of the IFRS 9 standards this year drove prudent provisioning in 2017. As a result, Saudi banks’ cost of risk declined to 12 per cent of pre-provision income in the first quarter from 15 per cent a year earlier. Although a slowing economy and more conservative provisioning policy under IFRS 9 are expected to drive higher and more volatile impairment charges at banks, Moody’s doesn’t expect banks’ credit costs to exceed 30 per cent of operating income, considering the moderate growth in lending volumes and banks' high loan-loss coverage. 

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