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Saudi banks to benefit from strong sukuk market growth

The Saudi sukuk market will continue to grow over the next 12-18 months, a credit positive for Saudi banks, following a new record SR 25.2 billion ($ 6.7 billion) issuance of riyal-denominated sukuk in 2012, says Moody's Investors Service in a new special report published yesterday. Strong sukuk issuance has continued in 2013, with SR 11.6 billion already issued during Q1, leading the rating agency to expect that 2013 sukuk issuance will surpass 2012 levels.
"We believe that the growing sukuk market will be credit positive for Saudi Banks because it will provide a deeper pool of Shariah-compliant securities to facilitate liquidity management and support profitability at Islamic financial institutions (IFIs)," says Khalid Howladar, VP — senior credit officer and co-author of the report. "We also believe that growth will support more term funding for all banks and ultimately encourage the reduction of persistent asset-liability mismatches, while facilitating further loan growth given regulatory constraints on loan-to-deposit ratios," adds Howladar.
With limited investment options available, IFIs tend to maintain higher levels of very low-yielding cash and Islamic interbank placements on their balance sheet, thus partly sacrificing profitability to sustain their liquidity positions. A larger sukuk market would facilitate liquidity management through a pool of higher-yielding Shariah-compliant securities and offer a profitability boost to local IFIs.
Moody's believes that a deeper sukuk market in Saudi Arabia also provides a competitively priced longer-term funding option in domestic currency, which will allow conventional and Islamic banks to diversify and lengthen their funding profiles and ultimately help reduce contractual mismatches in the maturity profiles of assets and liabilities.
"We expect that increased term funding in the form of sukuk will support banks' loan growth and franchise development, given rising loans-to-deposits ratios in Saudi Arabia," says Christos Theofilou, assistant vice president. "As more banks approach the regulatory 85 percent net loans-to-deposits ratio, both the availability and cost of deposits will be slightly affected, making sukuk issuance more attractive to banks and likely encouraging further sukuk issuance," explains Theofilou.
Moody's says that the record issuance is being driven by strong investor demand, with a marked preference for Islamic financing in the Kingdom; increased financing opportunities to fund the country's large-scale infrastructure projects; and a developing yield curve following the sovereign-guaranteed benchmark sukuk issuance by the General Authority of Civil Aviation in early 2012.

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