Meanwhile, following a sharp deceleration in lending, attributed to bank's cautiousness and slower demand for credit, a pick up in lending was resumed since the Q4, 2009. The Kingdom's number one source of domestic financing, banking sector, has managed to rebound on an aggregate level, but showed stronger growth rates with regards to consumer lending. Corporate sector demand for funding has expanded by 2.6 percent in Q3, 2010, marking the third quarter of consecutive growth since its pick-up in Q4, 2009, yet it is far away from the 2008's 30 percent average growth rate. Consumer lending rebounded from the -0.5 percent in Q2, 2009's, surging by 9.2 percent in Q2, 2010, and setting the highest pace since Q4, 2006. Real estate finance took the spotlight growing in double digits for the past four quarters. The momentum is expected to have carried through the rest of 2010 and to continue into 2011, the NCB report said.
The fact that the aforementioned performance materialized, with no recourse to interbank funding and, in turn, no wider maturity mismatches, reflects the strong discipline in managing funding gaps. Saudi banks' deposits base, the main source of funding to banks, comprised largely of short-term deposits, does not reflect un unmanageable maturity gap, as the short-term credit accounted for 59.5 percent of total loans. It is worth noting that the SR27.9 billion of credit and investment provisions accumulated since Q1, 2008 and up to Q3, 2010 to have remained just 3.6 percent of gross loans portfolio, the NCB said in its latest report.
Will Saudi banks have enough resources to deploy in 2011 and beyond after registering historically low levels of lending in 2009 and 2010? The answer is clearly a yes, given the fact that capacity utilization is unstrained, with loans to deposits ratio falling from around 83.5 percent in 2008 to 77.5 percent in Q3, 2010. This capacity manifested itself in the substantial increase in net foreign assets and excess deposits with SAMA (Saudi Arabian Monetary Agency), amounting to SR106.6 billion and SR65.3 billion in Q3, 2010, respectively.
The accommodative monetary policy, which was aimed to spur lending over the last two years, with SAMA implementing three consecutive cuts in the benchmark reverse repo rate from 1.5 percent to 0.25 percent, last of which in June 2009, however, mainly contributed to amassing of excess reserves at the central bank despite the low rate or return. On the demand side, an estimated $690 billion worth of projects planned and underway by the end of September 2010 are already tapping into conventional credit and most likely will create ample opportunities for banks. Project finance deals for the export refineries of Jubail and Yanbu are providing initial signs of recovery in lending by early 2011, with an estimated tranche for Saudi banks worth SR11 billion. Nonetheless, the report said, three critical bottlenecks do exist, which will limit the banks' abilities to fully leverage the project finance deals, particularly: (1) the limited capital base to single-handedly finance any of such large deals,(2) the risk involved with maturity mismatches given the long-term payment nature of such projects and the short-term funding base, and (3) the dollar funding restraint given the limited and decelerating share of foreign currency deposits that fell from 17.1 percent of total deposits in 2009 to 14.2 percent in September 2010, which is attributed to the withdrawal of SR24.7 billion by businesses and individuals.
As of September 2010, our coverage universe comprising the fully operational 11 locally incorporated banks that accounted for 94.8 percent of system wide total assets, lost around 1 percent market share over the past twelve months. On an aggregate level, the industry as a whole is going through a tough period, with total assets recording a meager annual growth rate of 0.8 percent in Q3, 2010. The four main industry leading players continuing to remain strong are: NCB, Samba Financial Group, Riyad Bank, and Al-Rajhi Bank. NCB maintained its leading share in total assets that increased to 20.8 percent (SR271.2 billion) from 19.6 percent in Q3, 2009. Al-Rajhi Bank has captured an additional share of 1.2 percent to reach 13.9 percent, thus, grapping third place. Apparently, the rising shares of NCB and Al-Rajhi Bank came at the expense of RIBL and SABB (Saudi British Bank) who lost 0.4 percent and 0.5 percent, respectively, the report said.
On the financing front, NCB had ousted Al-Rajhi Bank as the major lender in Q3, 2010, registering a 16.4 percent share of total loans and advances, yet Al-Rajhi Bank still commands a 16.0 percent share of total loans portfolio. Regarding deposits, the total industry rose by 2.4 percent to reach SR986 billion. The share distribution keeps its previous order with NCB at the top, holding almost 22 percent and Bank Albilad at the bottom of the list with 1.5 percent at a meager SR14.8 billion. Overall, the banking structure remains stable with insignificant changes going into 2011. Long-term funding, mostly in US dollar, had held steady at around SR21 billion, however, as noted earlier and with banks continuing to issue dollar bonds, such the BSF's March bond issue of $650 million, the bank believes that local banks will proceed to beef up their dollar funding for top-tier project finance deals.
By the end of Q3, 2010, banks reported an industry total net income of SAR20.3 billion, a decrease of 8.5 percent compared to Q3, 2009 on the back of higher provisions, a plunge in trading income, and a decline in net special commission income (NSCI), the NCB report said. Bank Albilad, Saudi Hollandi Bank (SHB), and NCB were the only banks that posted positive growth rates ranging between 72 percent and 6 percent. Most banks, however, showed declines in their net incomes, especially, Bank AlJazira and The Saudi Investment Bank (SAIB), plummeting by 81 percent and 69 percent, respectively, thus, weakening the industry's overall performance. Besides provisions, trading income, including income from fair value through income statement (FVIS) investments, had been a negative drag on profitability, falling by a substantial 47 percent to SR1.1 billion in Q3, 2010 from SR2.1 billion over the same period last year. This depressed income outcome was apparently expected, given the historically low level of interest rates globally and the reduced local lending and stock market trading activities, especially with the memory of Q4, 2008's and 2009's elevated investment and credit provisions are still fresh in mind.
Additionally, NSCI has contracted on an industry level by 1.2 percent, with spreads stagnating at 3.5 percent. While special commission expenses dropped by a staggering 55.5 percent, special commission income declined by 13.5 percent, bringing total NSCI to SR29.5 billion. Since cost cutting or "control" has been the trend with global financial instability and uncertain income flows, Saudi banks resorted to cutting the cost of funding to maintain income growth. Given the credit stagnation experienced since 2009, banks are justifiably not in need for funds; as they were able to re-price their deposit bases lower. The fact that deposits registered a small decrease reasserts this cycle going forward up until a robust pick up in lending activities takes place. Only five banks reported growth in NSCI, led by Al-Rajhi Bank and NCB, which posted 6.5 percent and 2.9 percent, respectively.
In analyzing the NSCI drivers, the average yield on earning assets stood at 4 percent, a decrease from 4.6 percent in Q3, 2009. Al-Rajhi Bank and NCB are the only banks outperforming the industry average with 5.9 percent and 4.2 percent, respectively. Cost of funding has contracted to an industry average of only 0.5 percent from 1.1 percent a year ago due to SAMA's rate cuts and to a lesser degree to the re-pricing of liabilities. Bank Albilad and Al-Rajhi Bank continue to benefit from the highest non-interest bearing deposits base, hovering near 90 percent of total deposits, to register the lowest cost of funds at 0.1 percent and 0.2 percent, respectively. The ongoing financial crisis had forced Saudi banks to alter their asset mix from credit facilities to safer investments, largely in foreign fixed income assets. Shifting funds from lower and unrated grades to investment grades clearly indicates an environment of continued risk averseness. While investment volumes have increased, the globally low interest rates weighed down on yields, the NCB report added.
Regarding banking fees, Bank AlJazira recorded around 33 percent decline last quarter; this came as no surprise due the bank's reliance on brokerage business, especially, with the average daily trading value of Tadawul reaching a five-year low of SR1.55 billion in 2010. On the positive side, Bank Albilad, SHB, RIBL and Al-Rajhi Bank topped the list in Q3, 2010, as their banking fees grew by around 23 percent, 19 percent, 12 percent and 6 percent, respectively, largely attributed to a climb in money transfers as well as higher fees on corporate account related transactions. On aggregate, banking fees for the coverage universe had increased by 2.6 percent by the end of September.
Nevertheless, two factors were at play to support earnings from falling further, notably the gains on non-trading investments and the slowest annual rate of increase in salaries and employee related expenses. Capital gains on available for sale, held at amortized cost, and held to maturity investments had increased by 68 percent to register SR1.3 billion. The upsurge in valuations on bonds and financial instruments on a global scale since the beginning of the year, definitely, allowed Saudi banks to recoup part of the unrealized and realized losses they encountered during the previous two years, with investment provisions amounting to SR5.3 billion by the end of 2009.
According to the NCB report, on the cost-side, the operating efficiency of Saudi banks continued to improve, as evident from the ability to contain operating expenses (excluding provisions), which rose by 3.4 percent in Q3, 2010, the lowest on record. Ostensibly, banks sustained their cost control tactics, with the increase in salaries at a meager 1.7 percent and the general and administrative expenses of 3.3 percent.
In contrast to 2008, whereby investment provisions took center stage, the provisions by the end of 2009 and Q3, 2010 were largely driven by deteriorating credit quality, apparently warranted after the industry's non-performing loans (NPLs) ratio surged to 3.3 percent from 1.4 percent. The credit provisioning cycle in 2009 provided a deeper insight into what lays beneath the balance sheets. In particular, NPLs and provisions that are allocated to such delinquent loans helped in highlighting credit stress at the sectoral level. At the same time, data pertaining to the past due but not impaired loans reflected upon the "pipeline credit risk", and in our opinion, was a prelude to the high provisions witnessed in Q3, 2010, the NCB report said.
In 2009, NPLs had increased from SR10.5 billion to SR25.8 billion, a 146 percent increase. Most of the NPLs were concentrated in the commerce, manufacturing and construction portfolios, with their shares standing at 44 percent, 14 percent, and 11 percent respectively. As expected, this sudden surge in NPLs forced the banks to allocate more credit provisions, rising by 215 percent from SR3.3 billion to SR10.4 billion. Assessing the past due but not yet impaired loans signified an elevated degree of stress at most banks, as past due loans between 60-90 days and more than 90 days had registered annual growth rates of 129 percent and 31 percent, respectively, indicating the in- creased probability of default and the difficulty in collection. In the more than 90 days category that represents a quarter of past due loans, delinquent loans pertaining to consumer loans increased to SR2.4 billion in 2009 from SR669 million in 2008. Yet, the practice of holding collaterals against loans will lessen such burden in case of default, with collaterals reported at around SR136.7 billion.
As expected during Q3, 2010, provisions persisted as an important theme for the banking story, closely similar to the dynamics of last year. On aggregate, provisions had amounted to SR7.6 billion by the end of Q3, 2010, showing a 29 percent increase. Local banks' incremental provisioning has risen from SR2.2 billion and SR2.4 billion in the first and second quarters, respectively, to SR3.1 billion in the third quarter, with SAMA stipulating banks to set aside more provisions, and the NPL coverage ratio to approach 150 percent, given that increased NPLs has reduced the ratio for most banks to below 100 percent. The improvement in valuations in capital markets globally has not only resulted in increased gains on investments as reiterated earlier, but also resulted in no additional provisioning for the investment portfolio on an industry-level.
The flip side of volume stagnation in loans and advances has continued to support the liquidity situation immensely across our coverage universe. In opting for highly liquid balance sheet items, mainly the cash and balances with SAMA and the due from banks, Saudi banks held their cash ratio at a comfortable 10 percent by the end of Q3, 2010 as well as striking a five-year high minimum risk assets ratio at 32.8 percent for 2009, reflecting continued risk averseness.
Samba, and Riyad Bank are ahead of the competitors and are among the most liquid banks with 15 percent and 10.9 percent of cash to total assets, while Bank AlJazira and The Saudi Investment Bank are holding the lowest cash ratios industry-wise.
With regards to fund utilization, all banks are above the industry's average except for Samba and NCB that are lagging at 61.6 percent and 57.0 percent, respectively, thus indicating that both have sufficient room for potential growth in their loan portfolios. Growth in deposits has surpassed the expansion in the lending base by the end of Q3, 2010, with loans barely growing at 0.1 percent compared to 2.4 percent for deposits. Accordingly, the loans to deposits (L/D) ratio has slid marginally by 0.8 percent, reaching 75.7 percent. Compared to other GCC counterparts, the Saudi banking system is still at relatively low levels of utilization, with Kuwait and the UAE posting L/D ratios of around 100 percent.
On the money market front, the NCB report said, the three-month Saudi Interbank Offer Rate (SAIBOR) has remained range-bound around 0.72-0.78 percent in Q3, 2010, signifying accommodative demand-supply dynamics for Saudi riyal denominated funds.
According to the NCB report, the capital adequacy ratio of the total coverage universe is at a comfortable 17 percent level. While Samba, NCB and Bank Albilad are above the industry average, SHB has the lowest ratio of 10.9 percent, yet still higher than the minimum requirement of 8 percent.
The incremental growth in net investments in 2009 and Q3, 2010 by SR25.9 billion has indicated that the 11 banks are more aware than ever of the need to mobilize the huge excess reserves that were left idle at SAMA, earning less than the reverse repo rate. Banks needed a more proactive stance to compensate for the slack left over by the sluggish growth in loans and advances. The need to deploy unutilized funds is a necessity due to three negative drivers. First, a sizable portion of the government securities will mature by the end of this year, mainly Saudi government development bonds (SGDBs) that were issued in 2005, 2006 and 2007. Second, these instruments that currently yield close to 5 percent, and will less likely be rolled-over, are expected to weigh negatively on the net interest margins (NIMs) due to a double whammy of lower volumes and lower reinvestment return rates. Finally, the same situation applies to floating rate notes (FRNs), albeit with benign impact, given the nature of pricing that adjusts according to the Saudi interbank bid rate (SIBID), which is currently at depressed levels. The fact that SAMA has expanded the Treasury bills issuance limit from SR3 billion to SR9 billion per week starting Q1, 2010 largely confirms the anticipated increase in liquidity due to matured issuances, which SAMA will try to proactively replace with T-bills.
Apparently, most banks have started to be more proactive in managing their excess cash flows, which is evident from the SR72.6 billion rise in net foreign assets by the end of Q3, 2010, the NCB report said.
