02-Sep-2015
In
early August 2015, the Saudi Arabian government issued Saudi Arabian
riyal (SAR) 20 billion in local currency debt subscribed by public
institutions and local banks. The bonds were
issued across three tranches with five-year (1.92% yield), seven-year
(2.34% yield), and 10-year (2.65% yield) maturities. The issuance
followed a SAR15 billion private placement with non-bank Saudi Arabian
financial institutions in July. Looking ahead, we
understand that the government is likely to continue issuing debt on a
monthly basis under this local currency program to finance its
burgeoning fiscal deficit (see "Middle East And North Africa Sovereign
Rating Trends Mid-Year 2015," published July 13, 2015,
on RatingsDirect).
In
this Credit FAQ, we address some of the questions from investors and
other market participants about the implications of this local currency
issuance on the local banking system.
Frequently Asked Questions
What are the likely benefits of the Saudi government's local currency debt issuance program for local banks?
Saudi
Arabia has one of the most liquid banking systems in the Gulf. We
believe the banks will accommodate government issuance through a gradual
shift from low-yielding, short-term
liquid assets and private sector credits to higher-yielding,
longer-term government exposures. We expect this shift to be positive
for the banks' net interest margins (NIMs) and revenue generation. It
will also benefit the banks' capital profiles since the
government securities are zero-risk-weighted under Basel.
However,
the upside from higher yields is likely to be muted to some extent over
the longer term due to increasing private sector credit losses related
to the slowdown in the Saudia
Arabian economy.
We
also expect corporate bank loan pricing in Saudi Arabia to increase as
the sovereign issuance absorbs the excess liquidity in the banking
system. We've already seen the beginning
of this trend in the three-month Saudi Interbank Offered Rate (SAIBOR):
Over the past 90 days, the three-month SAIBOR has widened by nine basis
points (bps).
Do the Saudi banks have the capacity to absorb this issuance?
Yes.
We believe the Saudi banking system is ready to accommodate sizable
government issuance in case of sustained low oil prices. The system's
stock of short-term liquid assets (cash,
statutory deposits with SAMA [Saudi Arabian Monetary Agency], deposits
with banks, and T-bills) was about $106 billion, or 18% of the banking
system's balance sheet, at the end of June 2015. Additionally, Saudi
banks hold substantial non-statutory deposits
at SAMA ($13 billion, 2% of total assets). While the banks will need to
maintain a certain portion of their allocation in short-term liquid
assets, we believe through balance-sheet reshuffling they have adequate
liquidity to comfortably fund $75 billion-$100
billion or more in sovereign issuance in 2015-2016 without much effect
on their overall balance-sheet. In our view, further issuance by the
sovereign could also be accomodated, but would entail crowding-out of
private sector lending and a level of concentration
in government lending.
The
banking system operates with a deposit base of about $440 billion,
which represents a loan-to-deposit ratio of 81% at June 30, 2015--one of
the lowest metrics in the Gulf region.
On the same date, the total asset base of the banking system stood at
$590 billion, while its equity base was $80 billion. Claims on
government and quasi-government institutions were only $25billion,
representing just 4% of the asset base of the Saudi banks.
In
addition, because the sovereign exposures will carry zero capital
charges under Basel, we contend that the additional sovereign exposures
that the banking system is likely to carry
will not pressure the capitalization of the banks.
Is the likely increased banking sector exposure to the government unprecendented?
No,
this is not the first time Saudi banks would carry large sovereign
exposures. Before the rise in oil prices to more than $100 per barrel,
which began in the early 2000s, the Saudi
government had an active issuance program and sovereign exposure was an
important asset class for the country's banks.
Between
1993 and 2003, for example, government and quasi-government exposures
averaged about 25% of the banking systems' balance sheet. After peaking
at 32% in 2003, this ratio subsequently
declined year by year, reaching 4% at June 30, 2015, as the Saudi
government gradually paid down any maturing debt thanks to strong oil
revenues (see chart 1).
During
this period, Saudi banks reallocated their maturing government and
quasi-government exposures to private sector credit exposures, as well
as to short-term liquid assets. For
instance, the banking system's local short-term liquid assets and
private sector credit were 5% and 42% of total assets in 2003,
respectively. These ratios are currently 18% and 60%.
What will be the impact on asset allocation for the banks, in Standard & Poor's opinion?
We
expect deposit growth to visibly slow down in the coming quarters due
to low oil prices and we expect banks' significant liquidity buffers to
gradually tighten. We anticipate that
Saudi banks will have to reduce their balance-sheet allocation to other
exposures to be able to accommodate the sovereign issuance.
Cash
and statutory deposits with SAMA, deposits with banks, and T-bills
represented 22.1% of the banking system's total balance sheet at Dec.
31, 2014. This ratio declined to 18% at
the end of June 2015. We expect the banks to visibly reduce their
liquid asset exposures over the next few quarters. The average yield on
the recent 10-year Saudi issuance is 265 bps or 49 bps over U.S.
treasuries (Aug. 7, 2015, market close rates), while
Saudi banks generate less than 15 bps blended yield on their interbank
placements as a result of the historically low interest rates. This
means we should see a visible increase in asset duration for the Saudi
banks.
Similarly,
we expect to see the banks' appetite for private sector lending
gradually decline. Since 2003, private sector lending has grown from a
base of 42% of system assets to 60%,
as banks placed the liquidity from maturing government securities into
other yield-generating assets. This shift was supported by the
acceleration in the government's capital spending, which fueled growth
in the private sector across various economic segments.
Since
the financial crisis of 2009, global and local interest rates have
declined sharply to historically low levels. As banks generate very
limited returns at the short end of the
yield curve, these conditions provided an incentive for banks to
increase asset duration through increasing exposure to longer tenor
private sector credit (see chart 2).
Meanwhile,
owing to increased competition (particularly in the corporate lending
market), corporate pricing has softened significantly in the past few
years resulting in visible margin
erosion for the banks. As a result, the NIM of rated Saudi banks
contracted 100 bps on aggregate between 2008 and 2014 (see chart 3). We
now expect a reversal in this trend because the banks will be able to
generate returns on zero-risk-weighted government
securities.
What changes does Standard & Poor's expect to see in Saudi banks' funding profiles as a result of the government's issuance program?
We
expect a further widening of the structural asset maturity mismatch in
the system due to our expectation of a gradual shift from shorter- to
longer-term assets. Saudi banks are almost
entirely funded via local customer deposits that generally have less
than six months' maturity and account for 74% of total liabilities.
Although
the deposit market is very liquid, we expect to see a gradual
tightening since we anticipate a slowdown in deposit growth in line with
lower oil prices and slowing economic
growth. We believe the government and public sector deposits could
prove to be particularly suscpetible to a decline because the
authorities might draw on these resources due to declining revenue
generation. These deposits represented 21% of the system deposit
base at June 30, 2015 (see chart 4). Besides the gradual increase in
asset duration as banks reallocate assets from liquid assets into
sovereign issuances, we expect Saudi banks to try to increase the
average tenor of their deposit base. However, we do not
foresee a major change in the liability duration of deposits in the
Gulf because of their structural short-term nature, unless the banks try
to address this via long-term issuance in the debt capital markets.
We
also expect to see a visible deterioration in the amount of current
accounts available to the banks. Before global interest rates began
their sharp decline in 2009, the overall current
account deposits-to-total deposits ratio in the Saudi banking system
was lower than it is at present. Between 1993 and 2009, it averaged 43%.
Since 2009, in line with the sharp decline in interest rates and
deposit prices, the ratio increased to 66% at June
30, 2015 (see chart 5). Given our expectation of a gradual slowdown in
deposit growth, local funding and deposit pricing to move up, and higher
deposit prices, we would therefore expect to see some decline in the
current account deposits built up in the system
over the past few years.
What is the likely impact of the issuance program on bank profitability, in Standard & Poor's view?
We
believe the overall impact will be positive. We expect the blended
average yield on earning assets for the banks to improve gradually as
they begin to shift from low-yielding, short-term
interbank placements to higher-yielding government securities.
Although
we expect the cost of funding for the banks to begin gradually moving
upward, we still believe asset yields will improve and believe banks'
NIMs will expand. NIMs for Saudi
banks have visibly shrunk in the past few years in line with declining
lending prices and low interest rates, to 2.9% last year from 3.9% in
2009 (see table 1).
In
addition, the Saudi sovereign debt will carry zero-risk-weighting under
Basel, and the capital charges for interbank and corporate lending are
higher than sovereign exposures. Therefore,
the banks' return on capital should benefit from this move, likewise
their return on equity generation.
What will be the impact of the issuance program in the corporate loan market?
Over
the past few years, due to the very low returns on the interbank market
and absence of sovereign issuances or other yield-generating assets,
the Saudi banks have had to compete
in the loan market, driving down prices. We now expect this trend to
reverse and corporate loan market pricing to gradually recover.
We
believe this might also provide an incentive for Saudi corporates to
begin issuing U.S. dollar debt. Saudi Arabia is the largest bond and
sukuk market in the Gulf, and traditionally
most of the issuance is unrated local currency issuance that's taken up
by local banks. In the near term, we believe the banks will have less
of an incentive to absorb this debt, due to the availablity of
higher-yielding sovereign issuance.