Saudi banking is least leveraged

Saudi Arabia is the largest economy and banking market in the Arab world, with almost 40 per cent of all deposits in interest free Shariah-compliant savings products and an embryonic, high growth mortgage, takaful (Islamic insurance), consumer credit and leasing industries.

Despite the $24 billion Al Gosaibi-Saad Group debt debacle, Saudi banking is the least leveraged in the GCC, with loans/deposit ratios rarely in excess of 80 per cent and a conservative, best in regional breed regulator in SAMA.

The persistence of $100-plus Brent crude oil prices, the government’s new $138 billion social welfare programme, a natural oligopoly with only 12 major banking networks across the kingdom, a fabulously wealthy sovereign that happens to be the world’s leading oil producer with $500 billion in central bank reserves, the largest public spending programme in the Middle East, tens of billions of riyals in non-interest bearing deposits, a huge capital market now opening up to foreign investors makes the macro case for Saudi bank investing compelling, even irresistible.

It is no coincidence that Saudi banks offer the highest net interest margins, lowest funding costs and most conservative NPL coverage ratios in GCC finance. However, a rise in loan defaults and lower Saudi riyal money market rates, as well as a protracted bear market in Saudi equities, and a sharp fall in investment banking income will all lead to lower profitability and growth metrics in Saudi banking.

The investment case in most GCC bank shares ranges from dubious to non-existent. After all, after 60-80 per cent drops in property prices, one third to one half loan book exposure to real estate/construction yet, miraculously one per cent NPL ratios! I just cannot swallow fairy tales that insult my admittedly limited intelligence! Who wants to sell me the Waterloo Bridge and unite me with Elvis?

However, while I wait for lower prices as attractive entry points, it makes sense to track Saudi bank shares for money making opportunities. Samba Financial, the former Citicorp joint venture bank in the kingdom, is the class act in Saudi banking.

This is easily the most liquid bank in the Gulf, with a loan/deposit ratio of a mere 63 per cent. Samba also has a stellar, conservative loan book, with exposure to Saudi government and blue chip corporate borrowers. Samba’s five per cent dividend and 1.2 times price to book value screams “value” to me, though global bank share correlation risk has spiked higher as the eurozone debt crisis obsesses the captains and kings of world finance. If Samba is cheap, global risk aversion, a fall in oil prices and a Greek sovereign default can easily mean its shares can get a lot cheaper.

Loan growth is a necessary if not sufficient condition for making money in emerging markets banks. Saudi Arabia is not a tiny, overbanked market like its GCC peers but a colossus with the largest, youngest population in the Gulf and a loan/GDP ratio well below 50 per cent. The Mortgage Law will create a new paradigm with mortgages a mere two per cent of GDP in a housing market that is destined to receive at least $100 billion in government/private investment.

The Saudi banking sector is no less than one fourth of the kingdom’s entire market capitalisation (though six per cent mere trading volume), so Saudi bank share performance will hugely influence the fate of the Tadawul index. Saudi banking trades at 10 times forward earnings at a significant premium to the UAE’s six times. This valuation premium makes me uneasy. The macro bull case is compelling but prices must fall big time for the risk-return calculus to flash a no-brainer buy.

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