- Banks in Saudi Arabia generally will benefit from the expected increase in interest rates. For every parallel shift upward in interest rates of 100 basis points, we expect a rise in net profit of 13% and return on equity of 1.5 percentage points.
- Higher rates will help banks promote savings products, in line with Vision 2030.
- A faster increase in rates could hamper credit growth, which we otherwise expect to stay strong.
- Higher profits will continue to support the strong credit profiles of rated Saudi banks.
S&P Global Ratings expects banks in Saudi Arabia to benefit from the expected increases in interest rates by the U.S. Federal Reserve, which the Saudi central bank typically mirrors because of the Saudi riyal peg to the U.S. dollar. Our economists expect the Fed to raise rates six times this year (including one that already took place in March), and five more times in total in 2023 and 2024--a steeper increase than base case assumptions of many Saudi banks. These changes will be earnings-accretive for Saudi banks because of the structure of their balance sheets. However, this is predicated on the assumption that the shift in the yield curve is parallel and that banks' balance sheets remain static. Second-round effects of the increase in interest rates could come from a higher cost of funding and slower-than-expected credit growth.
Benefits To Stem From Large Holdings Of Corporate Loans
We calculate that for every 100 basis point increase in rates, Saudi banks' net income is likely to rise 13% and return on equity an additional 1.5 percentage points, according to data from the country's 10 listed banks (see chart 1). While these numbers assume that balance sheets remain static and the shift in the yield curve is parallel, it is a broad indicator of the direction and magnitude of the impact of rising rates.
The magnitude of impact is not surprising. A large portion of corporate loans (about 55% of total loan books) extended by banks in the country are linked to a Saudi riyal benchmark rate. Meanwhile, most deposits (65%) are demand deposits with zero or very little funding costs; this ratio has been broadly stable over the past few years.
The Impact On Asset Quality Is Likely To Be Manageable
Saudi public corporates generally have reasonable financial profiles, with a median total debt/EBITDA ratio of around 3x in 2021, according to data from S&P Global Market Intelligence for corporates accounting for about 54% of all Saudi corporate debt or 35% excluding Saudi Aramco. This suggests that the corporate sector--traditionally funded at floating rates--should be able to face a gradual increase in interest rates. However, we note that stiff competition and the leveraged financial profiles of some borrowers may limit banks' capacity to pass on this increase to borrowers--highly leveraged borrowers with EBITDA interest coverage of less than 2x represented 5%-7% of the debt in our sample. Indeed, we don't expect Saudi banks to increase rates for fragile clients. Similarly, while there is less visibility about the actual credit quality of small and midsize enterprise loans, we expect government support to remain, particularly the Kafala program (the engine behind the recent expansion of this business in Saudi Arabia), which will mitigate fallout from rising rates, if any.
On the other side, rapidly growing portfolios of mortgages are predominantly fixed rate and salary assigned. Therefore, despite relatively high loan-to-value and payment-to-income ratios observed in the portfolios, we do not expect much stress to materialize from them.
Funding Profiles May Shift To Time And Savings Accounts
Rising interest rates may result in a shift of customer funding from demand deposits to time and savings accounts, even though that did not happen over the previous cycle of Fed tightening in 2016-2019 (see chart 2). This is because Vision 2030 and the Financial Sector Development Program in particular target an increase in savings products, including creation of government-backed savings products offered through a separate, newly created entity. Should this initiative be successful, Saudi banks may see a meaningful increase in longer-term domestic liabilities, which will be positive for the widening maturity mismatch arising from the recent expansion in long-term mortgage lending--but will come at a cost.
Should the rise in interest rates be rapid enough, we may also see some reversal of flows between asset management and brokerage, a business that almost doubled over 2020 and 2021, and retail banking. This can further decrease the share of demand deposits in the funding mix.
As interest rates rise, refinancing options for mortgage portfolios provided by government-related entities may become more attractive for banks. We expect sales of mortgage portfolios to grow in coming years compared to growth in 2020 and 2021.
Rate Increases Are Likely To Slow Credit Growth
Following strong expansion in 2020 and 2021, we continue to expect credit growth to stay strong at about 12% in 2022. This is slightly lower than the weighted-average public guidance of Saudi banks (13%-15%), reflecting mostly our expectations for steeper rate increases.
At some point, higher rates will gradually cool off lending growth. Specifically, we believe that mortgage growth will start to moderate, even in nominal terms, in 2022 as the market becomes more saturated. Between 2019 and 2021, more than 560,000 contracts (or one for every seven households in the country) were extended. Appetite for mortgages could also decline considering the rise in the household debt burden and as mortgages become more expensive.
Meanwhile, the increase in contracts extended related to Vision 2030 projects, along with private-sector support programs, should boost demand for credit among corporates. At this stage, we expect credit growth to normalize at about 10% by 2023.
On balance we believe that Saudi banks' credit profiles will benefits from rising rates, which will boost revenues while leading to a manageable weakening of credit quality. Strong capitalization of the banking sector will be further supported by an expected slowdown in lending growth, which will protect creditworthiness over the next 12-24 months. All Saudi banks we rate have strong capitalization, that is, S&P Global Ratings' risk-adjusted capital ratios between 10% and 15%, as defined by our bank rating methodology.
This report does not constitute a rating action.
|Primary Credit Analyst:||Puneet Tuli, Dubai + 97143727157;|
|Secondary Contacts:||Mohamed Damak, Dubai + 97143727153;|
|Benjamin J Young, Dubai +971 4 372 7191;|
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