Saudi Banking Sector 2021 Outlook Growth Hinges On

Roman Rybalkin Saudi Banking Sector 2021 Outlook Puneet Tuli Benjamin Young Growth Hinges On Mortgage Lending Mohamed Damak And Public Spending Feb. 23, 2021 Key Takeaways

– The Saudi economy will recover in 2021-2022 from the shocks of 2020 as global demand for oil recovers and private consumption increases. That said, real GDP will not return to 2019 levels until 2022, in our view. – The roll out of the vaccine may help avoid further lockdowns but remains contingent on availability. In addition, downside risks related to the virus remain. – We expect credit growth to stabilize in 2021 or reduce slightly. Mortgage origination will remain buoyant and corporate lending is likely to pick up as Public Investment Fund programs create business for contractors. – Cost of risk will remain elevated in 2021, despite stronger-than-expected estimates for 2020, as the Saudi Central Bank lifts its forbearance measures. Combined with very low interest rates, this will weigh on banks’ profitability. – We expect ratings on banks to remain stable in the next 12-24 months. The merger between National Commercial Bank (NCB) and Samba Financial Group (SFG) may create a national champion that could focus on financing large strategic projects.

Saudi Economy Will Recover In 2021 After 2020 Shock

Saudi Economy To Recover In 2021 As OPEC+ Cuts Gradually Expire Saudi Arabia annual real GDP growth: production

Hydrocarbon GDP Nonhydrocarbon GDP Real GDP – OPEC+ related oil production cuts and the impact of the pandemic on important 6 economic sectors eroded real GDP in 2020 by 4 over 4% and triggered a sharp decline in Saudi Arabia’s net exports. 2 – By 2022, we expect the expiry of OPEC+

0 quotas and higher oil prices to boost economic activity to close to 3%. (2) – In the years ahead, the government will

(4) continue to pursue its Vision 2030 program, Percentage change % which largely aims to support the non-oil (6) economy and social transformation of the country via a series of large projects. (8) – Downside risks related to the pandemic (10) remain significant. 2019 2020e 2021f 2022f 2023f

Source: S&P Global Ratings. e--Estimated. f--Forecast.

Corporate Credit Will Pick Up In 2021

Credit Growth Will Remain Strong In 2021-2022 Boosted By Corporate Segment Net change in credit by sector Mortgages Other retail credit Corporate loans Credit growth (right axis), % – CreditCredit growth growth picked picked up up in in 2020 2020basedbased on on strongerstronger mortgage mortgage and and small small and and midsize midsize 250 16 enterpriseenterprise (SME) (SME) lending. lending.

14 – WeWe expect expect credit credit growth growth to to stay stay strong strong in in 200 nominalnominal terms terms in in 2021 2021-2022,-2022, but but to to slow slow down down 12 duedue to to high high-base-base effect. effect.

10 – CorporateCorporate credit credit growth growth may will pickpick upup asas Publicpublic 150 . SAR Investmentinvestment Fund fund programs programs generate generate business business for Bil 8 contractors.for contractors. 100 6 – SMESME credit credit to to slow slow down down as as deferral deferral programs programs Percentage change areare wound wound out, out, but but remain remain material material because because of of 4 subsidies.subsidies. 50 2 – RetailRetail credit credit growth growth will will stay stay strong strong due due to to continuedcontinued focus focus on on mortgages, mortgages, although although the the 0 0 2019 2020e 2021f 2022f marketmarket will will gradually gradually saturate. saturate.

e--Estimated. f--Forecast. SAR--Saudi riyal. SME--Small and midsize enterprise. Source: S&P Global Ratings.

Cost Of Risk Will Stay Elevated Until 2022-2023

Cost Of Risk Will Gradually Normalize From 2022 Onward

140 120 120 110 110 – We expect cost of risk to stay elevated in 2021 100 at about 120 basis points. This reflects our 82 80 80 68 71 view that the volatile global health situation 55 60 and international travel restrictions still weigh on the economy.

Basis points Basis 40

20 – Although the 2020 results seemed stronger- 0 2016 2017 2018 2019 2020e 2021f 2022f 2023f than-expected, we view this as a distortion caused by fast growth in mortgages across Banks’ Cost Of Risk Benefitted From Longer Than Expected Forbearance the year and lending to government-related entities in the first quarter of 2020. Banks' weighted average 2020 CoR guidance S&P Global Ratings 2020 COR expectation 130 – Additional provisions may be needed to offset 110 the wind-down of SME support programs in

90 2021, including payment deferrals. Basis points Basis 70

50 Q1 2020 Q2 2020 Q3 2020 Q4 2020 e--Estimated. f--Forecast. COR--Cost of risk. Q--Quarter. SME--Small and midsize enterprises. Weighted average guidance of NCB, ARB, SFG, BSF, and Riyad Bank. Source: S&P Global Ratings.

Capitalization Will Stay Strong Through 2021-2022

– Saudi banks are well-capitalized by international standards. – We expect rated banks’ capitalization to stay strong, as measured by our risk-adjusted capital ratio.

Capitalization Is Strong … … And We Expect It To Remain So

RAC ratio, % Tier 1 capital ratio Capital and reserves/Total assets S&P Global Ratings threshold for adequate assessment S&P Global Ratings threshold for strong assessment 20 14 18 12 16 14 10 12 % 8 10 6 8 RAC ratio in 2021, % 2021, in ratio RAC 6 4 4 2 2 0 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 NCB + ARB Riyad BSF ANB SIB Global Average Average Samba top 100 U.S. bank German 2018 2019 2020 average bank

Source: Saudi Central Bank. RAC--Risk-adjusted capital. Source: S&P Global Ratings.

Saudis Are Withdrawing Less Cash – Payment in cash has gradually become less prevalent in Saudi Arabia, demonstrating a growing digitalisation of the banking system. This exposes Saudi financial institutions to competition from challenger banks in the future. – Banks face more competition in retail spaces because of open application programming interface (API) policies and the emergence of fintech companies. In particular, buy-now-pay-later cards and peer-to-peer lending are becoming popular.

ATM Cash Withdrawals Declined In Favor Of POS Payments ATM Use For Noncash Transactions Has Also Fallen

Share of cards in total retail spending, % Volume of ATM cash withdrawals, % change YoY (right scale) Number of ATM transactions per card issued except cash withdrawal Volume of POS payments, % change YoY (right scale) 40 40 10 8.7

8 30 20 change Percentage 6.7

% 20 0 4 Number of transactions of Number 10 (20) 2

0 (40) 0 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20

YoY--Year-on-year. POS—Point of sale. Q--Quarter. Source: S&P Global Ratings, Saudi Central Bank. Q--Quarter. Source: S&P Global Ratings, Saudi Central Bank.

NCB-SFG Merger Will Create A National Champion

Merger With SFG Will Double NCB’s Corporate Market Share

– Merger of NCB and SFG will sharply change 30 the landscape in corporate lending, creating a NCB+SFG (pro-forma) player with pro forma market share of almost

25 30%. – It is not yet clear to what extent the 20 government will use the merged bank’s balance sheet to finance strategic projects. 15 – Given that Al Rajhi Bank (ARB) already has a SFG NCB Riyad strong position in the retail segment, the BSF SABB 10 increase in competition may dent the ANB profitability of smaller players in the long Alinma ARB 5 BAB term.

Banks' share in total corporate loans (%) loans corporate total in share Banks' SIB BAJ

0 0 5 10 15 20 25 30 35 40

Banks' share in total retail loans (%)

Source: S&P Global Ratings based on banks’ financial statements as of Sept. 30, 2020.

Low Interest Rates Eat Into Profitability

1. We Project That Interest Rates Will Stay Low For Longer… 2. … Which Would Weigh On Saudi Banks’ Net Interest Margins… Federal funds target rate Saudi banks’ NIM

200 3.4

150 3.2

100 3.0 Percentage points Percentage

Basis points Basis 50 2.8

0 2.6 2019 2020 2021f 2022f 2023f 2018 2019 2020e 2021f 2022f 3. … Despite Increasing Share Of Higher-Rate Retail Business... 4 … Resulting In Lower Returns Share of retail in total credit Saudi banks’ ROA 50 2.0

40 1.5 30 1.0 20 0.5

10 points Percentage Percentage points Percentage 0 0.0 2018 2019 2020e 2021f 2022f 2018 2019 2020e 2021f 2022f f--Forecast. NIM--Net interest margin. ROA--Return on assets. Source: S&P Global Ratings.

Profitability Still Outperforms Regional Peers

Saudi Arabian Banks Will Outperform Their Regional Peers Projected return on assets for Gulf Cooperation Council banking systems in 2021

1.4 – Despite the lower profitability, we anticipate that, on average, Saudi banks will outperform their regional peers. 1.2 – This largely reflects the relatively modest 1.0 impact of the pandemic on the quality of banks’ loan books and stronger growth of

0.8 mortgage lending.

0.6 Percentage points Percentage 0.4

0.2

0.0 Saudi Arabia Qatar Kuwait Bahrain Oman UAE

Source: S&P Global Ratings. UAE--United Arab Emirates.

S&PGR Outlooks On Saudi Banks Are Mostly Stable

Our Outlooks On Saudi Banks Are Mostly Stable

Bank SACP Ratings – Our outlooks on Saudi banks are mostly stable, indicating that we expect the size of The National Commercial Bank bbb+ BBB+/Positive/A-2 the economy, conservative regulation, and lack of aggressive growth pre-2020 to help the banking sector navigate the challenges of Samba Financial Group bbb+ BBB+/Positive/A-2 2021-2022.

Al Rajhi Bank bbb+ BBB+/Stable/A-2 – The positive outlooks on NCB and SFG signify that the post-merger institution may have a stronger credit profile than the individual Riyad Bank bbb+ BBB+/Stable/A-2 banks.

Banque Saudi Fransi bbb BBB+/Stable/A-2

Arab National Bank bbb BBB+/Stable/A-2

The Saudi Investment Bank bbb- BBB/Stable/A-3

SACP--Stand-alone credit profile. Source: S&P Global Ratings.

Related Research

– GCC Economic Activity Held Back By Its Hydrocarbon-Heavy Economic Structure And OPEC-Related Production Cuts, Dec. 7, 2020 – Saudi Arabia-Based The National Commercial Bank And SAMBA Financial Group Outlooks Revised To Positive On Planned Merger, Oct. 16, 2020 – Banking Industry Country Risk Assessment: Saudi Arabia, Oct 13, 2020 – GCC Banks: Lower Profitability Is Here To Stay, Oct. 13, 2020 – Saudi Arabia 'A-/A-2' Ratings Affirmed; Outlook Stable, Sept. 25, 2020

Analytical Contacts

Roman Rybalkin, CFA Puneet Tuli

Associate Director Associate

[email protected] [email protected]

+7 495 783 40 94 +971 4 372 7157

Benjamin Young Mohamed Damak

Director Senior Director

[email protected] [email protected]

+ 971 4 372 7191 +971 4 372 7153

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