Saudi Arabia Commercial Banking Report Q3 2007

We maintain our cautious view on the Saudi All Share Index (SASI) given deteriorating fundamentals, though there are some small indications of a pick up in investor sentiment following last year's correction.

The SASI has plunged by over 60% from its zenith hit in February 2006 and is currently trading within the 7,300-7,600 band. Indeed, as with the UAE equity markets, the SASI has not seen a recovery, despite a still benign backdrop of ample liquidity, positive global dynamics, and a stream of good news. One example is the Saudi Basic Industries Corporation (SABIC), which announced a 50% year-on-year (yo- y) rise in Q107 profits, outperforming expectations, with its net income reaching US$1.7bn. A leading petrochemicals company, SABIC accounts for 24.3% of the total market capitalisation of the SASI and 66.6% of the sectoral index, which is the leading component of the general index. In addition, further positives have been the decision by ratings agency Moody's to upgrade SABIC's long-term foreign and local-currency rating to A1 with a stable outlook, coupled with the release of various bullish reports on the company and the SASI.

More importantly, in what seems like a modest improvement in investor sentiment, bank lending growth to the private sector picked up for the first time in March, rising to 7.8% y-o-y from 6.0% y-o-y in February, having fallen consecutively since December 2005 from 38.9% y-o-y. Lending for 'investments for private securities' also grew positively in February and March, for the first time since April 2006, by 3.9% y-o-y and 5.7% y-o-y, respectively. A close correlation between the SASI and lending growth suggests that this could result in some upside moves in the stock market, where a turnaround in retail investor sentiment remains necessary to drive a recovery.

The Commercial Banking Sector Although the economy is extremely strong, Saudi Arabia's well-developed banking sector remains underused.

Total assets in the banking sector of US$233bn are only slightly larger than those in the UAE - a country with less than half of the GDP and a population of only 4.6mn. In addition, per-capita deposits of US$6,743 are low for the region, especially among the oil-producing Gulf States.

In 2006 deposits in the Saudi Arabian banking sector grew by 3.8% and loans by 9.2%. This growth brings the loans/deposits ratio to 80.5%, which is 39th out of the 59 countries surveyed by BMI. The country's loans/GDP ratio of 37.1% places it in 39th position in this category.

Profit in the banking system is, predictably, strong.

Press Reports Recent reports in the Saudi and international press, reveal some expansion in the banking sector. SABB, for example, announced that it would increase its network of branches in the kingdom to tap growing consumer demand for borrowing and to offer other financial services. However, this expansion was not reflected in profit. Among others, Saudi Hollandi Bank, Bank Albilad, Bank Al-Jazira and Saudi Al Rajhi Bank announced lower first-quarter net profit. Earnings were reduced by a decline in brokerage revenue, and, in some cases, weaker income from banking services.

In other developments, Housing Finance Development Corporation was appointed by the International Finance Corporation to train the Saudi Home Loan Company, the country's first home loan company targeted at the middle and lower income population.