Investors snub Saudi’s lacklustre bank stocks

Reuters/Faisal Al Nasser

• 34% drop from May 2022 peak
• Investors ‘not excited’ by sector
• But profits up 16% in H1 2023

Saudi Arabia’s banking stocks have suffered a sustained slump despite lenders reporting steady earnings.

Experts believe they are unlikely to rebound in the near term as investors target higher-growth industries instead.

Banking is one of three heavyweight sectors on the kingdom’s bourse, along with energy and materials, the latter including petrochemical manufacturers.

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To Tuesday’s close, the banking stock index had fallen 10.6 percent since hitting a 2023 high on July 25, resuming a sustained decline, and is down 34.5 percent from a May 2022 peak.

The slump is a result of investor concerns over the sector’s liquidity constraints, the likelihood that net interest margins have peaked and Saudi National Bank (SNB)’s ill-fated investment in Credit Suisse, said Shabbir Malik, a bank analyst at EFG Hermes in Dubai.

Yet Saudi banks’ combined profits rose 16 percent in the first half of 2023 compared with last year as their aggregate loan book expanded by about 12 percent, according to EFG Hermes.

Other factors supporting the industry’s profit growth were rising interest rates, which boosted banks’ net interest margins, and relatively low provisioning levels, said Malik.

SNB, Saudi’s largest bank by assets, reported a 9.3 percent rise in second-quarter net profit to SAR 5.02 billion ($1.35 billion) thanks to higher fees and greater net interest income.

Quarterly profit at Al Rajhi Bank, the kingdom’s top lender by market capitalisation, fell 2.5 percent year on year to SAR 3.15 billion, as a result of higher costs.

Share price performance has been underwhelming, considering the strength of the domestic economy, said Akber Khan, acting chief executive officer of Al Rayan Investment in Doha.

“While they have delivered decent balance sheet growth, banks are struggling with tighter liquidity, which has pushed up funding costs and squeezed margins. Corporates are borrowing but consumer loan growth has slowed significantly.”

The decline in Saudi banking stock prices have made them more attractive in terms of valuations, “but overall, investors are not that excited about the banking industry – there are far [better] places to invest offering better visibility and stronger growth”, said Khan.

Al Rajhi, which historically has been valued at a premium to domestic and regional peers, is trading at a price-to-earnings ratio of 16.6, bourse data shows, while SNB’s PE is 10.6.

Smaller rivals Saudi Awwal Bank and Alinma Bank trade at price-to-earnings ratios of 11.5 and 17.0 respectively. Riyad Bank’s is 11.2.

“Al Rajhi has started to be more attractive again from a valuations perspective,” said Sara Boutros, sector head for real estate and financials research at Cairo’s CI Capital, predicting the bank will achieve a return on equity of 19-20 percent in 2023.

“It’ll get better from here – this is likely to be the bottom.”

The impact of interest

Saudi banks – which provided a return on average equity of 11.4 percent in 2022, according to data from S&P Global Market Intelligence – usually benefit more from rising interest rates than lenders in other countries, because a large precentage of their customers will not use interest-bearing accounts due to religious considerations.

So, Saudi banks’ margins increase as they raise the rates they charge on loans, while their funding costs remain largely unchanged.

But such has been the scale of rate rises, more and more deposits are being switched to interest-bearing accounts from savings accounts. This trend is pressuring banks’ net interest margins as their funding costs increase, while benchmark interest rates stabilise, said EFG’s Malik.

“Most of the growth in new deposits comes in the form of interest-bearing deposits,” he said.

Banks focused on corporate lending were favourably positioned for rising interest rates, said Malik, noting these included Saudi Awwal Bank and Riyad Bank.

Conversely, Al Rajhi and Al Jazira Bank were among those whose margins were negatively affected by rising rates, and so as rates start to decline – from mid-2024, according to widespread expectations – they should benefit the most.

Saudi banks had faced constrained liquidity as deposit growth failed to keep pace with lending demand, but these stresses have now eased, said EFG’s Malik, noting deposits have expanded faster than loans this year. Also, the central bank tweaked the formula to calculate the loan-to-deposit limits, effectively easing limitations on banks, he said.

Borrowing by corporations is increasing as companies win contracts to help fulfil the key objectives of Saudi Arabia’s Vision 2030 economic diversification programme, said Malik.

“A lot of projects that were in the design phase are now moving to implementation,” he said.

EFG Hermes has a buy rating on SNB, Riyad Bank and Banque Saudi Fransi.

“These three are corporate focused,” added Malik. “The growth outlook for the corporate sector is promising and these banks offer good exposure to this segment, while from a valuations perspective they’re more reasonably priced than some of the other Saudi banks.”