Announcement: Moody's: Reduced project pipeline and rising indebtedness in the Saudi construction sector pose risks for banks

Rising challenges in the Saudi construction sector will lead to rising nonperforming loans (NPLs) and higher provisioning costs for the country's banks, says Moody's Investors Service in a report published today.

Moody's report, entitled "Banking - Saudi Arabia: Challenges in the Saudi Construction Sector Pose Risks for Saudi Banks," is available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release. Please note that this report does not constitute a rating action.

"The Saudi construction sector has been negatively affected over the last two years by slowing economic activity and fiscal consolidation measures, stemming from a lower oil prices environment. We expect the pressures to continue as the Saudi government aims to reduce its large fiscal deficit" says Olivier Panis, a Vice President -- Senior Credit Officer, at Moody's. "As a result, the building and construction sector will likely contribute materially to the increase in nonperforming loans (NPLs) at Saudi banks -- we expect NPLs to rise to around 2.5% of gross loans in 2017, from around 1.5% estimated as of June 2016."

Saudi banks' exposure to the building and construction sector increased by 19.7% year-on-year as of June 2016. This is well above the 8.9% increase in total bank credit over the same period and has contributed to a material increase in the sector's indebtedness. The NPLs associated to the building and construction sector is already the highest when compared to other sectors, at 3.1% of gross loans as of year-end 2015 (up from 2.8% as of year-end 2015) versus a total reported NPL ratio of 1.2%.

"The building and construction sector in Saudi Arabia is already the main contributor to NPL formation at Saudi banks over the past five years and we expect this will remain the case in the coming quarters," explains Mr. Panis. "This is indicated by the increasing proportion of NPLs in this segment, accounting for SAR4.1 billion or 27% of system NPLs as of year-end-2015, up from SAR1.9 billion or 8% of system NPLs as of year-end 2010, and a number of leading indicators of asset-risk trends monitored by Moody's point to rising pressures that will stem from the construction sector in next 18 months."

While we expect Saudi banks to face increased problem loans and higher provisioning costs over the next 12 months, we expect the magnitude of the asset quality deterioration to be within the banks' profit margins. In addition, the banks' high capital buffers can absorb a material stress from downside scenarios in the building and construction sector. Loan-loss provisions are strong, representing around 178% of reported NPLs. Capital adequacy ratio and Tier 1 ratio stood at 18.3% and 16.4%, respectively, as of June 2016. Moody's says that all else being equal, the reported coverage ratio would still remain strong at around 150% if the NPL ratio in the building and construction sector were to increase to 4.5% from 3.1% as of year-end 2015 (representing SAR1.9 billion in additional NPLs).