Moody's revises outlook on Saudi Arabia's banking system to negative from stable

Moody's Investors Service has changed its outlook for the Saudi Arabian banking system to negative from stable, according to its latest outlook research report, published today. The outlook reflects the rating agency's expectation that the persistently low oil prices and resultant government spending declines will ultimately weigh on the Saudi banking sector.

"We expect the operating environment for Saudi banks to weaken over the next 12-18 months," says Olivier Panis, a Moody's Vice President -- Senior Credit Officer. "With the prospect of lower oil prices for longer and a 14% reduction in public spending in 2016, we believe that the credit risks across the system are rising."

Moody's forecasts real GDP growth to slow to 1.5% for 2016 and 2% for 2017 (well below the 3.4% growth of 2015) and for average oil prices to stay at $33 a barrel in 2016 and $38 in 2017. As a result, the rating agency expects loan growth to slow down to between 3% and 5% for 2016, from 8% in 2015 (and 12% in 2014). Moody's also expects asset risk to rise as a result of the deteriorating operating environment.

"We expect non-performing loans to increase to around 2.5% of total loans over our outlook horizon, from a very low average 1.4% in September 2015 -- still lower than for most other Gulf countries," says Panis. "Banks will also continue to remain exposed to event risks stemming from persistently high single-party exposures -- although we estimate that around 10%-25% of banks' top 20 loans are either to the government or wider public sector."

Capital buffers are likely to remain solid, in Moody's view, with the sector's average tangible common equity (TCE) ratio remaining broadly stable at around 15.7% by the end of 2016, up from 15.4% as of September 2015.

Profitability is also likely to remain strong, despite increased funding costs and loan-loss provisions, according to the rating agency due to the low cost of funding and the banks' lean cost structures and zero corporate tax rate. Moody's expects that, with an average of 143% of non-performing loans covered by provisions, provisioning costs will still remain one of the lowest in the GCC.

"Tightening liquidity -- as public-sector deposit inflows and corporate profits moderate -- will likely expose banks to greater funding volatility in line with regional pressures." explains Khalid Howladar, a Senior Credit Officer based in Dubai, "However, we expect the local impact to be manageable and funding structures to remain relatively stable thanks to a broad and growing depositor base." Moody's notes that deposits represented 90% of Saudi banks' non-equity funding as of September 2015.

Finally, although Moody's expects government support for the Saudi banking system to remain high, the rating agency notes there are signs that authorities' policy stance may evolve in line with global practices. In addition, government support assumptions could be further challenged on the basis of fiscal pressure for the Saudi government, signaling a potential reduction of government capacity to support banks in case of need.