Saudi Bank Subprime Difficulties

							March 2008

Weathering the storm

Still suffering from ramifications of the 2006 stock market collapse, Saudi banks
may have more difficulties to contend with as the full extent of their exposure to
the US subprime market is revealed.

Saudi Arabia banks managed to escape a dramatic correction in the overheated
domestic stock exchange relatively unscathed through 2006 and 2007. Lucrative
income related to the stock market fell away but was offset by other areas of
operations. While most Saudi banks have denied that poor performance in 2007 is
connected to US subprime market exposure this may be misleading. If lost income
from the stock market crash is compounded by subprime write-offs, the Saudi
banking sector could be in for a rough ride in 2008.

Limited impact
The overheated Saudi stock market peaked at 20,635 in February 2006 as confidence
grew with rising oil prices and retail interest increased supported by high levels of
consumer lending. Bank lending restrictions imposed by the Saudi Arabian Monetary
Authority (SAMA) combined with panic due to suspicions of market manipulation
triggered a dramatic correction. By June 2007 the index had plunged to 6,800 and
although it has recovered to current levels of 9,871, the market remained highly
volatile towards the end of 2007 largely driven by retail investors acting on market
rumour.

Despite wiping out over US$500bn in market capitalisation, there was little evidence
of a decline in the asset value of most bank investment portfolios. Income from
brokerage services and margin lending remained strong in 2006 but fell considerably
in 2007. The SAMA restrictions implemented in 2006 dampened consumer lending
growth although this recovered to some extent in 2007. Throughout the rise and fall of
the stock market, bank investment funds tended to perform consistently worse than
the market, encouraging investors to withdraw funds. The net effect, according to data
from SAMA, has been a 12.7% drop in 2007 profit levels on the previous year.

During the domestic stock market collapse large amounts of capital were transferred
abroad. In 2006 commercial bank foreign assets increased 42% on a year earlier from
SR91.4bn (US$24.4bn) to SR129.8bn (US$34.6bn). The increase in foreign assets
took place at the same time as subprime mortgage backed assets were performing
extremely well on global markets.

Poor results
While a number of major Saudi banks have reported worse than expected results and
investment portfolio devaluations for 2007, they have mostly denied any exposure to
the US “subprime crisis”. Saudi Hollandi blamed 2007 fourth quarter losses on “credit
losses”, denying a link with subprime assets. Arab National Bank attributed 2007
losses to lower investment and brokerage income. HSBC’s Saudi joint venture, Saudi
Arab British Bank (SABB), reported a fall in net profit of 14.2% for 2007. SABB’s
investment portfolio also shrunk from SR21.7bn (US$5.8bn) to SR14.9bn (US$4bn)
but no explanation was provided. Saudi Investment Bank made provisions of US$14m
for investment losses but did not elaborate.

The lack of explanations for poor performance and investment losses has aroused
suspicion of subprime exposure. Industry sources have suggested that they have
market intelligence of damaging subprime-related losses at Saudi banks, especially
the larger ones. It is likely that banks are concealing or simply unaware of the extent
of their exposure. Subprime-related investment products tend to be repackaged pools
of various assets which can be sold on a number of times, complicating the
identification of the underlying asset.

Samba Financial is the only Saudi bank to have revealed subprime exposure.
Financial statements for 2007 included SR111m (US$29.6m) set aside as “reserve
provisions” for investments in mortgage-backed securities. According to a bank
employee, the provisions are effectively a mark to market of losses related primarily
to US subprime assets. The bank does not regard the provisions as significant in the
context of its overall portfolio size of SR54bn (US$14.4bn) which contains an
estimated SR3.5bn (US$933m) of subprime exposure.

While the size of Saudi bank provisions and investment losses is not excessive,
subprime losses are likely to escalate. Worldwide subprime-related losses currently
amount to at least US$180bn. Estimates of total expected losses range from
US$400bn to US$1 trillion, according to recent studies.

The losses of gulf banks elsewhere in the region also suggest that Saudi banks are yet
to reveal all. Abu Dhabi Commercial Bank, Arab Banking Corporation and Bank of
Bahrain and Kuwait have together written off US$444m. Bahrain based Gulf
International Bank was forced to raise US$1bn of capital to cover reserve provisions
and write-offs of approximately the same amount. Numerous bankers, analysts and
Standard and Poor’s rating agency have expressed concern that gulf banks may be
concealing subprime-related exposure.

Even if future Saudi banking announcements reveal large subprime exposures it is
unlikely that there will be any major fallout from the crisis. High liquidity should
make it easy for Saudi banks to raise capital to cover losses. Income remains strong in
areas unaffected by the stock market crash, driven by robust government spending
and large investment projects. Nonetheless, life could be uncomfortable in 2008 for
banks that suffered losses in stock market related income and may now face
escalating subprime losses.