Rising challenges in the Saudi construction sector will lead to a surge in nonperforming loans (NPLs) and higher provisioning costs for the country's banks, said ratings agency Moody's Investors Service in a report published today (October 18).

The exposure of the kingdom's banks to the building and construction sector increased by 19.7 per cent year-on-year as of June 2016. This is well above the 8.9 per cent increase in total bank credit over the same period and has contributed to a material increase in the sector's indebtedness, stated the Moody's report, entitled "Banking - Saudi Arabia: Challenges in the Saudi Construction Sector Pose Risks for Saudi Banks."

The NPLs associated to the building and construction sector is already the highest when compared to other sectors, at 3.1 per cent of gross loans as of year-end 2015 (up from 2.8 per cent as of year-end 2015) versus a total reported NPL ratio of 1.2 per cent, it added.

"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," explained Olivier Panis, a vice president and senior credit officer at Moody's.

"As a result, the building and construction sector will likely contribute materially to the increase in nonperforming loans at Saudi banks. We expect NPLs to rise to around 2.5 per cent of gross loans in 2017, from around 1.5 per cent estimated as of June 2016," he added.

Panis pointed out that the country's building and construction sector was already the main contributor to NPL formation at Saudi banks over the past five years and it was likely to remain the same in the coming quarters.

"This is indicated by the increasing proportion of NPLs in this segment, accounting for SR4.1 billion ($1.09 billion) or 27 per cent of system NPLs as of year-end-2015, up from SR1.9 billion ($290 billion) or eight per cent 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," he stated.

"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," he added.

Moody's pointed out that 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 per cent of reported NPLs. Capital adequacy ratio and Tier One ratio stood at 18.3 per cent and 16.4 per cent, respectively, as of June 2016, it stated.

Moody's says that all else being equal, the reported coverage ratio would still remain strong at around 150 per cent if the NPL ratio in the building and construction sector were to increase to 4.5 per cent from 3.1 per cent as of year-end 2015 (representing SR1.9 billion - $506.2 million - in additional NPLs), it added.-TradeArabia News Service