NCB Capital, Saudi Arabia’s largest investment bank and leading GCC wealth manager, believes that lower YoY provisions will be a key factor behind strong net income growth for Saudi banks in 3Q11. However, despite the improved asset quality, expanded loan books and strong fee income, top-line growth is expected to remain subdued due to the low interest rate environment. Longer term fundamentals remain good with valuation levels attractive.
Commenting on the new report, Farouk Miah, Acting Head of Equity Research at NCB Capital said, “Saudi banks’ Non Performing Loans (NPLs) declined 13% YoY in 2Q11 and provision coverage increased to 122%. Off the back of better asset quality, we expect provisions in 3Q11 to decline by 52.8% YoY boosting the sector’s 3Q11 earnings.”
NCB Capital expects Saudi banks’ loan books to increase in 2011 on higher public spending which is likely to drive corporate loan books. Retail loans are also expected to remain strong on supportive demographics. Furthermore, the existing low loan-to-deposit ratio, increased low cost deposit base and better asset quality have enabled Saudi banks to grow its lending portfolio. This is likely to keep both retail as well as corporate loan growth healthy in 2011.
Net interest spreads of the Saudi banks are likely to remain depressed due to the low interest rate environment. “Although we expect NIMs to contract marginally in 2011, an increase in loan books is likely to off-set this decline,” said Mr. Miah. “Furthermore, strong non-interest income will make up for the decline in net special commission income leaving a minor impact on total operating income.”
According to the report, Saudi banking stocks have declined more than 13% YTD on global economic concerns. However, NCB Capital remains positive on the sector’s fundamentals and believes current low stock prices offer an attractive entry point. “Our top-picks in the sector remain Al Rajhi Bank and Banque Saudi Fransi. We are overweight on all other banking stocks except Bank Al Jazira and Bank Al Bilad where we are Neutral,” Mr. Miah explained.
Benefiting from lower provision charges, net income for the Saudi banking sector continued to grow both on a QoQ and YoY basis in 2Q11. Total operating income grew slightly YoY and QoQ mainly due to strong fee income. Loan book continued to expand in 2Q11; however lower net interest spreads kept net special commission income muted.
Banks under coverage at NCB Capital reported strong results for 2Q11 with aggregate net income of 10 banks growing 13.4% YoY and 8.7% QoQ to SR6,720 mn. However, SAMBA was the only bank reporting 9.7% YoY decline in net profits. Small sized banks such as SAIB, BJAZ and Al Bilad witnessed 9.6x, 3.0x and 2.5x times growth respectively.
Lending and investing activity increased during 2Q11 at most of the banks. According to SAMA data, retail lending increased 10.7% YoY while corporate loans grew 5.9%. The manufacturing sector, accounting for 13% of total lending grew 27.9% YoY and commerce grew 6.3%. Loans and investments of banks under our coverage grew 5.2% and 11.7% YoY respectively. BJAZ’s loans grew fastest at 26.5% YoY on a small base, while among the large banks, Al Rajhi showed notable growth of 7.2%.
Customer deposits for the coverage universe grew 8.3% YoY with BJAZ and Al Rajhi leading with YoY growth at 28.3% and 21.3% respectively, while SHB experienced a decline of 7.7% YoY.
Despite improved lending, banks’ net special commission income declined 2.5% YoY to SR7,746 mn mainly due to lower net interest spreads (29bps YoY decrease). Al Rajhi experienced the highest contraction of 98bps YoY, however due to strong growth in its loan books the bank’s net special commission income declined just 2.4% YoY and remained flat on QoQ. On the other side, Al Bilad’s net special commission income grew 17.3% YoY on flat net income spread and 10% YoY growth in loan book.
Total operating income of the covered banks grew marginally by 0.6% YoY to SR11,490 mn despite a decline in net special commission income. This is mainly attributable to strong fee income which grew 15.8% YoY. Al Bilad’s total operating income grew 24% YoY on higher net special commission income, while BJAZ’s topline expanded due to 33% growth in fee income.
Total operating expenses of the banks increased 7.1% YoY due to salary bonuses. However, lower provision charges (52.6% YoY decrease) enabled Saudi banks to post healthy bottom-line growth. SAMBA recorded only SR11 mn of provisions (80.8% lower than 2Q10) while, SHB’s provisions increased 22.2% YoY to SR41 mn.
Public spending to enhance credit growth
Social welfare spending by the government along with bonus salaries are likely to keep demand for corporate as well as retail loans high in the Kingdom. Furthermore, strong growth in the deposit base, lower loan-to-deposit ratios, adequate capital levels and improved asset quality allow Saudi banks to expand their credit portfolio. We forecast BJAZ, SABB and Al Rajhi’s loans book to grow faster than the industry average, while expecting SAMBA, SAIB and SHB’s loans to expand at a slower pace in 2011.
Net interest spreads are expected to remain low but stable
The lower interest rate environment has kept Saudi banks’ net interest spreads muted during 1H11. NCB Capital do not expect notable improvement in interest rates during 2H11, leading to pressure on net interest spreads of the banks. However, growth in high yielding retail loans and lower cost demand deposits will enable Saudi banks to maintain its NIMs by repricing their liabilities to match lower yielding assets. Furthermore, increased volumes are likely to partially offset decline in NIMs and marginally impact growth in net special commission income (0.8% YoY decline) in 2011.
Fee income and other non-interest income to offset decline in net special commission income
Increased banking activity and relatively improved market conditions YoY have kept the bank’s non-interest income growth strong during 1H11. NCB Capital expect the YoY gains in fee and other non-interest income to offset any decline in net special commission income (NSCI) and enable Saudi banks to increase total operating income marginally by 0.5% YoY in 2011.
2H11 is likely to see strong growth in net income on lower provisions
Saudi banks’ asset quality improved in 1H11 with a 13% decline in NPLs. Gross NPLs as a percent of gross loans stood at 2.4% at the end of 2Q11 as compared to 2.7% in 2010 and 2.9% in 2Q10. Provision coverage also increased to 122% against 117% in 2010 and 102% in 2Q10. Provision expenses charged for credit losses declined 47% YoY in 1H11 enabling a 9.5% YoY increase in net income. NCB Capital believe most of the Saudi banks will experience better growth in net income in 2H11, particularly in 3Q11 as banks recorded the highest provisions in 3Q10. NCB Capital forecast net income of the banks under its coverage to increase 13.3% YoY in 2011.
Despite expanded loan books, improved asset quality and enhanced bottom-lines, the Saudi banking sector index has declined 13.9% YTD driven by global economic conditions. However, NCB Capital remain positive on the sector’s fundamentals. The current low stock prices and attractive price multiples offer good entry points for investors.
Summary of company-specific ratings released:
NCB Capital remains Overweight on RIBL with a revised PT of SR32.2. It expects the bank to benefit from its strong corporate and retail presence, whilst expanding its credit portfolio. A strong performance in 1H11 and well covered NPLs requiring lower provisions in 2H11 keeps NCB Capital positive on the bank’s outlook.
Bank Al Jazira
NCB Capital remains Neutral on BJAZ with a revised PT of SR18.0. Strong loan growth and fee income is likely to add to the bank’s top-line. However, NCB Capital remains cautious on BJAZ’s high cost-to- income ratio and relatively low NPL coverage.
The Saudi Investment Bank
NCB Capital remains Overweight on SAIB with a revised PT of SR21.9. SAIB is likely to benefit from its change in strategy as the bank has been able to generate stable NSCI, despite flat loan books in a low interest rate environment. Furthermore, improved asset quality is likely to keep the bank’s net income growth high for 2011.
Saudi Hollandi Bank
NCB Capital remains Overweight on SHB with a revised PT of SR33.6. The bank’s focus on the retail segment is likely to safeguard its NIMs. Although slow loan growth will limit its NSCI in the short term, SHB has potential to grow its loans as well as NSCI in the long run.
Banque Saudi Fransi
NCB Capital remains Overweight on BSF with a revised PT of SR53. Its retail focus has enabled BSF to maintain its NIMs and keep NSCI strong. Loan growth is expected in line with the industry and better coverage ratio depicts BSF’s excellent credit book. Although the retail focus is likely to increase BSF’s operating costs, strong topline and better asset quality should counter this.
NCB Capital maintains an Overweight rating on SABB with a revised PT of SR49.0. NSCI driven by loan volumes and strong non-interest income are likely to enable the bank to post marginal growth in total operating income in 2011; lower operating expenses and provision charges should aid growth in net income for the bank.
Arab National Bank
NCB Capital remains Overweight on ANB with a revised PT of SR33.9. ANB’s retail focus and increased demand deposits are likely to safeguard its NIMs. NCB Capital believe the bank’s improved asset quality is a key positive which is likely to offset a decline in total operating income caused by lower loan growth.
SAMBA Financial Group
NCB Capital remains Overweight on SAMBA with a revised PT of SR56.8. As one of the more conservative banks in the Kingdom, SAMBA’s loan books are growing slowly as compared to industry peers, impacting its top and bottom-line growth. However, the recent weakness in the stock price suggests the weaker loan book outlook is priced in.
Al Rajhi Bank
NCB Capital remains Overweight on Al Rajhi with a revised PT of SR83.6. Al Rajhi is likely to benefit from its large deposit base which allows it to grow its credit portfolio faster than industry peers. Although the current low interest rates limit its NSCI growth in the short term, the bank will benefit from its lower cost of funds in the long run.
Bank Al Bilad
NCB Capital remains Neutral on Al Bilad with a revised PT of SR16.6. Al Bilad’s retail focus should lead to faster growth in its credit portfolio and increase its net special commission income for 2011. Furthermore, strong non-interest income and improved NPL coverage are likely to increase net income. However, the bank’s operating costs are a concern for its profitability.