· Improving Outlook, Time for Cyclicality: The slowdown in economic growth and deflation of asset prices has translated into strong headwinds for the banking sector. Credit growth has decelerated sharply across the region, but we expect a recovery in 2010e as the macro backdrop improves and risk appetite recovers. From a medium- to long-term perspective, favourable demographics and low penetration point towards a strong potential for credit growth.
· Overcoming Challenges, Positioned for a Recovery: We believe that banks in the MENA region still present attractive value relative to global peers, with ROEs expected to remain around 20% for most banks in the medium term. Banks have weathered the initial shock of the financial crisis and have spent most of 2009 strengthening their balance sheets. With the macro picture stabilising and improving visibility on risk, we believe that banks are strongly positioned for a recovery, justifying our view that the valuation discount for MENA banks to their historical averages should narrow. We highlight the UAE, Egypt and Saudi Arabia as our top picks.
· UAE - Better than Feared: From a macro perspective, the UAE has suffered the most from the global economic recession. Though risks to earnings still remain, Abu Dhabi is proving more resilient to the economic slowdown. Supported by the government, balance sheets have strengthened over the year, and banks appear to be in much better shape than was feared. First Gulf Bank and Emirates NBD are our top picks in the UAE.
· Saudi Arabia - Poised for a Strong Recovery: We believe Saudi banks will continue to head towards higher valuations; with the government taking a strong counter-cyclical stance to the slowdown in private sector spending, business confidence is gradually recovering. Strengthening capitalisation and liquidity levels have made banks less vulnerable to a sudden jump in NPLs. Samba is our top pick, despite continuing to suffer from overplayed risk perceptions. We also recommend Banque Saudi Fransi and Arab National Bank as both look attractive from a valuation stand point and are laggards to the recent rally.
· Egypt - Comfortable on Risks: We do not expect Egyptian banks' high profitability will be severely impaired by the rise in NPLs that we expect over the next year, with banks having been cautious on their lending practices over the recent short cycle of credit expansion. We expect banks to sustain ROEs at an average of 25% in 2010e. Low banking penetration makes Egypt one of the most attractive long-term growth stories in MENA. We highlight NSGB as our top pick in the country. We like CIB for its strong positioning and its ability to deliver strong returns, but we find its valuation demanding at current levels.
· Underweight on Kuwait and Morocco: Within our coverage universe, we believe that Kuwait’s path to recovery is likely to be the longest. Political deadlock remains a stumbling block to government investment spending, suggesting that there will be little momentum for credit growth relative to the rest of the GCC. Meanwhile, Moroccan banks trade at a premium to the MENA banks’ average, partially justified by capital controls. While long-term growth opportunities are attractive, especially in the SMEs and household sectors, we favour other banks with lower multiples valuations and higher profitability than Moroccan banks.
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