The Saudi Investment Bank
Analysis of 2006 Financial Performance
The Saudi Investment Bank (SAIB) reported net income of SR2,006.2mn in FY06, an increase of 88.5% over FY05, and 9.4% below our forecasted net income of SR2,215.6mn for 2006. The company reported an EPS of SR8.3 in 2006 as compared to SR6.2 reported in the previous year. Income from core banking activities i.e. net commission income increased from SR785.7mn in 2005 to reach SR1,030.5mn in 2006, registering a y-o-y growth of 31.1%.
Fees from banking services increased to SR783.9mn in 2006, recording a 19.6% increase y-o-y, while foreign exchange income rose by 26.9% to reach SR34.8mn. Profits from sale of investments were the biggest contributor to earnings for the year ended 2006. Gains of non-trading investments increased from SR25.4mn to reach SR672.6mn in 2006.
Return ratios, namely the return on average equity (ROAE) and the return on average assets (ROAA) improved on the back of strong growth in net income of the bank. ROAE increased from 24.1% in 2005 to 35.5% in 2006. Similarly, ROAA increased from 3.1% in 2005 to 5% in 2006.
In 2006, SAIB’s total assets expanded by 3.2% to reach SR40.8bn from SR39.6bn in 2005. Net loans and advances increased by a mere 4.5% attributed to the reduced appetite from retail clients. Customer deposits increased from SR27.86bn in 2005 to reach SR27.93bn in 2006, a marginal increase of 0.3% on y-o-y basis. Shareholders equity for the year ended 2006 stood at SR6.0bn as compared with SR5.3bn in 2005, an increase of 13.1% on a y-o-y basis.
The bank continued to provide aggressively. Provisions for loan losses for the year ended 2006 stood at SR96.5mn as compared to SR100.0mn in 2005. Non-performing loans of the bank as at year end 2006 stood at SR217.3mn in 2006. NPL's as a percentage of gross loans declined from 1.6% in 2004 to 1.0% in 2006. Due to the aggressive provisioning policy, the bank coverage ratio increased from 240.0% in 2003 to 357.7% in 2006.
SAIB is well capitalized to support growth in its risk-adjusted assets. As at the end of 2006, the bank’s Tier 1 ratio at end 2006 was 23.5%, giving the bank enough head room to grow its balance sheet size.
In terms of operating efficiency, the banks cost to income ratio improved significantly. Cost to income ratio declined from 24.8% in 2005 to 18.4% in 2006. Operating expense as a percentage of average assets increased marginally from 1.0% in 2005 to 1.1% in 2006.
1H2007 Financial Performance
Total assets in 1H2007 increased by 3.2% y-o-y to reach SR40.4bn. This is mainly driven by an increase of 52.6% increase in investments to reach SR15.2bn at the end of 1H2007. The banks’ investments are mainly comprised of fixed rate securities. Loans and advances on the other hand increased by 2.1% y-o-y to reach SR19.7bn. We expect loans to increase as banks aggressively pursue project finance lending on the back of increased government spending on infrastructure projects. We also expect retail lending to grow in the medium term.
On the liabilities side, core customer deposits increased by 2.8% y-o-y to reach SR27.7bn. Customer deposits continue to be the biggest contributor in terms of aggregate liabilities, constituting 83.9% of total funding mix at the end of Jun-07 as compared to 82.9% as at 1H2006.
Net income for the second quarter of the current fiscal declined from SR838.3mn in 2Q2006 to reach SR225.4mn in 2Q2007. Net special commission income in 2Q2007 was SR248.7mn, which was at similar levels achieved in 2Q2006. Non-commission income declined significantly from SR759.9mn in 2Q2006 to reach SR98.8mn in 2Q2007, a yearly decline of 87.0%.
Fees from banking services and gains on non-trading investments have been the biggest contributor for the reduced non-commission income of the bank. This has been due to the continued pessimism in the local capital market. New issuance of licenses by the Saudi financial authority (SAMA) to financial intermediaries for conducting brokerage, investment banking, and other financial services is likely to increase competition for those banking services.
Outlook and Valuation
It is evident that SAIB was adversely affected by the Saudi stock market crash in 2006. Loans and advances have modestly increased in FY2006; however we expect that this trend will reverse as the Saudi market is regaining its lost grounds. In addition, the mega infrastructure projects boom taking place in the Kingdom currently, has driven banks to aggressively pursue project finance lending, which will enhance the banks loan book.
The Saudi Monetary Agency (SAMA) has recently approved new licenses for brokerage, investment banking, and advisory services, amongst others. SAMA also ordered the separation of those activities from conventional banking activities, which consequently drove banks offering those services to spin them off under different legal entities. This is likely to increase competition in the financial industry, which will narrow down the banks income generating avenues. However, the down trend in the domestic capital market has affected the bank's profitability. As a result we have revised our projections to incorporate the impact of the capital market activity. Besides the revised projections, we have increased the risk-free rate assumed in our previous report from 5.1% to 5.8%. We have maintained a market risk premium of 5.0%, a beta of 1 and the terminal growth rate at 5%. The revised valuation parameters have resulted in a cost of equity of 10.8%.
The combination of the revised projections and the revised cost of equity have led to a value of SR36.6 per share, which is lower by 8.4% as compared to the current market price. Based on a forward P/BV multiple of 4.08x 2007 projected book value for the Saudi Banking sector, the peer valuation method results in a valuation of SR71.4 per share. Assigning an 80% weight to the DDM value and a 20% weight to the relative value, the weighted average share value of SAIB came out to SR43.6 per share. At the current market price of SR40.0, SAIB's share is quoting at a discount of 9% to its fair value. Hence we downgrade our earlier recommendation on the bank from “BUY” to "HOLD".
