Earnings up 2% Q-o-Q, beats estimate
Aljazira reported 2Q17 net profit of SAR220mn, +2% Q-o-Q and +24% Y-o-Y, beating our forecast of SAR178mn (and consensus of SAR178mn) due to strong net interest income and non-interest income. Spreads were the key positive surprise as they widened 12bps Q-o-Q to 2.66% driven by lower cost of funds, helped by an improvement in liquidity in the banking system. Non-interest income rose on strong FX and fee income; fee income was strong despite a likely weak quarter for its broking business. Brokerage fees accounted for 6% of the bank’s revenue in 2016, and these fees are likely to have been weaker this quarter as Tadawul’s turnover was down 26% Q-o-Q. 
 
Loan book continues to shrink; deposits decline likely on lower-term deposits
Loan growth was sluggish in 2Q17, in-line with sector trends. Aljazira’s loan book contracted sequentially for the fourth consecutive quarter. In 2Q17, the bank’s loan book was down 1% Q-o-Q and 7% Y-o-Y. Corporate appetite has weakened as the gov’t is paying down its arrears and working capital requirements have declined. Deposits declined 1% Q-o-Q (-3% Y-o-Y) in-line with the bank’s loan growth trend. Aljazira shed term deposits in 1Q17, and it is likely to have shed more term deposits this quarter, which contributed to the decline in cost of funds this quarter, in our view. The bank’s liquidity was relatively stable with LDR at 80%, comfortably below the regulatory ceiling of 90%.
 
Provisioning the key weakness
Provisioning continues to rise suggesting that credit quality is deteriorating. Cost of risk rose to 59bps from 45bps in 1Q17 and 28bps in 2Q16 (our forecast 43bps). Going into 2Q17, Aljazira’s credit quality metrics were relatively stable with the NPL ratio at 1.2% and NPL coverage at 165% as of 1Q17. Retail loans accounted for 41% of the bank’s overall loan book as of 2016, one of the highest in the segment. We believe retail exposure is defensive relative to the corporate segment in the current environment. The high risk building and construction segment accounted for just 4% of loans.