• 1Q16 earnings cushioned by provision reversals, capital gains Bank Aljazira’s 1Q2016 earnings of SAR381 million were driven by capital gain on land sale of SAR209mn and provision reversals. Pre-provision earnings (excl. one-off gains) have been weak for the third consecutive quarter, with NPL recoveries supporting earnings. Provisions could normalise at a higher base as NPL recoveries slow, in our view. We estimate that adjusting for one-offs, pre-provision ROEs have almost halved to c8% in the past three quarters compared to 2014-1H2015 levels. We slash our recurring earnings estimate by 31% for 2016 and 41% for 2017. We cut our fair value to SAR12.5 from SAR19.5, maintaining our Neutral rating. Better spreads and lower provisions are key upside risks to our estimates.
• Spreads vulnerable to funding cost pressures A smaller and weaker deposit franchise relative to peers exposes Aljazira to higher funding cost pressures, in our view. We estimate that Aljazira’s spreads have contracted by 17bps over 4Q15-1Q16, mainly on higher funding costs. The bank’s CASA deposit mix of 50% at end of 4Q15 was significantly below sector average of 63%. Funding costs have risen sharply over the previous two quarters and should remain high amidst a tight liquidity environment. Moreover, the bank has a high retail mix in its loan portfolio (38% of total loans), which should mean slower loan re-pricing as retail loans are at a fixed rate for the loan duration.
• Capital adequacy improves, but not sufficient for double-digit growth Aljazira’s total capital adequacy ratio (CAR) improved 200bps over the past year, helped by cumulative capital gains of SAR782mn on land sales. While the bank’s current CAR of c16.1% should ease pressure for further capital raising, it is insufficient to support sharp recovery in loan growth momentum, in our view. Aljazira’s net loans have remained broadly unchanged over 2015. While loan growth of 6% Y-o-Y in 1Q16 was relatively stronger, we expect growth to weaken over the next quarters.

Murad Ansari