• Non-II drives earnings beat, but challenges persist; Cut FV, estimates Banque Saudi Fransi (BSF) 1Q16 earnings rose 14% Q-o-Q to SAR1,078 mn, beating our estimate of SAR928 mn. Non-interest income re-bounded sharply from a seasonally weak base in 4Q15, driving the earnings beat. Fee and forex income were the key drivers of growth, according to the company, while investment income was weaker Q-o-Q. We cut our earnings by 7% for 2016e and 11% for 2017e, to factor in sluggish balance sheet growth, and rising credit costs. We cut our fair value to SAR30.0, but maintain our Buy rating. We view BSF as a relatively defensive play due to its better credit risk management track record and strong gearing to higher interest rates. While its valuation largely reflects asset quality pressure in our view, rising stress could provide a better entry point.
• Spreads to remain the bright spot in an otherwise dull year BSF’s net interest spreads rose 4bps Q-o-Q, which continues the steady rising trend since the end of 2014. The bank’s loan book is heavily tilted towards corporate (91% of total loans) of which almost 50% gets re-priced within 3 months, while 81% of total loans are re-priced within a year. This allows the bank to re-price its assets and offset the pressure of rising funding costs. The bank also has one of the highest CASA deposit mixes in the sector (63% of total deposits), which should allow steady improvement in spreads, in our view.
• Credit costs are cyclical lows and should rise Steady recoveries and low incremental NPL formation has driven BSF’s credit costs at cyclical lows. We estimate annualised cost of risk of c13bps in 1Q16. A weaker macro-environment coupled with slower government payment cycle should translate in to asset quality stress. While BSF has one of the strongest credit risk management track records amongst Saudi banks, we expect credit costs are unlikely to sustain at current levels.

Murad Ansari