Egyptian Gulf Bank (EGB) released its full financial statements for 1Q18, with net income of EGP137mn, up 13% Y-o-Y and 15% Q-o-Q, coming in 9% ahead of our estimate of EGP125mn. The earnings beat was driven by higher-than-expected net interest income, up 2% Y-o-Y and a strong 60% Q-o-Q (+28% ahead of our estimate), coming from a very low base in 4Q17. Provisioning costs and operating expenses came in higher than our estimate. 
 
Positives: i) Spreads; ii) loans and deposits; iii) credit quality
Negatives: i) Provisioning costs; ii) non-interest income
 
Key highlights of the results:
 
      Loan book growth recovers Q-o-Q as USD loan books stabilises: Loan growth improved to 4% Q-o-Q (+11% Y-o-Y), driven by a 5% Q-o-Q increase in EGP loans, while FX loans were flat Q-o-Q. During 2017, EGB had a large amount of USD repayments (a sector trend).
 
      Strong deposit growth; reliance on corporate deposits continues to be much higher than the market’s: Customer deposits grew 20% Q-o-Q (+15% Y-o-Y), as corporate deposits increased 18% Q-o-Q after falling 16% Q-o-Q in 4Q17. Retail deposits growth was also strong (28% Q-o-Q). EGB has a much higher reliance on corporate deposits than the rest of Egypt banks under coverage: corporate deposits account for 78% of total deposits (for most banks, the split is 50:50 retail/corporate). EGB has been very aggressive in expanding its loan book since 2014 (when a new management came on board), and because of its weaker franchise (weaker brand name, small branch network), growing corporate deposits at higher prices than the sector average has been the initial strategy. There is a strong focus now on improving the deposit mix and lowering funding costs, and the share of CASA deposits has increased to 52% in 1Q18 vs. 29% in 1Q17 and 44% in 4Q17.
 
      Q-o-Q recovery in spreads on lower funding costs: Net interest income rose 2% Y-o-Y and 60% Q-o-Q, with the net interest spread expanding Q-o-Q by 113 bps to 259 bps (-71 bps Y-o-Y). The Q-o-Q recovery in spreads was driven by lower funding costs, -117bps Q-o-Q after a strong increase in deposits costs in 2H17.  
 
      Weak fee income: EGB’s non-interest income fell 27% Y-o-Y and 2% Q-o-Q because of lower fees (-40% Y-o-Y and -35% Q-o-Q) and a Y-o-Y drop in investment income (-7% Y-o-Y and +98% Q-o-Q).
 
      Stable NPLs; past due loans might explain why provisioning costs were high in 1Q18: EGB’s NPL ratio is still one of the best in our coverage and was broadly flat Q-o-Q at 0.73% in 1Q18. NPL coverage rose to 509%, but EGB has a high balance of past due loans of 10.6% of total loans, up from 8.7% in 4Q17. Provisioning costs came in at 72 bps in 1Q18, up 54 bps Q-o-Q (vs. a high base of 352 bps in 1Q17).
 
A mixed set of results: The improvement in spreads in 1Q18 was a key positive, but EGB’s spreads are still well below the sector average, and this explains why EGB’s ROE is also lower than the average for the sector, at 16% in 1Q18 (below Egypt’s discount rate of 16.5%-17% and vs. average ROE of c28% for banks under coverage in Egypt). EGB’s strong balance sheet growth since 2014 has come at the expense of net interest margins. EGB’s management is shifting its strategy from the initial high growth phase to restoring profitability, but we expect ROEs to remain below sector average for 2018-19. 
                
Egyptian Gulf Bank: USD0.92 as of 16 May 2018, Rating: Neutral, TP: USD0.86/share, MCap: USD291mn, EGBE EY/EGBE.CA
Elena Sanchez-Cabezudo, Ahmed El Shazly