The Saudi Arabian Monetary Agency (SAMA) released monetary data for January 2017. Major points worth highlighting are:

-        Deposits decline 1% M-o-M as banks shed time deposits

-        Loan book shrinks 0.3% M-o-M, but lending to private sector rises after six months

-        Macro data –ATM, POS, Trade– weaken M-o-M

-        Sector aggregate profits recover to SAR4.35bn –all time high

Sector deposits declined 1% M-o-M, primarily driven by 4% M-o-M drop in time deposits. With liquidity situation easing, banks appear to be shedding expensive time deposits to reduce their funding costs. Demand deposit base continued to strengthen, rising 1% M-o-M. The sector demand deposit mix maintained a steady improvement, rising to 61.3%, recovering to a year ago level. While overall private sector deposits declined, public sector deposits rose slightly M-o-M.

While sector loan book contracted for the third consecutive month, it was largely due to decline in public sector borrowing. Private sector borrowing increased 0.4% M-o-M, recovering after six consecutive months of decline. Data for loan maturity profile suggests that long term loans rose M-o-M while short and medium term loans declined.

Sector profits at SAR4.35bn, however, were surprisingly strong, rising c4x M-o-M and 15.7% M-o-M, with recovery likely driven by normalisation of provisioning levels. Moreover, steady decline in time deposits should have driven funding costs lower, supporting some improvement in NIMs. For reference, this is the highest reported monthly sector profit. Sector profits have crossed the SAR4.0bn mark only twice previously –in April 2014 and April 2015. In the previous two occasions, sector profits were boosted by investment banking, forex and stock broking income.

New letter of credits declined by 20% M-o-M, while POS spending was broadly flat M-o-M. ATM withdrawals declined 2.2% M-o-M after steady improvement over the past six consecutive months.

We believe 2017 is likely to be a difficult year for banks. We see few opportunities for growth unless government spending recovers, or if private sector investment cycle picks up –both look difficult for now. Weak business activity, coupled with lower consumer spending, is also likely to dent fee income. We believe the key factors for 2017 are likely to be NIMs and credit costs. Should interest rates rise, this is likely to support improvement in NIMs. Credit quality outlook appears to remain challenging, in our view and is likely to offset the impact of NIM expansion on earnings. However, this is largely reflected in valuations, which, at P/BV of c1.0x, are already ex-growth. We prefer a selective stock exposure, with BSF and Samba remaining our picks in the sector. Al Rajhi, with its largely retail-dominated loan portfolio, is a more defensive play in the current environment. 

Samba Financial Group: SAR21.39 as of 28 Feb. 2017, Rating: Buy, TP: SAR25.00/share, MCap: USD11,408mn, SAMBA AB/1090.SE

Banque Saudi Fransi: SAR23.97 as of 28 Feb. 2017, Rating: Buy, TP: SAR30.00/share, MCap: USD7,702mn, BSFR AB/1050.SE

Al Rajhi Bank: SAR64.21 as of 28 Feb. 2017, Rating: Neutral, TP: SAR54.00/share, MCap: USD27,824mn, RJHI AB/1120.SE