• Challenging 2016 reflected in multi-year low valuations Listed banks’ aggregate earnings declined 4% Q-o-Q in 4Q2015. For FY2015, earnings growth eased to 5% Y-o-Y versus 8% in 2013. While we see 2016 as a challenging year for key earnings drivers – spreads, cost of risk, and loan growth – we believe that this is reflected in valuations, which at 8.3x 2016e P/E and 1.0x 2016e BV, are at their multi-year lows. BSF and Samba are our top picks in the sector for their strong deposit franchises, proven risk management track record, and potential to improve spreads. Though we have a Neutral rating on Aljazira, a steep discount to book value (2016e P/B of 0.6x) could help drive a relief rally should market sentiment improve. In terms of earnings surprise, Al Rajhi reported the strongest earnings beat to our estimates, while ANB’s earnings fell significantly short of expectations.
• Spreads hold up amid liquidity squeeze as banks shed deposits Amid a backdrop of tightening liquidity in the sector, net interest spreads for 4Q2015 (aggregate basis) were surprising resilient. Most banks reported broadly stable or better spreads on a Q-o-Q basis. However, the improvement came at a cost – a decline in deposits. Unlike in the past, where banks shored up deposits at year-end, this year saw deposits decline by 2.5% Q-o-Q. At 1.5% Y-o-Y for 2015, deposits grew at their slowest pace since 2010. This pushed the sector loans-to-deposit ratio to 82.4% in 4Q15, an almost 400bps Q-o-Q rise. However, with deposit rates easing slightly over the past week, we expect banks to rebuild their deposit bases.
• Provisioning costs jump; rising buffer or asset quality deterioration? We estimate that annualised cost of risk of the listed banks in 4Q2015 rose to 73bps, sustaining a steady uptrend since touching a low of 46bps in 1Q2015. In the absence of detailed results, it is difficult to assess whether banks beefed up their coverage, or if there was a deterioration in asset quality. We believe it was a mix of both. Nonetheless, we believe that 4Q2015 marks a turning point for asset quality indicators. Having said that, Saudi banks are well provisioned, with excess provisioning reserves (over 100% NPL coverage) accounting for c0.9x of gross loans at the end of 3Q15. This is likely to cushion the impact of rising NPLs initially in our view.
• Loan growth picks up, likely helped by slowdown in govt. payments After sluggish growth in 3Q15, loan growth momentum picked up slightly in 4Q15, with net loans growing 2.5% Q-o-Q / 8.2%Y-o-Y. We expect that corporate credit demand recovered after the summer and eid holidays. The slowdown in government payments, which closed its financial year earlier than usual (in October), is also likely to have driven credit demand on higher working capital requirements.

Murad Ansari