• Confluence of positive drivers delivers earning surprise Aggregate recurring earnings of listed Saudi banks grew 12% Q-o-Q, c8% ahead of our estimates, recovering from a sluggish 4Q15. All key earnings drivers were supportive –better spreads, resilient non-interest income, loan growth and benign provisioning levels. We prefer bigger banks with strong deposit franchises in the current environment; Samba and BSF remain our top picks. While Al Rajhi enjoys a safe-haven kind of status, we believe it is reflected in the stock’s premium valuations. In terms of earnings surprise, SABB and BSF delivered the strongest beat to our estimate, while Albilad’s earnings fell short of our forecast on higher provisioning.
• Net interest spreads surprise amidst strong liquidity pressures The improvement in net interest spreads, which rose 1bps Q-o-Q, was the biggest source of surprise. Though the trend varied across banks, larger banks were able to improve spreads (+3bps Q-o-Q), while smaller banks saw margins squeezed (-6bps Q-o-Q). The spread improvement was driven by two key factors, in our view: i) optimisation of balance sheet liquidity (see Fig. 4-6), by shedding low-yielding investments and growing high-yielding loan book; and ii) up-tick in asset yields (see Fig. 7-9), driven by asset re-pricing on higher SAIBOR, and switch from T-bills in to government bonds. While these factors can continue to support spreads in the short term, room for tweaking balance sheet liquidity appears limited.
• Loan growth – filling the gap Aggregate net loans of the sector grew 10% Y-o-Y in 1Q2016, sustaining the recovery that started in 4Q2015. Our initial impression is that this was driven by stronger corporate loan book expansion. A slowdown in government payments has triggered a pick-up in credit demand, as businesses seek working capital financing. Moreover, the scheduled run-off in the loan book has also likely to have slowed as a result of weaker government payments. We expect loan growth to moderate on i) weaker government capex programme; while ii) government payments could lead to re-payment of these working finance facilities.
• Provisioning - kicking the can down the road? Provisioning trends appear to have remained benign. We estimate that annualised credit costs of 49bps -though marginally higher than last year - eased compared to 4Q2015 average of 52bps. While slower government spending should weigh on corporate health, and in turn, on bank loan quality, we suspect that banks are opting to restructure/reschedule loans for now. We suspect that the strength of non-interest income was possibly due to fees charged on loan renewal/rescheduling.

Murad Ansari