Saudi Banking Sector - Aljazira Capital · Saudi Banking Sector Sector ... the Real Estate...

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1 © All rights reserved Saudi Banking Sector Sector Report June 2014 Please read Disclaimer on the back Executive Summary The long-term outlook for the sector remains positive due to the expected healthy loan growth (driven by mortgage lending and rising SME loans), well-capitalized balance sheets, and high coverage for loan losses. Mortgage and SME lending would be primary drivers of credit growth, given the low penetration levels and increased focus in recent years. Mortgage lending is expected to gain momentum in the coming years given the high proportion of the Saudi population under 30 years old and rising trend of nuclear families, leading to higher demand for housing units. Also, the Real Estate Additional Loan Program provides further boost to lending growth. Under this program, additional loan is available to Saudi nationals from real estate financing companies and banks whose projects have been approved by the Real Estate Development Fund. The government’s Kafala Program, launched in 2006, has facilitated increased participation of commercial banks in SME lending, consequently driving corporate loan growth. The banking sector’s performance in 1Q2014 was muted, with net earnings expanding just 5.4% despite a 9.5% YoY rise in overall operating income. Higher operating expenses, including provisioning, limited the earnings growth of Saudi banks in the quarter. Provisioning charges for all the banks increased by an overall 17.5% YoY in the quarter, in-line with the trend over the past few quarters. During 2014, we expect this trend to continue driven by concerns over slowdown in construction activity in the Kingdom owing to labor market pressures. In the coming quarters, we expect continued pressure on NIMs and higher asset quality risks to dent profitability. Intense industry competition is expected to pressurize NIMs, while slowdown in the construction sector due to labor shortage is impacting loan quality. The sector’s aggregate loan book and deposits expanded 11.3% YoY and 11.4% YoY, respectively. The sector’s loan to deposit ratio stood at 80.3% during 1Q2014 vis-à-vis 80.6% in 1Q2013. We expect loan book growth to continue, with the low loan to deposit and adequate capital levels on the balance sheet providing ample scope and liquidity. Analyst Jassim Al-Jubran [email protected] +966 11 2256248 AGM - Head of Research Abdullah Alawi [email protected] +966 11 2256250

Transcript of Saudi Banking Sector - Aljazira Capital · Saudi Banking Sector Sector ... the Real Estate...

1 © All rights reserved

Saudi Banking Sector

Sector Report

June 2014

Please read Disclaimer on the back

Executive Summary

• The long-term outlook for the sector remains positive due to the expected healthy loan growth (driven by mortgage

lending and rising SME loans), well-capitalized balance sheets, and high coverage for loan losses.

• Mortgage and SME lending would be primary drivers of credit growth, given the low penetration levels and increased

focus in recent years. Mortgage lending is expected to gain momentum in the coming years given the high proportion

of the Saudi population under 30 years old and rising trend of nuclear families, leading to higher demand for housing

units. Also, the Real Estate Additional Loan Program provides further boost to lending growth. Under this program,

additional loan is available to Saudi nationals from real estate financing companies and banks whose projects have been

approved by the Real Estate Development Fund. The government’s Kafala Program, launched in 2006, has facilitated

increased participation of commercial banks in SME lending, consequently driving corporate loan growth.

• The banking sector’s performance in 1Q2014 was muted, with net earnings expanding just 5.4% despite a 9.5% YoY rise

in overall operating income. Higher operating expenses, including provisioning, limited the earnings growth of Saudi

banks in the quarter.

• Provisioning charges for all the banks increased by an overall 17.5% YoY in the quarter, in-line with the trend over the

past few quarters. During 2014, we expect this trend to continue driven by concerns over slowdown in construction

activity in the Kingdom owing to labor market pressures.

• In the coming quarters, we expect continued pressure on NIMs and higher asset quality risks to dent profitability.

Intense industry competition is expected to pressurize NIMs, while slowdown in the construction sector due to labor

shortage is impacting loan quality.

• The sector’s aggregate loan book and deposits expanded 11.3% YoY and 11.4% YoY, respectively. The sector’s loan to

deposit ratio stood at 80.3% during 1Q2014 vis-à-vis 80.6% in 1Q2013. We expect loan book growth to continue, with

the low loan to deposit and adequate capital levels on the balance sheet providing ample scope and liquidity.

Analyst

Jassim Al-Jubran [email protected]+966 11 2256248

AGM - Head of Research

Abdullah [email protected]+966 11 2256250

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Key ThemesLending to be supported by mortgage credit and SMEsBank lending in KSA increased at a CAGR of 8.5% over 2008–13, supported by strong economic growth and increased �scal spending. The IMF expects the Kingdom’s real GDP growth to improve to 4.4% in 2014 from 3.8% in 2013. Consequently, we expect lending growth to remain healthy during 2014. The retail segment is expected to primarily bene�t from this. The higher proportion of younger population in KSA, robust demand for personal �nancing (cars, consumer durables, and mortgages), easier accessibility (online banking), and customized retail products, among others, would drive growth in retail lending. Moreover, the implementation of mortgage law is expected to boost growth in retail lending.

Low loan/deposit ratio (LDR) provides scope for substantial loan growth

The sector’s LDR stood at 80.3% during 1Q2014 vis-à-vis 80.6% in 1Q2013. This is well below SAMA’s regulatory limit of 85% and regional peers’ average of 92%. With adequate liquidity on balance sheets, banks can capitalize on this, thereby leading to a favorable supply environment for credit growth in the economy.

Adequate capital to facilitate credit growth

SAMA’s conservative and stringent regulations have helped KSA banks maintain adequate capital. The listed banks’ average capital adequacy ratio (CAR) of 18.1% in 2013 is well above the mandated CAR requirements of 8% under Basel II and 10.5% under Basel III. At the current capitalization, the industry can increase its risk-weighted assets about 2.2 times under Basel II norms and 1.7 times under Basel III norms before hitting regulatory ceilings. Consequently, we believe Saudi banks can continue their loan book expansion without impacting their credit pro�les substantially.

Mortgage law to support retail lending growth

On July 2, 2012, the long-awaited mortgage law was approved by the Council of Ministers; the law is expected to provide opportunities to real estate companies and mortgage lenders given the rising demand for residential units. There is huge scope for growth in terms of mortgages for funding real estate purchases in KSA. Currently, mortgages in KSA constitute merely 3% of GDP compared with more than 70% in other nations (e.g., the UK and US). Furthermore, the Real Estate Additional Loan Program also provides more promising opportunities in real estate �nancing. Some of the Saudi banks (NCB, Samba, ANB) have already signed memorandum of understanding with Real Estate Development Fund in order to begin implementing this loan program.

Figure 1: Real GDP, loans & deposits growth Figure 2: Scope for lending growth

Source: IMF, Company Reports, AlJazira Capital Source: Bloomberg, Company Reports, AlJazira Capital , Alinma (LTD – 114.7%) not included above

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Figure 3: Penetration of mortgage lending Figure 4: Market share of Saudi Banks

Source: Company Reports, AlJazira Capital Source: Company Reports, AlJazira Capital

Over 2008–13, mortgage lending growth (CAGR of 38.9%) outpaced retail loan growth (CAGR of 13.8%). At the end of 2013, KSA commercial banks’ mortgage lending peaked at nearly SAR 76bn compared with SAR 15bn in 2008. However, in terms of mortgage lending, KSA remains underpenetrated despite the sector’s asset base of over SAR 1.5tn. Mortgage lending contributed only 23% of total retail loans during 2013 compared with 66% for UAE. NCB and AlRajhi banks had the highest exposure to mortgage lending, representing around 41% of the market.

We estimate demand for mortgage loans will rise at about a CAGR of 17.7% over 2014–18 to SAR 181.4bn. Mortgage lending is expected to gain momentum in the coming years given the high proportion of the Saudi population under 30 years old and rising trend of nuclear families, leading to higher demand for housing units. Furthermore, the recent government development plan revealed that Saudi Arabia, with a population of around 29 million, requires to construct nearly 1.25 million houses over the next �ve years to meet growing demand. Moreover, the Saudi government has estimated that home ownership will rise to 80% by 2024 from just 30% currently (global average: 70%)1 .

Competition in mortgage lending is expected to intensify with new players entering the market. Bidaya, a joint venture between the �nance ministry’s Public Investment Fund and the Islamic Corporation for the Development of the Private Sector, is in its last phase of development with a paid-up capital of about SAR 900mn. SAMA has already issued six real estate �nancing licenses to institutions, including Riyad Bank, Arab National Bank, and Amlak International. We expect the banking sector to tap into the expanding mortgage credit market in the next two years. Furthermore, banks with high exposure to retail lending (Al Rajhi Bank and National Commercial Bank), strong branch network, and higher focus on mortgage lending products (Riyad Bank) would register a strong growth in mortgage lending. Moreover, Arab National Bank is well placed to capitalize on the Kingdom’s expanding mortgage market given its 40% ownership of Saudi Home Loans (held by Arab National Bank, International Finance Corporation, and Dar Al-Arkan).

the banking sector to tap into the expanding mortgage credit market in the next two years. Furthermore, banks with high exposure to retail lending (Al Rajhi Bank and National Commercial Bank), strong branch network, and higher focus on mortgage lending products (Riyad Bank) would register a strong growth in mortgage lending. Moreover, Arab National Bank is well placed to capitalize on the Kingdom’s expanding mortgage market given its 40% ownership of Saudi Home Loans (held by Arab National Bank, International Finance Corporation, and Dar Al-Arkan).

1. Jeddah Economic Gateway (February 2013 report); Media Reports

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Rising SME lending to boost corporate loan book growth

Besides a strong project pipeline (USD 83.4bn completed projects and USD 82.8bn awarded in 2014) the government’s focus on non-oil economy growth has provided a stimulus to private sector growth, with the SME segment also bene�ting. According to Zawya, investment in the segment is expected to grow to more than USD 70bn by the end of 2015 with the requisite funding provided by government and banks.

The government’s Kafala Program launched in 2006 has facilitated increased participation of commercial banks in SME lending. According to media reports, the volume of �nance provided by Saudi banks to small and medium enterprises (under the Kafala Program) grew 28% YoY to SAR 571.8mn in 1Q2014. Under the program, 652 guarantees were issued for SME projects in 1Q2014 compared with 488 in 1Q2013. National Commercial Bank accounted for 36% of the total guarantees, followed by Riyad Bank (22%) and Al Rajhi Bank (17%).

Uptrend in provisioning to continue in near termIn 1Q2014, six of the 11 listed banks in Saudi Arabia posted an increase in provisioning charges for impairments, leading to an overall 17.5% YoY rise to SAR 1.63bn in the sector. The asset quality of banks in the sector improved in 1Q2014, with NPLs, as a percentage (%) of gross loans, improving to 1.2% in 2013 from an average 1.8% in 1Q2013 and 1.3% in the prior quarter; the current level is the lowest in the last two years.

Construction, which accounted for 8.5% of the total corporate loan book of listed banks at the end of 2013, forms a signi�cant portion of the provisioning charges for banks. The construction sector accounted for 17–18% of the total provisions for Albilad Bank in 2013, indicating the bank’s high sensitivity to the sector. Consequently, any slowdown or delay in projects could be a concern for the banking sector, leading to higher provisioning.

Figure 5: Sectoral Credit Disbursement – 2013

Source: SAMA, Saudi Arabian Ministry of Labor, AlJazira Capital

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In December 2013, Saudi projects worth more than USD 26bn were stalled owing to labor shortage. Furthermore, Jones Lang LaSalle, a leading real estate consultant, stated labor shortage in key Saudi cities is likely to delay real estate projects and increase construction costs. Around 45% of bank credit is lent to sectors with a high proportion of non-Saudi employees (more than 80%), who are likely to be impacted by labor laws. These factors could increase NPLs in the banking industry, and hence, higher provisioning would continue during the year.

According to Business Monitor International (BMI), in light of the anticipated delays in projects due to shortages in labor and materials, growth in the construction sector would decelerate to 7.2% YoY in 2014. However, with the government continuing to award projects at a robust pace and the sizable backlog since 2011, Saudi Arabia’s project pipeline appears healthy. This would ensure overall higher growth in the sector in the medium term, with 10% YoY estimated for 2015.

The project pipeline comprises completed projects worth USD 83.4bn and projects worth USD 82.8bn expected to be awarded in 2014.

During 2014, we expect the uptrend in provisioning to continue due to concerns over slowdown in construction activity in the Kingdom owing to labor market pressures. With implementation of the ‘Saudization’ policy, the Kingdom has restricted employment of non-Saudi nationals in the private sector, leading to labor shortage, especially in the construction sector. Furthermore, we expect NPLs to rise in future led by construction sector concerns.

Despite the possibility of a rise in impairments, we believe the high coverage ratio of Saudi banks (sector average of 169% in 1Q2014 vs. 163.5% in 2013) makes them well poised to mitigate challenges arising from higher loan losses. We expect banks to remain cautious, considering the current volatile environment in the construction sector, and hence, forecast coverage ratios to remain high in 2014.

Figure 6: Asset Quality – 1Q2014

Source: Bloomberg, Company Reports, AlJazira Capital

ANB- Arab National Bank; BJAZ - Bank AlJazira; BSF - Banque Saudi Fransi; RIBL - Riyad Bank; SAIB - The Saudi Investment Bank; SABB- The Saudi British Bank; SHB - Saudi Hollandi Bank

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NIMs expected to stabilize from 2015

The net interest margins (NIMs) of KSA banks declined 79bps from 3.8% in 2008 to 3.0% in 2013, with the fall in yield on loans more than the decline in cost of funds over the same period. The yield on loans declined from 6.0% in 2008 to 3.4% in 2013, driven by intensifying industry competition and ample liquidity in the system. Money supply (M3)2 has been increasing steadily, recording a 4.9% growth in 1Q2014 comparing with 4.0% at the end of 2013 and 6.4% in 2012.

The cost of funds for Saudi banks decreased from 2.3% in 2008 to 0.5% in 2013, driven by the higher proportion of low-cost demand deposits. According to data from SAMA, demand deposits in the industry increased from 40.5% in 2008 to 62.1% in 1Q2014 (61.1% in 2013), while increase in overall customer deposits trailed loan growth during the last three years. We believe margins will remain under pressure due to intense industry competition and, consequently, yields on earning assets will continue declining through 2014.

Interest rates in the Kingdom remain low, mirroring the monetary rates in the US. The US Federal Reserve (Fed) has maintained record low interest rates at 0–0.25% since December 2008 to combat economic slowdown and high unemployment levels. Similarly, the Saudi central bank has kept its repo rate and reverse repo rate3 low at 2.0% and 0.25%, respectively, since 2009.

The unemployment level in the US has improved from its credit crisis peak of about 10% to 6.3% in April 2014, while GDP increased 1.9% in 2013 (IMF expects 2.8% growth in 2014). Therefore, the Fed is expected to gradually wind down its expansionary policy. The Fed has already begun tapering its bond-buying program, with a gradual reduction to USD 55bn for March 2014 from USD85bn for the year-ago period. Furthermore, it indicated that the interest rate would start rising in early 2015, six months after the completion of its buyback program.

Interest rates in Saudi Arabia are expected to follow suit; therefore, we expect NIMs to stabilize from 2015. According to S&P, lending growth in the banking sector is expected to be around 10% in 2014–15. Furthermore, with competition intensifying, smaller banks have been recently gaining market share in the retail segment at the cost of bigger players.

We expect NIMs to start rising from 2015, driven by the anticipated increase in interest rates and improvement in the domestic as well as global economy. Furthermore, KSA banks are gradually increasing focus on retail lending: the share of retail lending in the loan book grew from 24.4% in 2009 to 30.8% in 2013. The shift in banks’ loan mix from low-yield corporate assets to high-yield retail assets is expected to mitigate the downtrend in margins. However, owing to rising interest rates, depositors would move away from demand deposits, which have helped banks bu�er falling loan yields since 2008.

Figure 7: NIMs remain under pressure

Source: Company Annual Reports, AlJazira Capital

2. A measure of money supply that includes cash and checking deposits, savings deposits, money market mutual funds and other time deposit as well as long-term time deposits, institutional money market funds, short-term repurchase agreements and other larger liquid assets.

3٫ The rate at which the central bank of a country lends money to commercial banks is called repo rate. Reverse repo rate is the rate at which the central bank borrows money from commercial banks within the country.

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SAR Mn Net Income Operating Income NSCI*1Q2014 1Q2013 % YoY 1Q2014 1Q2013 % YoY 1Q2014 1Q2013

AlRajhi Bank 1,706 2,052 -16.9% 3,511 3,441 2.0% 2,439 2,360

Samba Banking Group 1,241 1,159 7.1% 1,873 1,897 -1.3% 1,083 1,082

Saudi British Bank 1,081 948 14.0% 1,621 1,438 12.8% 961 885

Riyadh Bank 1,079 951 13.5% 1,932 1,725 12.0% 1,230 1,090

Saudi Fransi Bank 856 684 25.1% 1,401 1,205 16.3% 897 799

Arab National Bank 713 679 5.0% 1,309 1,268 3.2% 857 775

Saudi Holandi Bank 417 346 20.4% 757 584 29.7% 447 352

Saudi Investment Bank 338 314 7.4% 757 505 49.8% 355 339

Alinma Bank 293 221 32.6% 600 522 14.9% 513 443

AlBilad Bank 174 143 21.9% 478 450 6.2% 227 222

AlJazira Bank 159 144 10.4% 517 443 16.7% 322 266

Total 8,056 7,641 5.4% 14,756 13,478 9.5% 9,330 8,613

Source: Bloomberg, Company Reports, AlJazira Capital

* Net Special Commission Income = Special Commission Income minus Special Commission Expenses

Figure 8: 1Q2014 financial results

The net earnings of Saudi Arabia’s banking sector increased 5.4% YoY to SAR 8.1bn in 1Q2014, after growing 0.4% YoY in 4Q2013. Loan book and deposits grew 11.3% YoY and 11.4% YoY, respectively. The weighted-average EPS stood at SAR 0.80per share. Al Rajhi was the only bank to register a decline in earnings (down 16.9% YoY), while Alinma Bank recorded the highest growth (32.3% YoY). Alinma’s growth was supported by higher net special commission income (up 15.8% YoY) and improved operational e�ciency due to maturity in operations. Among conventional banks, on a YoY basis, Banque Saudi Fransi (BSF) grew 25.1%, while heavyweights Riyad and Samba rose 13.5% and 7.1%, respectively.

Figure 9: Loan book (SAR bn) Figure 10: Deposit (SAR bn)

Source: Bloomberg, Tadawul, AlJazira Capital Source: Bloomberg, Tadawul, AlJazira Capital

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Valuations

Given the sound growth prospects of Saudi banks, they trade at a higher valuation multiple than that of their developed market peers. The average P/B ratio (TTM) at 2.0x for the Kingdom’s banks is 51.2% higher than that of their US counterparts. Furthermore, regional banks command a higher premium vis-à-vis banks of other developing markets and trade 30.5% higher

Among Saudi banks, Al Rajhi has the highest ROA at 2.8%, followed by Saudi British Bank (2.2%). Al Rajhi bene�ts from its robust Islamic �nance franchise—it is one of the largest Islamic banks worldwide—and retail banking, which has been growing rapidly. The bank trades at 2.7x in terms of P/B. Given its signi�cant retail foothold, dominant market position, strong fundamentals, and healthy growth potential, the stock has always traded at a high valuation. Bank AlBilad trades at the highest P/B multiple of 3.2x, 77% higher than the sector average.

Figure 11: Valuations

Figure 12: Valuations

Source: Bloomberg

Source: Bloomberg, AlJazira Capital

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Al Rajhi Bank: Higher provisioning dents earnings

• Profitability hit by higher operating expenses and provisions: Al Rajhi Bank (Al Rajhi) posted a 16.9% YoY dip in cumulative net income, driven by a higher-than-expected 74.8% YoY increase in provisioning charges and elevated operating expenses (up 11.9% YoY). The bank was also impacted by the slow 2.0% YoY growth in operating income, pressurized by a 10bps YoY decline in NIMs to 3.9%, which has been on a downtrend for the past few quarters. Loan book growth slowed to 7.0% YoY, while customer deposits rose 2.9% YoY, the lowest amongst its peers.

• Uptrend in provision to continue: We expect the trend to continue and the bank to record a 16.8% YoY rise in provisioning in 2014. The NPL ratio increased to 1.7% in 1Q2014 from 1.5% a year ago; however, the coverage ratio has remained stable (145% in 1Q2014 vis-à-vis 147% in 1Q2013).

• Margin pressure persists: We expect operating income growth to remain subdued in 2014, due to a slower rise in lending with increasing competition in the sector. Persistent flat interest rates would continue adding pressure on NIMs; average yields declined 17bps YoY during the quarter. Furthermore, rising costs and deceleration in income growth may dent the bank’s profitability. It has historically maintained one of the lowest cost-to-income ratios in the sector (29% vis-à-vis 38% sector average in 2013); however, the cost to income ratio increased to 28.7% in 1Q2014 from 25.9% in 1Q2013.

• Lending and deposit growth to remain muted in 2014: The bank’s growth in lending and deposits was one of the lowest among listed stocks in 1Q2014. We expect growth in lending and deposits to remain muted in 2014. However, we expect the bank’s credit growth to remain healthy and increase at a CAGR of 11.5% during 2014–18, supported by a strong capital base and lower loan-to-deposit ratio. Moreover, in terms of implementation of the mortgage law, Al Rajhi is better placed given its experience in retail lending.

• Valuation: We assign a Neutral rating on the stock and our 12-month target price is SAR 63.6 per share, with a downside potential of 4.7% from the current market price of SAR 66.8 per share.

Recommendation ‘Neutral’

12-month price target; SAR 63.6

Current Price: SAR 66.8

Upside / (downside): -4.7%

Reuters code: 1120.SEBloomberg code: RJHI ABCountry: Saudi ArabiaSector: BankingPrimary Listing: TASIM-Cap: SAR 108.5bn52 Weeks H/L (SAR): 75.0/62.3

SAR Mn Estimate ActualBanking Income 3,787 3,511Net Profit 2,108 1,706Loan Book 202,233 193,048

SAR Millions 2012 2013 2014 E 2015 E 2016 E 2017 E 2018 E

Net Income 7,884.7 7,438.0 7,007.0 7,827.6 9,109.9 10,621.9 12,493.2 YoY Growth (%) 6.9% -5.7% -5.8% 11.7% 16.4% 16.6% 17.6%EPS (SAR) 5.3 5.0 4.3 4.8 5.6 6.5 7.7PB (x) 3.1 2.8 2.8 2.6 2.5 2.3 2.0PE (x) 12.9 13.5 15.5 13.9 11.9 10.2 8.7Dividend Yield (%) 4.8% 3.7% 3.7% 3.7% 5.2% 5.2% 5.2%ROE (%) 25.3% 21.6% 18.8% 19.6% 21.3% 23.1% 24.7%ROA (%) 3.2% 2.7% 2.4% 2.5% 2.6% 2.8% 3.0%NPL Ratio (%) 2.0% 1.6% 1.6% 1.5% 1.6% 1.6% 1.5%NPL Cov. Ratio (%) 136.9% 143.6% 167.0% 172.8% 166.4% 161.8% 166.3%

Key information

1Q2014 vis-à-vis estimates

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Bank AlBilad: Rising costs limit growth prospects

• Strong earnings growth in 1Q2014 despite margin pressure: Bank AlBilad (AlBilad) reported a 21.9% YoY growth in net earnings in 1Q2014. This was primarily due to lower provisioning in the quarter. Provisions during 1Q2014 contracted 92.8% YoY to SAR 4.7mn from SAR 64.7mn in 1Q2013. Despite strong loan book growth (up 29.9% YoY), special commission income increased just 3.9% YoY. This was largely ascribed to lower yields. The bank’s average yields declined 45bps, while cost of funds increased, leading to a compression in NIMs to 2.8% in 1Q2014 from 3.3% a year ago.

• Low provisions boost earnings; a temporary trend?: AlBilad’s provisioning has been declining, from SAR 64.7mn in 1Q2013 to SAR 4.7mn in 1Q2014. This has been largely due to a decline in nonperforming loans (NPLs) from SAR786.3mn to SAR425.1mn. Consequently, the bank’s NPL ratio declined from 4.0% in 1Q2013 to 1.7% in 1Q2014. However, we remain cautious and expect NPLs to increase in the coming years, given the slowdown in the construction sector (impacted by labor laws) and rising lending to SMEs. The bank’s loan book is largely driven by the corporate segment (accounted for about 60% in 2013); the lending exposure to the building and construction sector was about 25% of the corporate segment in 2013. Hence, we believe the decline in provisions is a temporary trend, which would reverse in the coming quarters.

• Persistent concerns on rising costs: The bank reported an increase in the cost-to-income ratio to 62.6% from 53.9% in 1Q2013 and 53.1% in 4Q2013. In terms of the cost-to-income ratio, AlBilad has consistently lagged behind its peers, which average about 38%, in recent quarters. The increase in operating expenses of 23.3% YoY outpacing the total income growth of 6.2% YoY in the quarter poses a huge concern for the bank. Staff costs, accounting for 57.9% of total operating expenses, was the major driver for the increase in expenses, rising 19.6% YoY.

• Remains underweight given steep valuation: We reiterate our ‘Underweight’ rating for the stock, and maintain our target price at SAR 33.1 per share, with a downside potential of 29.5% from the current market price of SAR 46.9 per share. Further, the bank trades at the highest P/B multiple (2014E) of 3.2x, 77% higher than the sector average.

Recommendation ‘Underweight’

12-month price target; SAR 33.1

Current Price: SAR 46.9

Upside / (downside): -29.5%

Reuters code: 1140.SEBloomberg code: ALBI ABCountry: Saudi ArabiaSector: BankingPrimary Listing: TASIM-Cap: SAR 18.8bn52 Weeks H/L (SAR): 48.6/24.1

SAR Mn Estimate ActualBanking Income 537 478Net Profit 192 174Loan Book 24,266 24,277

SAR Millions 2012 2013 2014 E 2015 E 2016 E 2017 E 2018 E

Net Income 941.8 729.2 727.6 690.9 800.1 911.6 1,009.5 YoY Growth (%) 185.7% -22.6% -0.2% -5.0% 15.8% 13.9% 10.7%EPS (SAR) 1.9 1.8 1.8 1.7 2.0 2.3 2.5PB (x) 1.4 3.7 3.2 2.9 2.6 2.3 2.1PE (x) 6.5 25.7 25.8 27.2 23.4 20.6 18.6Dividend Yield (%) NA NA NA NA NA NA NAROE (%) 14.6% 15.4% 13.3% 11.3% 11.7% 11.8% 11.7%ROA (%) 2.0% 2.2% 1.8% 1.3% 1.2% 1.2% 1.1%NPL Ratio (%) 3.9% 1.9% 1.6% 1.5% 1.5% 1.5% 1.5%NPL Cov. Ratio (%) 145.4% 194.3% 202.3% 222.0% 236.9% 251.1% 263.3%

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11 © All rights reserved

Saudi Banking Sector

Sector Report

June 2014

Please read Disclaimer on the back

Alinma Bank: Lower provisioning boosts pro�tability

• Robust growth driven by higher operating income: Alinma Bank (Alinma) reported net profit growth of 32.3% YoY to SAR 292.8mn in 1Q2014, driven by increasing operating income along with a decline in provisioning. Banking income increased 15.0% YoY to SAR 599.8mn, as net special commission income and non-commission income rose 15.6% YoY and 11.2% YoY, respectively. The bank’s loan portfolio expanded 16.2% YoY, whereas deposits increased 31.4% YoY. Consequently, the loan-to-customer deposits ratio stood at 101.5% in 1Q2014 from 114.7% in 1Q2013. This is still above SAMA’s prescribed limit of 85%. Growth in retail lending continued to exceed that in corporate lending, as the bank focused on the former through branch expansion and new product launches.

• Lower provisioning supports growth: Apart from a strong rise in banking income, lower provisioning during the quarter led to higher earnings growth. The bank’s provisioning declined 51.1% YoY to SAR 25.0mn from SAR 51.0mn a year earlier. Despite a decline in provisioning, the bank’s coverage ratio remains high at 170.0% in 1Q2014. However, we expect provisioning expenses to increase in the coming quarters.

• Robust loan growth to drive profitability: Loan growth has consistently been strong for the bank historically, and is expected to grow at a CAGR of 18.6% during 2014–18E.

• Highest capital adequacy in the sector: In 2013, Alinma reported a CAR of 28.0% and combined tier I and tier II capital of SAR 17.1bn, the highest in the industry. However, high capital base impacted the bank’s RoE, which stood at 6.0% in 2013 compared with the peer average of 13.7%. Although we believe the bank is in the initial stage of expansion, with strong deposit and lending growth potential, its high price-to-earnings ratio and low RoE make the stock less attractive and limit its upside potential.

• Valuation: We assign a Neutral rating on the stock and our 12-month target price is SAR 18.8 per share, with a downside potential of 3.1% from the current market price of SAR 19.5 per share. However, given the recent run-up in share prices (up 28% YTD) and the bank’s expensive valuation (current PE at 26.8x; sector at 17.9), we expect the stock to have limited upside.

Recommendation ‘Neutral’

12-month price target; SAR 18.8

Current Price: SAR 19.5

Upside / (downside): -3.1%

Reuters code: 1150.SEBloomberg code: ALINMA ABCountry: Saudi ArabiaSector: BankingPrimary Listing: TASIM-Cap: SAR 29.2bn52 Weeks H/L (SAR): 19.9/13.1

SAR Mn Estimate ActualBanking Income 636 683Net Profit 302 303Loan Book 47,535 45,811

SAR Millions 2012 2013 2014 E 2015 E 2016 E 2017 E 2018 E

Net Income 733.2 1,004.8 1,245.6 1,519.6 1,887.6 2,268.3 2,753.3 YoY Growth (%) 70.0% 37.0% 24.0% 22.0% 24.2% 20.2% 21.4%EPS (SAR) 0.5 0.7 0.8 1.0 1.3 1.5 1.8PB (x) 1.2 1.3 1.2 1.1 1.0 0.9 0.8PE (x) 26.4 22.2 17.9 14.7 11.8 9.9 8.1Dividend Yield (%) NA NA NA NA NA NA NAROE (%) 4.5% 6.0% 7.1% 8.1% 9.2% 10.0% 10.9%ROA (%) 1.6% 1.7% 1.8% 1.7% 1.8% 1.7% 1.7%NPL Ratio (%) 0.3% 0.7% 0.8% 0.9% 1.0% 1.1% 1.2%NPL Cov. Ratio (%) 230.5% 170.0% 174.4% 174.8% 167.3% 162.8% 156.7%

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Asset Management | Brokerage | Corporate Finance | Custody | Advisory

Head Office: King Fahad Road, P.O. Box: 20438, Riyadh 11455, Saudi Arabia، Tel: 01 2256000 - Fax: 01 2256068

Aljazira Capital is a Saudi Investment Company licensed by the Capital Market Authority (CMA), license No. 07076-37

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