Dubai: Stronger than expected results in the second quarter of 2017 points to resilient performance of Saudi banks in second half of the year according to banking sector analysts,
“Earnings should be resilient in 2017 for Saudi banks, after stronger than expected Q2 results, 9.1 per cent above our expectations, mainly driven by robust margin improvement (still down by -2.4 per cent year on year),” said Jaap Meijer, Director of Research at Arqaam Capital.
Going forward, margin improvements are expected to come under pressure as net interest margin expansion is likely to slow because of increase in cost of funding in the second half.
In the first half of the year margins improved as a result of delayed asset re-pricing and lower funding costs, increasing by 28 basis points (bps) year on year. Although Saudi interbank offered rate (Saibor) declined in the first half of 2017 from the previous corresponding period, asset yields have benefited from continued asset re-pricing and increased credit restructuring.
Cost of funding is expected to increase again in the second half of the year due to higher Libor [London interbank offered rate] and potential widening of Saibor-Libor spreads driven by increased bond issuances. Balance sheet expansion should improve only slowly in the second half of this year, with deposit growth picking up as government deficit is now better funded, easing liquidity pressures.
Tepid balance sheet growth
During the first six months of the year loans contracted by 1.9 per cent year on year while deposits increased by 1.9 per cent, allowing all banks to significantly improve their loan to deposit ratios, down -300 bps to 81 per cent.
Saudi banks in general reported tepid balance sheet growth last quarter as credit demand remained subdued, however, competition for non-interest bearing deposits seems to be on the rise again. Balance sheet growth is likely to accelerate as crowding out effects of government deficits dissipate and capital expenditure increases.
This increased liquidity bodes well for margins, as some banks can further improve their investment yields by participating in the latest sovereign bond issuances. Analysts expect both interest income and non-interest income to recover gradually as credit demand to pick in the last quarter.
“We expect both fees and trading income to pick up in 2018, mainly as credit growth resumes underpinned by National Transformation Programme and phasing in of fiscal consolidation as Saudi Arabia’s fiscal deficit continues to improve,” said Karim Kekhia, an analyst at Arqaam Capital Offshore Research
Regulatory limit
The banking sector increased mobilisation of time accounts, moving away from non-interest bearing deposits, as they sought to address the increasing Saibor in the second half of 2016. This, however, resulted in a reduction in total deposit base, while loan to deposit began to tighten beyond the regulatory limit. Ultimately, it forced many banks to increase their deposit books again towards the end of last year by chasing more expensive time accounts. Only a few banks have been able to keep a tight lid on funding costs without sacrificing deposit growth. Those banks should have the strongest NIM expansion in the second half of this year.
Overall, the first half of the year, Saudi banks’ cost of revenue (CoR) remained in check, slightly up by 15 bps year on year, as provisions are remained under control. Asset quality metrics are expected to remain strong in the context of improving macro indicators. Saudi Arabia’s PMI rose to 55.7 from 54.3 in July, suggesting a recovery from the sluggish first quarter real non-oil GDP growth of 0.9 per cent.
Deposit growth picked up last quarter, mainly as some banks were forced to address their (too) high loan to deposit ratios, while others could be positioning themselves for a pickup in credit growth next year, or improving their liquidity to participate in sovereign bond issuances.
