Matein Khalid: Is The Bank Bull Market Near A Peak?

The past two years have been fabulous for the Gulf’s bank shares, which have outperformed the MSCI financials by a stellar 30 per cent. The reasons for Gulf bank sector outperformance to accelerating loan growth, MSCI index upgrades (UAE, Qatar), Saudi Arabia’s historic market opening to foreigners, the revaluation of regional property markets and a fall in non-performing loans.

However, there are now storm clouds on the Gulf macroeconomic and banking horizon.

A surge in the US dollar has led to a steep fall in Brent crude oil prices below $100 a barrel. The Federal Reserve could be on the precipice of monetary tightening and higher US dollar interest rates have historically led to a fall in the property markets of regions pegged to the US dollar, such as Hong Kong and the GCC.

Valuations are no longer cheap at 12 times earnings or a premium to the emerging markets banking index. Moreover, the escalating war against the insurgent ISIS caliphate in Iraq and Syria raises geopolitical risk in the Middle East.

Saudi Arabia has the largest, most attractive, most liquid banking market in the Gulf. Saudi bank shares surged 20 per cent after the Kingdom announced its historic new opening despite the Saudi Arabian Monetary Agency’s (SAMA) new restrictions on consumer banking loans.

This is the reason I recommended only the most liquid, corporate centric banks with potential for a valuation upgrade rather than retail banks whose net interest rate margins will be pressured by higher Saudi Riyal interest rates.

The obvious strategy choice is to focus on SAMBA Financial, the Kingdom’s preeminent corporate bank, trading at 10 times forward earnings and a loan to deposit ratio of only 76 per cent with a corporate loan book that will re-price higher as interest rates rise.

However, Saudi banks now trade at twice the forward book value, historically an expensive metric.

I expect Wall Street will have its first 10 per cent correction since August 2011 as stronger US growth data forces the Yellen Fed to tilt away from its “easy money” policies. This could lead to the dollar’s rise to 1.25 Euro, a fall in Brent to $94 a barrel, a spike in the Volatility Index (VIX) and a potential 15 to 20 per cent correction in Gulf bank shares this winter.

Gulf bank shares also benefited from offshore capital flows into the region once Field Marshal Sisi was elected President of Egypt and enacted pro-market reforms to stabilise the economy of the most populous state in the Arab world.

However, cuts in fuel subsidies, huge budget deficits, terrorism in the Sinai, the wheat import bill, low central bank reserves and a dependence on Saudi/ Kuwaiti/UAE financial aid means Egypt could well face solvency risk without a credible IMF stabilisation programme. Egypt was ballast for Gulf equities in 2013 to 14. Egypt could be a source of risk for Gulf equities in 2014 to 15.

In any correction in Gulf equities this winter, I believe National Bank of Abu Dhabi (NBAD), the flagship government bank of Abu Dhabi, with the lowest funding cost, lowest non-performing loans and highest fee income in UAE banking is a compelling buy at Dhs13 for a Dhs15 target.

UAE banks have been the best performers in the Gulf due to five per cent economic growth, successful debt restructuring, a vibrant property market, accelerating earnings growth and events such as the credit bureau and new trade finance flows with China.

I believe valuation rerating or debt repayment is no longer a compelling theme in UAE banking.

My ideal UAE bank share is cheap, liquid, with an underleveraged balance sheet and potential for corporate restructuring. Union National Bank (UNB) at 8.5 times forward earnings, 19 per cent Basel Tier One capital ratio and 15 per cent EPS growth potential meets all my criteria for a valuation rerating. A bull market peak does not mean the onset of a bear market.

To me, Saudi and UAE bank shares are classic “buy on dips” on any market correction.