Matein Khalid: Banking On Change

GCC banks were the beneficiaries of the broad stock market rallies in the region, in 2013, up 25 per cent at a time when the Morgan Stanley emerging markets bank index lost six per cent. This significant outperformance was due to a combination of earnings momentum, valuation reratings, accelerating credit growth, lower provisioning on real estate loans as property markets rose and global capital flows into frontier markets not exposed to dollar funding risks.

2013 was unquestionably the best year for GCC bank investing since the failure of Lehman, the subsequent ice age in global interbank and funding markets, the depositor run on Kuwait’s Gulf Bank, the $24 billion Saad Al-Gosaibi corporate loan scandal, the Nakheel standstill agreement and crash in Dubai real estate traumatised the sector.

I expect GCC banks to continue to be profitable investments in 2014, though investors will need to stock pick specific banks for outperformance. The macro environment will be less benign asthe Federal Reserve will decelerate the expansion of its balance sheet, now almost $4 trillion. This means global liquidity will contract and credit spreads for emerging market borrowers in global bank wholesale funding markets will rise.

Oil production growth in Iran, Iraq, Libya, US shale, Gulf of Mexico and offshore West Africa at a time when Saudi Arabia has refused to play the role of swing producer in OPEC and engineer a cut to OPEC’s 30 million output cap, means that there is now a non-trivial probability of a major fall in Brent crude oil, possibly to as low as $85-90. This is not bullish for GCC government infrastructure spending or the trade/ project finance component in GCC bank earnings central banks in the GCC are also concerned about embryonic asset bubbles in property markets, highlighted by the IMF’s warning about a property bubble in Dubai. The UAE Central Bank has introduced lending caps on retail lending and credit exposures to state owned companies. The Saudi Arabian Monetary Agency has cracked down on excessive fees in Saudi bank wealth management products. Kuwait has still not resolved its problems of zombie investment management companies whose failure could hit bank profits.

The ten year US Treasury bond note has risen from 1.4 per cent in July 2012 to as high as 2.9 per cent now, meaning GCC banks face losses on their inventories of regional corporate bonds and sukuk. Loan growth is flat in the UAE and Saudi Arabia and expected to decline in Qatar and Bahrain. Only Omani bank loan growth will rise from 10 per cent in 2013 to 14 per cent next year. Margin compression is inevitable in UAE banking as funding costs rise while spreads on corporate and retail lending compresses.

However, despite the regulatory and macro caveats, asset quality and earnings power of GCC banks will improve in 2014, as non-performing loans and provisioning for bad debt falls. The recent diplomatic rapprochement between Iran and the US could also be positive for trade finance in Dubai banks if sanctions ease. As political violence rages in Egypt, Syria, Lebanon, Iraq, Yemen and Sudan, losses on GCC banks Arab world subsidiaries and affiliates are inevitable.It is essential that investors be prudent and selective in their bank investment strategy in 2014.

Saudi bank shares have the greatest upside potential in 2014. SAMBA, with its 19 per cent capital adequacy and 73 per cent loan to deposit ration as well as its unique corporate lending franchise, is the most attractive bank share in Saudi Arabia. SAMBA trades at a modest 10 times forward earnings and 1.4 times price/book value. My buy/sell ranges on SAMBA are 45-60 Saudi riyal.

NBAD is the flagship state owned bank of Abu Dhabi, an Arab safe haven credit that boasts 100 billion barrels of proven crude oil reservs and $800 billion in sovereign external assets. NBAD has the lowest funding cost and NPL ratio in UAE banking with secular earnings growth rate of at least 12 per cent in 2014.