The sector capital adequacy (CAR) ratio is above 17.5%(average), which is above the 8% required by SAMA.

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1 Saudi Arabia by far is the largest economy in the MENA region, housing some of the largest banks in the region. Due to the strength of the local economy, the sector usually trades at a higher multiple as compared to it regional peers. The banking sector in 2014 saw its deposit book grow by 12.4%YoY, as it stood at SAR 1,575bn. Credit growth was slightly lower at 11.6%YoY. This is not a healthy sign as it shows either conservatism of banks or lack of suitable lending opportunities. This is evident in the sector ADR ratio, which are below the regulatory requirement. Advances to Deposit ratio (ADR) decreased slightly from 79.9% to 79.4%. In contrast, GDP in 2014 grew by 1.5% YoY as it stood at SAR 2,795bn (USD 745bn). Going forward, given that the government is looking to maintain its fiscal expenditures, we expect credit growth to be favorable. However, the government might look to finance its fiscal expenditure through debt financing, which can crowd out the retail loans. The sector s reliance on corporate loans is comparatively high, which provides the sector with an opportunity to improve its retail loans penetration. A higher concentration of retail loans can result in the improvement of Net Interest Margins (NIMs). Mobily owes around SAR 14.0bn to the Saudi banking sector. Recent financial performance has raised a number of question marks. The company in light of its performance has broken a number of covenants, which has resulted in the company readjusting its balance sheet by transferring a part of its long term loans to short term loans. The company is undergoing review by the Capital Market Authority. The United States Federal Reserve have given early indication of increase in interest rates by highlighting the strength of the US economy. This consequently will result in higher discount rates in Saudi Arabia due to the currency peg. Since the share of interest bearing deposit is very low, increase in interest rates will consequently result in higher NIMs. The sector capital adequacy (CAR) ratio is above 17.5%(average), which is above the 8% required by SAMA. The sector ADR is below the regulatory requirement of 85% which gives it enough room to improve its loans portfolio. The sectors non-performing loans are thoroughly covered given that the net provision are higher than the nonperforming loans. NPLs (Non-performing Loans) to total loans ratio stood at 1.3% in Q Penetration for mortgage finance has remained limited, due to down payment requirement of 30%. Secondly the mortgage law has provide support for the demand side of the housing shortfall, however the supply side still faces number of challenges, like labor shortage and and slow real estate development. Syndicated loans, in 2013, stood at SAR 237.3bn, depicting a jump of 35.3%YoY and a CAGR of 45%. The Saudi stock market (Tadawul ) showed strong performance in terms of its value traded. In 2014 value traded stood at SAR 2,146.51bn, as compared to SAR 1,369.67, depicting a jump of 56.7%YOY. Total market capitalization towards the end of 2014 stood at SAR bn. Daily average value trade stood at SAR 8,586.05mn, depicting a jump of 55.46% YoY. So far the trend has continued in 2015 as value traded in February stood at SAR 194.3bn, depicting a jump of 43.7%,which will help capital market related revenue at banks. The sectors profitability in 2014 stood at SAR 41.5bn, as compared to SAR 37.6bn in 2013, translating into a jump of 10.2%. Bank Alrajhi and Bank Aljazira are the only two banks which showed a decline in their profitability. However, the decline in Bank Aljazira profitability was due to extraordinary provisioning in 3Q Adjusting for Bank Alrajhi and Bank Aljaizra, the sector posted a jump of 15.3% YoY. The sector overall has limited avenues to tap in order for it to improve its growth trajectory. We believe retail loans market share will remain weak, whereas public sector lending is expected to pick up, however public sector lending will be at lower rates, which will impact the sectors NIMs. 1 Senior Analyst Talha Nazar t.nazar@aljaziracapital.com.sa

2 - 0 Banking Sector Deposits and Credits Millions SAR 1, , , T otal D eposits ( L H S ) Banks Credit to P rivate Banks Credit to P ub l ic AD R * D eposit G row th Credit G row th S ector ( L H S ) S ector ( L H S ) ( R H S ) ( % ) ( R H S ) ( % ) ( R H S ) Source: Saudi Arabia Monetary Agency Saudi GDP growth % B illions SAR % 4 % 2 % % Total GD P ( at constant price = 1999) GPD grow th ( R HS) Source: Saudi Arabia Monetary Agency Banking Sector ROE Sector R O E, 14.4% % % % % % % % % % % 0. Alinma Alj az ira Saudi I nvestment R iyadh Samb a Saudi Fransi Arab N ational AL B ilad Al R aj hi SAB B SHB N CB R O E Sector R O E Source:Tadawul 2

3 Saudi Economic activity might impact credit growth Credit growth might slowdown, as a result of cut in fiscal spending. Banks might shift focus to public loans, as the government might look to finance its deficit through borrowing. Retail loans growth can slow down. Saudi Arabia s underlying strength remains intact with strong reserves, diversification into non-oil economic sources, a strong infrastructure, and strong growth in the private sector. However, the economy is still heavily reliant on oil, since almost 90% of its export revenues are dependent on oil. Oil prices has declined 50% from its peak in The kingdom is looking to sustain fiscal expenditures; this will potentially result in deficit financing through reserves. The kingdom has around SAR 2.7 trillion in reserves and deposits. We believe, for a single year or a couple of years there is no harm in deficit financing through reserves. However, this can be difficult to sustain for the government if this goes for a longer period. We believe the government can also finance its deficit through debts, in our view the government has two options: Issuing Bonds or Sukuks; Borrow directly from local banks, which could potentially Crude Oil (Brent) % ( % ) J J S 1 4 N 1 4 J 1 5 Ann an- Mar- May- ul ep- ov- an- Source: Bloomberg Saudi Crude Oil production Million b b l per day cause a crowding-out effect, i.e. making funds less available and affordable to private sector B arrel per day % Change Source: United States Energy Information Administration % 1 5 % - 5 % % U S D / b b l Retail Loans showing stagnated growth Towards the end of 3Q-2014, retails loans 1 stood at 358bn depicting an increase of 7% YoY, as market share of retail loans stood at 28.9%, a fall of almost 150bps (basis point) from the market share realized in The overall growth in retail loans was much slower than 11.6%YoY growth in total loans. The fall in the market share for retail loans is negative for the sector given that retail loans usually provide the highest NIMs. Going forward, retail loans could face further pressure if the government decides to fund its budget deficit through borrowing, which will consequently result in some banks shifting their focus to low risk public sector lending. Retail Loans B illion SAR R etail L oans ( L HS) Share of R etail loans( R HS) 2 8 % % % 4 5 % % % % 1 5 % Source: SAMA, AlJazira Research 3 1. Includes real-estate renovation, furnishing, cars and equipment financing, credit card loans, personal finance

4 - Given the comparatively low ADR for the sector, which has been below the regulatory requirement. The sector still has room to Improve its loan book. ADR of Saudi Banks 1 0 R egulatory L imit, 85% AD R R egulatory L imit 6 5 % 6 4 % Credit Cards Business 6 2 % 6 8 % Credit Card Loans % of Retail Loans (including Credit Cards) % 1 6 % 1 4 % 1 2 % 1 8 % 6 % 4 % 2 % 7 6 % 9 2 % 8 4 % 8 3 % 8 8 % 7 8 % 7 9 % 7 8 % 7 9 % % Source: SAMA Credit card loans, which generates some of the highest NIMs, have also been witnessing a declining share. According to SAMA, credit card loans in 2013 stood at SAR 8.4bn, depicting a jump of 5.3%YoY; however share of credit card loans in total retail loans has declined to 2.5% in 2013 from 2.8% in Source: SAMA Revenue Per Employee- RPE The Saudi banking sector generated a revenue of SAR 1.45mn/employee, on average,in 2014, as compared to SAR 1.4mn/employee in 2013 ( a YoYgrowth of 3.5%)interestingly, the top three shariah compliant banks were below the market average. Alrajhi has the second lowest revenue/employee, followed by bank Aljazira. Bank Albilad is the least efficient on these parameters. Revenue/Employee Millions b R h j S H l Al il ad aj i Al az ira AN B Al inma audi ol andi R iyadh S I B S audi Fransi S ABB N CB S amb a R evenue/ empl oyee R evenue/ empl oyee Average Average Source: Bloomberg, Tadawul 4

5 Decreasing NIMs to prove challenging The low ADR as compared to the regulatory requirement has created excess liquidity in the sector, forcing banks to lower lending rates in order to attract more clientele. For 2015, the improvement in NIMs is unlikely given that the ADR situation has remained stagnant for the last couple of years where it has remained around the 80% mark. On the other hand, we do not expect any significant improvement in interest rates, since the Saudi riyal is pegged to the US dollar. The recent Fed meeting has highlighted the strength in the US economy, the underlying inflation has remained below the 2% mark; which might further go down if oil prices remain at current level. US unemployment rate stood at 5.6% in February-2015, slightly lower than 5.7% in January However this is much lower than 6.7% in February Some economists believe that the Federal Reserve s will start increasing interest rates in June. Given the slow paced inflation and a slight uptick in unemployment, some pundits were of the view that the increase will be delayed. The Federal Reserve is expected to issue the first increase in interest rates by June According to the Fed s latest statement (March 2015), the rate hike projection is expected to be at a slower pace than previously estimated, stating concerns over a rising Dollar. FOMC (Federal Open Market committee) members median outlook for interest rates increase was reduced, currently standing at 0.625% for 2015 and 1.875% for 2016, confirming the Fed s reserved outlook compared to previous predictions. It is worthy to note that the correlations between US and Saudi interest rate is high, at Any rise in US interest rates would naturally be followed by a rise in Saudi rates. This would be quite beneficial for Saudi banks especially that 64% of deposits are classified as deposits that pay no interest. The NIMs of the sector however will remain under pressure as the underlying challenges to the sector are still intact. Saudi Banks Net Interest Margins 7. 5 % % 4. 2 % % 2. 9 % 2. 3 % 1. 5 % 4. 4 % 3. 9 % 3. 6 % 3. 6 % 3. 4 % 3. 4 % 3. 5 % 3. 4 % 3. 3 % 3. 1 % % 0. 4 % 0. 4 % 0. 4 % 0. 5 % 0. 5 % N I Y Ms Average ield on earning assets Average Cost of funds Source: Company Annual Reports, Aljazira research SAIBOR Rate (Saudi Arabia Interbank Offer rates) Feb Mar- 1 4 Apr- 1 4 May- 1 4 J un- 1 4 J ul Aug- 1 4 S ep- 1 4 O ct- 1 4 N ov- 1 4 D ec- 1 4 J an- 1 5 Feb M 6M 12M Source: Bloomberg 5

6 Asset Quality The Sector NPL (Non-performing loans) ratio seems to have stabilized, as in 3Q-2014 it stood at 1.32% as compared to 1.31% towards the end of However it should be noted that around SAR 43bn have been allocated to the Telecommunication and Transport sectors. We believe that, in the Telecommunication segment, Mobily and Zain have been facing cash flow issues, especially Zain which on an operational level has been Mobily Loans Banks Loans in SAR mn generating losses. Zain owes almost 2.25bn to local banks. Mobily has Local Banks 8899 shown disappointing performance in the last couple of quarters, along Local and international Banks 1654 with weak cash flows and with a heavy burden of almost SAR 14bn to Saudi Investment Bank 1500 the local banks. We believe, Mobily may face liquidity issues after its 2014 Samba 591 audited results were announced, where the company announced that Saudi Fransi 500 it has re classified around SAR 2.0bn of its loans from long term to short, due to breach of a number of covenants. The company faces multiple Local Banks (Bayanat AlOula) 1291 issues, due to which, it will find it challenging to generate enough free cash flow to pay its creditors. Total Banks Claim on Private Sector -Non Performing Loans Agriculture and Fishing Mining and Quarrying Finance Utilities & Health Services Transport & Communications Government & Quasi Govt Services Construction Manufacturing and Processing Commerce Miscellaneous 0.9% 1.6% 2.8% 2.9% 3.5% 3.7% 4.8% 6.7% 12.7% 20.4% 40.0% Q N PL s/ Gross L oans Source: SAMA Source: SAMA, *Net NPLs are Gross NPLs adjusted for provision 6

7 RESEARCH DIVISION AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa Analyst Sultan Al Kadi s.alkadi@aljaziracapital.com.sa Senior Analyst Syed Taimure Akhtar s.akhtar@aljaziracapital.com.sa Analyst Jassim Al-Jubran j.aljabran@aljaziracapital.com.sa Senior Analyst Talha Nazar t.nazar@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager - Brokerage Division Ala a Al-Yousef a.yousef@aljaziracapital.com.sa Sales And Investment Centers Central Region Manger Sultan Ibrahim AL-Mutawa s.almutawa@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa lalmutawa@aljaziracapital.com.sa Area Manager - Qassim & Eastern Province Abdullah Al-Rahit aalrahit@aljaziracapital.com.sa Regional Manager - West and South Regions Abdullah Al-Misbahi a.almisbahi@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. RATING TERMINOLOGY 1. Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated Overweight will typically provide an upside potential of over 10% from the current price levels over next twelve months. 2. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. 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