Egyptian banks benefit from strong net interest margin expansion: Arqaam Capital

Egyptian banking stocks have outperformed EGX30 by +10.5% year-to-date

Egyptian bank stocks witnessed an upside despite a rally of +21.6% year-to-date (y-t-d), and the banking sector has increased +5.8% since the latest unexpected 200bps interest rate hike by the Central Bank of Egypt (CBE) on 9 July, outperforming the EGX30 index by 3.0%, according to the "Egyptian Bank" report published by Arqaam Capital.
Arqaam Capital estimates that the upside surpasses that of the real estate sector (15.1%), consumers sector (3.9%), telecommunications sector (+2.0%), and industrial sector (-0.7%). Arqaam Capital maintains their buying stance of Commercial International Bank (CIB), Credit Agricole Egypt (CIEB), and Qatar National Bank Al-Ahli (QNBA).
Moreover, in regards to net interest margin (NIM), the report indicates that they are supported by higher T-bill rates, as the government has funded its deficit mostly through T-bills as opposed to bonds. Higher lending rates witnessed the ongoing de-dollarisation of balance sheets, with EGP loans offering higher spreads and lower cost of revenue (COR), in addition to the witnessed improvement in the funding mix, with a higher share of retail deposits and current and savings accounts.
QNBA reported a net interest income growth of 6.1% on a quarter-over-quarter (q-o-q) basis, and 23.9% on a year-over-year basis (y-o-y), while CIB reported 6.3% q-o-q and 30.6% y-o-y. Such results reinforce Arqaam Capital's view of the interest margin growth.
Furthermore, QNBA and CIB have significantly de-dollarised their loan books following the flotation of the pound, which reduced US dollar loans to half of their loan books. CIB has increased their EGP loans by 14.0% q-o-q and 30.0% y-t-d, while their USD loans decreased by 2.2% q-o-q, and 10.2% y-t-d, with EGP loans now making up around 52.5% of total loans. QNBA increased EGP loans by 4.7% q-o-q and 5.0% y-t-d, on the other hand QNBA's USD loans decreased by 5.4% q-o-q, and 2.6% y-t-d, reducing USD loans to 30.3%, according to the report.
On the other hand, the deposit mix is improving for private banks. With the improvement of deposit spreads, CIB managed to improve its deposit mix with a higher share of retail deposits, while also increasing the share of current and savings account deposits (CASA).
With regards to asset quality trend, the report cites that it has defied economic stress. CIB's non-performing loans (NPL) declined by 19 basis points (bps) q-o-q to reach 681bps, while QNBA's NPLs remained virtually unchanged at 254bps.
Moreover, according to the report, Egyptian banks' capital generation has been strong, after a dent in capital ratios, as the depreciation of EGP led to strong balance sheet growth, but not book value growth. Banks have been able to strengthen their capital ratios by containing dividend payments as well as incorporating unappropriated earnings into their quarterly capital disclosures. QNBA's CAR increased to 15.1% and CIB to 15.6%.
Arqaam Capital forecasts higher interest rates to last into next year and to be cut only when the monthly inflation rate declines to 0.8-1.25% and real interest rates become positive, which they expect to occur by the middle of 2018.
On the other hand, the report forecasts NIMs to tighten; however, this should be offset by higher credit related fees; as credit demand picks up, banks will continue to enjoy higher NIMs than historically, thanks to the improved deposit mix.
Moreover, the latest 200bps hike has mainly supported the share price of the smaller listed banks, which still offer deep value at current prices. Conservative TPs still leave plenty of upside, while the positive stance on CIB (upside of 12.8%) is more driven by exceptionally strong appreciation in book value and steady EPS CAGR of 25%, which is driving a structural total return to shareholders well in excess of 20%, with limited room for multiple expansions.
On the other hand, yields on sovereign debt did rest, as the government has funded its deficit mainly via T-bills in anticipation of rate cuts as opposed to rise in rates. This policy came to the advantage of Egyptian banks, which enjoy higher yields on their sovereign bond investments. At the same time, a large part of the corporate loan book is on a floating basis.
However, Arqaam Capital expects loan spreads to become even more negative, although asset yields should rise nonetheless. The report forecasts policy rates to be cut only when monthly inflation rate comes down to 0.8-1.25% and real interest rates become positive, which is expected to take place by the mid 2018.
CIB remains geared for higher rates, with some delay, with a net asset liability management (ALM) gap reduced from -4.6% of assets to -1.6%, while the cumulative ALM 12 months gap is now 18.5% of assets.
On the other hand, QNBA was the second best beneficiary of interest rate changes after EGBE in Q1 2017, with 76.3% of its loans re-pricing 1M (to minimize its interest-rate risk and maximize its net interest income by minimizing the differences in re-pricing opportunities between its assets), and as of Q2, 75.1% of its loans will re-price during the same period, with the 12 month cumulative ALM gap sitting at 12.0% of total assets in Q2 2017, and the majority of its assets re-pricing in 1M, 43.3%, and 70.7% of its assets re-pricing in 12M.
Furthermore, EGBE, QNBA, CAE, CIB, and SCB can re-price more than 50% of their total loans in 1M, making them the biggest gainers of the recent double strike interest rate increase of a total of +400bps. T-bills represent 20.5%, 19.6%, 23.3%, 15.4%, and 29.7%, respectively, of sovereign exposures, allowing them to also benefit from their strong sovereign exposure.
Balance sheet growth driven by deposit growth, which has slowed, but translation effects still boosting y/y growth.
In regards to the balance sheet growth which is driven by the witnessed growth in deposit, it slowed to 1.8% q-o-q, 3.7% y-t-d, and 42.1% y-o-y, as CIB optimized its funding mix. Meanwhile, deposit growth stood at 5.3% q-o-q (51.3% y-o-y) and 5.8% y-t-d.
The share of current accounts increased from 25.5% in FY2016 to 29.0% and savings accounts from 18.1% in the same period to 20.0%, while certificate deposits and time deposits declined to 28.8% and 20.1% from 29.6% and 24.4% in FY 2016, respectively. Retail deposits witnessed 5.7% increase in q-o-q, 14.4% y-t-d, and 66.6% y-o-y.
According to the report, QNBA's balance sheet continues to grow slowly, as QNBA is managing its deposit base carefully (+2.8% y-t-d). Yet deposit growth was limited, but mix improved with retail at 46.7% of total (+3.4ppt y-t-d) and lower share of expensive time deposits (41.4%, -2.6% ppt y-t-d) and borrowings declined due to repayment of ERBD loans. However, lending growth has decreased by 20.2% in Q1 FY 2017 vs. FY 2016, with retail lending picking up as corporations wait till interest rates come down. Deposit growth has also declined in Q1 FY 2017, due to base effect, with an average growth rate of 2.7% q-o-q.
In terms of de-dollarisation, the loan mix has been increasingly de-dollarized. QNBA and CIB have strongly de-dollarized their loan mix since the flotation of the Egyptian pound and have reduced their US dollar loans to almost half of their loan books.
CIB has increased Egyptian pound loans by 14.0% q-o-q and 30.0% y-t-d, while CIB's US dollar loans continue to decline by 2.2% q-o-q, and 10.2% y-t-d, Egyptian pound loans now make up around 45.2% of the bank's total loans. In QNBA's case, Egyptian pound loans did increase by 7.2% q-o-q and 7.8% y-t-d, while QNBA's US dollar loans continue to decrease by 1.9% q-o-q and 7.4% y-t-d, reducing US dollar loans to 30.3%.