Banque Saudi Fransi (1050) Earnings Call Transcript & Summary

Good day, ladies and gentlemen. Welcome to Banque Saudi Fransi's Third Quarter Results Call in Collaboration with EFG Hermes. My name is Shabbir Malik. This call is being recorded. Joining us today is the Senior Management of Banque Saudi Fransi. We will start the presentation with an opening remarks from management and then we will proceed to a Q&A session. I will now hand the call over to Yasminah Abbas, the Head of Investor Relations. Yasminah, over to you.

Welcome, ladies and gentlemen to BSF's earnings call for the third quarter '23. Thank you, Shabbir. Thank you, EFG Hermes team for hosting this call. Our CEO, Bader Alsalloom, will go over the earnings summary and strategy update; and then followed by our CFO, Ramzy Darwish, who will go through a more detailed walk through on the financial performance. Before I hand over to our CEO, I just would like to encourage everyone to download our IR app. The QR code is available on the last page of the earnings deck. This will give you access to all the earnings presentations as well as keep you updated on all our news. Over to you, Bader.

Thank you, Yasminah. Welcome everyone, and thank you for attending the BSF third quarter earnings call. I'm pleased to report a strong set of results for the first 9 months of 2023. The impressive performance was underpinned by a favorable economic backdrop and focused execution of our strategic and operational agenda. Let me begin by summarizing our financial performance for the period. Starting with the balance sheet, loans and advances grew by 10% year-on-year, driven by balanced and high-quality lending growth of 11% in commercial and 7% in consumer. In addition, investments grew by 7% year-on-year as we continue to fortify our high-quality liquid assets and lock in higher rates for longer maturities. On the liability side, deposits expanded 5% year-on-year, mostly in interest-bearing deposits given the higher rate environment. We also raised additional longer duration debt securities and utilized additional short-term interbank and SAMA facilities to fund our asset growth. On the P&L side, the rising benchmark rates translated to solid NIM expansion, which together with the robust balance sheet growth resulted in 24% top-line and 27% bottom-line growth. On the asset quality side, the NPL and coverage ratios both improved, but cost of risk increased to 0.98%, mainly from coverage enhancements on isolated pockets in our commercial book. [indiscernible] has however trended down for the last 2 consecutive quarters and this will continue to normalize into the fourth quarter. Our capital position remains very strong with a Tier 1 ratio of 18.7%. On the liquidity side, our NIBD percentage of total deposits moderated to 55.9% from the expected shift of interest-bearing deposits in the rising interest rate environment. Our overall liquidity remains comfortable. However, LCR at 171% and SAMA LDR at 84%. Moving on to our strategy on Slide 4. As you recall, back in the first quarter of this year, we refocused and simplified our existing strategy to 10 vital initiatives, which you can see on the slide. For Wholesale Banking, of course, it was to expand our financial institutions and government function and also our new multinational corporate coverage and also to revamp our global transactional solutions. For Personal Banking, we are focused on scaling up an affluent and providing superior daily banking for our non-affluent. For Private Banking, expanding our product suite and experience-centric rewards are key initiatives. At Saudi Fransi Leasing, our new brand JB, we plan to scale up financing and leasing. And last but not least, Saudi Fransi Capital. We aim to [Technical Difficulty] opportunities in capital markets. Finally, the 2 key priorities for the first half of 2024 are to complete our technology infrastructure upgrade and rebranding. I'll give you a quick update on these initiatives on the next slide. Overall, we are seeing positive momentum in our strategy execution with overall progress now at 56% compared to 51% last quarter. Starting with Wholesale Banking, we've made strong progress with 65% completion compared with 51% completion last quarter. Here, we enhanced the operating model for our global transactional banking, finalized the scope of our new digital cash management solutions and established the new multinational corporate unit. Progress on Personal Banking was more modest with completion now at 33% versus 31% last quarter, a reflection of the greater complexity of these initiatives. During the third quarter, we kickstarted the affluent strategy implementation and launched Version 2 of our omnichannel staff pilot. We also initiated the partnership model between Wholesale Banking and Personal Banking, which is set to create more synergies and improve cross-sell. In Private Banking, progress is now at 78%, which is a solid improvement from 68% last quarter as we closed key investment offerings with Saudi Fransi Capital and secured several significant transactions under a special private banking program. We also introduced a new off-plan product to our private banking clients and successfully executed several VIP experience events. Saudi Fransi Leasing now rebranded to JB, we made significant progress in digitalizing personal finance products and overall digital IT capabilities with the percentage now at 81% versus 73% in the previous quarter. We also repositioned the business to JB, which I will expand on shortly. Finally, on Saudi Fransi Capital, more modest 37% progress has been reported given the complex nature of the business. This progress includes the finalization and commencement of our wealth management collaboration strategy during the quarter. Moving on to Slide #6. Here, I just wanted to elaborate on 2 key strategic milestones which were realized during the third quarter. First, a moment ago, I mentioned the successful rebranding of Saudi Fransi Leasing to JB, which is a repositioning of this business to diversify its offering to target distinct new market segments in the personal financing space. This strategic realignment was underpinned by a robust marketing campaign during the quarter, and we are excited by the potential in this business. Second, we opened our Sur Multifamily Office during the third quarter, which caters to the needs of our ultra-high net worth and high net worth clients, helping them to institutionalize, protect and grow their wealth through access to diverse opportunities and a specialist team of advisers. Moving next to Slide #7. Looking first at our technology infrastructure upgrade on ICP, our new integrated corporate portal. The build of the Phase 1 back end is in progress, while business requirements for Phase 2 front end have been finalized. We remain on track for a phased rollout after the second half of next year. For omnichannel, we have been working hard with ongoing future development, testing and marketing activities, readying for the launch in the first quarter of 2024. Finally, with our core banking system, we finalized testing activities for the second phase with friends and family and [Technical Difficulty] implementation is expected to be completed by year end. Thereafter, development activities for the third phase will continue into 2024. Next, on the rebranding, we have finalized the brand and go-to-market strategy and we are getting geared up for a go-live in the first half of 2024. In conclusion, I am pleased with the progress we are making on our strategic priorities. And I'm excited by the opportunities and value this will unlock going forward. With that, I'll pass it on to our CFO, Ramzy Darwish, to go through the financial performance in more detail. Over to you, Ramzy.

Thank you, Bader. Good afternoon, and a warm welcome to everyone taking the time to join us today for the Q3 2023 earnings presentation. On the strategy side, as the CEO highlighted, we had 2 major strategic initiative launches with JB and Sur, along with good traction on many others, which should help drive longer term prospects. On the financial side, overall, we reported a strong third quarter, continuing the momentum from the first half with bottom-line growth driven primarily by interest rate increases and lending growth. We will go through the rest of the financial details over the coming slides. Starting off with our balance sheet on Slide 9. The bank grew total assets by 8% year-to-date. This was mainly from 10% lending growth. And this is coming predominantly from the commercial book. The asset growth constituents are highlighted in the top right chart, whereby the loan growth is the dominant factor for the year. Investments increased by 4% year-to-date as the bank continues to invest and maintain overall liquidity ratio and interest rate risk. Investments did decrease 6% quarter-on-quarter, as expected and highlighted in our previous call, given expected maturities. On the liability side, we had growth of 9% year-to-date. This was driven by debt securities, the interbank and client deposit growth and mainly from IBDs or interest-bearing deposits, and this is highlighted in the bottom right chart on the slide. Total equity increased by 1% year-to-date. This was driven by internally generated capital via the earnings, partially offset by dividends and movements in cash flow hedge and revaluation reserves. On the next few slides, we will unpack some of the major balance sheet items. On Slide 10, in the top left chart, you will note a healthy 10% year-to-date growth for loans and advances or 3% for the quarter. This was driven by both the commercial and consumer segments with a greater tilt towards commercial lending, which grew by SAR 3.8 billion or 3% for the quarter or 11% during the 9 month period. And this was mainly in the commerce, services, financial and manufacturing sectors, as highlighted in the middle top chart. In terms of composition, commerce and services continue to represent the largest proportion of the commercial book, totaling 42% of the book compared to 37% in the previous quarter as the bank continues to focus on more value segments. The pipeline for commercial lending still presents attractive prospects for growth, especially given the healthy liquidity and capital position of the bank. On the consumer lending side, we had 7% growth year-to-date with a really solid pick-up in the third quarter of 4% sequentially with personal financing and auto loans both showing solid growth momentum. As a result, the composition of the non-mortgage book out of consumer loans increased to over 51% from just under 50% previously. On Slide 11, we highlight the main funding element, and this is the deposit base, which grew 6% year-to-date or 3% Q-on-Q and was primarily from interest-bearing deposits where we had a growth of 20% year-to-date or 12% on a sequential basis as corporate interest-bearing deposits growth was offset by a decline in retail, mainly from the Private Banking segment. Non-interest-bearing deposits were down 3% both on a year-to-date and a sequential basis, quarterly due to a 19% decline in corporate, which was partly offset by a 9% growth in the Retail segment. Overall, given the increase in interest-bearing deposits and the modest decline in non-interest-bearing deposit volumes, the percentage of NIBDs to total deposits now stands at 55.9% to 61.1% at 2022 year end. On Slide 12, we provide the broad strokes for what was another strong quarter in terms of performance with another record in terms of net operating income before impairments. This was at SAR 1.7 billion for the quarter, 23% higher than Q3 last year and up 6% on a sequential basis. Along the same lines, net income grew 27% year-on-year and 6% on a sequential basis from strong net interest income growth, which benefited both from lending and higher margins due to higher benchmark rates. This was partly offset by higher operating and risk costs. The varying contributions are [Technical Difficulty] highlighted in the bottom right chart on the slide. I'll go over a few of the main highlights here and dive into the details over the next few slides. The main contributors included net interest income, which was up 28% year-on-year and 5% over the previous quarter. This was accentuated by NIM expansion of 65 basis points. Non-interest income was up 3% year-on-year. It was driven by higher fees and commission income as well as trading income. And on a sequential basis, non-interest income improved by 7%. Operating expenses were 13% higher year-on-year due to employee-related and G&A expenses in addition to one-off reversals in Q1 of 2022. Impairments at SAR 1.18 billion were 34% higher year-on-year, but 20% lower on a sequential basis. On operational efficiency, in terms of cost to income, we had very strong momentum there. And this continued, thanks to loan growth and better interest margins, leading to higher earnings. The ratio standing at 30.5% is a 2.9% improvement compared to the 9 month period from last year. And finally, on profitability, as a result of all these items, both the return on equity and return on assets improved year-on-year to above 12.5% and 2% levels respectively. Now we'll take a deeper dive into the individual components of P&L in more detail. On Slide 13, we unpack the main driver in operating income growth. That's the net interest income, as mentioned, grew 28% year-on-year as earning asset growth of 6% year-on-year and NIM expansion both played positively. Average interest-earning assets growing by SAR 11.5 billion outpaced the SAR 4.4 billion in average interest-earning liabilities and higher interest rates improved lending yields, which more than offsets correspondingly higher funding costs and the cash flow hedge impact, leading to a 65 basis point NIM increase to reach 363 basis points for the 9 month period in 2023. On a quarterly basis, as shown in the bottom left chart, net interest margin expanded 9 basis points quarter-on-quarter to 366 basis points, which is now at or near peak levels with the majority of floating rate assets having repriced to higher rates. On Slide 14, we bring about focus on one of the larger performance drivers given the bank's overall structure and interest rate standing, and that is the positive gearing to rates. To reemphasize, our rate sensitivity was around plus or minus 10 basis points for every 100 basis points change in rates. This reflects the net long position in variable rate assets, driven primarily by the balance sheet skewed towards floating corporate loans. The size of the cash flow hedge portfolio is driven by the development of the bank's balance sheet structure and our expectations for interest rates. As such, the cash flow hedge position has increased since the second half of 2022 to now cover 30% of our interest rate sensitivity gap. Nevertheless, it is important to reiterate the cash flow hedge book has a relatively low average duration of between 2 to 2.5 years. And as they mature, the mark-to-market reserves improve and replacement hedges provide for an improvement in the gross yields. Now as rates have stabilized, the intention is to manage potential future volatility in earnings by increasing the received fixed hedges. On Slide 15, we zoom in on non-interest income, which witnessed a 3% year-on-year increase or 7% growth on a sequential basis. The main drivers of the year-on-year growth were 4% higher fee and commission income from higher trade finance and other fee income, which was offset by lower brokerage and asset management income. Additionally, we had 19% growth in trading income due to increased activity in the treasury markets business. These were partly offset by lower one-off investment income [Technical Difficulty] made on FVOCI investments. The final element of the net operating income on Slide 16 is on operating expenses, which has increased 13% year-on-year. Again, this was due to employee-related costs, but also excess accrual reversals in the first quarter of last year. And for reference, excluding these reversals, growth would have been more in the range of 10% year-on-year. And as highlighted previously in the calls in Q1 and Q2, this would trend lower over the course of the year when we had been at 18% growth year-on-year in the first quarter, trending lower to 15% in the first half and now down to 13% for the 9 month period. We'll continue to exercise discipline in the budgeting and procurement process to identify efficiency opportunities and to improve the bank's overall cost to income ratio, which now stands at 30.5%. On Slide 17, we highlight the credit trends where the year-to-date impairment charge increased 34% year-on-year due to the enhanced coverage on isolated legacy exposures, which migrated to NPL last year. As a result, the cost of risk rose 14 basis points year-on-year to 98 basis points, but has declined sequentially during the last 2 quarters from the 116 basis points we had during the first quarter. The NPL ratio improved to 1.97% during the quarter with the sequential trend impacted by write-offs. The NPL coverage improved both year-on-year and Q-on-Q to 139.5% mainly from additional Stage 2 and 3 coverage. We expect that when considering loan growth, fresh NPLs, recoveries and write-offs, the improvements witnessed in these credit metrics over the last 2 quarters will continue into the fourth quarter. On Slide 18, we discuss liquidity and capital, which both remain solid and continue to provide ample room to sustain our growth momentum. The liquidity coverage ratio now stands at 171% and the net stable funding ratio at 116%. While the headline loan-to-deposit ratio increased to 105%, our regulatory loan-to-deposit ratio remains at a comfortable 84% relative to the 90% maximum. With respect to capital, total capital declined 1% year-to-date as net income generation was more than offset by dividend payments and movements in cash flow hedge and FVOCI reserves. Together with the 2% risk-weighted asset growth from lending, the CAR declined modestly to 18.2% and the Tier 1 now stands at 18.7%. Lastly, on Slide 19, we provide a quick snapshot on where we stand against the guidance. In terms of loan growth being above target and although we would still caveat the potential for prepayments and settlements, especially given the seasonality in the fourth quarter, we are revising the financing growth for the full year to low-double-digits. Similarly, on the net interest margin currently above guidance at 363 basis points, we're revising the guidance to 3.5% to 3.6% with potential to be slightly above the range. Cost of risk at 98 basis points for the year and 79 basis points for the third quarter provide some visibility on the full year. And as such, we retain the guidance as is. Cost to income at 30.5% is in line with expectations and we continue to remain within guidance. On return on equity at 11.5%, it's an area where we've had great traction and we expect to remain within guidance on a full year basis. Lastly, the CET1 ratio at 16.4% is expected to improve to within the lower 17% to 18% range as capital generation through earnings is supplemented with partial reversal in mark-to-market. With that, we can move on to Q&A.

Thank you very much for the presentation. We'll now move to the Q&A session. [Operator Instructions] We'll move to our first question from Waleed Mohsin.

Three questions please from my side. First, I wanted to ask around the headline loan-to-deposit ratio, 105%. We acknowledged that the regulatory LDR sits at 84%, so comfortably below the 90% regulatory maximum. However, just wanted to get your thoughts on how much do you intend to flex this ratio? Because technically speaking, you can move closer to 90% on the regulatory LDR which will help your headline LDR even higher and avoid competition of deposits. So I just wanted to get your thinking around that how are you going to manage the headline and the regulatory LDR ratio? That's question one. Secondly, despite the upgrade in your net interest margin guidance, your range still implies some NIM compression for the fourth quarter. Just wanted to get your thoughts there. Is this how we should think about or should we read more into your last comment, Ramzy, which was that there could be some upside and you might end up with a net interest margin which is above the guidance range? Third and final question on loan growth. I recall at the end of the second quarter, you were cautious and you talked about repayments and you've highlighted this again, but at least there have been some trends which have convinced you to upgrade guidance. So I wanted to get a sense of what has changed. Is the corporate lending pipeline materializing faster than expected? Are you seeing that in terms of committed, but undrawn facilities? So any color on the pipeline and what convinced you to upgrade the guidance other than obviously the outcome for 9 month, would be extremely helpful?

Waleed, this is Zuhair. So with regards to your question on the loan-to-deposit ratio, so our simple LDR is intentionally maintained to optimize our funding costs. So looking ahead to 2024, we anticipate the deposit growth will grow as needed to support our projected expansion with carefully managing costs. It's important to recognize that the deposit of the banking sector will likely come from the time deposits as opposed to current accounts given the projected higher rates environment. Consequently, we do not foresee any improvement in the CASA ratio. As you mentioned, the LDR across the sector is above 100%. As for the bank, we have also raised within the past year, a DCM twice. So we've raised SAR 700 million in late 2022 as well as a $900 million sukuk in 2023, whereby they do have a comfortable weighting towards the liability denominator base that will obviously improve our regulatory ratio. So it's a matter of whether we -- is it needed or not and we manage it to optimizing our costs.

Ramzy here. Thank you, Waleed, for the questions. On the net interest margin question, I think, again, there's lots of variables at play when we look at the net interest margin. Part of it is going to be the non-interest-bearing deposits percentage of total deposits, where I think at a sector level, we still see pressure on that front. So we wanted to be more conservative. And when we look at rates overall in terms of the movement, it has been volatile I think at the long end. But with the pause in the Federal Reserve rates and the feed-through that that has on the rates locally, we don't expect much more repricing to take place. So we view it more as a stabilization than a pure contraction. And that's why we've highlighted that there could be upside to this level as well. And then lastly, in terms of the loan growth, I think when we look at the historical period, namely last year, the third and fourth quarter, it was fairly flat in terms of loan growth. I think there were expectations that there could be potentially the same type of outcome. But when you look at the loan growth that we had in the third quarter across the board with both the commercial side, but also on the retail side in terms of personal loans and auto loans, we've had good traction on that front. So that gave us a bit more confidence in upgrading this to the low-double-digit side. But we would still I think caveat that there is potential for prepayments and settlements throughout the year. But mainly in terms of seasonality, we typically see this in the fourth quarter.

Got it. That's very helpful. Just one follow-up on the first question regarding the LDR. Should we expect similar kind of levels, gradual increases? Did I get that correct? Gradual increases in LDR or broadly stable levels?

Yes. I would say that you expect similar levels going forward.

We'll now move to the next question. This is from Nida Iqbal.

[Technical Difficulty]

Okay, we will try the next question. Rahul, your line is open. Please go ahead.

Yes. This is Rahul Bajaj from Citi. I have 3 quick questions actually. The first one is a follow-up on the margin question which was asked earlier. So I understand as you kind of alluded that most part of the repricing is already done. So how should we now think about the hedges that you are building? So are these hedges coming with a negative NIM impact or are they neutral as you go into the fourth quarter? I'm just trying to understand, will fourth quarter margins be negatively impacted due to the cost of funding increases and the cost of -- the impact of these hedges on your margins? So that's my kind of the first question. The second question pertains to staff cost. We see a sizable jump in the quarterly run rate for staff costs in 3Q versus the previous quarters. I just wanted to understand if there is any one-off element there? And if the third quarter staff cost is a new run rate we should be thinking about? And my final question is around this comment you made earlier around funding sources. And you mentioned short-term interbank lending -- short-term interbank funding and long-term debt are available options for the bank. If you could please provide us some color around the range of kind of pricing where these -- at which these funding is available? So for example, a time deposit versus a short-term interbank versus a long-term debt for the bank or are they pretty similar in terms of pricing? I mean, any color there would help us kind of think through how cost of funding could behave as we head into 2024. Those are my 3 questions.

Okay. So with regards to the hedging activities we have, so any replacement of current outstanding, so as the cash flow hedge contract matures, replacements would be in a favorable rate environment. So those will have a positive impact on net interest margins. However, any additional contracts that enter, we enter into, would have our NIM detractors, which will impact obviously the NIM given the inversion of the yield curve and the current environment. However, if you look at our net interest margin in this current environment, we have seen quite a significant movement, which places us in an extreme exposure towards higher interest rates. So we continue assessing our fixed rate exposure and acknowledge the fact that it is a detractor. However, we should not ignore the current rates environment as a significantly higher. Our hedging of our loan book is used as a risk management tool since we have relatively a small fixed rate loan book when compared to our peers due to the large proportion of assets into our corporate lending. So also I'd like to add one more aspect to this is that we have done a switch exercise in government securities to extend our interest rate risk duration, which will also contribute towards probably a reduction in some of our hedging activities. However, we'll continue assessing hedging our loan book at a certain pace given the current environment based on our interest rate gaps.

So on the third question, I'll take the third question with regards to short-term funding vis-a-vis medium-term funding. Obviously, medium-term funding comes at a cost, which is the cost of funding of the bank. Now given the fact that we do have a migration from current accounts to time deposits that will have an impact on our cost of funding and it has been evident. However, as we continue growing our asset book, medium-term liability is required in order to manage our asset liability mismatches. And this will put some pressure on cost of funding. However, as we speak, we are -- we have a relatively contained cost of funding when compared to our peers. And I think we do have some room to grow in that respect. Short-term funding is relatively cheap and they are done on collateralized basis using the repo or the interbank activity. And these are tools that maintain our day-to-day shortage of liquidity in case we're short on day to day.

And then just on your last question, Rahul, on the staff cost, there's a few elements that are going to be at play here. There's obviously going to be accruals for management bonus that would have to kick in. So as the bank is performing better, there's a set formula that is accrued on a monthly basis, and this will show up in the quarterly staff cost. There are also variables in terms of cost increases, but this would be offset to a certain extent by resignations and shifts within the organization. But I would say so long as the performance is going to be at this level or stronger, this would be the new run rate.

We'll try Chiro one more time.

This is Chiro Ghosh from SICO Bahrain. A couple of questions from my side. Is the retail loan growth in this quarter appeared to be quite strong? So I just want to get a sense of what would be your strategy going forward? And what kind of margin are you making on this retail business? I mean, because you're still not a major player in the retail business, are you cutting costs to gain some market share? If you can throw some light on that. Second is about the write-off. The write-off was quite strong. So what would be your write-off strategy going forward? And which are the sectors which contributed to this write-off? And third one was very quickly, I know you've answered it a bit, the cost-to-income ratio has been quite well. I mean, how sustainable it is going forward?

I'll just maybe start with the second one on the write-off. So the question is just in terms of the size, is this abnormal. I think all the banks will look at the NPL portfolio, and there is a designation that is set by IFRS, but also each bank will have their own policy. And whenever the recovery is deemed no longer possible or the timing is out of question, then the bank would look at taking through a write-off. It does go through the necessary approvals in terms of governance within the bank, with the Board or Board delegated committees. And this is something I think we have seen other banks do also in the past. So from our perspective, we want to make sure that we are in line with the rest of the market and nothing really abnormal that we've seen at least on the write-offs.

These are mostly legacy loans, right?

Correct. So they would be fully provided for. And this one specifically is the holding company for the name that was shifted to NPLs last year.

And regarding the retail loan growth strategy and more specifically when it comes to pricing, we haven't changed the [Technical Difficulty] strategy when it comes to pricing nor are we really focusing on market share. However, the only shift that we have made to that strategy is more focused when it comes to our affluent segment, especially with the recent rollout of our segmentation program.

And on the last question in terms of the cost-to-income ratio in terms of the sustainability, I think we've had tremendous growth really in terms of the earnings profile. The cost side has grown as well, but not to the same extent. So we've had a positive jaws. And I think looking forward to next year, with the risk costs hopefully looking in a better position, we would view this as something that is sustainable and hopefully also something that we can improve going forward.

So is there still a massive line-up of digital spending or you are comfortable at this stage?

In terms of spending, so a lot has already been invested in terms of the technology transformation. A lot of these would start to -- some have already come online this year and some of them will be towards the end of next year.

We'll move to the next question from [ Mohammad Al-Rasheed. ]