We remain cautious on the sector
On the back of the recent increase in non-performing loans outstanding, the sector’s systematic risk remains high. Relaxation in NPL classification and higher rescheduling activity coupled with existing low provisions coverage have increased the systematic risk further. However, low valuations (sector median 0.7x PB) suggest that this systematic risk is mostly priced in. We expect banks with better corporate governance practices and capital/funding advantages will gain higher market share and thus, improve their profitability.
We remain positive on BRAC, CITY, EBL, DUTCH and PRIME. Among these names, we prefer BRAC because of its strong balance sheet, higher profitability and superior management. Besides, BRAC subsidiary bKash is the dominant market leader in the Mobile Financial System (MFS) industry with a 73% market share. We see significant upside potential in the MFS space in Bangladesh.
BRAC remains our top pick
SME focus, advantage in deposit mobilisation and high investment in digitalisation are the long-term value drivers for BRAC, while the bank’s subsidiary bKash is the dominant leader in the MFS industry. Our TP of BDT82.6 suggests 35.9% ETR, and we reiterate Buy.
We also maintain our Buy rating for CITYBANK (52.2% ETR). We downgrade our recommendation for EBL to Hold from Buy with a TP of BDT39.4 (ETR 5.9%); reiterate Hold for DUBA (ETR 2.2%); maintain Hold for PRIME with a higher TP of BDT20.9 (ETR 11.2%); maintain Hold for UCB (ETR 1.8%); Sell for ISLAMI (ETR -20.3%).
Asset quality remains our prime concern; listed banks’ provisioning increased by 25% yoy in Q1 19
Asset quality continues to deteriorate as NPLs increased by 26% yoy in 2018. The industry NPL ratio was 10.3% in December 2018, versus 9.3% a year ago. In addition, we estimate 8-10% of the total loan consists of rescheduled and restructured loans. In aggregate, the current extended NPL or stressed ratio amounts to 19%-20%. Although the overall industry coverage ratio is on the lower side, BRAC, CITYBA, EBL, and DUBA are better placed than the industry average (75.8% versus 63.4%). In Q1 19, total provisioning of listed banks increased by 25% yoy. Cost of risk of the listed banks stood at 115bps in Q1 19 up by 10bps compared with Q1 18.
Deposit growth remains subdued, liquidity crunch prevails
Liquidity conditions didn’t improve due to higher credit growth, lower deposit growth and higher money flow into National Savings Certificates (NSC). Loan size of listed banks increased by 15.4% yoy and 2.9% YTD at end-March compared with deposit growth of 10.2% yoy and 1.1% YTD. Higher sales of National Savings Certificates (NSC) continue as it grew by 8.2% in 9M FY 19. However, we expect the new reform in NSC selling process, ie implementation of digital database and mandatory TIN number, will stop excess NSC subscription over regulatory limit. It is expected to take effect in July.
Higher interest rate to prevail for now
Most banks had to raise deposit rates as they needed to match the return offered by the NSC instruments (11% yield). Besides, banks were aggressive in deposit collection as they needed to comply with new ADR requirement (83.5% by September 2019) and with new offshore banking regulations. As a result, average spread of the banks declined to 4.1% in March 2019 from 4.5% in March 2018. However, the impact is mostly factored in financial statements and we don’t expect any further deterioration in the spread. Among top tier banks, we have already seen NIM improvements in Q1 19. In particular, BRAC, CITY, EBL, PRIME and DUTCH were able to pass the cost of fund hike to borrowers. We expect this trend to continue this year.