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BRAC Bank: Management call – growth orientation to continue

  • In our view, BRAC Bank remains the most investable Bangladesh banking name.

  • We summarise below some of the key points from management’s recent investor call.

  • bKash is still prioritising growth over profitability.

Rahul Shah
Rahul Shah

Head of Corporate & Thematic Research

Tellimer Research
11 March 2020
Published byTellimer Research

In our view, BRAC Bank remains the most investable Bangladesh banking name. The loan rate cap, coronavirus, overvalued BDT and heavy investment needs of bKash present a potent cocktail of near-term risks, but the c50% yoy decline in the share price largely reflects these difficult conditions, in our view. The shares currently trade at 7.4x 2020 PE and 1.0x PB. Assuming the market is valuing bKash at half our BDT27/ share number, that leaves the shares pricing in a sustainable ROE of 8% for the banking business, which we think is achievable in the short term and conservative if the current loan rate cap rules are subsequently watered down.

We summarise below some of the key points from management’s recent investor call. Note that our partner broker in Bangladesh, IDLC, will be updating their sector views and forecasts to reflect the loan rate cap’s implementation in the near future.

The motivation for the loan rate cap seems to be centred around ensuring that large industrial corporations receive adequate levels of credit at low cost, to support the economy and to prevent the formation of significant NPLs. The current form of the rate cap (which encompasses all loan categories except for credit cards) seems to us a very blunt instrument to achieve what is in any case a questionable regulatory policy goal. The historical experience in Bangladesh and elsewhere is also not supportive, as entities such as the IMF have already pointed out.

Financial implications are negative but manageable. Although BRAC Bank’s margins will be squeezed, even in a stress test scenario management does not see the business moving into loss, even temporarily. Management will increase focus on cost efficiency (process optimisation), lowering funding costs and boosting fee income, while at the same time keeping a tighter control on credit risk. Management also believes it can continue to grow its credit book strongly, but we see this as being perhaps more aspirational than realistic at this stage.

Loan yields will fall sharply. At end-19, BRAC Bank’s loan book was yielding 11.2%, with its SME loans yielding 13.8%. With loan yields now capped at 9.0%, and this cap also applying to the existing loan book, it is likely that BRAC’s margins will be squeezed, even if the bank can grow its credit card business (where yields are not capped) and lower its funding costs.

Credit cards are a big focus for the bank. BRAC has seen good growth over the past eighteen months or so and this is likely to continue. Market share for this product is estimated at 23-25% by management. However, credit cards are still a small part of the balance sheet, accounting for just 2.5% of loans.

Bank system lending to the government likely to increase. The loan rate cap has increased the relative attraction of sovereign debt, bank holdings of which had already increased sharply yoy even prior to the introduction of the rate cap. Given less issuance of National Savings Certificates (which is helpful for bank funding costs), the government is likely to rely on greater issuance of debt to the banks.

Funding costs have already fallen significantly in February. BRAC has already shifted its time deposits rates down to c6%, although it is possible that these may need to rise in future. In addition, there is an increased focus on CASA deposits; the bank is signing up c800 new accounts each day. We note that BRAC Bank likely has less scope for funding cost reduction than its peers, as its deposit mix is already more CASA-oriented than most. Management believed that no deposit rate ceiling was imposed by the regulator as this move would not have been popular with the general population.

Fee income is likely to become more important, given the pressure on margins. Management noted that regulations governing fees on SME products were quite strict, meaning that fee-raising efforts will more likely be focused on large corporate and retail borrowers. Management was understandably not willing to go into details on how product structures might be changed to shift the fee income component.

Credit risk appetite will be reduced. With less ability to charge a risk premium, BRAC Bank will focus much more on risk selection and mitigation. Nevertheless, the focus of new business is likely to be small/ micro enterprises and retail borrowers. Credit cards will also be a strong area of attention.

Industry risk profile remains poor. For the past two years, BRAC Bank has taken a very low-risk approach to the interbank market, where it is a net borrower. While there is scope for (and a need for) industry consolidation, BRAC Bank is unlikely to participate in inorganic growth. In management’s view, a state-sponsored Asset Management Company (to take on bad debts) remains a ‘pipe dream’. It also believes that some smaller banks will face challenges in attracting liquidity/ funding.

BRAC Bank’s growth orientation will continue. The loan rate cap means that SME lending may not always be profitable, but management prefers to take a long-term view. Remaining engaged with customers now will generate significant goodwill which will be repaid when the rate cap regime shifts. With funding costs falling, management also sees scope to win loan market share from non-banking financial institutions.

The loan rate cap will not be around forever. Management noted that previous rate cap regimes in both Bangladesh and elsewhere had had a limited shelf life, and this was also likely to be the case here. Discussions around the viability of the cap for micro/ cottage industries and retail lending are already ongoing; BRAC Bank’s exposure to both these segments is c26-27% of the loan book and 17-18% respectively.

bKash is still prioritising growth over profitability. The business is seeing good levels of customer acquisition, but heavy investment is taking place in customer acquisition, technology development and building the ecosystem.

The impact of coronavirus on the ready-made garments industry has so far been negative, because c30% of the industry’s inputs come from China, where factory production had stalled, but is now recovering. In theory the industry may be able to replace Chinese market share in developed markets, but this opportunity may be overshadowed by any slowdown in demand in key markets like the US and Europe.