Equity Analysis /
Pakistan

Pakistan Banks – 2QCY22 Previews - Hit hard by tax

  • Expect Pakistan Banks to report sharply lower earnings in 2Q with the effective tax rate to come in at an average of 70%

  • This can affect cash payouts. Banks above the 50% Gross ADR (MEBL, BAFL and BAHL), should be relatively protected

  • Valuations are attractive but visibility is needed on politics/economy. Best-in-class names are MEBL and UBL

Yusra Beg
Yusra Beg

Senior Investment Analyst

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Intermarket Securities
19 July 2022
  • The banking sector is expected to post sharply lower earnings in 2QCY22, on high taxation post the changes introduced in the FY23 Budget. For our coverage, we expect the effective tax rate to come in at an average of 70% in 2Q, driven up by MCB, UBL and HBL. This can affect their accompanied cash payouts. Banks meeting the 50% Gross ADR threshold, such as MEBL, BAFL and BAHL, should be relatively protected.

  • The higher interest rate environment will drive up margins while balance sheet growth remains strong. Upcoming results should deliver another quarter of soft credit costs. Going forward though, pressure points on the economy are emerging, underpinned by inflation and currency weakness.

  • Our covered banks have shed c.15% CY22td. Valuations are attractive - CY22f P/B of 0.7x and P/E of 3.9x - but we believe more visibility is needed on politics and the economy for banks to start performing. Best-in-class names are MEBL and UBL. 

Revisiting tax changes

Tax changes announced in the Federal Budget 2023 will kick in during this quarter. These include (i) corporate tax rate of 39% vs. 35% previously, (ii) 10% super tax in CY22 and 4% from CY23 onwards, and (iii) additional tax on income from federal government securities for banks with Gross ADR below 50%, to be applied retrospectively. Within our coverage, the latter threshold is not met by MCB, UBL and HBL. 

Sharp drop in 2QCY22 profits

We expect the IMS Banking Universe to report cumulative profits of PKR25.9bn in 2QCY22, down by a sharp 34% yoy and 44% qoq. We estimate effective tax rate will register at 75-80% for MCB, UBL and HBL, and in the 55-60% range for MEBL, BAFL and BAHL. This should reflect in cash payouts also, with lower dividends for the former subset in the coming results, before they revert to their usual quarterly dividend from 3QCY22 onwards as earnings normalize after one-off heavy taxation. 

Core revenue to be strong

Net interest income of our covered banks is projected to grow 28%yoy and 9%qoq. We expect strong margin expansion as secondary market yields continue to outpace the Policy rate. So far, SBP has raised the Policy rate by 525bps in CY22 to 15.0%. Balance sheet growth is strong, with sector data showing a 22%yoy rise in loans and a 11%yoy growth in deposits. This should be accompanied with strong growth in fee income (up 25% yoy) on rising trade commissions and card related fee. It is still early for an asset quality downturn, however, equity impairment may keep overall provisions sequentially elevated. There is room for positive surprises on Fx income, given the volatility in the currency. We estimate cost to income of 50% in 2Q.

Too early for asset quality headwinds

Asset quality remains intact where we estimate an annualized cost of risk of less than 20bps, similar to 1Q. That said, stress points could emerge, going forward; given expectations for inflation to average 18-20% over the next 12 months, coupled with the ongoing incessant pressure on the PKR. High sector provisioning coverage of about 100% provides some comfort, with some banks yet to reverse their Covid-related general provisions.

Macroeconomic comfort is missing

Valuations are attractive with 2022f P/B of 0.7x and P/E of 3.9x against a mid-cycle ROE of 18.5% (17.3% ex MEBL). While earnings are set to post a sharp dip in upcoming 2QCY22 results, they should normalize from 3QCY22 onwards. Although we have a Buy rating on banks in our coverage, we believe, a more conducive political and macroeconomic environment is needed before banks start performing to potential. Our preference is for MEBL (high ROE and margin sensitivity) and UBL (relatively defendable cash payouts).