Equity Analysis /
Pakistan

Pakistan Banks: Strong momentum to continue in Q2 CY 19

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Yusra Beg
    Yusra Beg

    Senior Investment Analyst

    Intermarket Securities
    23 July 2019
    • The IMS Banking Universe is expected to post combined profits of PKR27bn in Q2 CY 19, up by 39% yoy (+28% qoq). We expect strong earnings growth to be led by (i) a margin-led pick-up in NII, (ii) high FX income (except for HBL) and (iii) normalised taxation. These should more than offset a higher cost of risk.
    • We expect UBL and MEBL to deliver the strongest earnings growth. UBL is recovering from a string of one-offs that are unlikely to repeat, while it is also due for a lagged pick-up in NII. MEBL’s margins are one of the most sensitive to rising interest rates, which should reflect in its results. HBL will also likely depict an improvement, but its high cost base and FX hits imply its profits may remain below potential, for now. 
    • Upcoming results should continue the momentum of the previous quarter; reported profits in Q1 CY 19 profits were flat, but up 35% yoy on a pre-tax basis. An improvement in ROE should be clearly visible in Q2 CY 19, and this should continue over the medium-term. This, together with attractive valuations (median 2020f PB: 0.9x, P/E: 6.1x), underpins our liking for the sector.

    Strong growth in Q2 CY 19 profitability

    We expect the IMS Banking Universe to post combined Q2 CY 19 profits of PKR27.5bn, up by 39% yoy (+28% qoq). This should be led by a strong pick-up in NII (+28% yoy, +7% qoq), owing to continued margin expansion, which should more than offset provisioning charges. It is possible that some banks may face impairments on their equity portfolios, but we also see prospects for high FX income (ex-HBL) given the c12% PKR devaluation during Q2 CY 19. UBL and MEBL should deliver the highest growth in our coverage. HBL should also continue with its recovery, but a high cost base and likely FX losses on the income statement imply its profitability may remain below potential, for now. 

    Margins to continue expanding

    With interest rates up 325bps this year (led by a 150-bp increase in May), banks should continue to see margin expansion, particularly as investments have tilted to T-bills.  We estimate Q1 CY 19 NIMs for our universe at 4.25%, which should expand to 4.50% in Q2 CY 19. Loan growth is expected to decelerate to the high single-digits in Q2 CY 19, down from 14% yoy in Q1 CY 19, but this is in keeping with a more challenging economic environment, and not enough to offset the margin expansion, in our view. Sequentially, ABL and BAFL should deliver the highest lift to margins in Q2 CY 19, in our view. 

    Asset quality is under control
    The stock of NPLs (including legacy NPLs) for commercial banks rose from PKR581bn in Sep’18 to PKR624bn in Dec’18, up 7% qoq, but we understand this was due to the effects of PKR depreciation on overseas NPLs and asset quality deterioration for an unlisted public sector bank. The NPL stock rose by a more moderate 3% qoq in Q1 CY 19 and SBP data suggest that the provisioning charge has remained in control in H1 CY 19. For our universe, the cost of risk is expected to rise to 27bps in Q2 CY 19 vs. 7bps in Q1 CY 19; asset quality stress will likely increase going forward, but these are at manageable levels for now. We expect MCB, MEBL and ABL to post net provisioning reversals in Q2 CY 19. 

    We remain Overweight on Pakistan banks

    The upcoming Q2 CY 19 banking sector results should continue the momentum of the last few quarters. With taxation set to normalise, and one-offs out of the way, the sector’s ROE should depict a strong uptick in Q2 CY 19. We expect ROEs to expand across the medium-term for our banking universe, rising from 14% in 2019f to 17% in 2023f, which underpins our preference for the sector. This is buttressed by supportive flows – foreign investors have bought US$79mn worth of Pakistani banks this year (vs. a net sell in other sectors), and local mutual funds have also looked to limit their selling in banks (in 2019td, selling in banks has been c20% of mutual fund selling, lower than the 28% (free-float-based) weight of banks in the KSE-100 Index). We remain Overweight on Pakistan banks where we believe the large banks such as HBL, UBL and MCB offer superior value-for-money relative to peers. Within medium banks, BAFL is also beginning to look attractive, after its recent correction.

    Risks: (i) Greater-than-expected asset quality deterioration and impairment on equity portfolios, (ii) regulatory risks such as the Single Treasury Account and higher taxation on income from  government securities, and (iii) higher-than-expected admin costs.