Equity Analysis /
Pakistan

Pakistan Banks: Stress testing on revenues & asset quality

  • If the coronavirus pandemic extends for a prolonged period, banks will face pressure on both revenues and asset quality

  • Stress testing concludes earnings are most vulnerable to a spike in loan provisions vs. margin compression

  • Even in a stressed scenario, IMS Banks trade at a forward P/E /P/B of 0.77x /7.47x which is not particularly expensive

Raza Jafri
Raza Jafri

Executive Director, Research

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Yusra Beg
Yusra Beg

Senior Investment Analyst

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Intermarket Securities
19 March 2020
  • Pakistan banks are down 30% in March’ 20 vs. a 20% decline for the KSE-100. If the coronavirus pandemic extends for a prolonged period, banks will face pressure on revenue (both funded and non-funded lines) and asset quality (including impairment on equities). The SBP has not yet announced any relief measures for banks.
  • We stress test our models to gauge possible earnings ranges in a bear case scenario. Banks earnings are most vulnerable to a spike in loan provisions (ignoring the potential for availing FSV benefits). Margin compression is less of a concern even though the offsetting prospects via higher loan growth and capital gains are slim. Systemic CAR of over 16% appears adequate but some smaller banks, not in our coverage, could potentially be vulnerable.
  • Assuming swift margin compression, lower fee income and a cost of risk similar to the last downcycle (2008-11), our base-case 2020/21f EPS estimates come off by 30/39%. Even on this stressed scenario, the IMS Banks Universe is trading at a forward P/B of 0.79x/0.77x and P/E of 7.75x/7.47x – not particularly expensive, which may help arrest further large declines in share prices and possibly compel value buyers to build positions. 


SBP cuts policy rate by 75bps – monetary easing begins

The SBP cut the policy rate by 75bps to 12.5% in the March 2020 monetary policy. This is the first rate cut in almost four years. The SBP has also shifted the interest rate corridor up by 50bps; this move will serve to cut banks’ earnings by c 5%, all else the same, as it reduces the quantum by which savings deposits (40% of overall deposits) will reprice. Following the 75bps cut in the policy rate, margin compression would have begun to come through from 2H20 but the shift in the interest rate corridor brings this timeline forward. 

Limited room to offset margin compression

Earnings for Pakistan banks have grown even during times of monetary easing. This holds true for the more margin sensitive banks such as BAFL and MEBL as well – benchmark interest rates fell from 12% in early 2012 to about 6% in 2017 but BAFL’s earnings did not decline in any year and MEBL reported a decline only in 2017 (down 9%yoy) and that too due to a loss on associates. While bottomline growth does slow to a lower clip on NII deceleration (7% normalized CAGR in 2012-17), banks are typically able to offset margin compression by growing loans, realizing capital gains and focusing on cost control. 

It may, however, be more difficult to offset margin compression in the current environment. Our base-case loan growth assumption of 7.5%/11.0% in 2020/21f faces downside risk while equities may see impairment come through, instead of any gains. ABL has the largest exposure to listed equities among our coverage while HBL and UBL have the least exposure. 

That said, we flag that there may be room for realizing capital gains on PIBs in a quickly declining interest rate environment. Banks that have a relatively high proportion of PIBs include HBL, UBL and BAFL, while ABL is a laggard.