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  August 28, 2007 Industry View Pakistan Banks Attractive High Risk but Huge Opportunity  
 

August 28, 2007

Industry View

Pakistan Banks

Attractive

High Risk but Huge Opportunity

 

Initiate on Pakistan Banks with an Attractive View:

Pakistan has obvious challenges regularly broadcast by the media. However, we believe Pakistan offers significant upside, most of which is over-shadowed by its image. In the current context of unsettled investment markets, pending elections, and uncertainty over leadership, Pakistan today may not appear to present a choice destination. However, if we look beyond the immediate future, we believe Pakistan presents an interesting real emerging market opportunity for the patient long-term investor. Bank returns are some of the widest on offer in Asia and growth potential is vast, in our view. Progress with privatization, regulation, execution, and balance sheet repair is impressive, as is the attitude to open markets. Pakistan is worth a look and visit; you may just be surprised.

MCB Overweight, Rs267, 12-month PT Rs340, which equates to a total potential return of 31%. MCB is trading on 8.9x EPS, 2.5x book, with three-year earnings CAGR of 16%, an RoE of 31%, and a dividend yield of 4.1%, on our FY08 estimates. MCB offers a high-quality play on Pakistan’s emerging financial system. It has a well-buttressed balance sheet and a high-return franchise (RoRWA is 6.14%). The cream comes from the “Mansha” influence, canny investments in Adamjee Insurance (well below current market), Sui Pipelines, and a large and growing pension fund surplus.

UBL Overweight, Rs171, 12-month PT Rs193, which equates to a total potential return of 16%. UBL is trading on 9.1x EPS, 2.5x book, with three-year earnings CAGR of 10%, an RoE of 32%, and a dividend yield of 4.1%, on our FY08 estimates. UBL offers leadership in retail and investment banking, and a potentially strong Middle East proposition. The balance sheet is solid and return structures are healthy. UBL is currently undertaking a comprehensive project to transform the internal business processes, replace IT platforms, and revitalize distribution. This project is expected to take two to three years to complete.

MORGAN

ASIA/PACIFIC

STANLEY

RESEARCH

Morgan Stanley Asia (Singapore) Pte.+

Matthew S Wilson, CFA

Matthew.Wilson@morganstanley.com +65 6834 6746

Samantha L Horton

Samantha.Horton@morganstanley.com +65 6834 8975

Price Target Summary

 

Share

Shares

Mkt cap

Target

Target

Total

price

o/s (m)

Rs bn

price

P/E

return

MCB (O/W)

Rs267

628

Rs168

Rs340

11.3

31%

UBL (O/W)

Rs171

809

Rs138

Rs193

10.2

16%

Source: Company data, Morgan Stanley Research. As at 27 Aug 2007 Total return includes dividends but does not include transaction costs.

Return on RWAs (latest reported)

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Pakistan Indonesia Malaysia Thailand
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Pakistan
Indonesia
Malaysia
Thailand
Australia
Singapore
Vietnam
India
Hong Kong
China

Source: Company data, Morgan Stanley Research

Morgan Stanley does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

For analyst certification and other important disclosures, refer to the Disclosure Section.

+= Analysts employed by non-U.S. affiliates are not registered pursuant to NASD/NYSE rules.

High Risk but Huge Opportunity Pakistan has obvious challenges regularly broadcast by the media. However,

High Risk but Huge Opportunity

Pakistan has obvious challenges regularly broadcast by the media. However, we believe Pakistan offers significant upside, most of which is over-shadowed by its image.

In the current context of unsettled investment markets, pending elections, and uncertainty over leadership, Pakistan today may not appear to present a choice destination for investment capital. However, if we look beyond the immediate future, we believe Pakistan presents an interesting emerging market opportunity for the patient long-term investor. Returns are wide and growth potential is vast, in our view. Near term concerns provide an inexpensive buying opportunity.

We initiate coverage of the Pakistan bank sector with an Attractive industry view and Overweight ratings on MCB and United Bank Ltd (UBL).

The bank sector stands out as a key success story of economic development, structural change, and reform. The sector is in the midst of a comprehensive privatization program with 80% of banking assets now in private hands and growing. The central bank, the State Bank of Pakistan (SBP), has been instrumental in this story; prudential requirements have been re-written in consultation with leading regulators around the world and supervision standards have been improved. This has not happened overnight – the process began in 1991, resulting in 16 years of learning, stumbling, and eventual improvement. It continues.

Today we find banks with rebuilt and strong balance sheets, improved management (many with senior international experience), enhanced distribution, evolving product suites, and revamped risk management. They take this stronger platform into an environment that we believe has vast growth and high returns.

Exhibit 1

Pakistan Snapshot

Population (mn) GDP per capita (US$) Credit/ GDP Retail credit/ GDP Deposits/ GDP Loans/ deposits Net interest margins RoRWAS No. of deposit accounts (mn) No. of loan accounts (mn) Credit cards on issue (mn) No. of mobile phones (mn)

156

834

29%

4%

39%

75%

6.8%

5.5%

26.6

4.9

1.5

55

Source: Company data, SBP, Morgan Stanley Research

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Positive View

The macro growth story delivers, confidence grows, law and order is maintained, politics is managed, Investment accelerates, worker remittances continue and emerging market risk aversion stabilises. Banks harness the inherent growth potential with expanded product suites, improved financial market access, crisp execution, and sensible risk management.

Vast growth potential achieved

The growth potential is manifest in demographics and the extent of financial system penetration and sophistication.

High returns extended

Net interest margins average 6.8% for our coverage banks and 70% of the margin originates from deposit spreads. This equates to an average return on RWAS of 5.5% for our coverage and thus rich organic capital generation. These banks can fund RWA growth of 20% and still maintain dividend payouts of at least 50%. Refer to Exhibits 5, 6 and 59. Vast opportunity equates to measured competition.

Risk managed

Bank balance sheets are simple and well buttressed, with Tier I ratios of 12.7%. There is little exposure to exotic instruments and foreign currency. These are classic intermediating banks, and as such, asset quality and interest rate structures are the key risks. Gross NPL ratios average 5% and provisions represent 5% of loans. Investments represent 18% of assets with the following composition: 73% government securities, 16% corporate bonds, and 8% equities. A total of 85% of assets are denominated in Pakistan rupees.

Negative View

The macro story stumbles, hampered by protracted political issues and/or a change in policy direction. In a difficult macro setting, risk premia widen, investment slows, defaults rise, and a breakdown in law and order produces general economic chaos.

Growth potential unrealized

Wealth growth turns negative, confidence collapses, and investment slows.

Returns collapse

Slowed economic growth drives increased competition and return compression. Loan losses augment the return crunch.

The risks manifest

Total

Total MORGAN STANLEY RESEARCH   August 28, 2007 Pakistan Banks Exhibit 2 Exhibit 5 Population …

MORGAN

STANLEY

RESEARCH

 

August 28, 2007 Pakistan Banks

Exhibit 2

Exhibit 5

Population … 6th largest and 70% < 30yo

Foreign Investment … open economy key to growth

FDI Portfolio as a % of GDP (rhs) 1,400 1,300 4,000 3.0% 1,200 US$ mn
FDI
Portfolio
as a % of GDP (rhs)
1,400
1,300
4,000
3.0%
1,200
US$ mn
1,100
3,400
2.6%
1,000
2,800
2.1%
900
800
2,200
1.7%
700
600
1,600
1.3%
500
400
1,000
0.9%
300
200
400
0.4%
100
0
-200
0.0%
China
India
United
Indonesia
Brazil
Pakistan
Bangladesh
Russia
Nigeria
Japan
States
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
Source: US Census Bureau, Morgan Stanley Research, Data as at Dec 2006
Source: CEIC, Morgan Stanley Research
Exhibit 3
Exhibit 6

Low Total Credit Penetration … and retail is only 4%

200% Over-penetrated Hong Kong 180% Australia 160% Taiwan 140% China Singapore 120% Malaysia 100% Thailand
200%
Over-penetrated
Hong Kong
180%
Australia
160%
Taiwan
140%
China
Singapore
120%
Malaysia
100%
Thailand
Korea
80%
60%
Vietnam
India
40%
Philippines
Pakistan
20%
Indo
Under-penetrated
0%
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
credit/ GDP

GDP per capita (US$)

Source: Respective central banks, CEIC, Morgan Stanley Research. Data as of 2006

Exhibit 4

GNP per Capita and Growth … growing wealth

GNP per capita YoY growth (rhs)
GNP per capita YoY growth (rhs)

GNP per capita

YoY growth (rhs)

900 17 US % 800 14 700 10 600 7 500 3 400 0 300
900
17
US
%
800
14
700
10
600
7
500
3
400
0
300
-4
200
-7
1982/83
1984/85
1986/87
1988/89
1990/91
1992/93
1994/95
1996/97
1998/99
2000/01
2002/03
2004/05
Source: CEIC, Morgan Stanley Research.

Net Interest Margins … wide and sustainable

8.00 % 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 Indonesia Pakistan Thailand India Korea
8.00
%
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
Indonesia
Pakistan
Thailand
India
Korea
Vietnam
China
Malaysia
Australia
Singapore
Taiwan
HK

Source: Company data, Morgan Stanley Research, Data as at Dec 2006

Exhibit 7

RoRWAs … large generator of organic capital

5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Pakistan Indonesia Malaysia Thailand
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Pakistan
Indonesia
Malaysia
Thailand
Australia
Singapore
Vietnam
India
Hong Kong
China

Source: Company data, Morgan Stanley Research. Data as at Dec 2006

Contents MORGAN STANLEY August 28, 2007 Pakistan Banks RESEARCH High Risk but Huge Opportunity 2

Contents

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

High Risk but Huge Opportunity

2

Positive View

2

Negative View

2

Stock Views

5

Macro Perspective

6

Positioned for Growth

11

Bank Sector Overview

13

Balance Sheet Analysis

21

Return Decomposition

27

MCB Bank … Canny

28

Valuation

29

United Bank Ltd … Retailer

32

Valuation

33

Forecasts and Assumptions

36

Stock Views MCB: Overweight, PT Rs340 • We initiate coverage of MCB with an Overweight

Stock Views

MCB: Overweight, PT Rs340

We initiate coverage of MCB with an Overweight rating and a 12-month price target of Rs340, which equates to a total potential return of 31%.

MCB is trading on 8.9x EPS, 2.5x book, with three-year earnings CAGR of 16%, an RoE of 30%, and a dividend yield of 4.1%, on our FY08 estimates.

We believe MCB offers a high-quality play on Pakistan’s emerging financial system. MCB has a well-buttressed balance sheet – Tier I of 16.6% and gross NPL ratio of 4% with 100% coverage.

Return structures are eye-catching. MCB has a net interest margin of 7.55% driven by a strong deposit franchise with superior mix. The return on RWAs is a bumper 6.14% (the regional average is a mere 2.1%), which equates to very strong organic capital generation – enough to sustain 20%+ RWA growth and a dividend payout ratio of at least 50%, in our view.

The cream comes from the “Mansha” influence, canny investments in Adamjee (well below current market), Sui Pipelines, and a large and growing pension fund surplus.

UBL: Overweight, PT Rs193

We initiate coverage of UBL with an Overweight rating and a 12-month price target of Rs193, which equates to a total potential return of 16%.

UBL is trading on 9.1x EPS, 2.5x book, with three year earnings CAGR of 10%, an RoE of 32%, and a dividend yield of 4.1%, on our FY08 estimates.

UBL offers leadership in retail and investment banking, and a potentially strong Middle East proposition. The balance sheet is solid, with Tier I of 8% and a gross NPL ratio of 5.3% with 77% coverage.

Return structures are healthy. UBL has a net interest margin of 6.03% due to its low-cost deposit franchise.

UBL is currently undertaking a comprehensive project to transform the internal business processes, replace IT platforms, and revitalize distribution. The core banking system is currently being replaced with “Genesis”. This project is expected to take two to three years to complete.

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Exhibit 8

Price Target Summary

 

Share

Shares

Mkt cap

Target

Target

Total

price

o/s (m)

Rs bn

price

P/E

return

MCB (O/W)

Rs267

628

Rs168

Rs340

11.3

31%

UBL (O/W)

Rs171

809

Rs138

Rs193

10.2

16%

Source: Company data, Morgan Stanley Research. Total return includes dividends but does not include transaction costs.

Exhibit 9

Investment Arithmetic

FY04

FY05

FY06

FY07e

FY08e

FY09e

ModelWare fully diluted EPS

MCB

Rs5.1

Rs17.3

Rs24.1

Rs27.9

Rs30.2

Rs35.0

UBL

Rs7.3

Rs11.7

Rs16.4

Rs17.5

Rs18.8

Rs21.1

ModelWare EPS growth

 

MCB

(34.4%) 239.9%

38.9%

15.9%

8.1%

15.9%

UBL ModelWare P/E MCB UBL Gross dividend yield MCB UBL Cash payout ratio MCB UBL Price/ NTA MCB UBL Price/ book MCB UBL Pre-goodwill ROE MCB UBL Price/ core profit MCB UBL Market cap/ deposits MCB UBL Tier I MCB UBL

35.1%

60.9%

39.4%

6.9%

7.7%

12.0%

52.4

15.4

11.1

9.6

8.9

7.6

23.5

14.6

10.5

9.8

9.1

8.1

0.9%

1.6%

2.8%

3.7%

4.1%

4.5%

0.9%

1.5%

1.8%

2.9%

4.1%

5.3%

49%

25%

31%

36%

36%

34%

21%

21%

18%

29%

37%

43%

6.1

4.8

3.5

3.1

2.5

2.1

5.0

3.9

3.5

3.3

2.6

2.1

6.1

4.7

3.5

3.1

2.5

2.1

5.0

3.9

3.5

3.3

2.6

2.1

16.0%

45.4%

37.6%

33.9%

31.2%

29.6%

23.7%

30.0%

35.2%

34.6%

31.8%

28.8%

37.4

11.9

8.5

6.6

5.6

4.8

25.8

12.4

8.3

6.4

5.5

4.9

76.5%

73.9%

66.1%

53.2%

46.2%

38.0%

58.4%

46.7%

40.3%

31.4%

27.6%

23.3%

6.4%

9.5%

16.6%

17.9%

18.2%

18.7%

7.9%

7.7%

8.9%

9.2%

10.2%

10.7%

Source: Company data, Morgan Stanley Research. e = Morgan Stanley Research estimates

Macro Perspective • Real GDP growth has averaged 7% for the last five years, propelled

Macro Perspective

Real GDP growth has averaged 7% for the last five years, propelled by renewed domestic confidence, consumption, and investment supported by the buoyant global economic environment. Agriculture is critical to the economy – it comprises 45% of employment, and 66% of the population lives in rural areas.

Inflation has abated and is now running at 7.4%. Food, energy costs, and housing have been key drivers.

Monetary policy has a dual objective of balancing growth and price stability. It is still in tightening mode. The privatization, growth, and enhancement of the financial sector have been central to recent economic stability.

Fiscal policy: The fiscal deficit has improved from an average of 7% in the 1990s to 4% today. Tax reform, debt reduction and growth stimulus need to be balanced.

External sector: Domestic growth and high oil prices have led to a surge in imports. Exports are highly concentrated: cotton, leather and rice. Imports are equally concentrated: machinery and oil associated products.

Worker remittances are the second-largest source of foreign exchange inflow after exports, totaling 4% of GDP.

Foreign direct investment is at record levels of 2.7% of GDP. The Middle East (U.A.E) is the key contributor. The telecom sector (US$1.0 bn) is the largest recipient, then energy (US$305 mn), and financial services (US$266 mn).

External debt is falling. Growth has slowed from 7% in the 1990s to 2% this decade. It has fallen from 44% of GDP as of June 2000 to 26% at present.

Demographics: A population of 156 million is growing at 2% per annum, with 70% under the age of 30 years. Life expectancy at birth is 64 years for males and 66 years for females. The sex ratio is 107. Punjab is the most populous province, with 56% of the population, while Karachi is the most populous city, with 10% of the population.

Poverty is still a key concern. In 2005, 24% of the population lived below the poverty line, improving from 35% in 2001. Rural poverty levels have improved from 39% to 28%, and urban poverty levels from 23% to 14%.

Education: The literacy rate is estimated at 53%, which is still well below the target of 80% by 2015. Low enrollment rates persist at 52% and the standard of education in the public sector is very low. Public spending on education is a mere 2.1%.

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Exhibit 10

GDP Growth … four years of strength Nominal GDP growth Real GDP growth 20% 18%
GDP Growth … four years of strength
Nominal GDP growth
Real GDP growth
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Jun-90
Jun-92
Jun-94
Jun-96
Jun-98
Jun-00
Jun-02
Jun-04
Jun-06

Source: CEIC, Morgan Stanley Research.

Exhibit 11

GDP by Sector … underpinned by growth in services

Agriculture Industry Services 9,000,000 PKR mn 8,000,000 7,000,000 6,000,000 54% 53% 5,000,000 51% 4,000,000
Agriculture
Industry
Services
9,000,000
PKR mn
8,000,000
7,000,000
6,000,000
54%
53%
5,000,000
51%
4,000,000
51%
53%
3,000,000
53%
52%
51%
27%
49%
27%
49%
27%
2,000,000
50%
27%
50%
24%
50%
24%
24%
23%
24%
24%
1,000,000
24%
25%
24%
20%
21%
19%
23%
22%
27%
26%
24%
23%
26%
27%
26%
25%
0
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07

Source: CEIC, Morgan Stanley Research.

Exhibit 12

GNP per Capita and Growth … growing wealth

GNP per capita YoY growth (rhs)
GNP per capita YoY growth (rhs)

GNP per capita

YoY growth (rhs)

900 17 US 800 14 700 10 600 7 500 3 400 0 300 -4
900
17
US
800
14
700
10
600
7
500
3
400
0
300
-4
200
-7
1982/83
1984/85
1986/87
1988/89
1990/91
1992/93
1994/95
1996/97
1998/99
2000/01
2002/03
2004/05
Source: CEIC, Morgan Stanley Research.
MORGAN STANLEY RESEARCH   August 28, 2007 Pakistan Banks Exhibit 13 Exhibit 16 Contribution to

MORGAN

STANLEY

RESEARCH

 

August 28, 2007 Pakistan Banks

Exhibit 13

Exhibit 16

Contribution to GDP … private consumption critical

SBP Policy Rate … measured increases to 10.0%

Private consumption Government consumption 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1999/00
Private consumption
Government consumption
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
Source: CEIC, Morgan Stanley Research.
22 20 18 16 14 12 10 8 6 4 2 Feb-92 Apr-93 Jun-94 Aug-95
22
20
18
16
14
12
10
8
6
4
2
Feb-92
Apr-93
Jun-94
Aug-95
Oct-96
Dec-97
Feb-99
Apr-00
Jun-01
Aug-02
Oct-03
Dec-04
Feb-06
Apr-07

Source: CEIC, Morgan Stanley Research.

Exhibit 14 Exhibit 17 Contribution to GDP … large investment phase Reserve Requirements … measured
Exhibit 14
Exhibit 17
Contribution to GDP … large investment phase
Reserve Requirements … measured increases
Domestic savings
Total investment
25%
40
%
35
20%
Statutory Liquidity Requirement (SLR)
30
25
15%
20
10%
15
10
Demand
5%
5
Cash Reserve Requirement (CRR)
Time
0%
0
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
Jan-60
Jan-64
Jan-68
Jan-72
Jan-76
Jan-80
Jan-84
Jan-88
Jan-92
Jan-96
Jan-00
Jan-04

Source: CEIC, Morgan Stanley Research.

Exhibit 15

Inflation … still above SBPs target of 6.5%

CPI - YoY chg CPI - annual ave chg 15 % 14 13 12 11
CPI - YoY chg
CPI - annual ave chg
15
%
14
13
12
11
10
9
8
7
6
5
4
3
2
1
Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06

Source: CEIC, Morgan Stanley Research.

Source: CEIC, Morgan Stanley Research

Exhibit 18

Money Supply and Growth … tightening stance

M2 YoY growth 3MMA (rhs)
M2 YoY growth 3MMA (rhs)

M2

YoY growth 3MMA (rhs)

4,500 35% PKR 4,000 31% 3,500 27% 3,000 23% 2,500 19% 2,000 16% 1,500 12%
4,500
35%
PKR
4,000
31%
3,500
27%
3,000
23%
2,500
19%
2,000
16%
1,500
12%
1,000
8%
500
4%
0
0%
Jan-88 Apr-89 Jul-90 Oct-91 Jan-93 Apr-94 Jul-95 Oct-96 Jan-98 Apr-99 Jul-00 Oct-01 Jan-03 Apr-04 Jul-05 Oct-06
Source: CEIC, Morgan Stanley Research
MORGAN STANLEY RESEARCH   August 28, 2007 Pakistan Banks Exhibit 19 Exhibit 22 Fiscal Deficit

MORGAN

STANLEY

RESEARCH

 

August 28, 2007 Pakistan Banks

Exhibit 19

Exhibit 22

Fiscal Deficit as a % of GDP … greater discipline

Export Mix … huge textile concentration (cotton)

Food Textile Manufactures Petroleum & Coal Other Manufactures 10.0 % 80% 9.0 70% 8.0 7.0
Food
Textile Manufactures
Petroleum & Coal
Other Manufactures
10.0
%
80%
9.0
70%
8.0
7.0
60%
6.0
50%
5.0
40%
4.0
30%
3.0
20%
2.0
10%
1.0
0.0
0%
1990/91
1992/93
1994/95
1996/97
1998/99
2000/01
2002/03
2004/05
2006/07
Sep-99
Jun-00
Mar-01
Dec-01
Sep-02
Jun-03
Mar-04
Dec-04
Sep-05
Jun-06
Mar-07
Source: CEIC, Morgan Stanley Research
Source: CEIC, Morgan Stanley Research
Exhibit 20
Exhibit 23

Mismatch between Contributions to Growth and Taxes … seeking an efficient & effective tax system

(% - FY2005)

Share in GDP

Share in Taxes

Point contribution to GDP growth

Agriculture Manufacturing Construction Electricity & gas distn Trans, Storage & Comm Wholesale & Retail Trade Finance & Insurance Public Admin & Defense Social & Comm Services Other

23.0

1.2

1.5

18.0

62.2

2.2

2.1

2.9

0.5

3.5

5.3

0.2

10.5

4.5

0.5

19.0

2.8

2.0

4.0

3.9

1.0

6.0

5.0

0.0

9.6

7.8

0.6

4.3

4.4

0.1

Total

100.0

100.0

8.6

Source: SBP, Morgan Stanley Research

Import Mix … huge oil & machinery concentration

Food Machinery & transport Petroleum Chemicals Metal 45% 40% 35% 30% 25% 20% 15% 10%
Food
Machinery & transport
Petroleum
Chemicals
Metal
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Sep-99
Jun-00
Mar-01
Dec-01
Sep-02
Jun-03
Mar-04
Dec-04
Sep-05
Jun-06
Mar-07

Source: CEIC, Morgan Stanley Research

Exhibit 21 Exhibit 24 Current A/C … surging imports (domestic demand) Foreign Trade Growth …
Exhibit 21
Exhibit 24
Current A/C … surging imports (domestic demand)
Foreign Trade Growth … import dependant
BoP - Current A/C
as % of GDP (rhs)
Exports, YoY% Chg 3MMA
Imports, YoY% Chg 3MMA
US$m
5,000
5%
70%
4,000
4%
60%
3,000
3%
50%
2,000
2%
40%
1,000
1%
30%
0
0%
20%
-1,000
-1%
10%
-2,000
-2%
0%
-3,000
-3%
-10%
-4,000
-4%
-20%
-5,000
-5%
-30%
-6,000
-6%
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
Jul-
1992/93
1994/95
1996/97
1998/99
2000/01
2002/03
2004/05
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
Source: CEIC, Morgan Stanley Research
Source: CEIC, Morgan Stanley Research
MORGAN STANLEY RESEARCH   August 28, 2007 Pakistan Banks Exhibit 25 Exhibit 28 Forex Reserves

MORGAN

STANLEY

RESEARCH

 

August 28, 2007 Pakistan Banks

Exhibit 25

Exhibit 28

Forex Reserves and Import Cover …better positioned

Forex reserves Monthly import cover (rhs)

Forex reserves

Monthly import cover (rhs)

14,000 12 US$ X 12,000 10 10,000 9 8,000 7 6,000 5 4,000 3 2,000
14,000
12
US$
X
12,000
10
10,000
9
8,000
7
6,000
5
4,000
3
2,000
2
0
0
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
Jan-
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
Source: CEIC, Morgan Stanley Research

Exhibit 26

Worker Remittances (% of GDP) … important sector 5% 4% 3% 2% 1% 0% 1995/96
Worker Remittances (% of GDP) … important sector
5%
4%
3%
2%
1%
0%
1995/96
1996/97
1997/98
1998/99
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07

Source: CEIC, Morgan Stanley Research

Exhibit 27

Worker Remittances (by geo) … Middle East centric

Middle East Nth Amercia Europe 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
Middle East
Nth Amercia
Europe
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Jul-95
Jul-96
Jul-97
Jul-98
Jul-99
Jul-00
Jul-01
Jul-02
Jul-03
Jul-04
Jul-05
Jul-06

Source: CEIC, Morgan Stanley Research

Foreign Investment … key to supporting growth

FDI Portfolio as a % of GDP (rhs)
FDI Portfolio as a % of GDP (rhs)

FDI

FDI Portfolio as a % of GDP (rhs)

Portfolio

as a % of GDP (rhs)

4,000 3.0% US$ mn 3,400 2.6% 2,800 2.1% 2,200 1.7% 1,600 1.3% 1,000 0.9% 400
4,000
3.0%
US$ mn
3,400
2.6%
2,800
2.1%
2,200
1.7%
1,600
1.3%
1,000
0.9%
400
0.4%
-200
0.0%
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
Source: CEIC, Morgan Stanley Research

Exhibit 29

Foreign Investment (by geo) … Middle East centric Nth America Middle East Europe 80% 70%
Foreign Investment (by geo) … Middle East centric
Nth America
Middle East
Europe
80%
70%
60%
50%
40%
30%
20%
10%
0%
1997/98
1998/99
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06

Source: CEIC, Morgan Stanley Research

Exhibit 30

Exchange Rate (USD:PKR) … recent stability 70 60 50 40 30 20 10 0 Jan-85
Exchange Rate (USD:PKR) … recent stability
70
60
50
40
30
20
10
0
Jan-85
Jan-87
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07

Source: CEIC, Morgan Stanley Research

MORGAN STANLEY RESEARCH   August 28, 2007 Pakistan Banks Exhibit 31 Exhibit 34 External Debt

MORGAN

STANLEY

RESEARCH

 

August 28, 2007 Pakistan Banks

Exhibit 31

Exhibit 34

External Debt Outstanding … reducing the burden

Employment Mix (2006) … agri centric

External debt outstanding as a % of GDP (rhs)
External debt outstanding as a % of GDP (rhs)

External debt outstanding

as a % of GDP (rhs)

38,000

US$

36,000

34,000

32,000

30,000

28,000

26,000

24,000

22,000

20,000

1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
50% 46% 41% Non-Agriculture - Informal (41%) 37% 32% 28% 23% 19% 14% Non-Agriculture -
50%
46%
41%
Non-Agriculture -
Informal
(41%)
37%
32%
28%
23%
19%
14%
Non-Agriculture -
10%
Formal
(15%)

Agriculture

(44%)

Source: CEIC, Morgan Stanley Research

Source: Federal Bureau of Statistics, Morgan Stanley Research

Exhibit 32 Exhibit 35 Foreign Economic Assistance Population Mix … predominantly rural Loans Grants Rural
Exhibit 32
Exhibit 35
Foreign Economic Assistance
Population Mix … predominantly rural
Loans
Grants
Rural
Urban
3,500
80%
US$
3,000
70%
2,500
60%
2,000
50%
1,500
40%
1,000
30%
500
0
20%
1960/61
1964/65
1968/69
1972/73
1976/77
1980/81
1984/85
1988/89
1992/93
1996/97
2000/01
2004/05
1989/90
1991/92
1993/94
1995/96
1997/98
1999/00
2001/02
2003/04
2005/06

Source: CEIC, Morgan Stanley Research

Source: CEIC, Morgan Stanley Research

Exhibit 33

Population & Unemployment …

Exhibit 36

Motor Vehicles … rapid take up

Population Unemployment rate (rhs) YoY pop growth (rhs)
Population Unemployment rate (rhs) YoY pop growth (rhs)

Population

Unemployment rate (rhs)

Unemployment rate (rhs)
Population Unemployment rate (rhs) YoY pop growth (rhs)

YoY pop growth (rhs)

160

mn

150

140

130

120

110

100

90

80

70

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
Motor Vehicles on road per 1000/pop Motor Vehicles sales per 1000/pop (rhs) 9.0 % 50
Motor Vehicles on road per 1000/pop
Motor Vehicles sales per 1000/pop (rhs)
9.0
%
50
5.0
8.0
45
4.5
7.0
40
4.0
6.0
35
3.5
5.0
30
3.0
4.0
25
2.5
3.0
20
2.0
2.0
15
1.5
1.0
10
1.0
0.0
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
Jun-
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06

Source: CEIC, Morgan Stanley Research.

Source: CEIC, Morgan Stanley Research

MORGAN STANLEY August 28, 2007 Pakistan Banks RESEARCH Positioned for Growth Pakistan presents a very

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Positioned for Growth

Pakistan presents a very obvious growth opportunity, in our view.

1. Demographics – vast and young: It is the sixth most populous nation in the world, and 70% of its people are below 30 years of age.

2. Credit penetration - very low: Total credit outstanding is only 29% of GDP. Moreover, the valuable retail segment is a mere 4%. In addition, only 33% of the adult population has bank accounts.

3. Growing wealth: GDP per capita is running at 5-year CAGR of 15%.

Exhibit 37

Demographics, Wealth and Credit Penetration (latest reported)

 

China

India

Indonesia

Pakistan

Philippines

Vietnam

Thailand

Korea

Malaysia

Taiwan

Australia Hong Kong

Singapore

Total popn (mns)

1,314.5

1,096.0

219.2

156.8

85.3

84.2

65.5

48.3

26.6

22.8

20.8

6.9

4.2

Split:-

     
 

<30

42%

61%

57%

70%

63%

62%

48%

41%

60%

43%

41%

34%

40%

30-49

34%

24%

28%

19%

24%

25%

33%

35%

26%

32%

30%

37%

36%

 

50+

23%

14%

15%

11%

13%

13%

19%

24%

14%

25%

30%

29%

24%

 

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

GDP (US$m) GDP per capita (US$)

2,746,321

1,012,026

375,078

135,684

131,516

60,437

239,916

912,873

167,267

304,482

786,663

188,580

136,606

2,089

923

1,711

865

1,543

718

3,663

18,901

6,279

13,360

37,809

27,328

32,218

US$ mn

   

Total credit outstanding Corporate Retail

3,315,858

497,926

89,294

38,710

52,902

34,328

227,391

751,697

175,737

462,135

1,318,027

337,972

170,307

2,762,546

356,082

51,202

33,460

48,448

33,641

167,929

375,292

83,365

242,448

492,754

237,566

69,320

553,311

141,844

38,092

5,250

4,454

687

59,462

376,405

92,371

219,687

825,273

100,406

100,987

- mortgage

316,066

81,973

8,647

831

2,222

0

41,919

233,673

48,190

159,516

709,446

75,969

81,263

- non-mortgage

237,246

59,871

29,444

4,419

2,233

687

17,543

142,732

44,182

60,171

115,828

24,437

19,724

Total deposits

4,813,123

636,363

146,396

52,401

75,494

40,304

254,878

709,475

245,933

609,754

732,320

636,049

193,472

-

as % of GDP

 

Total credit outstanding Corporate Retail

121%

49%

24%

29%

40%

57%

95%

82%

105%

152%

168%

179%

125%

101%

35%

14%

25%

37%

56%

70%

41%

50%

80%

63%

126%

51%

20%

14%

10%

4%

3%

1%

25%

41%

55%

72%

105%

53%

74%

- mortgage

12%

8%

2%

1%

2%

0%

17%

26%

29%

52%

90%

40%

59%

- non-mortgage

9%

6%

8%

3%

2%

1%

7%

16%

26%

20%

15%

13%

14%

Total deposits

175%

63%

39%

39%

57%

67%

106%

78%

147%

200%

93%

337%

142%

-

per capita (US$)

 

Total credit outstanding Corporate Retail

2,523

454

407

247

620

408

3,472

15,564

6,597

20,278

63,348

48,977

40,167

2,102

325

234

213

568

400

2,564

7,770

3,129

10,638

23,683

34,426

16,349

421

129

174

33

52

8

908

7,794

3,467

9,639

39,665

14,550

23,818

- mortgage

240

75

39

5

26

0

640

4,838

1,809

6,999

34,098

11,009

19,166

- non-mortgage

180

55

134

28

26

8

268

2,955

1,658

2,640

5,567

3,541

4,652

Total deposits

3,662

581

668

334

885

479

3,892

14,690

9,232

26,755

35,197

92,172

45,630

Source: Respective central banks, CEIC, Morgan Stanley Research

Total

Total MORGAN STANLEY August 28, 2007 Pakistan Banks RESEARCH Exhibit 38 Total Debt to GDP vs.

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Exhibit 38

Total Debt to GDP vs. GDP per Capita (latest reported)

200% Over-penetrated Hong Kong 180% Australia 160% Taiwan 140% China Singapore 120% Malaysia 100% Thailand
200%
Over-penetrated
Hong Kong
180%
Australia
160%
Taiwan
140%
China
Singapore
120%
Malaysia
100%
Thailand
Korea
80%
60%
Vietnam
India
40%
Philippines
Pakistan
20%
Indo
Under-penetrated
0%
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
credit/ GDP

GDP per capita (US$)

Source: Respective central banks, CEIC, Morgan Stanley Research

Exhibit 39

Total Retail Debt to GDP vs. GDP per Capita (latest reported)

120% Over-penetrated Australia 100% 80% Singapore Taiwan 60% Malaysia Hong Kong Korea 40% Thailand China
120%
Over-penetrated
Australia
100%
80%
Singapore
Taiwan
60%
Malaysia
Hong Kong
Korea
40%
Thailand
China
20%
India
Indo
Pakistan
Philippines
Under-penetrated
0%
Vietnam
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
Total retail debt/ GDP

GDP per capita (US$)

Source: Respective central banks, CEIC, Morgan Stanley Research

Exhibit 40

Mortgage Debt to GDP vs. GDP per Capita (latest reported)

100% Over-penetrated Australia 90% 80% 70% 60% Singapore Taiwan 50% 40% Hong Kong 30% Malaysia
100%
Over-penetrated
Australia
90%
80%
70%
60%
Singapore
Taiwan
50%
40%
Hong Kong
30%
Malaysia
Korea
Thailand
20%
China
10%
India
Indo
Under-penetrated
Philippines
Pakistan
0%
Vietnam
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
Mortgage retail debt/ GDP

GDP per capita (US$)

Source: Respective central banks, CEIC, Morgan Stanley Research

Exhibit 41

Deposits to GDP vs. GDP per Capita (latest reported)

400% 350% Hong Kong 300% 250% Taiwan 200% China Malaysia 150% Singapore Thailand 100% India
400%
350%
Hong Kong
300%
250%
Taiwan
200%
China
Malaysia
150%
Singapore
Thailand
100%
India
Korea
Australia
Vietnam Philippines
50%
Pakistan
Indo
0%
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
Deposits/ GDP

GDP per capita (US$)

Source: Respective central banks, CEIC, Morgan Stanley Research

Bank Sector Overview The Pakistan bank and telco sectors are the success stories of economic

Bank Sector Overview

The Pakistan bank and telco sectors are the success stories of economic reform in Pakistan.

Commercial banks were nationalized in 1972, with the formation of five major banking groups (National Bank of Pakistan, Habib Bank, United Bank, MCB, and Allied Bank of Pakistan).

This policy was reversed in 1991. MCB was the first major bank to begin the reprivatization process, with 75% of its equity divested to the private sector over two years. Ten new banking licenses were also issued.

However, the process was slow and poorly executed. With little capacity and capability enhancement combined with weak supervision, the bank sector found itself in trouble.

In 1997, the State Bank of Pakistan (“SBP”) was granted more autonomy and sole authority over the commercial banking sector. SBP set about to better equip itself, build capacity and improve banking standards. It consulted with the key overseas banking regulators, invested heavily in IT and training, and recruited staff with foreign banking and regulatory experience.

Exhibit 42

Pakistan Banking Landscape (2006)

PKR millions

Assets

Share Deposits Share Branches

Share

1.

National Bank of Pakistan

625,592

16%

483,232

16%

1,250

17%

2.

Habib Bank Limited

513,876

13%

411,246

14%

1,425

20%

3.

United Bank Ltd.

388,177

10%

308,065

10%

1,056

15%

4.

MCB Bank Ltd.

317,608

8%

251,092

8%

994

14%

5.

Bank Alfalah Ltd. Standard Chartered Bank

261,499

7%

214,843

7%

195

3%

6.

246,318

6%

156,878

5%

115

2%

7.

Allied Bank Limited

232,178

6%

198,030

7%

700

10%

8.

Askari Commercial Bank Ltd.

152,484

4%

122,701

4%

53

1%

9.

The Bank of Punjab

139,223

3%

114,898

4%

266

4%

10.

ABN AMRO Bank N.V.

124,000

3%

95,736

3%

80

1%

11.

Faysal Bank Ltd.

116,847

3%

78,229

3%

75

1%

12.

Bank AL Habib Ltd.

108,205

3%

88,003

3%

157

2%

13.

Metropolitan Bank Ltd.

94,298

2%

60,377

2%

82

1%

14.

Citibank N.A.

89,088

2%

61,905

2%

18

0%

15.

Zarai Taraqiati Bank Ltd.

85,479

2%

2,645

0%

342

5%

16.

Soneri Bank Ltd.

67,014

2%

50,931

2%

72

1%

17.

PICIC Commercial Bank Ltd.

65,349

2%

53,150

2%

129

2%

18.

SaudiPak Commercial Bank Ltd

49,480

1%

40,692

1%

50

1%

19.

Habib Bank AG Zurich

45,186

1%

33,191

1%

25

0%

20.

NIB Bank Limited

40,258

1%

21,709

1%

41

1%

21.

Meezan Bank Limited

38,831

1%

29,447

1%

63

1%

22.

The Bank of Khyber

26,522

1%

19,440

1%

29

0%

23.

KASB Bank Ltd.

23,461

1%

19,051

1%

35

0%

Other

25. HSBC Bank

15,544

0%

10,753

0%

5

0%

26. Deutsche Bank AG

7,581

0%

2,649

0%

2

0%

27. American Express Bank Ltd.

6,660

0%

5,581

0%

1

0%

28. The Bank of Tokyo - Mitsubishi

6,097

0%

1,209

0%

1

0%

System - gross

4,005,491

97%

3,012,836

97%

7,261

100%

Domestic bank share

3,346,381

84%

2,567,781

85%

7,014

97%

- Public sector bank share

791,337

20%

617,570

20%

1,545

21%

Source: State Bank of Pakistan, Company data, Morgan Stanley Research

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Once the SBP achieved its stronger positioning, the privatization program restarted. In the early 2000s, United Bank, Habib Bank, and Allied Bank were privatized and the remaining government stake in MCB was sold.

Today 80% of banking assets are in private hands. SBP promotes an open and transparent system. Foreign banks and investors are encouraged, and they now hold around 50% of banking assets.

Further strengthening of the banking system is required and is currently underway:

Voluntary consolidation, particularly the smaller banks (paid-up capital requirements to be a catalyst).

Ongoing strengthening of legal infrastructure.

Banking Law revision to deal with future challenges.

Deposit insurance scheme under consideration.

Basel II implementation… by 2008.

Sustained ongoing improvement in disclosure, supervision, corporate governance, risk management, and product development to meet international standards.

While there are around 38 banks in the banking system, operations tend to be concentrated with the larger banks. The top seven banks manage 65% of system assets, hold 67% of system deposits, and run 79% of branches.

In the following sections, we focus on:

1. Loan books … predominantly commercial, huge scope to grow into consumer and SME. Auto, unsecured, and cards are key to consumer growth; housing is structurally challenged and will take much time.

2. Deposit books … 68% of system deposits are low cost. This is a huge spread driver. As deposits are largely a function of faith and culture, dramatic change is unlikely, despite efforts by SBP to encourage greater TD usage.

3. Net interest margins … wide and largely driven by deposit spreads (70%). Gradual deposit migration and competition is likely to be offset by improving loan mix (more SME and consumer).

4. Asset quality … improving and adequately covered.

5. Capital Intensity … rich organic capital generation.

6. SBP regulations … a vigilant and proactive regulator.

MORGAN STANLEY RESEARCH 1) Loan Books August 28, 2007 Pakistan Banks Exhibit 43 Exhibit 46

MORGAN

STANLEY

RESEARCH

1) Loan Books

August 28, 2007 Pakistan Banks

Exhibit 43

Exhibit 46

System Loan & Deposit Growth … sustained growth

Corporate Mix (2006) … large corporate centric

Deposits, YoY% chg Loans, YoY% chg 40% 35% 30% 25% 20% 15% 10% 5% 0%
Deposits, YoY% chg
Loans, YoY% chg
40%
35%
30%
25%
20%
15%
10%
5%
0%
Jan-03
May-03
Sep-03
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07

Source: CEIC, Morgan Stanley Research

Exhibit 44

System Loans/ Deposits … gradual liquidity soak up 90% 85% 80% 75% 70% 65% 60%
System Loans/ Deposits … gradual liquidity soak up
90%
85%
80%
75%
70%
65%
60%
55%
50%
Jan-02
Jun-02
Nov-02
Apr-03
Sep-03
Feb-04
Jul-04
Dec-04
May-05
Oct-05
Mar-06
Aug-06
Jan-07

Source: CEIC, Morgan Stanley Research

Exhibit 45

Loan Mix … only 16% is personal

Government Personal Commercial 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Dec-01 Jun-02
Government
Personal
Commercial
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Dec-01
Jun-02
Dec-02
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06

Source: CEIC, Morgan Stanley Research

Other, 4% Commodity ops, 8% Agri production, 7% SME, 19% Corporate, 62%
Other, 4%
Commodity ops, 8%
Agri production, 7%
SME, 19%
Corporate, 62%

Source: SBP, Morgan Stanley Research

Credit outstanding amounts to only 29% of GDP, split 25% corporate and 4% retail, and there are only 5 mn loan accounts.

Corporate loan growth is running at 15% YoY. As economic development continues in Pakistan, capacity and infrastructure investment will continue to drive corporate loan growth. Moreover, SME is still very much an immature banking segment and hence an untapped opportunity.

Exhibit 47

Personal Loan Mix (2006) … autos and unsecured

Unsecured

40%

Other

1% Housing 16% Auto's 31%
1%
Housing
16%
Auto's
31%

Credit cards

12%

Source: SBP, Morgan Stanley Research

Consumer loans are growing at 19% YoY. Unsecured personal loans represent 33% of this growth, housing loans 25%, and auto loans 23%.

Housing loans represent a mere 2% of system lending outstanding or 16% of consumer lending outstanding. Access to housing is a structural problem in Pakistan, with poverty, red tape, and a chronic lack of supply. The housing shortfall is

estimated at 6.2 million units. Moreover, the present stock is rapidly ageing: 50% is over

estimated at 6.2 million units. Moreover, the present stock is rapidly ageing: 50% is over 50 years old. Estimates suggest that around 50% of the urban population now lives in slums and squatter settlements.

This is not lost on the government, which has implemented policies to incentivise the construction industry and the private sector builders/ developers. This ambitious policy offers the following, inter alia:-

Identify state and other lands for housing development, and provide land at concessionary rates for housing schemes, provided the subsidy is passed on.

Encourage banks to originate mortgages.

Increase annual HBFC loan disbursement from Rs1.2 bn to Rs7.0 bn.

Simplify land and mortgage transaction paperwork.

Reduce stamp duties and registration fees; no stamp duty shall be charged for a housing mortgage.

Reduce property tax on rented property from 25% to 5%.

Exempt construction of housing plots up to 150 sq. yards and flats/ apartments of 1,000 sq. ft from all types of taxes for a period of five years.

Credit cards are also a very immature segment with only 1.5 mn cards on issue.

Before a bank can extend loans in the consumer space, the SBP must be satisfied that the bank has sufficient capability in IT, risk management, and personnel. Moreover, a separate provisioning policy has been enforced requiring banks to set aside a general provision as follows:

5% general provision for unsecured consumer.

1.5% general provision for secured consumer.

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

2) Deposit Books

Deposit penetration is also very low, with only 26 million deposit accounts (retail and corporate) versus a population of 156 million. As a % of GDP deposits represent 39%, in line with Indonesia’s.

Exhibit 48

Deposit Mix by Customer

Government Commercial Personal 60% 50% 40% 30% 20% 10% 0% Dec-01 Jun-02 Dec-02 Jun-03 Dec-03
Government
Commercial
Personal
60%
50%
40%
30%
20%
10%
0%
Dec-01
Jun-02
Dec-02
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06

Source: CEIC, Morgan Stanley Research

Exhibit 49

Deposit Mix by Account … 68% of deposits low cost

Current Savings Fixed Other 60% 50% 40% 30% 20% 10% 0% Jun-97 Mar-98 Dec-98 Sep-99
Current
Savings
Fixed
Other
60%
50%
40%
30%
20%
10%
0%
Jun-97
Mar-98
Dec-98
Sep-99
Jun-00
Mar-01
Dec-01
Sep-02
Jun-03
Mar-04
Dec-04
Sep-05
Jun-06

Source: CEIC, Morgan Stanley Research

While higher interest rates and competition are seeing some migration to higher-yielding deposits, Pakistan is characterized by its large proportion of low-cost deposits – 68% of the system’s. This is a function of a number of factors, such as faith (sharia prohibits interest), risk aversion (customers not willing to lock away money for a period of time), convenience (at-call access), fragmentation (rural based and small value), and lack of sophistication. This will only gradually change.

With a system loan/deposit ratio of 75% and prospects of continued high double-digit loan growth, banks must continue to strive to grow deposits and increase penetration. Financial access remains immature.

3) Net Interest Margins Pakistan enjoys very wide margins, second only to Indonesia in the

3) Net Interest Margins

Pakistan enjoys very wide margins, second only to Indonesia in the broader region at 6.40%. The well-placed full-suite banks with far reaching deposit franchises earn net interest margins of between 7% and 8%. This makes for a strong banking platform. However, while Indonesia derives much of its margin from assets – very wide spreads on micro and consumer lending – Pakistan’s key source is rich deposit spreads, which are a function of structurally high interest rates and indifferent depositors.

Exhibit 50

System Net Interest Spreads 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1998 1999 2000
System Net Interest Spreads
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
1998
1999
2000
2001
2002
2003
2004
2005
2006

Source: SBP, Morgan Stanley Research

Exhibit 51

Regional Average Net Interest Margins

8.00 % 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 Indonesia Pakistan Thailand India Korea
8.00
%
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
Indonesia
Pakistan
Thailand
India
Korea
Vietnam
China
Malaysia
Australia
Singapore
Taiwan
HK

Source: Company data, Morgan Stanley Research

In the following tables, we model a basic system pro-forma balance sheet comprising required liquidity and loans, and funded by deposits and equity, to illustrate the de-composition of Pakistan net interest margins. Around 73% of net interest income is derived from deposit spreads.

MORGAN

STANLEY

August 28, 2007 Pakistan Banks

RESEARCH

Exhibit 52

Pro-forma Net Interest Margin/Income Breakdown

Margin reconciliation Earning rate Funding rate Net interest spread Free funds

10.64%

2.14%

8.50%

0.22%

Net interest margin

8.72%

Net interest income/ margin de-composition

Loan spread

67,070

21%

1.87%

Deposit spread

229,441

73%

6.39%

Liquidity reserve

(17,069)

(5%)

(0.48%)

Excess liquidity

0

0%

0.00%

Free funds

33,718

11%

0.94%

Net interest income

313,160

100%

8.72%

Source: Company data, SBP, Morgan Stanley Research

Exhibit 53

Pro-forma System Balance Sheet

 

Rs mns

Yield

Income

Spread

Contn

CRR

184,534

0.00%

0

(9.25%)

(17,069)

(5%)

SLR

580,701

9.25%

53,715

0.00%

0

0%

Loans

2,430,090

12.01%

291,854

2.76%

67,070

21%

Corporate

1,579,559

10.50%

165,854

1.25%

19,744

6%

SME

364,514

14.00%

51,032

4.75%

17,314

6%

Housing

48,602

13.00%

6,318

3.75%

1,823

1%

Auto

170,106

13.00%

22,114

3.75%

6,379

2%

Unsecured

194,407

20.00%

38,881

10.75%

20,899

7%

Gov't

72,903

10.50%

7,655

1.25%

911

0%

Liquidity

395,307

9.25%

36,566

0.00%

0

0%

Earning assets

3,590,632

10.64%

382,135

1.39%

50,001

16%

 

Cost

Expense

Spread

 

Deposits

3,226,117

2.14%