Pakistan Banks

Sector Update 28th August, 2015

Spread compression to continue; we like UBL, ABL & BAFL

 Banking sector spreads of private sector banks fell by 29 basis points (bp) MoM to 5.12%. Spreads will
decline by a further 75-90bp to settle around 4.25%-4.40%, in our view, as loan re-pricing continues.
 Current spread of private sector banks’ lending rate above KIBOR is an elevated 184bp, compared to an
Pakistan Banks earnings expectations average of 62bp in the 12 months from Nov-13 to Oct-14 (a period in which DR was constant at 10%).
EPS CY14 CY15E CY16E  NII of Next Capital’s banking universe rose on average by 6% QoQ in 2QCY15 results. This was achieved
HBL A
21.6 22.2 20.5 despite the sharp decline in interest rates; however, we wish to flag that spreads of pvt sector banks fell
UBL 17.9 2 21.0 20.6 by a mere 22bp QoQ in 2QCY15. Excluding capital gains, other income and tax expenses, strong
MCB 21.9 2 2. 25.2 24.5 underlying profitability is seen in UBL and BAFL during 2QCY15.
ABL 13.1 2 1 13.4
0. 14.7  UBL, ABL, and BAFL are our preferred plays in the sector; given their large PIB portfolio, will see less
BAFL 3.6 5 9 4.5
5.
1 4.4
9
1 downward pressure on NII’s in the quarters ahead. They also offer strong valuations compared to peers.
BAHL 5.7 3.4. 5.7 5.6
HMB 4.7 5.7 6.2
4
5 4.8
3
4
7
Source: Next Research 6. Pvt-sector banking spreads declined by 29 bp in July-15; we expect further compression– As per SBP data
1 released recently, banking sector spreads of private sector banks fell by 29 basis points (bp) MoM to 5.12% in July
8 2015. A fall in spreads was expected, as significant loan re-pricing happens in the month of July. However, we
believe spreads will decline by a further 75-90 bp in the coming 3-4 months, as the remaining loans in the system
get re-priced. Spreads should settle around 4.25%-4.40% in the next 2-3 months, highlighting the pressure on
banking NIMs in the quarters ahead.

Elevated credit spreads to reduce as loan re-pricing continues- Since Oct-2014, when the current monetary easing
cycle began, KIBOR has declined by 312 bp, whereas weighted average lending rates have only fallen by 168bp.
Current spread of private sector banks lending rate above KIBOR is at an elevated 184bp, compared to an average
of 62bp in the 12 months from Nov-13 to Oct-14, a period in which the DR was constant at 10%. As per our
discussions with bank managements, we understand that recovery in credit spreads would take some time, thus
the current increase can largely be attributed to lag impact of loan re-pricings.

Figure 1 –Spreads of pvt. Sector banks fell by Figure 2 –Lending rate spread to KIBOR
29 bp MoM to 5.12% in July-15 expected to shrink by a further 75-90bp
0 WALR spread to KIBOR
15.00 3.00
averaged 62bp during Nov-
2.50
10.00 13 to Oct-14
2.00
5.00 1.50
1.00
0.00
0.50
May-11

May-12

May-13

May-14

May-15
Jan-14
Jan-11

Sep-11
Jan-12

Sep-12
Jan-13

Sep-13

Sep-14
Jan-15

-
Aug-13

Apr-15
Apr-14

Jun-14

Aug-14

Jun-15
Dec-13

Feb-14

Dec-14

Feb-15
Oct-13

Oct-14

WALR WADR Spread

Source: SBP, Next Research Source: SBP, Next Research

2QCY15 review: Impact of monetary easing not yet showing in NII– In Next Capital’s banking universe, net interest
income (NII) rose on average by 6% QoQ in 2QCY15 results. This was achieved despite the sharp decline in interest
rates; however, we wish to flag that spreads of pvt sector banks fell by a mere 22bp QoQ in 2QCY15. Rising PIB
holdings and deposit growth off-set the small decline in spreads, resulting in improvement NII. However, in the
quarters ahead, we expect NII shrinkage, as spreads reduce. Capital gains cushioned impact of one of tax jump in
2Q earnings, which came in better-than-expected. Excluding capital gains, other income and tax expenses (please
refer to figure 4), strong underlying profitability was seen in UBL and BAFL during 2QCY15. Excluding capital gains,
other income and one-off tax impacts, UBL’s 2Q EPS was PKR 5.54, versus PKR 5.25 for HBL. ABL’s QoQ dip was
due to normalization of dividend income, ex-dividend income, ABL witnessed a 17% QoQ increase in profitability.

Figure 3 –Capital gains and one-off gains Figure 4 – … however, ex-one offs, UBL, ABL
limit hit from super tax… and BAFL’s prospects seem promising
Ameet Doulat
ameet.doulat@nextcapital.com.pk EPS Reported EPS (ex -cap gains, other
+92-21-111-639-825 1QCY15 2QCY15 QoQ income & super tax)
HBL 6.80 4.90 -28% 1QCY15 2QCY15 QoQ
UBL 5.82 4.57 -21% HBL 5.46 5.25 -4%
MCB 7.11 5.06 -29% UBL 4.62 5.54 20%
ABL 3.68 2.75 -25% MCB 5.44 6.12 12%
BAFL 1.25 1.09 -13% ABL 3.92 3.48 -11%
BAHL 1.44 1.57 9% BAFL 0.82 1.16 41%
HMB 1.35 2.88 113% BAHL 1.33 1.81 36%
Source: Next Research HMB 0.83 0.95 15%
Source: Next Research
Figure 5 –UBL and ABL’s PIB
position places them in a PIBs portfolios to cushion NIM decline for some- Banks with significant PIB portfolios can remain relatively
favorable position immune to the decline in lending rates, going forward. In top Tier banks, UBL, MCB, and ABL all have very large PIB
portfolios, in excess of 40% of deposits. HBL is quite low at 22%, despite an increase of PKR89bn in 2QCY15.
Amongst Tier II banks, both BAFL and BAHL have built up strong PIB books as well. HMB has realized a
% of Loans PIB MTB considerable portion of its PIBs in 1HCY15 (capital gains of PKR 4.48bn in IHCY15), and is now likely to face some
deposits pressure on NII in the quarters ahead.
HBL 37% 22% 38%
UBL 43% 41% 12% Our top picks are UBL, ABL, and BAFL- Our top picks in the sector are UBL and ABL, which given their large PIB
portfolio, will see less downward pressure on NII’s in the quarters ahead. These two banks also stand out in terms
MCB 41% 43% 32% of relative valuation. ABL currently trades at a P/B of 1.4x at CY15E earnings, a 7% discount to its 5-yr average
ABL 42% 45% 14% P/B. It offers an unmatched ROE-P/B profile vis-à-vis peers and a 22% upside from current levels. Likewise, UBL
BAFL 50% 37% 7% offers a 21% upside and looks particularly attractive compared to its immediate peer, HBL. We also like BAFL,
where our channel checks suggest that Mobilink’s acquisition of Warid is likely. Although the deal size remains
BAHL 41% 36% 30% undisclosed, even a conservative US$600mn valuation would increase BVPS of BAFL by approx. PKR 2/share, and
HMB* 39% 31% 42% imply that BAFL is currently trading at an attractive P/B of 0.8x. The stock offers a 22% upside to our target price of
Source: Company Accounts, Next Research PKR 33. HMB, which was previously our top pick in the sector, has significantly out-performed peers since our
*1Q accounts
initiation (up 21% since April 2015, compared to Next banks universe avg. of 11%). Now, with future earnings
outlook less strong, we believe UBL, ABL, and BAFL offer a better relative valuation.

Figure 6 –ABL ,UBL and BAFL stand out in terms of relative valuation

0
2.50
MCB
2.00
HBL
UBL
1.50
BAHL
P/B

HMB ABL
1.00
BAFL
0.50

-
12% 14% 16% 18% 20% 22%
ROE (based on 2015E ex 2Q one-offs)
Source: Next Research

Figure 7 –ABL and BAFL look attractive on a Figure 8 – … and a similar trend can be
P/B(x) basis relative to peers… seen in PER(x)

Price to Book P/E

P/B Current 1 Yr Avg 2 Yr Avg 5 Yr Avg CY14A CY15E CY16E CY17E CY18E
HBL 1.7 1.9 1.5 1.4 HBL 9.6 9.4 10.1 9.2 8.4
UBL 1.5 1.8 1.6 1.3 UBL 9.2 7.9 8.8 8.0 7.7
MCB 2.1 2.5 2.4 2.1 MCB 11.7 10.1 10.6 10.2 10.0
ABL 1.4 1.6 1.5 1.5 ABL 7.8 7.6 7.0 7.1 7.3
BAFL 0.9 1.1 1.0 0.9 BAFL 7.6 6.0 6.2 6.3 5.7
BAHL 1.5 1.7 1.6 1.6 BAHL 7.6 7.6 7.8 7.7 6.8
HMB 1.0 1.2 1.0 0.9 HMB 7.1 5.4 7.0 6.2 6.0
Source: Bloomberg, Next Research Source: Next Research

2
APPENDIX 1

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