Karachi, September 12, 2023 (PPI-OT): Banks: Focus on CAR bodes well for dividend sustainability

Latest stock filing by United Bank Ltd (UBL) notifies intention to sell 55% holding in UNBL UK which takes up 200bp of UBL's consolidated CAR - a move which highlights increased focus on management of capital structure.

Comments from management of other banks in recent corporate briefings suggest that capital management is likely to remain an important sector theme over the near term.

Importance of the same has been magnified following the recent T-Bill auction which has fueled expectations of an impending rate hike - which is directionally positive for banking sector's profit and adequacy levels over the medium term but comes with a near term risk of Mark-to-Market (MTM) losses on bonds and negative drag on CAR.

Continued proactive focus and actions by bank's management would help allay concerns, in our view, on one of the pillars of investment thesis of Pakistan banks - i.e. sustainability of dividend policy.

Expectations of further policy tightening expand yields

Anticipation of another round of Policy Rate hike has already been reflected in secondary market yields and lending rate benchmarks post the latest T-Bill auctions. Prior to that, market expectation had also begun to reflect in the 3YR secondary market yield, which had already increased ~100bp during Aug-2023. For the banking sector, while higher yields would improve revenue streams, mark- to-market of banks’ ‘Available-for sale’ (AFS) fixed rate securities will once again result in a one-time dent on its unrealized gain or increase in its unrealized losses.

Where yield increase in the shorter tenors have been relatively lower, compared to previous high change quarters, movement in the longer tenor yields some similar (or in some cases higher) in 3QCY23 so far when compared to 1QCY23 (1Q: Policy Rate increase accumulated to 400bp).

Efforts towards countering CAR impact become tangible

For the banking sector, where much support to book value growth, and adequacy ratios, would be led by further increase in asset yields, an immediate negative impact from potential rise in mark-to-market losses is on the cards. In this scenario, banks that announce quarterly dividends and / or banks falling under requirement 442 441 418 259 58 148 124 80 175 7689 34 108 251 168 173 185 122 to maintain a higher minimum CAR (due to falling under D-SIB) may come under debate. The impact may be slightly magnified for banks holding foreign operations earnings lower than domestic operations’ ROE, if PKR against US$ closes below Jun-2023 end levels.

Banks, however, continue to focus on CAR levels to maintain comfortable buffer on its minimum adequacy requirements. Today’s stock filing by United Bank Ltd (UBL) affirms this strategy where it notifies the bank’s intention to sell its 55% holding in UNBL UK that takes up 200bp of its consolidated CAR. The transaction is subject to regulatory approvals from Pakistan and UK, which may take some months.

A glimpse on current standing

We present banks’ current adequacy levels and buffer on their respective minimum requirements. While we understand, the impact of rising secondary market yields would not replicate 1QCY23 as it incorporates other moving parts as well, we present quantum of decline in Surplus on revaluation of Available-for-sale category for reference.