Karachi, December 27, 2021 (PPI-OT): Banks: Putting the spotlight on mid-tiers

Cascading performance of mid-tier banks and large banks reveals that former set of banks is relatively better placed owing to higher ROE generation, prevailing since CY18, based on higher deposit growth mix and operational deleveraging; albeit reflecting a divergence in trading multiples with an expanding discount during the same period.

Even though the entire banking sector currently looks very attractive, mid-tier banks stand out with higher growth in fee income and superior asset quality, offering a higher upside as compared to large banks (P/B: Mid-tier 0.61x vs Big5 0.71x).

We cherry pick BAHL, BAFL and HMB as our favourites among the mid-tiers that offer a mix of growth, value and D/Y play.

Case for re-rating of Pakistan banks

We bring to attention, better fundamentals of Pakistan mid-tier banks, where our sample depicts higher return generation since CY18, albeit reflects a divergence in trading multiples trend with an expanding discount during the same period. The higher ROE generation has been a result of (1) higher growth in deposit base coupled with faster pace of increase in zero-cost deposit mix, (2) optimal use of equity on the back of a higher leverage and (3) operational deleveraging.

Mid-tiers – the pick for passive long-term investors

Without disregarding that the overall banking sector is currently available at lucrative multiples, we believe mid-tier banks offer a higher upside compared to large banks. Conversely, preference for mid-tier banks over large banks is recommended for investors with longer time horizons, given the relatively lesser float (and hence liquidity) available in scrip of the said segment.

With a higher growth in core income growth, the mid-tier banks also stand out with higher growth in Fee Income and superior asset quality as compared to the larger banks. The mid-tier segment is presently trading at P/B of 0.61x with a sustainable ROE of 20% vs. the Big-5 at a P/B of 0.71x and with a sustainable ROE of 21%. However, excluding the premiums pinned to Meezan Bank (MEBL), we highlight the Big-4 trade at 0.57x, while its sustainable ROE averages to 19%. Key risks to our investment thesis include (1) potential of greater NPL accretion and (2) change in investment mix post stability in interest rates.

Top picks from mid-tier banks

HMB: We reiterate Habib Metropolitan Bank (HMB, TP: Rs80) as our top pick in mid-sized banks (refer to our note ‘HMB: Structural improvements outweigh possible bond book overhang’).

BAHL: While flat earnings in the medium term remains a concern for some quarters of the market, we believe Bank Al Habib’s (BAHL TP: Rs135) is currently undervalued owing to (1) higher growth and (2) superior asset quality, resulting a recurring Tier I ROE of 20%. We expect the bank to continue expanding its market share every year broadly through branch expansion as we assume deposit growth of 14% per annum (sector: 12% per annum) while maintaining a higher leverage against its assets. Hence, despite its ROA at par to peers, the bank is likely to keep generating a higher ROE.

BAFL: Our Target Price for Bank Alfalah (BAFL) of Rs75 reflects an upside of 2x. The stock trades at a lower P/B of 0.6x, ~25% below banking stocks that generate similar ROE of ~21%. The bank holds a higher ratio of interest earning assets over interest bearing liabilities as BAFL currently holds an ADR of 60% and a zero-cost deposit mix of 47%, leading to the bank ranking as one of the highest beneficiaries of the ongoing interest rate increase.