Karachi, June 13, 2022 (PPI-OT): Pak Banks: As expected, worst hit by FY23 Budget
As per the details available, the Federal Budget FY23 was most harsh on Pak Banks. The corporate tax rate of 35% (i.e., 39% including 4% super tax has been revised to a rate of 45% (no super tax from now on). We believe that the 2% poverty alleviation tax for all companies reporting profits of over Rs300mn will also be applicable on banks.
Moreover, additional taxes of 5%/2.5% on income from govt securities for banks with Gross ADR below 40% and between 40%-50%, respectively, have been increased to 10%/4%. The raised taxes combined take sector’s effective tax rate from ~40% to ~51%.
On top of this, for the higher taxes linked to ADR levels and poverty alleviation, Finance Bill proposes new rates applicable from Tax year 2022, which means CY21 profits for banks. If we account for retrospective impact, projected CY22 earnings trim by 12% – 32%. The worst-case scenario brings sector’s average Tier I ROE for next 5 years down from 22% to 18%.
The tax levies imposed on banks were broadly expected and we reiterate our liking for Banks. However, given higher impact of tax measures on the bigger players, we limit our top picks to mid-tiers till clarity emerges. Valuations are still at 0.6x P/B and sub 4x P/E beyond CY22. We highlight even with the worst-case scenario, the sector’s D/Y remains intact.
Higher tax measures expand effective tax rate to 51%
The Federal Budget FY23 has been announced, and the fear for the banking sector addressed in our note, ‘Banks: Quantifying the fear of budget measures’, released last month has come true. The sector has been laden with hefty taxes across the board, over expanding profits earned by the sector in the ongoing monetary tightening environment, in addition to being penalized for higher income from federal government securities while maintaining a lower ADR (Advances to Deposit Ratio).
To summarize, the corporate tax rate of 35% (i.e., 39% including 4% super tax has been revised to a rate of 45% (no super tax from now on). We believe that the 2% poverty alleviation tax for all companies reporting profits of over Rs300mn will also be applicable on banks. Moreover, additional taxes of 5%/2.5% on income from govt securities for banks with Gross ADR below 40% and between 40%-50%, respectively, have been increased to 10%/4%. The raised taxes combined take sector’s effective tax rate from ~40% to ~51%.
The measures are estimated to collect an increment of Rs70bn – 80bn of taxes per annum. This is not a new ordeal for the sector as it has faced corporate tax as high as 58% until 2001, which was then gradually reduced over the years.
Higher ADR banks emerge as relative winners
While impact on each bank is broadly similar for higher corporate tax, measures that are pinned to investment levels have a relatively higher impact on banks with (1) lower ADR and (2) higher contribution of federal government securities to its total revenue. We present position of different banks and impact of these measures below.
Tax year 2022 may mean taxing CY21 profits for banks
On top of this, for the higher taxes linked to ADR levels and poverty alleviation, Finance Bill proposes new rates applicable from Tax year 2022, which means CY21 profits for banks. However, some industry experts view any tax on retrospective basis being eligible to be contested in courts. In the worst-case scenario, 2QCY22 results of the sector would report one-time hefty tax expenses, taking sequential earnings down by c.65%, where a few banks may even report losses.
Outlook
We reiterate our liking for Pak Banks, however, given the higher impact of tax measures discussed above on the bigger players, we limit our top picks to mid-tiers till clarity emerges on the subject. If we account for the retrospective working, our projected earnings for CY22 trim by 12% – 32%. The worst-case scenario brings the sector’s average Tier I ROE for the next 5 years down from 22% to 18%. Valuations for banks are still at 0.6x P/B and sub 4x P/E beyond CY22. We highlight even with the worst-case scenario, the sector’s D/Y remains intact.