Karachi, June 30, 2022 (PPI-OT): Banks: Some positives amidst barrage of negative tax changes

The document detailing amendments regarding Finance Bill 2022 has reported key changes for the banking sector, including (1) Corporate Tax maintained at 39%, earlier increased to 45%, (2) shift of 10% Super Tax charge to CY22, earlier to be charged on CY21 earnings and (3) continuing Super Tax at 4% beyond CY22.

The decrease in Corporate Tax will only impact ~45% of the income, as there is no change reported in the higher taxes on income from federal government securities. This limits positive earnings impact to 7% for the Big 4 and ABL, while extends it to 13% for mid-tier banks and MEBL, as the latter meet the 50% Gross ADR benchmark.

Another area of discussion not related to the budget is the likely drag on adequacy ratios due to unrealized losses on fixed income bonds. We however find our universe banks well placed to remain on track for 2Q22 dividends, barring HBL which faces both higher capital requirements due to DSIB status, with limited buffer on balance sheet.

39% Corporate Tax for banks, only for ~45% of the income

The amendments regarding Finance Bill 2022 finally came on the second last day before the start of FY23, bringing significant changes for the banking sector. The key changes for the sector were (1) Corporate Tax maintained at 39%, earlier increased to 45%, (2) shift of 10% Super Tax charge to CY22, earlier to be charged on CY21 earnings and (3) continuing Super Tax at 4% beyond CY22.

The decrease in Corporate Tax will only impact income derived from sources other than federal government securities, limiting positive earnings impact to 7% for the Big 4 and ABL, as there is no change in the higher taxes on income from federal government securities (~55% of income), subject to each bank’s Gross ADR levels (refer table). For mid-tiers and MEBL, the positive impact increases to an average of 13% as these banks meet the 50% Gross ADR benchmark in Mar-2022 and in our estimated projections for CY22-end. Moreover, the higher taxes subject to ADR levels will also be charged on CY21 income and 1QCY22 income, which is likely to be reported in 2QCY22.

The changes related to Super Tax do not change our earnings estimates materially as we had incorporated the same on a recurring basis into our base case post the Budget announcement. We present JS Banking Universe key stats post the amendments, where we also incorporate a 100bps hike in the Policy Rate in July-2022, followed by a monetary easing cycle from 3QCY23, taking the Policy Rate down to 10% from 2QCY24 onward.

Higher bond yields to pinch adequacy ratios once again

While higher yields improve revenue streams of the banking sector, especially at the time when Investment portfolios are tilted towards floating instruments and shorter tenor government securities, there is the other side to this coin as well. With yields inching upwards, mark-to-market of the banking sector’s ‘Available-for-sale’ fixed rate securities will result in a one-time dent on its unrealized gain or increase in its unrealized losses, which may also trim adequacy ratios. The impact may be magnified as compared to 1QCY22 given a sharper movement in bond yields in 2QCY22. This will also be pounded by the upward movement in Euro Bond yields, in addition to sharp PKR depreciation of ~8% during the quarter.

SBP likely to provide an option to support CAR

In view of the same, banks have, as per media reports, requested the central bank for allowance of reclassification of some securities from the ‘Available-for-sale’ category to the ‘Held-to-Maturity’ category for the purpose of providing cushion to respective CAR levels. It is also being reported that the central bank nod to the proposal will be accompanied by restriction on dividend payouts for a certain period for the purpose of conserving adequacy ratios.

We believe most banks under our coverage are comfortable on the buffer currently maintained at their CAR levels. In addition, the shift of 10% Super Tax on CY22 earnings, rather than CY21, also now gives the sector some room to spread out some of the tax charge for the remainder of CY22. Albeit, with the exception of five banks announcing quarterly dividends, namely HBL, UBL, MCB, MEBL and ABL, we find our HBL dividend forecast faces downside risk due to their higher capital requirements and limited buffer on the balance sheet.