Karachi, May 15, 2023 (PPI-OT): Banks: Quantifying investor concerns

Banking sector profits are scaling historic highs (CY23E Tier I ROE estimated at 27%; highest in 17 years). Valuations for the sector however remain depressed. For perspective, last time sector's Tier I ROE was 20%+ was during CY14 - CY16 and CY06 - CY07. During both periods, sector's trailing P/E and P/B were ~7.5x and 1.2x, respectively (2x - 3x higher than current multiples).

In today's note we discuss and quantify investor concerns on regulatory measures which, if materialized, can dent future profitability i.e. potential cut in investment yields and possible increase in taxes, and impact of the same on base case earnings.

We run sensitivity on two scenarios (i) 200bp cut on investment yields and (ii) flat 30% additional tax on income from GoP securities - in addition to regular Income Tax and Super Tax. Our estimates suggest that either of two scenarios does not dip banking ROEs below 20%, indicating that market has potentially overplayed the fears. We also visit adequacy ratio and equity buffer enjoyed by each bank and capacity to withstands NPL and / or any other unforeseen shock that would limit BV growth.

Among the two risks, we assign higher probability to increase in taxes but reiterate Overweight stance on the sector. While multiples remain attractive across the board, we highlight UBL, BAFL and MEBL among our preferred picks from the sector.