Karachi, November 29, 2022 (PPI-OT): PR hike bodes well for near term earnings of banks

We tweak our near-term earnings estimates upwards by 3-8% following the recent Policy Rate (PR) hike of 100bp to 16%. The impact is limited to CY23E earnings only, as we maintain monetary easing cycle assumption mid-CY23 onwards. As a result, our long-term ROE also remains intact at 20%.

We highlight, shorter tenor secondary market yields moved up by ~100bp yesterday, which is in addition to the ~20bp increase posted in the last couple of weeks. This may lead to higher asset re-pricing than is incorporated in our base case for coming quarters.

We reiterate the sector trades at attractive multiples with CY22E P/B of 0.65x and P/E of 3.8x, in addition to double-digit D/Y. We highlight UBL, MEBL and BAFL as our top picks from the sector.

PR hike increases banking sector earnings estimates

We tweak our near-term earnings estimates upwards by 3-8% following the recent Policy Rate (PR) hike of 100bp to 16%. While all banks would benefit from the ongoing monetary tightening, banks with a higher ADR and variable-rate investment instruments, zero-cost deposit mix, higher leverage and higher contribution from core income to bottom line would witness a higher impact than peers.

Albeit limited to CY23

Our earnings estimates, however, only revise upward for CY23E. This is due to our assumptions of maintaining our view on headline inflation sliding down to 8% – 10% by 2HCY23, leading to a monetary easing during the same time. Our Policy Rate assumption beyond mid-CY23 is intact, which gradually declines to 10% by mid-CY24. The same keeps our projected recurring ROE broadly unchanged. Nonetheless, expanding banking spreads as compared to previous estimates add to our Overweight stance on the banking sector.

Asset re-pricing greater than PR hike quantum likely

While shorter tenor secondary market yields had moved upward ~100bp yesterday following the surprise PR hike announcement, longer tenor yields have jumped by 50bp. We highlight, the movement in shorter tenor yields is in addition to the ~20bp increase posted in the last couple of weeks. KIBOR also moved upward by 95bp. The higher than PR hike increase in yields in some tenors is likely to lead to higher asset re-pricing than incorporated in our base case in coming quarters. The change in shorter tenor yields would not only re-price the banking sector’s T-Bill Investments, but also the Floater PIB Investments (following weighted average yields of T-Bill auctions). Both these investment segments make up for almost half of the total investment book.

On the cost front, increase in the Minimum Deposit Rate (40% of deposits currently in savings) to 14.5% would be effective from Dec-2022, while we expect re-pricing of term deposits (18% of deposits) would reflect during 2QCY23, given the current maturity. Moreover, banks that are levered by borrowing from SBP through Repo borrowing, which is another Monetary Policy instrument and linked to the Policy Rate, will also witness rate increase of 100bp.

Current levels offer opportunity

Despite ROE averaging at 20% in the next five years, the sector trades below BV. Pak banks currently trade at CY22E P/B of 0.65x and P/E of 3.8x, which we believe are unjustified. We recommend current levels as attractive entry level to investors over (1) double-digit growth in deposit mobilization, (2) NIMs expansion and (3) sound asset quality.

While the sector continues to report reasonable CET1 ratios, and comfortable Tier II CAR and despite upward revision in CY23E earnings, we keep our absolute pay- out assumptions unchanged, offering D/Y of 12%. We reason this on the back of expectations of banks wanting to maintain absolute dividends in the prospective monetary easing cycle. While most players from the banking space currently offer decent capital upside and double-digit D/Y, we highlight United Bank (UBL), Meezan Bank (MEBL) and Bank Alfalah (BAFL) as our top picks from the sector.