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Banking sector update

Banking Spreads withhold decline in 0ct-09

Banking spreads haveincreased marginally by 3bp MoM to 7.41% in Oct. Rate on outstanding deposits declined by 3bp MoM whereas that on loans remained constant. Rate on fresh deposits is declining vis-à-vis lower lending rates; however, we expect a secular decline in spreads due to 1) lower average KIBOR vs Jul 08 – Jun 09 average, 2) 5% floor on PLS saving accounts and 3) persistent non-bank government borrowing. Also note that spreads data does not include yield on fixed income securities which results in an upward bias in spreads. We expect our universe margins to decline by 60bp YoY in 2010E.

Spreads historical trend and peak

Historically banking spreads were supported by hefty liquidity in the system but peak i.e. 2009 (Jan 09-Oct 09 avg: 7.54%) has been a manifestation of record high lending rates, despite regulatory floor on PLS savings deposits (~40% of total). Lending rates declined to low single-digit in 2004 to support output which kept spreads relatively low. However with gradual increase in lending rates, spreads started to trend upward from 2005 as deposit cost remained upward sticky due to high CASA amid excess system liquidity. Average annual banking sector spread was 5.33%, 6.57%, 7.40%, 7.29% & 7.29% in 2004, 2005, 2006, 2007 & 2008 respectively.

NPLs cycle nearing peak – be wary of tail risk

NPL accumulation rate has slowed down substantially as evident from 3Q09 results – our banking universe quarterly run rate declined to 4% from 8% in 2Q09. However, the sector might not be out of the woods just yet and could see the tail-end of credit cycle unfolding in the near future before NPLs hit their peak. Two cases i.e. cement sector and the Dubai crisis (particularly exposure of UBL, ~17% of loan book in UAE) are in limelight off-late. Meanwhile post Aug-09 price war, small cement manufacturers are struggling to meet debt obligations and concerns have surfaced on potential flow of NPLs in the sector. Total loans to cement sector amount to ~PRs100bn, ~4% of private loans, with cement sector NPL ratio of at 11.1% as of Jun-09 (latest data) vs 9.9% in Sep-08. Bank-wise, HBL and ABL lead the pack in cement exposure whereas MCB Bank remains a safe haven.

Investment perspective

We downgraded our stance on Pakistan banks in Oct-09 due to strong run up in prices, since then the sector is down 9.33% (KSE: -7.63%). Our view remains that reversion to historical mean multiples remains a long shot for Pakistan Banks as trading history ex-MCB is skewed to the bull cycle of 2004-2008 (see our report “mean reversion unlikely for the near term”) and banks’ share prices would have to find a new mean with economic cycle. Our top pick for now remains MCB on 1) attractive return metrics 2) superior asset quality and 3) asset growth potential.

KASB Securities and Economics Research



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