Banks – blanket exposure to economy

2010: A step up from the trough
Bottom line: Post earning consolidation cycle of 2008-2009, we eye a step up in banks’ fundamentals in 2010E inline with our thesis of a gradual recovery in economic and monetary landscape. Likewise from a low base, our Banks’ universe recurring profit growth is expected to clock +16% YoY in 2010 underpinned by a decline in credit costs (half from 2009 to 1.1%). The sector has gone through a roller coaster in the last 18mths and we now foresee relative momentum change towards improvement.

• Macro: Foremost, with classic intermediation structure of Pakistan Banks, an uptick in domestic economic activity should foster banking growth and at the same time lower asset risk – Low banking penetration (loan-to-GDP: 26%).
• Regulation: Second, regulation remains a key sentiment driver. A revision in the 5% floor on savings deposits (~40% of total) could re-rate fundamentals where a 100bp lower rate would up 2010E universe earnings growth to +24% YoY – Margins and credit costs are the two vital drivers of Pak Banks’ earnings.
• Disintermediation: Transition of Government deposits to a Single treasury account (STA) with the Central Bank (SBP) could hurt banking liquidity and asset growth – Government deposits constitute 11% of total bank deposits.
• Consolidation: Also, consolidation is likely to gather pace as benchmarks on Minimum Capital Requirement (PRs10bn by 2013) and Capital Adequacy (variable with 10% floor) draw closer. This should assist in validating current valuations as against previous M & As which ranged between 3.0x-4.5x P/B.
• Tactical: And last, from a bottom-up perspective, tactical positioning of individual banks ie (i) Gearing (ii) Deposit franchise & (iii) Momentum. MCB – Deposit franchise & low risk/high growth, UBL & NBP – Momentum change plays, HBL – Valuable deposit franchise & ABL – low risk/low growth.

A range trade play, though upside to valuation 
We shifted to a neutral stance and a range-trade thesis for our banks universe in Oct-09, currently trading slightly below Oct-09 level at 1.3x 2010E P/B, where we highlighted downside protection at 1.2x P/B on consistent book value growth and upside limit at 1.5x P/B. While share prices are largely incorporating our base case macro improvements, we believe valuation range could open on the upside if floor on savings deposit is reduced. In the meantime, we reiterate that reversion to historical multiples could be a long shot for Pakistan Bank sector as trading history, ex-MCB Bank, is skewed to the bull cycle of 2004-2007 – do read our report “Near term mean reversion unlikely” dated Oct-09.

KASB Securities Economics & Research

February 4 2010