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Banks-Retail: Asset growth to outpace NPLs going forward

3Q09 system NPLs: A familiar trend
The latest system NPLs data released by the Central Bank (SBP) depicts that system NPLs inched up by PRs23bn QoQ in the 3Q09 to PRs435bn (NPL ratio: 13.5% domestic ops only). The quarterly trend was primarily akin to that of 2Q09 on two counts; (1) NPL growth outpaced that of loans, +5.3% vs -1.7% & (2) NPL run rate in percentage terms remained somewhat constant QoQ. Year-to-date in 2009, NPLs have gained a stronger foothold on banks balance sheet vs asset and loan growth – NPLs outpaced both by +11% & +24% respectively as of 3Q09.

Increase in Net NPLs = higher provisions?
System net NPL ratio increased to 4.18% in 3Q09, suggesting provisioning flow should continue as a result however re-rescheduling can nullify the impact to some extent, in our view. Segment wise, commercial banks fared relatively better than the system where sequential NPL run-rate in 3Q09 declined in both percentage, from +6% to +4%, and absolute term, from +PRs22bn to +PRs16bn. Our banks’ universe gross NPL ratio stood at 10.3% with slight increase in net NPL ratio to 2.7% in 3Q09.

We believe NPLs are yet to peak
We continue to remain wary of tail end risk of the credit cycle which could unfold before NPLs hit their ultimate peak. Two recently unveiled grey areas of concern are worth mentioning 1) Cement sector repayment woes and the Dubai crisis & 2) While difficult to assign a point estimate due to limited data and absent historical evidence, some of the earlier restructured or refinanced loans and hybrids (TFC) could also come under stress as their re-payments fall due.

….Asset growth set to out pace that of NPLs in 2010E
While the inflection point on reversals is not visible at this point in time, we believe we could start witnessing asset and loan growth outpacing that of NPLs going forward – contrary to the theme in 2009. Key fitness indicators on the macro front such as inflation, rebound in manufacturing sector, potential resolve of energy bottleneck & improvement in external position are beginning to show some signs of relief. Continuation of this theme would ultimately see assets and loan growth outpace NPL growth and arrest the deterioration in asset quality indicators for banks.

Investment perspective
While we retain our neutral sector stance for now, we prefer MCB Bank within our universe based on superior return metrics, asset quality & growth potential plus lowest capital impairment (net NPLs/ equity). However if the thesis of reversals in NPLs were to materialize, we could also turn more positive on UBL given their higher NPL accumulation.

KASB Securities & Economics Research

December 23 2009

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