JS Securities Limited – JS Research (27-03-2020)

Karachi, March 27, 2020 (PPI-OT): Banks: SBP relief package and interest rate cuts

Post our last update ‘Banks: Change in interest rate corridor to further squeeze NIMs’ on 18th March 2020, the SBP has announced another 150bps cut in the Policy Rate, bringing the cumulative cut to 225bps and taking the Policy Rate down to 11%.

The sooner than expected interest rate decline cuts our earnings estimates for the sector by ~9% (Big 5: ~6%, Mid-tiers: ~13%), with Islamic banks witnessing a larger hit.

However, the simultaneous drag in bond yields is expected to limit the hit on the sector’s book value through higher unrealized gains on the balance sheet.

Following the government’s relief package to combat COVID-19 implications, the SBP further extended the relief package to industries at large for deferment of loan repayments (principal only).

Banks (especially with lower capital buffers) may avail this facility to defer classifying on-going distressed borrowers (pre-COVID 19) without incurring any credit cost to be charged under their provisioning expenses.

Post our last update ‘Banks: Change in interest rate corridor to further squeeze NIMs’ on 18th March 2020, the SBP has announced another 150bps cut in the Policy Rate, bringing the cumulative cut to 225bps and taking the Policy Rate down to 11%. The current monetary easing is pushed by expected decline in the country’s GDP growth and inflation reading amid impact of the pandemic Coronavirus outbreak. Given the special circumstances, we do not expect higher money supply growth despite lower interest rate; hence we keep our Deposits growth assumption unchanged at low double-digits as well. The sooner than expected interest rate decline cuts our earnings estimates for the sector by ~9% (Big 5: ~6%, Mid-tiers: ~13%), with Islamic banks witnessing a larger hit. However, the simultaneous drag in bond yields is expected to limit the hit on the sector’s book value through higher unrealized gains on the balance sheet.

Moreover, a government’s relief package was announced this week as a measure for combatting against the economic and social implications of Coronavirus outbreak in the country. This was followed by a relief package announced by SBP as well. While the government’s relief package included deferred loan and interest payments for the export, SME and Agriculture sectors, SBP’s package has extended the scope of this facility to other segments, however note that the extended facility is limited to loan principal only, and specified the delay for up to one year. The SBP package also stated that banks may continue to report these payments as usual in their respective income statement, without any credit cost charged under provisioning expenses. These relaxations would result in no negative impact on banks’ earnings if any loan payment is treated as delayed under this package.

Given no specifications provided, banks (especially with lower capital buffers) may avail this facility to defer classifying on-going distressed borrowers (pre- COVID 19) in order to avoid considering the same in their credit cost. To recall, our base case incorporates credit cost to go up to 0.9% during CY20, which amounts to almost 3xYoY higher absolute provisioning expenses as compared to CY19. Note that although the recent earlier-than-expected rate cuts would have improved the borrowers’ debt repayment capacity in a normal situation, this has now been offset by the dampening business environment at the moment. And the extent to which pandemic could potentially damage the economy still remains quite uncertain which could result in even higher credit costs (than our already conservative assumptions) for banks. Though, it remains to be seen how the government in this case would assist the banks later into CY20 as well as CY21. Now, as far as the recent meltdown in local equity markets (-33% YTD CY20) is concerned, what needs to be kept in mind is that this may take a toll on upcoming quarterly earnings of the sector though likely through a staggering method.

Other salient features of the SBP package include relaxation in capital adequacy and increasing credit limits for SMEs and individuals, with the objective to increase lending appetite of banks. However, it is possible that the emerging situation may keep banks shy from fresh lending, resulting in a further shift towards Investments to Deposit ratio in the coming months. We believe, if this really becomes a trend, it would defeat the whole purpose of providing the necessary liquidity available to the downbeat business industry. On valuations, while recent correction in the sector (-34% YTD CY20) make a number of stocks attractive on P/B and dividend yield (given comfortable buffer on capital adequacy as well), we highlight building exposures considering long-term investment horizons only.

Leave a Reply