Karachi, March 28, 2023 (PPI-OT): HMB: Compelling valuations and yield; caution on asset quality warranted

Expanding deposits by 14% YoY, CY22 appeared a year with higher focus on Islamic Banking business for HMB with 28% YoY deposit growth in the segment.

The bank continued to maintain IDR levels above 80%, while ADR levels complied to the normalized tax requirements. The investment mix was dominated by variable-rated instruments (~72% of book), availing optimal benefit of rising interest rates.

The market has been assigning a P/B of 0.4x to HMB, despite reported and potential ROEs of 21%, which incorporates more than usual credit costs from here onwards. The compelling multiples are in addition to DY of 20%, based on payout ratio of 35% (CY19 – 22: ~40%). Banks generating ROE similar to HMB trade at 35% – 45% premium to HMB.

Asset quality remains a key concern especially with more than 40% of loan book exposure to Textile sector, a notable NPL increase in CY22 and Forced Sale Value (FSV) benefit amounting to 12% of its NPL stock (Rs2.6bn), mainly during 4Q.

CY22: Deposits up 14% YoY, share from Shariah expands

Reaching its targeted branch network for CY22, Habib Metropolitan Bank (HMB) closed CY22 with 500 branches (+41), expanding deposits by 14% YoY. Deposit mobilization efforts have visibly been skewed towards zero-cost deposits which have witnessed a 5-year CAGR of 18% (vs overall deposit CAGR of 12%). This has taken the share of current account deposits within the mix to 35% – while the share of fixed deposits has receded to 30% (from being consistently above the 40%-mark till CY19).

The year also highlighted focus on expanding Islamic banking business with 28% YoY deposit growth in the segment, taking its contribution in total deposits to now 12%. The same was also reflected through new branches tilting towards Shariah business, where a similar trend is targeted for CY23 as well.

Investments broadly remain in variable instruments

Despite maintaining leverage at 19x, HMB’s Investment book and Advances book both witnessed an 8% YoY growth only, as higher increase was reported in Lending to Financial Institutions (9% of Deposits versus normal trend of ~1%). While this resulted in the ADR and IDR, both, to decline in CY22, the IDR levels still remained above 80%, while ADR levels complied to the normalized tax requirements. The investment mix moved towards PIBs (55% of Investments) and 39% of the book was placed in TBills. Out of the total PIBs, 60% are floater PIBs. Moreover, duration on the remaining 40% of PIBs remains relatively shorter, when compared to peers as two third of the fixed PIBs are scheduled to mature in CY24.

Supporting bottom-line expansion

The higher interest rates and timely placed investments led to reporting 38% higher Net Interest Income in CY22, taking 5-year CAGR to 24%. Moreover, despite declining trade activity in the country, the bank’s Fee Income witnessed an impressive growth of 15% YoY. While over 60% of bank’s Fee Income is derived from Commission on Trade, despite being among the market leaders, the bank only reported 5% YoY growth in the same, vis-à-vis 20% YoY average by peers.

These factors assisted in maintaining the Cost to Income at 41% (sector: 50%) and report 28% YoY higher PBT. However, with the higher Super Tax marked for CY22, bottom-line growth limited to 6% YoY.

Eyes on asset quality as NPL stock rises

Asset quality has been a key concern for many existing and prospective investors as HMB’s NPL stock reported a notable increase in CY22, broadly pertaining to the Textile segment. While HMB carries a concentration risk with 42% of loans to the Textile sector, 60% of the NPL stock pertains to the said sector.

Moreover, the current coverage of the segment’s NPLs has dropped from 99% to 77%. Though overall coverage ratio stands above 100% due to prudent General Provisions of Rs4.6bn recorded over time, HMB also opted to avail a hefty Forced Sale Value (FSV) in CY22 that amounts to 12% of its NPL stock (Rs2.6bn), broadly booked during 4Q.

The management apprised most of the Textile sector’s NPL accretion belongs to a single party. So far, no meaningful broad-based worries have been observed in segment by the bank apart from some delays by a few names. Having said that, current macro challenges do not rule out expectations of provisioning expenses in the future.

Attractive multiples with high D/Y keep Buy rating intact

The market has been assigning a P/B of 0.4x to the stock, regardless of reported and potential ROEs of 21%, which incorporates more than usual credit costs from here onwards. The compelling multiples hence maintain the stock’s Buy rating.

We highlight Banks generating ROE similar to HMB trade at 35% – 45% premium to HMB. The attractive capital upside is in addition to DY of 20%, based on payout ratio of 35%. We highlight the strong CET-I ratio that the bank maintains at 13.6%, one of the highest among peers. We hence do not rule out that the bank has the muscles to gradually return to its previous payout ratio (~55% during CY11-17), which has dropped to ~40% between CY19-22.

Among key risks to our investment thesis are prolonged declining trend in trade activity negatively impacting HMB’s income stream as it ranks as one of the leaders in trade activity amongst peers. The trade income contributes ~10% to total revenue as compared to average 3%-5% for peers. Moreover, higher than expected NPL accretion given ongoing challenges faced by the textile sector.