Karachi, July 14, 2022 (PPI-OT): Banks: Taxes to dent 2Q earnings; payouts to largely hold ground

We preview 2QCY22 results for Pakistan banks under our coverage, where we expect Net Interest Income (NII) expansion to continue driven by higher yields.

Having said that, we expect the sector’s bottom-line to contract by ~40% as we incorporate the higher taxes announced in Federal Budget FY23.

While higher yields will potentially lead to a one-time dent on sector’s ‘Available-for sale’ fixed rate debt securities and resultantly its book value, we expect most banks to maintain stable dividend announcements.

Core Income improvement on higher yields

We preview 2QCY22 results for the Pakistan banks under our coverage, where we expect Net Interest Income (NII) expansion to continue despite higher deposit costs from the 400bp increase in Policy Rate during the quarter. The higher NII would likely be a result of asset yields moving upward earlier than the actual increase in Policy Rates, as reflected in the movement of KIBOR and shorter tenor PKRVs. We expect NII to jump by an average of 15% QoQ, and by 28% YoY as investment portfolios are tilted towards floating instruments and shorter tenor government securities.

Moreover, in addition to organic transaction banking, we expect the volatile PKR movement against the greenback (2QCY22: -11%), higher trade bills and higher remittances to support Non-Interest Income during the quarter as well. As a result, despite inflationary pressure potentially increasing the pace of Admin expenses growth, we expect Cost to Income to remain below 50% (seven-quarter low).

To be partially wiped off by higher taxes

Even with higher core and non-core income, we expect the sector’s bottom-line to contract by ~40% on a sequential basis and versus the same period last year as we incorporate the higher taxes announced in Federal Budget FY23.

Pertaining to 2QCY22, the sector has been slammed with (1) 39% corporate tax from CY22 (retrospective impact of 1QCY22), (2) higher tax on income from federal govt securities on various ADR slabs (retrospective impact of CY21 and 1QCY22) and (3) 10% Super Tax on CY22 income (retrospective impact of 1QCY22).

The quarter is likely to witness an effective tax rate of 70%, where the conventional bigger banks, with a lower ADR, are expected to report an average effective tax rate of up to 84%.

Stress on CAR may not impact dividends of most banks

While higher yields improve revenue streams, mark-to-market of the banks’ ‘Available-for sale’ fixed rate securities will result in a one-time dent on its unrealized gain or increase in its unrealized losses, which may also trim adequacy ratios. The impact may be magnified as compared to 1QCY22 given a sharper movement in bond yields in 2QCY22 (refer to table on right). This will also be compounded by the upward movement in Euro Bond yields, in addition to sharp PKR depreciation of ~11% during the quarter.

While we see a trim on the sector’s Tier II CAR levels, we believe most banks would still maintain a comfortable buffer above their respective minimum requirement levels, allowing a stable dividend announcement to continue this quarter. While some banks may also opt for a higher payout than the quarter’s earnings, we believe any scenario of a dividend cut (barring HBL) would be adjusted in future quarters, keeping the stock’s annual D/Y intact.