Karachi, May 19, 2022 (PPI-OT): Asset quality may remain robust despite headwinds
Despite parallels being drawn to earlier Pakistan’s economic crises, including 2008, we believe that the credit costs may not see a similar strain in this cycle even with strong headwinds.
Our argument is backed by (1) change in segment mix in Pak Banks’ loan portfolio, (2) relatively cautious exposure toward lending, (3) diversification in income streams of the sector and (4) relatively lower debt leverage held by the corporate sector.
Though textiles still contributes 16% to the sector’s lending book, opportunity of the low fixed rate TERF facility (almost 60% of LTFFs and TERF availed by textile manufacturers) and all-time high textile exports have assisted in improving the textile sector’s debt payment capacity.
Credit cost uptick may remain in check despite tightening
A monetary tightening cycle generally invites concerns over asset quality of the banking sector and potentially large provisioning expenses. This cycle, that has witnessed a 525 bp expansion in Policy Rate (12.25%) in the past seven months, is no different when it comes to similar concerns. However, where one may expect rising interest rates and potential higher inflation to impact capability of borrowers to repay loans, we argue low probability of repeat scenario as witnessed post 2008 crisis.
Our argument of relatively lower deterioration in asset quality is backed by (1) change in segment mix in Pak Banks’ loan portfolio, (2) relatively cautious exposure toward lending, (3) diversification in income streams of the sector and (4) relatively lower debt leverage held by the corporate sector.
The high infection levels post 2008
The sour taste left by the 2008 financial crisis was led by higher Advances to Deposit levels of c. 80%, lending towards high-risk sectors and expanding leverage ratios of corporates. The sharp increase of 500 bp in Policy Rate during 2008 led to the banking sector’s NPLs to expand by almost two folds by 2011. This led to infection ratio increasing to an alarming level of 16%, from 8% in 2007, where Textile sector was cited among the highest contributors to the asset quality deterioration, followed by individuals segment (Consumer).
The Textile sector contributed c. 20% to total loan portfolio of the banking sector (Gross infection: 29%), while Individuals (Consumer) loans contributed c. 10% that carried an infection ratio of 16%.
Have been worked upon over the years
Over the years, the banking sector’s Infection ratio has improved to 8% by limiting lending to high quality assets and diversifying lending to other sectors. With loan growth opportunity arising from the Energy sector over the past couple of years, the banking sector has increased share of Production / Transmission of Energy segment from 9% to 14% in its loan-book, leading to partially substitute the share of Textile segment in the total pie. The segment holds an Infection ratio of 5%.
Though textiles still contributes 16% to the sector’s lending book, reliefs announced in the Federal Budget FY22 to cushion the textile sector’s working capital, all-time high textile exports with robust growth and opportunity of the low fixed rate TERF facility (almost 60% of LTFFs and TERF availed by textile manufacturers) have assisted in improving the textile sector’s debt payment capacity.
Improvement in debt paying capacity of Consumer and Textile sectors have also been visible with their Infection ratio dropping to 6% and 9%, respectively. In addition, preparing for application of IFRS 9 as recently led the sector to build more General provisions, which coupled with prudent accounting on Specific provisions, has taken the Coverage Ratio up to 99%. Among our coverage, Coverage Ratios for five banks surpass the 100% mark.
With expectations of Policy Rate peaking at c. 13.50%, we believe the banking sector will undergo a lower effect of potential increase in provisioning expenses. We expect worsening asset quality to stem from the consumer, partially textiles and other miscellaneous segments that now hold a lower exposure in total loan portfolio, while the sector’s already higher coverage ratio will also likely limit the size of provisioning expenses. On the external front, with developing business infrastructure, lower debt leverage and higher corporate profitability also keeps concerns of bulky provisioning expenses on the lower side.