Karachi, May 10, 2012 (PPI-OT): Following robust 1QCY12 results (listed banks’ profits up 31%YoY to PKR32.5bn), the banking sector has gained 44%CYTD, beating the KSE-100 Index by 15% in the process.
According to AKD Securities, however, unfolding of regulatory risks coupled with disconcerting pre-budget news flow has recently curbed share price momentum. While AKD Securities sees implementation risks for proposals such as increasing tax rate on interest earned from T-bills, AKD Securities believes increase in corporate tax rate on banks cannot completely be ruled out. As such, the next few weeks until the FY13 Budget could potentially see choppy banking sector price performance. Nevertheless, medium-term prospects appear bright where positives include 1) strong balance sheet growth which should counter NIM compression, 2) balance sheet de-risking leading to continued reduction in loans provisions and 3) initiation of interim payouts by some large banks which could drive the overall valuation rerating process. At current levels, AKD Securities has a Market weight stance on Pakistan Banks with a selective preference for BAFL.
Banks in the spotlight: Listed banking sector 1QCY12 profits clocked in at PKR32.5bn, up a robust 31%YoY. While the recent increase in rate floor on savings deposits may potentially stem sequential profitability, double-digit profit growth in CY12F appears easily achievable. Strong banking sector, profitability, primarily a result of risk-free lending to the GoP over the last few years, has now brought the sector into the limelight particularly from a regulatory risk vantage. In AKD Securities’ view, removal of tax arbitrage on investment in own mutual funds will likely come to pass in the Budget.
Higher floor on savings rate? Effective May 1’12, the floor on savings accounts has been raised by 1ppt to 6%, ostensibly to encourage banks to lend to the private sector so as to stave off higher NIMs. Considering further interest rate reductions are unlikely while channel checks rule out material pickup in private sector credit off take (-1%YoY at last count), further increases in the savings rate floor remain a risk over the medium-term. Another 1ppt increase would reduce banking sector profits by up to 5%, in AKD Securities’ view.
Increase in corporate income tax rate to 40%? Traditionally, pre-budget news flow points towards increase in income tax rate for banks (tax rate has remained unchanged at 35% since CY06, down from a peak of 58%). A 5% increase in tax rate for banks would reduce AKD Banking Universe’s profits by 6.5% -7.0% across AKD Securities’ forecast range. While news reports have reportedly ruled out corporate income tax rate increases, strong banking performance lead us to believe higher tax rate on banks remains a possibility.
Increases in interest earned on T-bills to 50%? Reportedly proposed by the FBR, and in line with SBP’s objective to revive private sector lending, all else the same this may reduce banking sector profit estimates by at least ~10%. That said, AKD Securities sees sizeable implementation risk where hefty GoP borrowing needs from the local banking sector places policymakers in a catch-22 situation.