Pakistani banks report 9% negative return

The Pakistani banks have reported a negative return of 9 percent year to-date (YTD) and 6 percent month to-date (MTD) on the concerns over the anticipation of unfavourable budgetary measures on the sector. The underperformance has led to the sector’s multiples dropping to the all-time lows, despite expanding return on equities (ROEs).

We illustrate historical multiples of the banking sector that have broadly been correlated to the sector’s return on equities.

At present, the sector’s ROEs are expected to jump to a 16-year high. CY22E/CY23F ROE (Tier I) is expected to average at 21 per cent and 26 per cent, which was last seen during CY06/07. Besides, the current multiples reflect a more than 75 per cent discount to P/B the sector traded in CY06/07.

While it is understood that the market participants fear hefty taxes to be placed on the banking sector over expanding profits earned by the sector in the ongoing monetary tightening environment, we believe the massive discount reflects more than quantitative factors and the negative sentiments regarding uncertainty over macro decisions have a key role, as well.

To understand the intensity of potential tax measures on the sector, we pick precedents from earlier budgetary measures and compute the sector’s Tier I ROE and P/B post any harsh measures.

We present scenarios with application of every 5 percent additional corporate tax (or super tax) and every 5 percent additional tax on the income from the federal government securities.

To recall, the banking sector has faced corporate tax as high as 58 percent until 2001, which was then gradually reduced over the years. Moreover, the government has also penalised the banks for placing higher deposits in the federal government securities in 2018/19 through higher taxes on the income from the same.

While the impact on each bank is broadly similar, measures that are pinned to investment levels have a relatively higher impact on the banks with low advances to deposit ratio (ADR), higher federal government securities to deposits and low non-interest income (NII) to the profit-after-tax (PAT). We present the earnings contribution of different segments to interest income of different banks below.

Even if we account for the penal tax measures repeating themselves, and take a 30 percent hit (extreme case) on CY23 earnings, the valuations for the banks are at 0.6x P/B and sub 4x P/E. In the 30 percent earnings cut scenario, the sector’s Tier I ROE still comes to 19 percent, highest since CY16.

We reiterate our liking for the Pakistani banks, maintaining our overweight stance, where we expect the earnings to grow at a three-year CAGR of 14 percent on the back of improvement in the net interest income coupled with the fee income growth. Our base case accounts for the monetary easing in CY23, taking the policy rate down to 9.75 percent.

We believe these concerns are somewhat overplayed, as the change in asset mix and early play of higher yields have improved the sector’s return generation potential, making the current multiples attractive even with the incorporation of higher taxation measures.