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Bank Alfalah Limited (BAFL): Downgraded to ‘Hold’ on limited upside

• We downgrade Bank Alfalah Limited (BAFL) from a ‘Buy’ to ‘Hold’ with a revised Target Price of Rs38.
• The stock offers a limited upside of 4%, alongside 2020E D/Y of 8%. The bank trades at a 2020E P/B of 0.7x, P/E of 6.6x and offers a ROE of 11%.
• However, we revise up our earnings estimates for Bank Alfalah Limited (BAFL) by 5-8% over 2020E-2022F. Our earnings revision primarily stems from (1) revaluation buffer on the investment book of Rs9.5bn and (2) strict cost controls.
• In 2Q2020, strong Non Funded Income performance led by capital gains (government securities: Rs2.2bn) and decline in operating expenses by 6.8% QoQ kept profitability in tact, given a 2% QoQ decline in (NII). 
• That being said, 46% of the bank’s investments are concentrated in T-bills that are expected to be re-priced in 2H2020 and 62% of the loan book is yet to be re-priced.
• Both factors are expected to put downward pressure on Net Interest Income (NII) in 2H2020, which has already depicted a decline of 2% QoQ in 2Q2020.  
• The mark up deferrals in Bangladesh under the COVID-19 relief measures have dented the interest earned as well.

Concentration in Consumer and Retail maybe a concern due to COVID-19

• The bank commands an ADR of 64%. The loan book stands at Rs514bn out of which 38% is allocated to Retail (22%) and Consumer (16%) segments.
• COVID-19 has affected the mentioned segments the most, although the bank has created the extra buffer of Rs2bn, taking that out, the provision for 1H2020 for loans comes to Rs4.4bn, higher than Rs2.1bn for 2019.

IDR Rising – Possible support to Non Funded Income

• PIB accretion at the correct time has been beneficial for the bank in terms of providing support to NII. Although the adjustment of the T-bill portfolio as mentioned earlier may overshadow the gains in NII.
• The silver lining may come through the Non Funded Income in capital gains as the PIB book boasts a revaluation surplus of Rs4.9bn on the AFS holding. Our view is that till there is significant pick up in loan growth, the capital gains will be used to buffer earnings.

BAFL keeping costs under check

• The bank known for its traditionally high Cost to Income has made major inroads over the past two years. The Cost to Income has dropped to 48% in 2Q2020, which was around the 65% mark.
• This is all the more impressive given the limited increase in total income. Our year end estimate stands at 58%.

Medium Term Note (MTN) – IPO coming up

• In a first, the bank has embarked on launching a new capital market product which will be a listed, secured, rated fixed rate medium term instrument.
• Purpose of the instrument is to hedge the Issuer’s fixed rate assets i.e. staff loans, consumer loan portfolio etc. with fixed rate liabilities.
• The instrument is AAA (Triple A) by PACRA and is expected to be issued in flexible tranches of up to 3-5 years, however the first tranche tenor will be of 3 years.
• MTN is expected to yield 9% or 3M PKRV + 75bps whichever is higher (at time of the listing) per annum, payable semi-annually.

The first tranche of the total Rs50bn on offer is expected to be closed soon. The size of which is Rs10bn and the book is almost full in pre-open. 10% of the book will be for IPO.