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Pakistan Banks: HBL & UBL earnings revised up ‘Buy’ maintained

• We are revising up our earnings estimates for Habib Bank Limited (HBL) by 9-37% over 2020E-2022F, following higher-than-expected 2Q2020 results.
• The Net Interest Income (NII) and Operating Costs were key positive surprises in the 2Q2020 results, where the strong result was slightly subdued due to higher provisions.
• We maintain our ‘Buy’ rating on HBL with a revised Target Price of Rs148. The bank trades at 2020E P/B of 0.8x and P/E of 7.6x.
• Our earnings revision primarily stems from (1) strong Pakistan Investment Bonds (PIB) book build up which also saw revaluation surplus surge, of which 22% was realized in 2Q2020 and (2) reduction in operating expenses as costs related to New York branch closure and business transformation wane off.

Build-up of PIBs supporting investment income and capital gains

• Over the past 12 months, the bank has moved from 33% allocation in PIBs to 48%, which essentially has laid solid foundation for sustained investment income at high yields. The apt entry on to the longer end of government paper spectrum resulted in a 5% QoQ rise in 2Q2020 investment income.
• We expect the same to rise 18% YoY in 2020E (1H2020: 75% YoY) vs. our earlier estimate of 10% YoY with lagged impact of asset re-pricing expected in the latter half of the year.
• Certain portion of loan re-pricing is visible, where Mark-up income from loans is down by 9% QoQ. We expect a decline of 20% YoY in 2020E.
• The bank has a revaluation surplus of Rs21bn as of Jun-2020. In 2Q2020, the bank realized Rs5bn capital gains driven by gains on government papers.
• The management does not expect major impact of IFRS-9 on profitability as significant amount has been provided under General Provisioning.

Operating costs waning off

• The bank was operating at a Cost to Income of 81% in 1H2019, which has come down to 61% in 1H2020. The New York closure related costs have subsided, evident from the Rs1.2bn YoY decline in 1H2020.
• The bank also underwent business transformation program which was expensive, however the process is complete and is expected to bring synergies and operational efficiencies which are visible in the considerable drop in costs.  
• We expect overall Admin costs to clock in at Rs91bn in 2020E compared to our earlier estimate of Rs96bn.

Provisioning increasing as COVID-19 concerns emerge

• The bank’s international loan book stands at Rs212bn. NPLs are of Rs34bn translating into an infection ratio of 16% and a coverage of 84%.
• That said, in 1H2020 provisioning charge includes exposure against one large ticket party and IFRS-9 related charge. In addition, a Rs2.4bn general provision charge was recorded to cater for COVID-19 related impact.

Other income taking a hit due to COVID-19

• COVID-19 impact was explicably visible in the Fee income as decline in Bancassurance fees, lower branch banking fee and lower card related fees added up to weigh down the head by 17% YoY; the trend is expected to continue.

Deposit growth impressive at 15% YoY during 1H2020

• On the deposit front the bank posted a growth of 15% YoY for 1H2020. The increase was of 12% QoQ in 2Q2020, with current level of deposits at Rs2.6trn. This increase was primarily driven by Ehsas Emergency Cash program launched by the Prime Minister in Apr-2020.
• With YTD growth in deposits of 8% already, the bank has managed to maintain its Current Account (CA) percentage at 36%. On the interest bearing deposit front, fixed accounts have depicted an increase of 11.5% YTD while saving accounts which constitute the bulk of deposits increased by 7.7% YTD.
• We revise up our earnings forecasts for United Bank (UBL) by 8-16% for 2020E-2022F given higher-than-expected 2Q2020 earnings announcement. The earnings beat expectation on account of higher Net Interest Income (NII).
• We maintain our ‘Buy’ stance on the bank with a revised Target Price of Rs145. The bank trades at a 2020E P/B of 0.7x and P/E of 8.0x.
• The bank is also expected to re-strategize with the arrival of new President and CEO Mr. Shahzad Dada. Seasoned banker with rich experience intimated that focus will be on 1) Customers, UBL bank has an end to end product suit and aim is to further enhance the experience; 2) Expansion on the digital front, upgrade the technology platform and 3) increase operational efficiency to minimize costs. 

International loan book remains a concern

• The big concern for the bank has been its international loan book. Constituting 19% of total loans, the book carries an infection ratio of 55% with coverage of 76%. The management is continually monitoring the situation and is focused on de-risking with an aim to get coverage as close to 100% as possible.
• This is also visible in 2Q2020 results where provision charge on loans is of Rs5.6bn. 1H2020 total provision charge was of Rs9.9bn of which 8.3bn pertained to the international book. As mentioned above the bank is aggressively focused towards a de-risking strategy and increasing coverage will be the major tool in the process.
• We expect international coverage to reach 85% by 2020E end from 77% currently, which would mean an additional charge of Rs5.3bn in 2H2020E bringing the total provision charge for the year to  Rs16.7bn.

Improvement in deposit mix boosting NII

• Over the past six quarters, the bank has maintained Current Accounts (CA) at 40% of total deposits, contributing immensely towards keeping the cost of funds low.
• YTD performance on the deposit front has been exceptional with CA growing by 17.6%, Saving Accounts by 9.9% while Fixed Accounts declined by 6.6%.
• As a result, the banks CASA also improved from 73% in Dec-2019 to 77% as of Jun-2020. The deposit cost has declined by 23% QoQ in 2Q2020 and are expected to decline by 9% YoY for 2020E.

Build up PIBs at high yields turning up Book Value

• The bank has had issues with the legacy PIBs, where last year at the end of 2H2019, the deficit on the AFS holding was of Rs15.3bn.
• The decline in interest rates amidst SBP’s easing cycle contributed immensely and on YoY basis that deficit is now a surplus of Rs925mn. The duration of the book is also down to ~2yrs.
• The bank was standing at a Cost to Income of 57%, however in 2020 thus far, the performance has been exceptional with 2Q2020 Cost to Income arriving at 40% with 1H2020 ratio of 43%.

COVID-19 hits Fee income

The fee income in line with the sector took a hit. Fee income of the bank decreased by 34% YoY and 25% QoQ. Reduced branch operations and branch closures due to COVID-19 were the main reasons.