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Pakistan Banks: Profits surge 66% YoY in 2Q2020; Higher NII offsets increase in provisioning

• We present review of Pak Banks’ profitability for 2Q2020, which includes a sample of 18 banks (out of a total listed 20 banks), representing 99% of the banking sector’s capitalization at the PSX.
• The sector’s Profit after Tax has increased by 66% YoY in 2Q2020 on the back of (1) immediate repricing of liabilities and (2) capital gains on government securities. The profits are also up by 44% QoQ, driven by instant benefits of decline in interest rates.
• Net Interest Income (NII) increased by 41% YoY, while Non-Interest Income improved by 36% YoY during 2Q2020.
• On the other hand, Provisions increased by 212% YoY, where majority of the banks booked General Provisions in light of COVID-19. This is a precautionary measure adopted by banks even if they feel that their respective loan book is not under particular duress.
• To give perspective, of the sample, the cumulative absolute increase in NII and Non-Interest Income are Rs63bn and Rs17bn (total Rs80bn) respectively, whereas Provisions and Operating Costs are higher by Rs30bn and Rs6bn (total Rs36bn) respectively.
• In absolute terms, the highest quarterly profit has been earned by HBL (Rs11.0bn) followed by NBP (Rs10.9bn), MCB (Rs6.8bn) and MEBL (Rs6.2bn).
• In terms of NII, the highest increases were recorded by SNBL (+71%), AKBL (+67% YoY), BAHL (+63% YoY), NBP (+58%) and JSBL (+57%).
• NII of the banks was driven by higher investment income. The banks have aggressively bought PIBs, as view shifted towards declining interest rates at the behest of COVID-19. As a result, Interest Earned increased by 24% YoY (but was down by 4% QoQ) in 2Q2020.
• Top banks with the highest increases in Interest Earned were SNBL (+45% YoY), BAHL (+40%) and NBP (+40%).
• At the same time, Interest Expense increased by only 12% YoY (and down 21% QoQ) during the quarter due to immediate repricing of deposits. The bank’s with least increases in deposit costs were ABL (-11% YoY), MCB (-6% YoY) and FABL (-4% YoY). 
• Non-Interest Income has also increased by 36% YoY even though Fee Income declined by 22% YoY due to COVID-19.
• The main reasons for increase were (1) improvement in Forex Income of 23% YoY and (2) capital gains which came in at Rs18.7bn (vs. a loss of Rs2.4bn for the same period last year). Capital gains were primarily driven by gains on government papers.
• To recall, in 1Q2020 under the relief measures, banks booked impairment on equity book to an extent. This quarter we also saw some reversals given the market performance in 2Q2020.
• The Cost to Income was at 43% for 2Q2020 compared to 58% in 2Q2019 and 55% in 1Q2020. The improvement was a function of higher income along with a limited increase in Operating Expenses of 6% YoY.
• The lowest Cost to Income were booked by SCBPL (26%), BOK (34%), MCB (39%), MEBL (40%) and UBL (40%). The least growth in costs were recorded by HBL (-5%), UBL (-4%) and MCB (+0%).
• As expected provisions for the listed banks have grown by 212% YoY for the quarter. The increase has been dominated by loan provisions of which certain percentage has been allocated due to COVID-19 as general provisions.
• The year 2020 has been adversely affected by the COVID-19 Global Pandemic. In a series of emergency/regular meetings, the Policy rate has been brought down by 6.25% to 7% by the Pak Central Bank.
• Additionally, with the interest rate corridor now symmetrical to the Policy Rate, banks’ MDR is 1.5% below policy rate from 2% earlier.
• Due to falling interest rate scenario, banks’ NIMs will come under pressure during 2H2020 as assets re-pricing kicks in.
• We maintain our Market-weight stance on Pak Banks, which trades at 2020 P/E of 7.8x and PBV of 0.8x with ROE of 11%.

Our top picks from the sector include MCB, BAHL and MEBL.