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Pakistan Banks: Sector Profits down 3% YoY in 2Q2018

• Pakistan Banking Sector profitability declined by 3% YoY to Rs39bn mainly on account of increased expenses incurred by big banks on the back of pension & compliance cost.  For our analysis, we have taken results of all listed banks that have announced 2Q2018 financial results except Summit Bank (SMBL).
• Net Interest Income (NII) of the banks improved by 8% YoY to Rs124bn in 2Q2018, led by higher interest rates & improved deposit mix. SBP had raised policy rate by 75bps by 2Q2018 vs. 2Q2017 & a further 100bps has been increased in Jul 2018 which will continue to support NII going ahead.
• Mid tier banks remained outperformers as they posted above average NII growth during the quarter. Amongst large banks, MCB Bank (MCB) and National Bank (NBP) posted NII growth of 13%.  
• Total provisioning expense of sector was up by 5% as banks continued to see major NPL recoveries as bank booked provision reversals. United Bank (UBL) and National Bank (NBP) continued to book higher provisions charge against NPLs as they booked provision expense of Rs2.3bn & Rs2.6bn respectively.
• Non-markup expense of the sector was up 14% to Rs102bn as big banks like UBL and Habib Bank (HBL) registered higher cost amid pension charges and compliance cost.  UBL booked additional pension charge of Rs2bn during 2Q2018, whereas HBL increased compliance cost on the back of ongoing concerns on its international operations. This restricted bottom-line growth of the sector.
• Along with higher Non-markup expense, Non-markup income of the sector was down by 5% YoY to Rs48bn driven by lower capital gains registered by the banks on account of lower gains on equities and Pakistan Investment Bonds (PIBs).  
• During the period under review, effective tax rate of the sector also declined to 41% in 2Q2018 as compared to 44% in 2Q2017 as banks booked super taxation on the basis of 6M2018 profitability compared to full year super tax charged during same period last year after change in tax laws.  
• We maintain our ‘Overweight’ stance on banking Sector as the sector is anticipated to benefit from rising interest rates scenario. We anticipate SBP to increase interest rates by further 225bps to 9.75% by 2020. BAFL, BAHL and MCB are our top picks for the sector.