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Pakistan Banks: Sector profits down by 27% YoY in 3Q2018

• During 3Q2018, Pakistan Banking Sector profitability declined to Rs31.6bn, down by 27% YoY adjusted for penalty on HBL. To recall, New York State Department of Financial Services levied a penalty of Rs23.7bn on HBL in 3Q2017. The decline in sector profits is primarily owed to Rs6.8bn total provision charge, lower non interest income and higher non-interest expense during the outgoing quarter. For our analysis, we have taken results of all listed banks that have announced 3Q2018 financial results.
• Net Interest Income (NII) of the banks improved by 9% YoY to Rs122bn in 3Q2018, led by higher interest rates & better deposit mix. However, on a sequential basis, NII is down 2% despite higher rates due to lower asset base as well as differences in re-pricing period of assets and liabilities post change in policy rate.
• To note, SBP has raised policy rate by 275bps in 2018, 100bps of which were raised at the beginning of 3Q2018.  
• Within the listed banks, the 5 largest banks (HBL, UBL, MCB, NBP, ABL) depicted a 48% YoY decline in earnings (Normalized for HBL penalty). On the other hand, mid tier banks (BAHL, BAFL, MEBL) continued with growth momentum and reported profitability growth of 17% YoY.      
• The sector booked significantly higher provisioning charge during the quarter, clocking in at Rs6.8bn compared to Rs2.1bn provision reversal in the same period last year. Majority of this charge originates from big banks with UBL, NBP and HBL contributing Rs3.1bn, Rs2.0bn and Rs1.7bn to the total, respectively. NBP booked significant provision charge on its loan portfolio while HBL booked charge for impairment in investments. Simultaneously, UBLs provision charge originates from both its international loan book as well as impairment of equities. 
• Non-interest income of the banks declined by 11% YoY, mainly due to lower capital gains (Rs993mn in 3Q2018 vs Rs7.8bn in 3Q2017).
• Non-interest expense rose by 12% YoY mainly led by HBL (non-interest expense up by 29% YoY) due to costs associated with compliance. Excluding HBL, expenses rose by 8% YoY. Resultantly, cost to income of the sector increased by 4.7ppts YoY to 63.5% in 3Q2018.
• During the period under review, effective tax rate of the sector declined to 40% in 3Q2018 as compared to 54% in 3Q2017. However, normalized for HBL penalty amount, effective tax rate was at 35% in 3Q2017. The higher effective tax rate is due to banks booking super tax on a quarterly basis (as a result of change in law) as compared to no super tax charge in 3Q2017.
• We maintain our ‘Overweight’ stance on banking Sector as we expect monetary tightening to boost sector profitability. We anticipate SBP to increase interest rates by further 125bps to 9.75% by Jun 2019. MEBL, BAFL and MCB are our top picks for the sector.