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Bank of Punjab (BOP): Reinstate with 'Hold'

• We reinstate our stance on Bank of Punjab (BOP) as ‘Hold’ after the announcement of its 2017 and 1Q2018 financial results. The bank has 1) booked required provisions well in advance; 2) depicted improved earnings profile as BOP booked earnings of Rs0.7/share, up 24% YoY in 1Q2018,  and 3) achieved capital requirement of SBP but is expected to remain on borderline, which warrant caution.
• BOP booked pending provisioning against NPLs of Rs14bn in 2017, an year earlier than it was actually required by SBP based on Letter of Comfort (LOC) given to the bank by Govt. of Punjab. To recall, bank did not provide against certain loans in past and SBP had provided relaxation to bank to book these by 2018.
• After taking this provisioning charge, bank’s coverage ratio has now increased from 57% in 2016 to 90% in 1Q2018, which is slightly below industry average of 92%. Being a government owned bank, BOP lends aggressively to govt./public sector entities (33% of advances) however they are not subject to NPL & provisioning classification criteria of SBP. Despite this, coverage ratio of the bank remains below industry and the bank has an above average Net Infection ratio of ~1.6% vs. industry average of 1% as of 1Q2018.
• During 1Q2018, total assets of BOP increased by 19% to Rs552bn driven by strong advances growth and lending to FIs. This was mainly funded by strong deposit growth that rose by 24% due to expanding branch network.
• Cost of deposit of BOP has also come down which has contributed to strong NII growth during 1Q2018 which jumped by 42% YoY. Markup interest expense as percentage of total deposits clocked in at 3.6% in 1Q2018 vs. 3.8% in  1Q2017.
• NPL ratio of BOP has improved to 14% in 1Q2018 as compared to 18% in 1Q2017 and 15% in 2017 however it still remain high compared to industry average of 8%. Net NPLs (net of provisions) of BOP is at 1.6% or Rs5bn, which is higher than the industry average of 1%. We believe this is a key risk for BOP as an expected uptick in interest rates could lead to higher NPLs & provisioning charge going forward. BOP booked provision reversal of Rs182mn during 1Q2018.
• In summary, the improvement in earnings is primarily attributed to strong asset growth, lower cost of deposit and improvement in NPL ratio.
• CAR ratio of the bank stood at 10.5% as of 1Q2018, which has improved to 11.42% as the bank raised Rs4.3bn as Tier II capital post 1Q2018 results. Tier I CAR ratio also stood at 7.55% as per the latest available data of BOP.  BOP is now compliant in terms of CAR requirements of SBP but it remains at the borderline and is below industry average CAR of 14%. SBP requires banks to maintain Tier I and Total CAR ratio of 7.5% and 11.9%, respectively by 2018.
• Outlook on CAR’s ratio will largely depend upon sustainability of profitability and the extent of growth in Risk Weighted Assets (RWA). We are of the view that the bank will have to take maximum exposure in government backed assets that has a 0% RWA to maintain or improve CAR. Any deterioration in profitability going forward could dent CAR ratio and in such a case further capital issue (Tier I or Tier II) by the bank can not be ruled out.
• We revise up our earnings estimates by ~20% for 2018 & 2019 on basis of better than expected results & improved earnings outlook. Our revised target price for BOP is Rs13 and we have a ‘Hold’ call on the stock. The stock is currently trading at PBV of ~1x with average ROE of 15%. This compares with another state owned bank NBP that trades at a PBV of 0.6x with ROE of 13%.