Banking Sector Lookout

The banking system is one of the most important parts of the economy. Banks perform two key functions - accepting money as deposit for safe-keeping and lending to individuals as well as government bodies. Major corporate companies also borrow from banks to fund their projects, keeping the economy running. This shows the sheer power the banking system wields. We are done with the Financial Year ended results season, most leading banking sector have released their financial results.  We would analyze the performance of the banking sector in CY17 & taken 18 listed commercial banks in consideration which represent 95% of the sector market capitalization.

Diminishing Earnings: 

This was even more eventful considering the tumultuous performance banking sector had in the last year. Earnings of the banking sector drop by 17% in the calendar year 2017 as profit after taxation stood at Rs 142.70 billion in CY17 against Rs 170.97 billion in CY16. Factors for decline in profitability are:

·         One time penalty of Habib bank,

·         Stable net interest income

·         Flat non funded income.

However, excluding one time penalty of Habib bank, profit after tax of the sector down by 3% to Rs 166.42 billion in CY17 versus Rs 170.97 billion in CY16 owing to higher administrative expenses despite 93% lower provisions. However, there’s more to the story.

Net Interest Income Remained Flat:

Interest income of the bank increased by 4% to Rs 864.42 billion against Rs 827.78 billion in CY16 mainly due to higher earnings assets and maturity of PIBs despite reduction in interest rate. Similarly, Interest expense surge by 9% to Rs 435.03 billion versus Rs 399.18 billion in CY16 mainly due to higher deposits growth. Consequently, net interest income marginally rise by 0.2% to Rs 429.39 billion in CY17 compared to Rs 428.60 billion in CY16. Net Interest Income is one of the most important indicators of profitability for banks. It measures the difference in interest paid on deposits and interest earned through loans. So, the larger the NII, the more a bank earns from its loans.

Massive Decline in Provisions Provided Support:

Profitability of the sector was supported by 93% YoY drop in provisions to Rs 377 million in CY17 against Rs 5,080 million in CY16 owing to lower speed of accretions and better coverage of bad loans during the period. On the other hand, non-funded income of the sector totaled to Rs176,260 million in CY17 which is 0.2% YoY up from non-interest income of Rs 175,911 million in CY16. This growth was mainly on back of higher income from fees and commission.

Recovery in Numbers:

Meezan Bank, Bank Al Habib and Bank Alfalah remain the top performers in banking sector with earnings growth of 13.5%, 6.5% & 6% respectively. Among the top five banks, MCB posted highest growth of 3% as profit after taxation (PAT) to clock at Rs 22.45 billion (EPS: Rs 18.95) compared to Rs 21.89 billion (EPS: Rs 18.47) in CY16 due to tax reversal as AZEE Securities research report said.

Overall, earnings of big 5 banks (excluding one off of HBL) namely ABL, HBL, MCB, NBP & UBL posted decline in earnings growth of 3.5% to Rs 114.42 billion from Rs 118.62 billion in CY16 owing to lower spreads.

Future Outlook:

 

Two areas which need to be attended urgently by the banking authorities to increase the development prospects of the country. Firstly, spreads between the deposit and lending rates need to be reduced and profits on deposits may be particularly increased so as to encourage the depositors to save more rather than consume. And secondly, the investment in securities like MTBs, PIBs and Sukuk need to be substantially reduced in order to advance more credit to the private sector to accelerate economic growth. However we have market weight stance on the sector with our Dec'18 target price for ABL, BAFL, HBL, MCB, NBP & UBL of Rs 104/share, Rs 53/share, Rs 215/share, Rs 242/share, Rs 56/share and Rs 219/share respectively.

TECHNOLOGY SECTOR IN PAKISTAN - OPPORTUNITY AWAITS

In the past few years, if any sector has seen explosive growth and innovation, it is the Technology sector. How large is $1 billion? Even by Pakistan’s standards, that’s quite a lot. With the combination of youth and technology Pakistan’s information technology (IT) exports expected to jump to $5 billion in this current financial year. However Pakistan’s technology sector exports were $3.3 Bn in 2016-17 financial year.

Technology Sector in Pakistan continues to grow at a higher pace compared to India. Pakistan’s IT sector is growing by 20% per year as opposed to Indian industry’s growth of only 7-8%. 

Tech Sector & Government’s Initiative: 

Pakistan’s Govt. developed phenomenally generous incentives and facilitation with constant efforts granting technology sector to grow it for which includes,

·        

•      Income tax exemption on IT exports till June 2019,
• ·        100pc foreign ownership,
• ·        100pc repatriation of capital and dividends,
• ·        3-year tax exemption for IT startups,
• ·        Tax holiday for venture capital funds till June 2024.

About 60% of Pakistan’s youth is below 30 years of age, wherein Govt. is aiming to prepare 1 Mn. youth   to streamline excellence in technology, innovation, and professionalism.

Tech Sector from a broader perspective:

A dive into Pakistan's startup ecosystem, which highlights shape & future of Pakistan. According to one survey in Pakistan 202 startups, 22 incubators & accelerators not only in Private but Public sector supported initiatives are also there. Pakistan’s start-up sustainability is also higher compared to the global average.  On contrary not only startups emerge from Lahore or Karachi but from small cities also. Facebook, Amazon and other giants of IT sector are anticipating something huge in the start-up world of Pakistan.

Tech industry is growing at a fast pace across different streams. Enterprise software has grown by 17%, marketing tech 15%, financial services 13%, consumer goods 9%, retail/e-commerce 8%, professional services 8%, internet of things/hardware 7%, health care 4%, media 4% and non-profit 3%. This growth cycle is not only adding value to economy but also creating jobs.

Foreign Investment in Tech Sector:

Having witnessed an unprecedented boom in the recent years, China’s internet finance Fintech company, Webull, is all set to jump in to capitalize in Pakistan. Besides Alibaba’s Ant Financial stepping into Pakistan recently to give new dimension to internet shopping. Webull is to be the best financial data and trading service provider for individual investors around the world. Webull already been providing advanced global financial information service to the Pakistan Stock Exchange (PSX) since September 2017. By integrating advanced information technology, data technology and financial technology, the users can enjoy a stable, reliable and an efficient financial data and trading service. Investors can not only manage the stock portfolios in Webull but can also complete stock transaction through , graphical financial data, business analysis, industry contrast and rich tool also.

Investments like this may be a must-have for growth, we can look forward to better traction on the overall growth front. That could be the key take-away from the numbers!

TAX REFORMS & AMNESTY IN PAKISTAN

There was considerable expectation in Pakistan that the incumbent Govt. would activate long awaited tax reforms process & to roll out one-time amnesty for undisclosed foreign assets to unearth black money. An attempt to simplified tax mechanism to replace a complex web of central and province level taxes, through National Database & Registration (NADRA)   bringing the larger chunk in tax net and expand Pakistan's economic growth.

Here are key things to note about the Tax Reforms: 

• CNIC numbers to be made NTN numbers for future course to keep better vigilance and compliance of all citizens.
• Substantial cut for salaried class introduced wherein annual income of Rs1.2 MN would be exempted from income tax maximum of 15% to be levied on income above Rs4.8 MN per annum.
• Undisclosed wealth held locally or abroad to be declared after payment of nominal penalty. Pakistani’s living abroad can benefit from this scheme after paying only 2% penalty, while those in Pakistan will be required to pay 5%. Those who avail scheme to be granted one-time amnesty from accountability laws.
• On all property transactions made a uniform 1% presumptive tax (adjustable). Govt. to have the right to purchase any property by paying 100pc over and above its declared value within six months of its registration.
• Govt. to monitor citizens' financial records and issue notices if they find evidence of tax evasion. Penalties to be decided in parliament.

Offshore Assets Declaration:

a)     The foreign exchange repatriation on 2% payment of tax and offers two options for repatriation. The foreign asset holders can invest in five-year bonds at the rate of 3% per annum. But they cannot encash the bond before one year and all encashment will be in Pakistan rupee at the prevailing interbank dollar rate.

b)     Foreign liquid assets like cash, securities and bonds held abroad and in local dollar accounts may be declared with a 5% penalty.

c)     Dollar account holders in Pakistan who have purchased dollars with undeclared funds can also regularise them on 2% payment.

Property Tax Reforms:

On any property transaction citizen will have to pay a 1% 'presumptive tax', tax will be adjusted in their annual taxes. FBR/DC rate on property being abolished from 1st July 2018 and provinces being also taken onboard. Property worth over Rs4 MN is not allowed for non-filers from July 1, 2018 to be purchased.

Govt. now holds the right to buy any property that a citizen holds by paying 100% over its declared price, this will hold for six months from the registration of the property starting fiscal 2019.  The rate will fall to 75% in fiscal 2020, and 50% in fiscal 2021 to dis-incentivise under reporting.

Prospects of the Reforms & Amnesty:

Tax reforms and amnesty scheme to bring back the offshore wealth and regularize foreign assets of Pakistanis living abroad, paving way for the country to repatriate not only considerable foreign remittances but also give all Pakistani citizens a opportunity weather local or living abroad to legitimate their wealth and bring into the fold of documented economy. It will not only enhance foreign capital inflows into the capital market but also give impetus to economic activity in country at large.

Capital Market Expectations & Budget 2018-19

27^th April is one of the important day for the government as well as for the industry. But it’s even more for investors. It’s natural to look at the budget each year with the lens of Stock Market. PSX – Pakistan Stock Exchange is the barometer of the market value and economic activity. Last 4 years been instrumental for Stock Market and KSE-100 Index witnessed all time high during last year. However Capital Market has expectation from upcoming budget 2018-19.

Keep Check on Fiscal Deficit:

Government managed to keep in check on fiscal deficit in last 4 years and revival of economic activity & industrial growth remained evident. That was well received by market and eventually international credit rating agencies also. The larger challenge is the balance of payments to honour debt servicing.  The sharp rise of trade deficit in recent months to $11bn. The incumbent govt. should contain fiscal deficit within the range in order to get the dividends of structured reforms and attain political consensuses.

Rationalization of Tax on Bonus Shares:

In 2014-15 Govt. introduced 5% tax on value of bonus shares. The levy instead increasing revenue not only dropped the number of bonus issues but also reduce the revenue significantly. The markets are expecting govt. to do rethink and cut the tax on bonus shares.      

CGT on Disposal of Securities:

Frequent change in CGT regime is discouraging for the growth of Capital Market. Market are willing to pay CGT as introducing in 2010 with subsequently change in rates & holding period. Existing rate of 7.5% for securities regardless of holding period needed to be rationalized. CGT has not only affected local but also Foreign Institutional Portfolio Investment. 4 tiers of holding period proposed and caped at 3 years of holding period. However after 3 years of holding period zero rate will give big boost for long term investment in capital markets.           

CGT collection for foreigners:

As being practiced in most of the countries and even in regional markets foreign investors are not being imposed CGT. In Pakistan Foreign Investors do file returns and pay taxes according to the law of the land. It would give impetus to Foreign Portfolio Investment if Govt. choose to exempt on collection of advance CGT.

Rationalization of tax on Dividends:

The markets are expecting the government to reconsider tax on dividends. This is leading to dual taxation of dividends. Firstly, dividends are a post-tax appropriation. Secondly, the 15% to 20% tax on dividends in the hands of the shareholders is leading to dual taxation. Markets are hoping that this tax needed to be revisited and rationalized.

Lastly, the one thing that markets always expect a boost for small investors. In the last few years lot had been done on the regulatory side however awaiting initiatives for incentives for retail investors. That will be a big boost for market sentiments. After all, markets are substantially about investor sentiments!