Karachi: Weighted average spreads have registered at 7.59% in Aug’11, down 29bpsMoM but up 3bpsYoY.
According to AKD Securities, sequential contraction in spreads is due to a combination of 11bpsMoM decline in WA lending yields and 18bpsMoM increase in WA deposit cost. While the former tracks lower KIBOR following the Jul’11 50bps cut in the DR, deposit cost has remained upward sticky due to lag effect and potential funds flow into expensive term deposits in anticipation of further monetary easing ahead. Considering that WA spreads contracted from 7.78% in Jan’09 to 7.25% in Jan’10 (DR reduced from 15% to 12.5% in this period), likely monetary easing ahead should lead to continued spread/NIMs contraction. However, tighter margins should be compensated by asset quality improvement where the last interest rate down-cycle coincided with deceleration in both NPL formation/provisions and earnings momentum was maintained. We retain our Overweight stance on Banks where we highlight likely valuation multiples’ rerating in a lower interest rate environment. Our top banking sector picks are MCB and UBL. For yield-seekers, NBP (D/Y: 14.2%) may offer near- term attraction while value hunters may look to AKBL and MEBL.
Margins, Asset Quality and Rerating: Going by the last monetary easing cycle (2009), spreads/NIMs are likely to compress further, leading to NII growth deceleration. However, this should be compensated for by likely improvement in asset quality with a slowdown in both NPL formation and credit costs. Moreover, Pakistan banking sector average P/B multiple expanded train O.92x to 1.37x across Apr’09-Nov09 (DR reduced from 15% to 12.5%). We believe similar dynamics are likely to unfold across the near-term, with monetary easing set to continue. Considering that Pakistan Banks tend to post their best price performance in the first quarter of the calendar year, we retain our Overweight stance on Banks (top picks: MCB and UBL) with a 6m investment horizon. That said, we caution that potential macroeconomic deterioration beyond the near-term may compel us to revisit our investment case.