THIS TIME IS DIFFERENT

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1 THIS TIME IS DIFFERENT BANKING SECTOR 25 th September 2017 Aijaz Siddique Research Entity Notification No.: REP-116 See last page for analyst certification and other important disclosures

2 Banking Sector Table of Contents Investment Thesis Interest Rate Outlook Margins Outlook Current Deposits Operating Expenses NPLs Risk ROE Analysis Taxation Capital Adequacy Industry Consolidation Valuations

3 Investment Thesis This Time Is Different Banking sector appears to be going through significant transition with consolidation pulling down number of banks operating in the country while historic low interest rates have been putting a check on banking margins. Although, interest rate cycle seems to have bottomed out, this time is different for banking sector as net interest income expansion amid rising interest rates may not be able to offset new NPL formation and inflationary pressures on operating costs by a wide margin. We estimate only 9% growth in pre-tax profitability of our sample under an optimistic set of assumptions for 2% increase in interest rates. Banks exposure to interest rate volatility is now only limited to current deposits on the liabilities side, which is further constrained by large holdings of fixed rate longer tenor PIBs on the assets side. Hence, effective net exposure of banks to interest rates is restricted to [PIBs Current Deposits]. Banks with low PIB / Current Deposits ratio are likely to benefit more in this scenario. Regulatory spreads tightening together with historic low interest rates have already taken their toll on the banking sector ROE with incremental ROE of our sample falling to 10.1%, at current interest rates, on new deposits generation. Our sample reported an ROE of 16.1% in 2016, which found staunch support from realization of large capital gains and subdued credit costs. Whereas, normalized ROE stood at 13.8% in 2016 as per our estimates. Govt. borrowings from SBP for budgetary support have resulted in large surplus liquidity in the banking system, which can now be seen shaping into an upward trend in ADRs. With blue chips significantly less leveraged today than a decade ago, rapid private sector credit expansion [+19% Y/Y] may be finding its way into the second tiers. 0.5% new NPLs may trim Tier-1 ROE by 1.4% of our sample. Banks with higher ADRs are more exposed to the risk. Banking spreads over advances have also fallen to cyclical lows; however, we expect budgetary borrowing to return to the banking system if govt. goes back to the IMF for BOP support, which should provide some respite to the spreads as well as limit risks of new NPL formation. The global lending authority may also provide additional targets of retiring outstanding stock of borrowings from the SBP. Corporate taxation of 35% from all sources of income and super taxation of 4% remain discriminatory vis-à-vis other sectors. IMF may provide stiff fiscal deficit targets to the govt. under the new program. The incumbent government may raise the tax burden further on the banking sector, as it has often not shied away from levying further taxes on the already taxed sectors, if it wins a majority in next general elections. Though capital adequacy ratio of our sample has risen from 14.1% in 2011 to 16.6% in 2016, it remains a fact that decline in assets risk density has been the primary factor behind CAR expansion which can be explained by the shift in asset mix towards govt. securities. Conversely, equity concentration has remained flattish which can be attributed to increase in dividend payouts and balance sheets leveraging through REPO borrowings. From a valuation standpoint, the sector looks marginally undervalued from both justified and relative valuation techniques. Nevertheless, amid clouded earnings growth outlook, banking sector seems better positioned to benefit from macroeconomic fundamentals.

4 INTEREST RATE OUTLOOK

5 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Widening twin deficits demand policy measures Inflation follows currency devaluation Twin deficits reach 10% in FY17 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0% Inflation bears an understandable relationship with currency 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -10.0% Consolidated Budget Balance (% GDP) Current Account Balance (%GDP) PKR / USD (%Y/Y) CPI (%Y/Y) Source: SBP, PBS, Zakheera

6 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Interest rates play a crucial role in influencing aggregate demand Double digit interest rates cannot be ruled out With FX reserves cover running thin, external vulnerabilities have risen significantly amid growing domestic demand due to which consolidation as well as windfall gains achieved during the past few years are at risk. Addressing external account woes requires a combination of policy measures including currency depreciation, raising interest rates, curtailing public spending, etc. There has been a strong relationship between interest rates and imports growth. Hence, interest rates may need to be raised to ease domestic demand besides addressing soaring inflation. Being a demand center, historical trends show that interest rates may need to be raised to double digits to pull down imports growth. Expansionary policies have already pushed imports growth to a 9 year high. 50% 40% 30% 20% 10% 0% -10% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% -20% 0% Goods Imports (PBS)(%Y/Y) Discount Rate (RHS) Source: SBP, PBS, Zakheera

7 MARGINS OUTLOOK

8 Jun'08 Nov'08 Apr'09 Sep'09 Feb'10 Jul'10 Dec'10 May'11 Oct'11 Mar'12 Aug'12 Jan'13 Jun'13 Nov'13 Apr'14 Sep'14 Feb'15 Jul'15 Dec'15 May'16 Oct'16 Mar'17 Aug'17 MDR trims banking spreads Narrowing interest rate corridor Minimum Deposit Rate [MDR] was introduced in 2008 with the aim of reducing banking spreads to enhance sector efficiency and bringing in more currency in circulation into the financial intermediation process. Moreover, SBP introduced an Interest Rate Corridor [IRC] in Aug-2009 with the aim of strengthening monetary policy transmission mechanism to minimize volatility of short term interest rates. IRC has been gradually reduced to 200 bps from 300 bps introduced initially. As a result, banking spreads as measured by the difference between 6M PKRV Rate and MDR have reached historic lows to a point where the going gets tough. While regulatory tightening has been gradually translating into margins attrition over time [next slide], net interest spreads of our banking sample rose marginally in 2014 and 2015 despite sliding interest rates thanks to hefty accumulation of high yield PIBs. Nevertheless, with high yield PIBs hitting maturity, margins can be seen coming under pressure once again. We estimate that Jul-2016 maturity of PKR 1.2 tn carried weighted average yield of 12%. Likewise, we estimate Jul-2017 maturity of PKR 431 bn to have carried weighted average yield of 11%. 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% MDR 6M T-Bill Source: SBP, Zakheera

9 Margins rose slightly in 2014 and 2015 despite declining interest rates primarily on account of high yield PIBs accumulated in 2014 Regulatory tightening gradually translating into margins compression High yield PIBs helped protect NIM erosion in 2014 and % 7.0% 14.0% 45% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 40% 35% 30% 25% 20% 15% 10% 5% 0.0% 3.0% 4.0% 0% Net Interest Spread (RHS) MDR 6M T-Bill PIB / PKR Deposits (RHS) PIB Yields - New Issue 6M T-Bill Our banking sample includes ABL, BAFL, BAHL, FABL, HBL, HMB, MCB, NBP, UBL Source: SBP, Zakheera, Next Research, Banks Financial Statements

10 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Mar-17 Jun-17 NIM attrition likely to continue into 2018 owing to high yield maturity Low yield PIBs likely to pressurize margins in case of reversal in interest rates PIB maturity in 2018 estimated to carry a weighted average yield of 9.6% PKR 1.6 tn PIBs issued in past 6 quarters at a weighted average yield of 6.8% 1,200 PKR BN 12.0% 1,200 PKR BN 14.0% 1, % 1, % % % % 4.0% 2.0% % 6.0% - 4.0% % PIB Maturity Yield on Maturity PIB Issued Yield on Issue Source: SBP, Zakheera, Next Research

11 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Gap b/w outstanding PIBs & PKRV rates to narrow as interest rates rise Surplus on revaluation of AFS portfolio may be at risk 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% PKR BN Yield on Outstanding PIBs PKRV 3Y Surplus on Revaluation of AFS Investments Source: SBP, Zakheera, Next Research, Banks Financial Statements

12 UBL ABL HBL HMB Sample BAFL MCB BAHL NBP FABL UBL HMB ABL HBL Sample MCB BAFL NBP BAHL FABL FABL, BAHL, NBP, BAFL well positioned to evade NIM contraction on PIBs UBL, holding more PIBs than current deposits, may witness spreads contraction PIBs / Total Deposits [Jun-2017] 60% PIBs / Current Deposits [Jun-2017] 140% 130% 50% 49% 120% 107% 40% 30% 20% 34% 33% 33% 31% 31% 30% 21% 19% 12% 100% 80% 60% 40% 96% 89% 82% 75% 65% 56% 56% 34% 10% 20% 0% 0% Source: Next Research, Banks Financial Statements

13 BAFL MCB BAHL UBL Sample HBL FABL ABL NBP HMB HBL BAHL HMB FABL Sample UBL ABL BAFL MCB NBP CA matters more than CASA Banks with greater current deposits ratio shall benefit as MDR is now linked to REPO Current Deposits Ratio [Jun-2017] Current Deposits CAGR 55% 50% 45% 40% 35% 30% 47% 40% 38% 38% 37% 37% 36% 36% 34% 31% 25% 20% 15% 10% 23% 22% 22% 18% 17% 15% 15% 15% 12% 12% 25% 5% 20% 0% Source: Next Research, Banks Financial Statements

14 This time is different NIM expansion may not be able to offset emerging risks by a wide margin Sharp rise in inflation and interest rates amid fixed MDR helped net interest incomes to grow abnormally, which more than offset increase in provisioning and operating expenses, and allowed the banks to report net increase in profit after tax between 2007 and Net interest income of our banking sample grew at a CAGR of 15.0% between 2007 and 2010 against 13.1% compounded growth in deposits. Operating costs expanded at a CAGR of 18.6% during this period. Credit costs rose to an average of 1.6% of gross advances between 2008 and 2010 against an average of 1.0% observed between 2005 and Yet, coverage ratio dropped from 86% in 2007 to 74% in However, things are quite different this time post linkage of MDR with REPO rate. Banks exposure to interest rate volatility is now only limited to current deposits. At the same time, banks have large holdings of fixed rate longer tenor PIBs as assets which will only be re-priced at maturity. Hence, it may not be wrong to say that effectively banks exposure to interest rate volatility is contained to [Current Deposits PIBs]. In this backdrop, we have tried to estimate the net impact of increase in interest rates on net interest income, provisioning expense, operating expense, and non-interest income. Incremental net interest income may not be able to outpace emerging risks by a wide margin based on the 2016 year-end numbers. Ensuing large PIB maturity of PKR 1.0 tn in 2018 should bring down PIB holdings and should have positive impact on earnings. Taking out entire PKR 1.0 tn maturity from current PIB holdings of PKR 2.5 tn, we find that the net impact of the increase in interest rates comes to around PKR 21 bn, which is equal to 9% of 2016 reported pre-tax profit of our sample. We have taken some optimistic assumptions in these calculations, such as no additional investments in PIBs, only 0.3% deterioration in NPLs / Gross Loans Ratio, and only 0.1% increase in Operating Costs / Deposits Ratio. Assuming interest rates rise 2% PKR Million Deposits ,320,269 Current Deposits Ratio 36.0% 2,995,297 Deposits Growth 10.0% 832,027 Current Deposits Ratio 38.0% 316,170 Pakistan Investment Bonds Adjusted 1,581,642 Gross Loans ,937,241 Operating Expenses ,642 Net Impact Incremental 21,105 Incremental Interest Income 2.00% 58,476 NPL Ratio Rises 0.30% (11,812) Operating Costs / Deposits Ratio Rises 0.10% (34,919) Non Interest Income [Excl. Cap. Gains] 1.50% 9,360 Source: Next Research, Banks Financial Statements

15 CURRENT DEPOSITS

16 While logic says current deposits ratio should fall amid rising rates historical trend suggests otherwise Current deposits have grown at a healthy CAGR of 16.6% b/w % Current deposits ratio has kept trending upwards 40.0% 14.0% 20.0% 35.0% 12.0% 10.0% 15.0% 30.0% 8.0% 6.0% 10.0% 25.0% 4.0% 2.0% 5.0% 20.0% 0.0% Current Deposits Growth Current Deposits Ratio 6M PKRV [RHS] Source: SBP, Zakheera, Next Research, Banks Financial Statements

17 OPERATING EXPENSES

18 HMB ABL UBL Sample BAHL NBP HBL MCB BAFL FABL Growth in operating expenses is closely tied with inflation 0.1% increase in operating costs / deposits ratio can lift expenses growth to 15% HMB appears to have the most efficient cost structure The two variables carry a strong correlation of % 3.7% 3.7% 30.0% 3.5% 3.0% 2.5% 2.0% 2.3% 2.7% 3.0% 3.1% 3.1% 3.1% 3.2% 3.3% 25.0% 20.0% 15.0% 1.5% 10.0% 1.0% 5.0% 0.5% 0.0% 0.0% Operating Costs / Branch [%Y/Y] CPI [%Y/Y] Source: PBS, Zakheera, Next Research, Banks Financial Statements

19 NPLs RISK

20 Jun ADR showing some pick up off its lows Private sector credit expansion is cyclical in nature 90.0% 80.0% PKR TN 40.0% 35.0% 30.0% 70.0% % 60.0% % 15.0% 50.0% % 40.0% % 0.0% 30.0% % ADR Private Sector Credit Private Sector Credit [%Y/Y] Source: SBP, Zakheera, Next Research, Banks Financial Statements

21 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY Government resumes borrowings from SBP Surplus liquidity triggers private sector credit off-take [+19% Y/Y as of Jul-2017] 120% 18% 14.0% 80.0% 100% 80% 60% 40% 16% 14% 12% 10% 8% 12.0% 10.0% 8.0% 70.0% 60.0% 20% 0% -20% 6% 4% 2% 0% 6.0% 4.0% 2.0% 50.0% 40.0% -40% -2% 0.0% 30.0% Govt. Borrowing From SBP [%Y/Y] - LHS Credit to Private Sector [%Y/Y] ADR - RHS NPL Ratio - LHS Source: SBP, Zakheera, Next Research, Banks Financial Statements

22 NPLs tend to follow interest rates 18 blue chips have significantly lower leverage today than in the past 14.0% 12.0% 10.0% 8.0% 140% 120% 100% 80% 128% 6.0% 60% 58% 4.0% 40% 2.0% 20% 0.0% 0% Dec-2009 Mar-2017 NPL Ratio 6M PKRV Debt / Equity Ratio [18 Blue Chip Companies] Source: SBP, Zakheera, Next Research, Financial Statements

23 BAFL FABL BAHL NBP Sample HBL UBL ABL HMB MCB FABL BAFL NBP BAHL ABL Sample HMB HBL MCB UBL 0.5% new NPL formation may trim Tier-1 ROE by 1.4% Banks with higher ADRs may be more exposed to the risk 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 0.5% New NPLs / Tier - 1 Equity [2016] 0.5% New NPLs / Pre Provisioning Pre Tax Profit [2016] Source: Next Research, Banks Financial Statements

24 Current Surplus liquidity also brings spreads on advances under pressure return of government borrowing may provide respite to the spreads 14.0% 3.0% 12.0% 2.5% 10.0% 2.0% 8.0% 6.0% 4.0% 2.0% 1.5% 1.0% 0.5% 0.0% Yield on Advances Advances Spread Over Benchmark Source: SBP, Next Research, Banks Financial Statements

25 Budgetary borrowing likely to return if government goes back to IMF IMF may provide additional target of retiring borrowings from SBP Given widening current account deficits, it seems highly likely that the govt. could knock on the doors of IMF for support sometime in The economic reforms program could well likely be tougher this time with IMF providing strict borrowing targets from the central bank, which could bring back govt. borrowing to scheduled banks. Moreover, the government may also be required to bring down its stock of borrowings from the central bank, which also holds positive implications for the banking sector. 1, PKR BN Govt. Borrowing From SBP Consequently, pressure on advances spreads should also ease as the government would absorb surplus liquidity from banks. The same shall also deter rapid private sector credit expansion and subsequent creation of NPLs IMF may also ask the government to elongate its debt profile like it did in the past, prompting the government to issue large quantum of PIBs. (200) However, in a rising interest rate scenario, fixed rate PIBs may not be a lucrative investment for the banking sector and hence the yield gap between shorter and longer tenor instruments may widen. (400) (600) Source: SBP, Next Research

26 TAXATION

27 Corporate taxation remains discriminatory Risk of further taxation looms if orthodoxy is to prevail While corporate taxation has been reduced to 30% as part of the 5 year plan, banking sector has been deprived of the incentive as taxation remains 35%. Moreover, taxation on different sources of income such as capital gains and dividends, which were previously subject to lower taxes, has also been increased to 35% during the current government s tenure. 45% 40% 35% Besides, super taxation of 4% as opposed to 3% for other sectors also remains discriminatory. PML-N government has clearly struggled with generating tax revenues as evident from the imposition of new / higher taxation over the past 4 years. The burden of increased taxation has primarily fallen on existing tax payers with sectors such as retail, agriculture, and power generation continuing to contribute negligible amounts to the revenue collection. Fiscal deficit has already reached 5.8% of GDP in FY17 and expansionary fiscal policy may cause it to deteriorate further in FY18. 30% 25% 20% 15% 10% 5% Assuming current government wins a majority in next elections and goes back to IMF, there may be stiff targets with respect to curtailing fiscal deficit which may force the government to impose new taxation measures. Increase in taxation beyond 35% for banking sector cannot be ruled out in this regard. 0% Effective Tax Rate Source: Banks Financial Statements

28 ROE ANALYSIS

29 2016 ROE [sample] broken down into components Elevated capital gains and muted provisions inflated ROE in 2016 Reported ROE +16.1% Net Interest Non Interest Provisioning = Income + Income + Expense % +9.4% -0.2% Operating Expense -16.2% Fee Income +4.7% Capital Gains % + Other Income +2.3% Normalized ROE +13.8% Net Interest Non Interest Provisioning = Income + Income + Expense % +8.6% -1.7% Operating Expense -16.2% Source: Next Research, Banks Financial Statements

30 % 8.8% 9.5% 15.2% 13.9% 13.9% 12.2% 13.2% 16.0% 15.3% 14.1% 13.2% 16.1% 13.8% 18.2% 17.4% 20.2% 19.4% 18.9% 16.8% BAHL reported the healthiest ROE in 2016 Sector ROE seems to be gradually adjusting downwards ROE [Reported] vs ROE [Normalized for capital gains and provisions] Banking Sample ROE Trend 25.0% 30.0% 20.0% 25.0% 15.0% 20.0% 10.0% 5.0% 15.0% 0.0% ABL BAFL BAHL FABL HBL HMB MCB NBP UBL Sample 10.0% Reported ROE Normalized ROE Source: Next Research, Banks Financial Statements

31 Incremental ROE excluding capital gains is not very impressive Regulatory spreads tightening and surplus liquidity putting strain on ROE Regulatory spreads tightening coupled with decline in interest rates to historic lows has kept operating environment quite tough for the banking industry. Rubbing salt into the wound, surplus liquidity in the banking system has even turned lending spreads over benchmark negative in certain cases. The table on the right provides our estimation of incremental ROE, excluding capital gains, on new deposits generation for our banking sample at current interest rates. We have assumed that current deposits earn a spread of discount rate plus 0.25%, savings deposits earn a spread of interest rate corridor plus 0.25%, and fixed deposits earn a fixed spread of 1.5%. Furthermore, we have also assumed that operating expenses grow at the rate of inflation, which has been kept 1% below the discount rate, whereas both deposits and non-interest income excluding capital gains grow at 10%. Our banking sample earned an ROE of 16.1% in 2016; however, large capital gains and subdued credit costs helped bolster the bottom line. Assuming normalized capital gains and credit costs, we find that the ROE drops to 13.8%. While current low interest rates have pulled down banking sector ROEs, we foresee positives in the form of reversal in interest rates and govt. returning to banking system for borrowing post entry into IMF program [discussed earlier]. Source: Next Research, Banks Financial Statements Sample [9 Banks] Unit Working Deposits PKR Million 8,320,269 Deposits Growth [10%] PKR Million 832,027 Current Deposits PKR Million 295,370 Savings Deposits PKR Million 357,772 Fixed Deposits PKR Million 178,886 Deposits Mix % 100.0% Current Deposits % 35.5% Savings Deposits % 43.0% Fixed Deposits % 21.5% Spreads Earned % 3.8% Current Deposits % 6.5% Savings Deposits % 2.8% Fixed Deposits % 1.5% Net Interest Income PKR Million 31,721 Non Interest Income PKR Million 11,066 Provisions PKR Million 2,496 Operating Expense PKR Million 24,838 Net Income PKR Million 10,045 ROE % 10.1%

32 CAPITAL ADEQUACY

33 Rapid credit expansion may put capital adequacy under pressure However, return of risk free investments could keep off such pressures Our banking sample remains well capitalized with a CAR of 16.6% at the end of 2016, which has risen sharply from 14.1% at the end of However, it remains a fact that decline in assets risk density has been the primary factor behind CAR expansion rather than growth in equity base. Risk weighted assets as a fraction of total assets have fallen from 64.6% at the end of 2010 to 47.7% at the end of 2016 whereas total equity as a proportion of total assets has dropped marginally from 9.9% at the end of 2010 to 8.7% in Shift in assets mix towards government securities can explain lower assets risk density while flattish equity can be explained through a combination of increase in dividend payouts and leveraging of balance sheets through REPO borrowings. Low interest rate cycle has finally started shaping into increase in ADRs, discussed earlier, which poses downside risks to capital adequacy amid limited equity base. Nevertheless, we maintain our comfort on this account given risk free investments are likely to inch up again as soon as government starts curtailing its borrowings from the central bank, which is not a sustainable phenomenon. 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 20.0% 18.0% 16.0% 14.0% 12.0% We expect the banks to prefer govt. securities over high risk advances. Though, good quality advances were never an issue and the banks are likely to continue with the low risk lending spree. Equity / Assets RWA / Total Assets Capital Adequacy Ratio [RHS] Source: Next Research, Banks Financial Statements

34 INDUSTRY CONSOLIDATION

35 Stiff regulations and competition encouraging industry consolidation Effectively, number of banks has reduced from 38 in 2014 to 32 recently The number of banks operating in the country has reduced from 38 at the end of 2014 to 34 at the end of However, the list included MCB Islamic Bank and NIB Bank as separate entities at the end of Treating MCB Islamic Bank and NIB Bank as part of MCB Bank along with incorporating Sindh-Summit Merger and expected commencement of Bank of China s operations, we find that effectively the number of banks currently operating in the country has dropped to 32, which represents a decline of 16% in 2 years. Spreads tightening by the regulator coupled with strict industry competition has kept ROEs in check, specially for smaller banks. Capital requirements have also been toughened up under BASEL-III regulations. In this backdrop, we expect industry consolidation to continue with larger banks taking over smaller banks that are finding it hard to survive with unimpressive ROEs. Industry competition should come down as a result Total Number of Banks Source: SBP

36 VALUATIONS

37 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Our banking sample has outperformed KSE-100 by a CAGR of 5.5% Banking sector looks undervalued by historical standards on a trailing P/E basis Banking Sample & KSE-100 Total Returns Sample s trailing 4Q P/E of 8.1x is 12.6% below LT average of 9.3x Banking Sample KSE-100 Banking Sample P / E Average Source: PSX, Zakheera, Next Research

38 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 NBP HMB FABL BAHL HBL BAFL ABL UBL MCB Trading at a discount of 22.5% to KSE-100 on a trailing P/E basis against historical average discount of 8.3% Banking Sample P / E KSE-100 P / E Trailing 4Q P/E Source: PSX, Zakheera, Next Research

39 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 NBP FABL HMB ABL BAFL HBL BAHL UBL MCB Trading at a discount of 23.0% on P/B by historical standards However, book value of equity is inflated by large unrealized surplus on AFS portfolio Excluding Pre-2010 period, long term P/B average is 1.5x only P / B Average Trailing P/B Source: PSX, Zakheera, Next Research

40 Fairly valued in theory Reversal in interest rates may also trim justified valuations Justified Price To Book Valuation Past 5-YR Average ROE 16.5% Payout Ratio 50.0% Retention Ratio 50.0% Sustainable Growth 8.3% Cost of Equity 14.5% Risk Free Rate 8.5% Risk Premium 6.0% Justified Price To Earnings Valuation Past 5-YR Average ROE 16.5% Payout Ratio 50.0% Retention Ratio 50.0% Sustainable Growth 8.3% Cost of Equity 14.5% Risk Free Rate 8.5% Risk Premium 6.0% Justified P/B 1.33 x Justified P/E 8.02 x Trailing P/B 1.34 x Trailing P/E 8.12 x Forward P/B 1.17 x Forward P/E 7.99 x Source: Next Research

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