EARNINGS ERODE DUE TO HIGHER PROVISIONING

PROVISIONS A MAJOR CHALLENGE AND LIKELY TO PLAY DEFINING ROLE IN SHAPING OVERALL PERFORMANCE DURING 2008

SHABBIR H. KAZMI
May 12 - 18, 2008

By this time almost all the commercial banks have released their first quarter financial results. The salient features of the results include improved credit off take and strong non-interest income growth besides other positives. However, there was also significant increase in provisions diluting the impact of core interest income growth. The increase in non-interest income also provided significant growth impetus in reducing adverse impact of higher provisions. It is feared that the higher provisions may continue to erode the benefit of higher income.

Banks have registered improved performance despite political uncertainty and volatile law and order situation. Banks have posted bottom line growth. With political and law and order headwinds having eased off considerably, the core performance will likely continue to display consistent improvement going forward. Nevertheless, provisions represent a near-term challenge and will likely play a defining role in shaping overall performance during 2008. From an investment perspective, investors should identify banks that have struck the right blend of risk and growth.

The Banks have posted net interest income growth during the quarter. It is the outcome of a combination factors from increased working capital financing requirements to government-sponsored borrowing coupled with the prevalence of relatively high spreads. Moving forward the overall credit off take during the current year is likely to be better than that witnessed last year. At the same time, spreads are likely to remain relatively high during 2008, especially for the bigger banks, whereby full-year net interest income growth cannot be ruled out.

Keeping in view the presence of one-offs such as capital gains and miscellaneous items within the other income head the growth in fee and commission based income will be a relatively better indicator of recurring performance. The commissions on trade and remittances have likely played an important role. In light of expected improvement in trade and record remittances we expect the fee & commission income segment to continue providing valuable support to banks' bottom line.

Despite stronger economic headwinds in the current year, the short to medium term impact on the banking sector will be positive. Greater input costs for corporates and continued government borrowing is likely to boost overall credit off take, while relatively high spreads are expected to persist. However, if economic challenges persist for long, increased delinquencies, resulting in higher provisions, may lead to continued dilution of core operating performance going forward.

As expected, provisions have played a key role. A combination of textile-related delinquencies and consumer portfolio cleanups, among other factors, is the primary reason behind increased provisions. However, the effect of the FSV has lingered; for instance UBL has indicated that Rs 260 million worth of provisions is a direct result of tightened provisioning criteria by the central bank. For UBL, this represented about 29% of provisions (excluding bad debts directly written off and consumer-specific general provisions) during this period.

Subsequent to the implementation of the FSV regulation, the overall provisions 'base' has raised. However, in this raised base does not imply a change in fundamentals, rather it paves the way for future reversals, arising from liquidation of illiquid collateral.

Furthermore, although provisions have been relatively high these represent a decline from provisions made during last quarter of 2007. However, the increased provisions remain a concern given the prevailing economic backdrop. Therefore the investors should focus those banks which have displayed relatively better asset quality.

MAYBANK ACQUIRES STAKE IN MCB BANK

Despite denying acquisition of stake by the Malaysian Bank in the past, at last MCB Bank has confirmed Maybank signing an agreement to buy 15% shares now and another 5% after a year. This deal will result into a transaction worth $680 million (Rs 44.3 billion) for the15% stake. Maybank has agreed to buy MCB Bank shares at 5.1 times book value and 15 times the Karachi-based bank's earnings in 2008.

In certain ways it is a very unique transaction because for the first time any Malaysian bank has entered Pakistan's banking arena, Pakistani banks have already attracted substantial foreign investment due to mergers and acquisitions of banks over the last three years. Maybank, the largest bank of Malaysia, is expanding its foreign operations to exploit the opportunities available in Pakistan.

Banking emerged as the most attractive sector in Pakistan during the last five years as the banks booked record profits, while the country witnessed an average 7 per cent economic growth. Bankers believe that an economy of $146 billion with a population of 160 million and the expected growth of over six per cent is still attractive for the banking giants.

The transaction represents the largest foreign direct investment into Pakistan in 2008 and the largest-ever private sector cross border transaction in Pakistan. In due course Maybank will have the right to appoint two directors on the board of MCB Bank.

According to the details Maybank has signed five separate Share Purchase Agreements with 1) Mian Umer Mansha, Mian Hassan Mansha, Muhammad Saleem (collectively referred as individual sellers); 2) MCB Bank Employees' Provident Fund; 3) MCB Bank Provident Fund; 4) Nishat Mills Employees Provident Fund Trust; and 5) Adamjee Insurance Company for the acquisition of 94.2 million shares at a per share price of Rs 470.