Bank Earnings After 700bp of Rate Cuts
A mid-sized listed commercial bank reports CY24 profit after tax of PKR 21.4bn, up 9%, in a year when the SBP cut the policy rate by 700bp to 13%. Net interest margin fell to 4.1% from 5.0%. The result includes PKR 6.8bn of gain on sale of securities, arising mainly from PIBs held in the available-for-sale book that were sold during the year, against PKR 1.2bn a year earlier, and PKR 1.9bn of dividend income from an insurance subsidiary. Provisions were PKR 2.2bn while the gross NPL ratio rose from 7.1% to 8.9% and coverage fell to 71% against a sector average of 82%. Advances grew 6% and deposits 19%, pushing the advances-to-deposits ratio from 58% to 52%. CET-1 is 12.6% against a regulatory minimum of 11.5% including the capital conservation buffer, on risk-weighted assets of PKR 310bn. The board has proposed a cash dividend of PKR 12.00 per share on 1.40bn shares, and management guides to "stable earnings" next year as rates bottom out.
1. Normalise CY24 earnings. What is your estimate of sustainable net profit, and how sensitive is it to the coverage assumption?
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Strip the non-core items. Securities gains of 6.8bn and subsidiary dividend of 1.9bn = 8.7bn pre-tax. At an effective 39% (29% corporate plus super tax), that is 5.31bn after tax, giving 16.1bn on a strict basis. Excluding only the securities gain gives 21.4 - (6.8 x 0.61) = 17.3bn; the subsidiary dividend is cash but is a return on capital outside the banking business, so a middle figure of 16.5-17.0bn is defensible.
Then add back the provisioning shortfall. If gross advances are about PKR 245bn (implied by an ADR of 52%), NPLs at 8.9% are roughly 21.8bn. Lifting coverage from 71% to the sector's 82% needs 11% x 21.8 = 2.4bn pre-tax, 1.46bn after tax. Each 5pp of coverage is worth about 1.1bn pre-tax / 0.67bn after tax.
Result. Normalised PAT of PKR 14.5-15.0bn, or 30-32% below the reported 21.4bn once both adjustments are made.
Forward NIM. 4.1% was earned with the average policy rate well above 13%. Deposit repricing lags on the way down and cushions for one or two quarters only. Plan on 3.6-3.8% for CY25, so normalised earning power is below the adjusted CY24 figure, not merely at it.
2. Is the proposed PKR 12.00 dividend sustainable? Support your answer with the capital arithmetic.
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Size. 12.00 x 1.40bn shares = PKR 16.8bn, a 78% payout of reported profit and roughly 112% of normalised profit.
Capital arithmetic. CET-1 capital = 12.6% x 310bn = 39.06bn. Minimum = 11.5% x 310 = 35.65bn. Headroom = 3.41bn. RWA growth of 6% takes RWA to 328.6bn and the minimum requirement to 37.8bn.
- If reported PAT of 21.4bn is repeated: retained earnings 4.6bn, capital 43.66bn, CET-1 = 13.3%. Comfortable.
- If normalised PAT of 14.6bn is earned: retained earnings are negative 2.2bn, capital 36.86bn, CET-1 = 36.86 / 328.6 = 11.2%, below the 11.5% requirement.
Conclusion. The dividend is funded by realising the AFS revaluation reserve, which is a finite inventory. Worse, selling the PIBs removes the high-yielding assets and the proceeds reinvest at lower rates, so the gain and the future NIM loss land in consecutive periods. The market is treating a one-off liquidation of the bond book as recurring earnings.
Recommendation. Expect the DPS to be cut to PKR 8-9 unless the rate cycle reverses; treat management's "stable earnings" guidance as a statement about the AFS book, not about the franchise.
3. List the three questions you would put to management and state what answer would change your view.
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1. Composition and remaining size of the AFS surplus. How much of the 6.8bn was a realised recycling from OCI versus a mark-to-market through profit or loss, and what unrealised OCI surplus remains? A small residual (under, say, 2bn) confirms the earnings reservoir is nearly drained; a large residual means another year of similar gains is embedded.
2. Deposit beta and CASA mix. How much of the 700bp has already passed through to depositors, and what is left? If deposit costs are still catching up, NIM has further to fall than the 3.6-3.8% I have assumed; if most of the repricing is done, the 4.1% is close to the floor.
3. Provisioning quality. Of the 8.9% NPLs, how much is legacy versus formed in the last four quarters, and does coverage include forced-sale collateral values? Rising NPLs with falling coverage in a 22%-to-13% easing cycle is the classic pattern of a bank using recoveries to smooth earnings.
What would change my view. A credible disclosure that 3-4bn of OCI surplus remains and a flat CASA-backed NIM would support the higher dividend. Conversely, if the 1.9bn subsidiary dividend was paid out of the subsidiary's reserves rather than earnings, I would treat the whole 8.7bn as non-recurring and value the bank on 14bn of earnings.