Cumulative profit of scheduled banks could drop by 18 percent in 2008 in case the central bank proposal for 100 percent cash provisioning is to become applicable in one year. According to an analyst, the cumulative profit of banks in 2008 is estimated at Rs 140 billion, taking into account the tax rate 35 percent and the net provisioning estimated at Rs 25 billion in 2008.
The State Bank of Pakistan (SBP) provisioning proposal is difficult to be implemented from the current calendar year as the new tax law aligned with prudential regulation that become applicable in next year.
For the current year, under the old tax law, banks have to exhaust all legal efforts before they can book the loss provision totally in cash from their income.
According to banking sources, bankers are likely to press the central bank for phasing the applicability of 100 percent cash provisioning. In case the SBP agrees with Pakistan Bankers Association (PBA), the drop in banks'' profitability in 2008 would only be in the negative by 7 percent.
The State Bank recently issued a draft circular regarding amendments in prudential regulations related to provisioning for loans and advances. In the draft, the SBP has proposed to withdraw the benefit of ''Forced Sale Value'' (FSV) against all non-performing loans (NPLs) for calculating provisioning requirement with effect from December 31, 2007.
Owing to increased provisioning envisaged in this draft, the banks are likely to get a 4-year cumulative hit of Rs 38 billion (net of taxes) on their earnings. This potential impact is based on the assumption that SBP would phase in this new requirement over a period of four years, leading to its annual negative impact of 7 percent on banking sector''s post-2007 profitability, Atif Malik, senior analyst at JS Global Capital, in his report issued here said.
"Contrary to the general belief that this would have a drastic impact on banks'' profitability, we believe that this is just a draft for discussion, and may or may not be implemented. Thus, we maintain our ''Overweight'' stance on Pakistan''s banking sector. Moreover, we believe that the impact of these proposed amendments on the future earnings of the banking sector would not be as severe as was initially portrayed", he said.
Under the existing regulations, banks are allowed to deduct FSV of collateral from the NPL outstanding principal before making provisions against it.
There are three NPL classifications, based on the number of days for which mark-up/interest or principal payment is overdue. In case payment is overdue by 90 days or more, NPL is considered ''substandard'', requiring 25 percent provisioning for the difference between the outstanding balance of NPL principal and FSV of its collateral.
This provisioning requirement is increased to 50 percent and 100 percent, if the overdue period for NPL payment gets to 180+days (''doubtful ''NPL) and 360+days (''loss ''NPL), respectively.
This draft circular, if implemented, could have a substantial negative impact on the banking sector profitability. As per the latest numbers, the size of total NPLs of the banking sector stands at Rs 184 billion (as on Mar 31, 2007), which is 74 percent covered by provisions.
The remaining 26 percent (Rs 47 billion) uncovered NPLs is mainly explained by the fact that banks take FSV of collateral away from NPL value before making provisioning against it. As per calculation, the weighted average overdue period of total NPLs of the banking sector is 10 months, implying weighted average 83 percent provisioning requirement for the uncovered NPLs under the new draft. As a result, banks will make an additional provision of Rs 39 billion for the existing stock of NPLs, having an after-tax earnings impact of Rs 25 billion.
"Similarly, as per our calculations, the incremental after-tax earnings impact of this new provisioning requirement for the post-2007 new NPLs would be around Rs 3.3 billion a year", the report said.
"Since this new requirement will be having a significant effect on the bottom line of the banks, we believe, if implemented, it would be phased in over a certain period of time. Taking clue from four-year timeframe set by SBP in November 2005 for raising the paid-up capital requirements for banks to Rs 6billion by end of 2009, we expect SBP to phase this new provisioning requirement over a period of four years for the existing stock of loans from December 31, 2007. However, for post-2007 new loans, we expect this requirement to immediately come into effect", the report added.
The report said: "Based on this four-year phasing-in assumption, we expect banks to get a cumulative hit of around Rs 38 billion (net of taxes) (Rs 25 billion on existing loans and Rs 13.3 billion on new loans in each of the next four years) on their earnings over a period of four years from December 31, 2007, resulting into an annual impact of Rs 9.5 billion. Since banks'' total profitability in 2008 is expected to touch Rs 140 billion, the net impact of this new provisioning requirement could reduce post-2007 banks'' annual profits by 7 percent". The tables illustrates the impact on the individual banks and their future profitability:
JS RESEARCH BEEP:
Table 1: Impact of Increased Provisioning on Existing NPLs Under Proposed Amendments:
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Existing Method Proposed Method Additional Per Share
Bank NPL Provisioning Total NPL* Provision Held Provision Held Provisioning Impact After
Category Required (Rs mn) (Rs mn) (Rs mn) (Rs mn) Tax (Rs)
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ABL OAEM* 25 -
Substandard 25% 838 92 210 118
Doubtful 50% 537 215 269 54
Loss 100% 9,219 7,182 9,219 2,037
Total 10,619 7,489 9,697 2,208 2.7
AKBL OAEM* 4 112
Substandard 25% 137 15 34 19
Doubtful 50% 1,252 171 626 455
Loss 100% 4,550 3,141 4,550 1,408
Total 5,942 3,440 5,210 1,882 4.1
BAFL OAEM* 42 -
Substandard 25% 1,123 170 281 111
Doubtful 50% 468 133 234 101
Loss 100% 1,898 1,424 1,898 475
Total 3,532 1,727 2,413 687 0.7
BOP OAEM* 171 -
Substandard 25% 263 33 66 33
Doubtful 50% 451 110 226 115
Loss 100% 1,467 1,016 1,467 451
Total 2,352 1,159 1,759 599 1.0
FABL OAEM* 44 174
Substandard 25% 429 45 107 62
Doubtful 50% 249 50 124 74
Loss 100% 2,374 921 2,374 1,453
Total 3,095 1,190 2,606 1,590 2.4
HBL OAEM* 610 -
Substandard 25% 7,404 674 1,851 1,177
Doubtful 50% 3,155 1,252 1,577 325
Loss 100% 20,412 16,535 20,412 3,877
Total 31,580 18,462 23,840 5,379 5.1
MCB OAEM* 87 -
Substandard 25% 562 130 141 10
Doubtful 50% 952 460 476 16
Loss 100% 7,803 6,043 7,803 1,760
Total 9,405 6,633 8,420 1,787 1.8
NBP OAEM* 727 -
Substandard 3,474 689 868 179
Doubtful 25% 3,101 1,265 1,550 285
Loss 50% 30,093 26,787 30,093 3,306
Total 100% 37,395 28,741 32,512 3,771 3.0
UBL OAEM* 561 -
Substandard 25% 2,586 410 646 236
Doubtful 50% 2,096 864 1,048 184
Loss 100% 12,657 10,900 12,657 1,757
Total 17,900 12,175 14,351 2,176 1.7
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Source: JS Research
-- OAEM - Used to be an NPL category before 2006
-- Total NPL figure is as of Jun 30, 2007
-- JS Research Beep
-- Table 2: Annual Impact of the Proposed Provisioning on Future Non Performing Loans (NPLs):
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Average Provisions as Provisions as
Annual NPL as New Weightage per Existing per Proposed Per
Bank Rise in % of NPL Average Method Method Additional Share
Advances Gross (F) Overdue Provision Provision Provisioning Impact
(F) Advances (Rs mn) Period Held Held (Rs mn) AfterTax
(Rs mn) (F) (Rs mn) (Rs mn) (Rs)
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ABL 26,169 6.9% 1,806 91% 1,167 1,643 477 0.6
AKBL 16,950 3.6% 610 88% 311 537 226 0.5
BAFL 25,119 1.5% 377 68% 126 256 131 0.1
BOP 33,303 2.3% 766 75% 281 574 293 0.5
FABL 13,159 4.6% 605 84% 193 508 315 0.5
HBL 58,542 7.6% 4,449 75% 1,935 3,337 1,401 1.3
MCB 34,130 4.1% 1,399 90% 894 1,259 365 0.4
NBP 57,481 10.4% 5,978 87% 4,005 5,201 1,196 1.0
UBL 45,007 6.2% 2,790 80% 1,518 2,232 714 0.6
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SOURCE: JS RESEARCH
Table 3: Earnings (EPS) Impact (incase of 4-year phase-in period) of Proposed Method:
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Total Impact
Bank Impact 2008F Impact 2009F Impact 2010F Impact 2011F (4-years) Impact as % of
(Rs) (Rs) (Rs) (Rs) (Rs) 2008F earnings
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ABL 1.2 1.2 1.2 1.2 5.0 10%
AKBL 1.5 1.5 1.5 1.5 6.0 13%
BAFL 0.3 0.3 0.3 0.3 1.2 6%
BOP 0.7 0.7 0.7 0.7 3.0 5%
FABL 1.1 1.1 1.1 1.1 4.4 13%
HBL 2.6 2.6 2.6 2.6 10.3 10%
MCB 0.8 0.8 0.8 0.8 3.4 3%
NBP 1.7 1.7 1.7 1.7 6.8 6%
UBL 1.0 1.0 1.0 1.0 4.0 6%
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