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Thursday Dec 12, 2024
Thursday, 16 August 2018 00:00 - - {{hitsCtrl.values.hits}}
Sri Lankan banks to face a new era with added CET 1 from the recent rights issues of the LCB sector, the main driving segment of the SL banking sector. When compared to regional banking operations, SL banks remained relatively strong with lesser NPLs and relatively lower net open credit exposures. In line with that, the regulatory environment has also been more accommodative given the leeway provided on the (new) adjustment of IFRS (SLFRS) 09.
New Basel III introductions in the likes of LCR, NSFR and Leverage are likely to make the sector even stronger in the near term, although conservative labour laws are likely to not help mergers between LCBs.
Near term NPL rise will largely be driven by the retail tilt in incremental credit with CASA growth strategies needing re-thinking, given increased customer awareness of deposit yield differences. GoSL banks need capital to remain relevant in the economy either by way of private equity injections or listing, whereas the latter seems to be challenging. GoSL banks and some private LCBs may have to reduce their exposure on cross holdings in some private LCBs to improve efficiency of their current capital levels.
The top three Private LCBs (T3PL) were increasingly used as GoSL project financiers during past five years whilst also reducing dependency on GoSL banks.
T3PL’s adoption of technology to redefine their growth in the new era with better customer analytics and e banking methodologies is expected to follow a “S” curve as seen in other regions.
DFI root LCBs in the Mid-Size Private LCB segment struggled in increasing leverage, whilst pure LCBs in this segment remained competitive with T3PL at the ROE level, driven by their improved strategies to mobilise deposits, usage of analytics in lending and acquisition of high yielding credit cards.
A majority of Relatively Smaller Domestic Private LCBs (RSDPLs) remained under capitalised compared to Jan 2020 absolute minimum capital requirements, and a select few may face their leverages declining below the regulatory minimum, where the regulatory leeway may come-in. One of the key challenges faced by RSDPLs is absorbing fixed costs of tech, distribution and marketing, given their relatively low absolute top line figures.
On improving economic dynamics and given rising international interest rates, the CBSL may not be able to continue its soft monetary policy without overheating economic signals. Credit growth may continue at current levels and possibly increase closer to IMF’s departure, on anticipated consumption kick start by the Government, likely to be stimulated from election-focused free fiscal handouts. In spite of declining G-sec yields in 2H2018E, interest rate pressures could increase, especially in 2H2019E, owing to relatively high sovereign debt settlements.
Private LCB tilt towards GoSL projects may result in a GoSL cash flow linked NPL adjustments, even though there is a lesser probability in eventual significant impairment.
Energy related reforms in the economy are to maintain price pressures at high midsingle digit levels in the near term, even though it may likely be contained by possible decline in global commodity prices in the latter part of 2019E owing to the current monetary tightening adopted by major economies.
The reappointment of CBSL Governor, following his current term will likely enable the strong outlook for the economy from a monetary policy framework point as key debt settlements from 2019-2022 could likely be managed only with a disciplined monetary framework.
Internet banking transactions grew 3X during FY2010-16, lowering the need of the domestic cheque-clearing system by a fifth. Whilst SL accounts for a smart phone penetration above 50% as at mid-2018, a notable increase in mobile transactions have been utilised only for utility allied regular settlements, which may likely follow a growth phase in the medium term. Implementation of a bio metric ID system by the GoSL (if introduced) could however fast track the current banking facilities as proved by some of the regional counterparts.
SL banks have seen their valuations fall during the past few years amidst high returns creating a strong entry point for investors. Listed BFI sector accounts for ~50% of the overall CSE earnings whilst accounting for a good third of the CSE market cap.
The fundamentally strong sector offers decent dividend yields that could now be reserved as the currency hedge by overseas investors.
While SL bank forward EPS growth slows on recent and anticipated CET 1 injections, it’s hard to see a scenario where they have to cut their dividends.
SL banks now offer “relative” valuation appeal and we recommend moving back to market over-weight on this sector.
Our pecking order is:
By CT CLSA
Despite the recent slowdown in credit, 1H2018 private sector credit growth remained at 15% YoY levels, indicating stable but healthy growth at the macroeconomic level. Even though the regulator (The CBSL) desired a high level of economic efficiency via increasing unutilized capacity, it seems difficult to continue to adopt a soft monetary policy given the CBSL’s April 2018 rate cut which was followed by inflationary - fuel pricing reforms.
Growth in overall banking sector credit is likely to continue at these levels (~15% YoY) at least in the near term, however, with a tilt towards retail credit which is depicted by reduction in spreads in lending to Corporates by the Banking sector. However, credit growth is likely to increase slightly in 2019E, which will largely be driven by consumption and other key thrust sector driven lending.
The tilt in corporate to retail credit is in turn anticipated to increase near term NPAs (with high PLR banks likely to be impacted first) of the sector whilst fiscal reform driven price pressures are also likely to sustain the 2018E end NPA pressures owing to short term cash flow management issues of the borrowers.
However, NPA pressures may stabilise and possibly reduce despite anticipated slight increase in interest rates in 2019E, owing to the anticipated consumption rebound in mid 2019E
Given that there is less space for market interest rates to decline, we still believe that the Government Securities (G-Secs: especially the 12 month T Bill yield) will continue its decline at least till the end of 2018E before it rebounds to rise in tandem with market interest rates in 2019E, on account of mid 2019E consumption rebound and owing to liquidity pressures that‘ll likely hit the domestic market by 2019E on Sovereign bond bullet payments.
On account of relatively flat market interest rates during 2H2018E (as opposed to slightly declining G-sec rates), owing to inflationary pressures, and on account of rising interest rates in 2019E, Banking sector spreads may continue to stabilise (or slightly gain) in 2H2018E and improve in 2019E as we forecast LCBs to reprice their assets faster than their liabilities during the short to medium term (i.e. during next 12 to 18 months).
Given Fees and commission income is largely correlated with advances growth, LCB fees and commission income may slightly increase especially in 2H2019E. Foreign exchange income may however continue to increase for the overall sector as we forecast LKR to remain relatively volatile in 2019E (similar to 1H2018 – as the LKR depreciated ~-3.5% during 1H2018). However, the CBSL’s recent strategy to accumulate reserves by absorbing FX into its Gross Official Forex Reserve (GOFR) may limit the LKR depreciation to Rs.169.50/US$ by end of 2019E, even after adjusting for the US$ outflows from the GOFR.
Operational Expense growth may continue to remain in at least mid to high single digit levels given recent fuel pricing reforms and anticipated energy pricing reforms (by late 3Q2018E / early 4Q2018E) to reduce fiscal drain of the GoSL. On credit costs, IFRS 09 will play a key role in increasing overall loan loss impairment based on the newly introduced “Expected Credit Loss (ECL)” model from the previous “Incurred Credit Loss (ICL)” model. As the resultant impact will be adjusted as a prior year adjustment by the banking sector, 1Q2019 ROEs may increase significantly as opposed to 4Q2018E ROEs due to the negative impact on the denominator (i.e. on Shareholder funds). We expect this increase of loan loss impairment (even though directly not expected to impact P&L of the sector) to be in the range of 25% to 45% YoY for the sector for 2018E. However, 2019E loan loss provisions are expected to only increase by ~5% - 10% for the overall sector on the assumption that the sector as a whole will comply with CBSL slated guidelines by Y/E 2018E.
Whilst we do not anticipate the Debt repayment Levy (DRL – proposed via the 2018E fiscal budget) to be implemented on the banking sector, removal of some tax exemptions on LCBs from the new IRD act increased the overall effective tax rate on the banking sector by an estimated ~2%, increasing the ETR of the sector to ~47.5% in 2018E and 48.5% in 2019E (full year impact in 2019E as the provisions were introduced only from 1 April 2018). However, the above ETR calculation does not consider any tax efficient investments, which is a highly unlikely scenario for domestic licensed banks.
Whilst relatively all new Basel III regulations on capital and liquidity are likely to be met by domestic private LCBs (even though GoSL may directly not participate in any new capital issues as a shareholder [where BOC and or SLIC owns significant stakes e.g. SEYB and NDB] given its fiscal consolidation initiative), GoSL LCBs, BoC and PB may find it difficult to raise capital by way of a listing, owing to likely friction by the strong staff unions of same. This may likely leave the GoSL with only few options to make BoC and PB Basel III compliant, which needs to be acted upon in the near term (ideally before 1 January 2019).
