Valuation boost from FSV relaxation already priced in

The impact on banks profitability by the relaxation of 40 percent of Forced Sale Value on industrial land and building is just a fraction of benefit that could have accrued in case the central bank had allowed the inclusion of other industrial property ie plants and machinery.
However, incorporating the additional benefit of 10 percent of FSV on pledged stocks, residential and commercial properties, the impact is meaningful for some banks. (See table for the impact of reversals in provisioning for nine top listed banks).
In a circular issued yesterday, State Bank of Pakistan allowed the benefit of 40 percent of FSV on pledged stocks, residential, commercial properties and industrial land and building to the provisioning of substandard, doubtful and bad loans. It is pertinent to note that apart from industrial land and building, 30 percent benefit of FSV was already allowed.
In addition SBP also allowed banks to reschedule the loans classified as substandard to regular category and doubtful to substandard category. The benefit will be attained in a staged manner under certain conditions. Initially the provisioning for substandard will be reduced by 50 percent and doubtful by 25 percent. However, the benefit is allowed to be booked only in equity and not a reversal in profit and loss accounts. Thus, based on price multiples and adjusted book value, the increase in valuation is either none or minimal.
The regulator has not only allowed banks to provide less provisioning in case of FSV relaxation and reversal of provisioning on existing delayed loans but has also implicitly relaxed certain conditions for reluctant borrowers. In case of former, both the profit and equity of banks will increase by the reversal amount and boost the valuation of banks on price and book multiple and also on adjusted book value basis.
However, in case of latter, the banks will have benefit on their equity value, which might not increase the valuation of banks on commonly used methodologies but will improve their risk soundness indicators. This benefit will also improve the position of the borrowers, and will enable the bank to allow those marginally infectious borrowers to take more credit. On a related note, the borrower will also gain benefit to avail the lending options available to him.
Taking a cue from this, share prices of many banks surged remarkably on Tuesday where some such as NBP and UBL also hit their upper circuit limits. But considering that the market had been anticipating this change in prudential regulations amid the 48 percent out performance of BR Commercial Bank Index, since the rumours began early September, one can expect that the rally in banking stocks will lose its steam soon.
ASSUMPTIONS:
-- Relaxation of FSV by 40% on industrial land and building is on all corporate loans.
-- The 10% additional benefit on non industrial FSV is computed as difference between the required provisioning in the absence of any FSV benefit and actual provisioning.
-- Only 15% of collateral is industrial land and building and the rest as residential, commercial, pledged stocks and industrial other property.
-Normal tax (35%) is applied on reversal of NPLs provisioning.

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                EPS     INCREASE IN    ANNUALIZED

         1HCY09 (RS)   EPS AFTER FSV       IMPACT

                        BENEFIT (RS)

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ABL             4.30           0.74            9%

AKBL            1.15           0.96           42%

BAFL            0.94           0.57           30%

FABL            0.35           0.66           94%

HBL             7.20           1.82           13%

MCB            11.22           1.94            9%

NBP             5.84           0.80            7%

NIB               na           0.49            na

UBL             5.03           1.71           17%

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