Light on advances - heavy on treasury

Result season has set in. Banking sector is likely to shower hefty profits for CY11. With industry asset base expanded by 15 percent during CY11 to Rs.7,777 billion at the end of 31 December 2011 the strong growth in the industrys bottom-line is imminent. As evident from the industrys (sample of twenty-eight banks) first three quarters results, the combined net profit grew by 50 percent, year on year, to Rs.79 billion during the first nine months of CY11. At the current level, the industrys bottom-line is stronger compared to CY07, when the industrys profitability touched its peak after recording a combined annual net profit of around Rs.67 billion. Another noteworthy development is a slight tilt in the industrys profitability towards mid-sized and smaller banks. This can be analysed from the fact that top five banks contribution in the industrys bottom line (net) fell to 76 percent during 9MCY11 from around 93 percent in the same period of last year. Since investments in treasury instruments were at the heart of the industrys business strategy, the industrys investment portfolio grew by a whopping 41 percent during CY11, lifting Investment to Deposit Ratio (IDR) by 10 percentage points to 51 percent. The growing interest in sovereign instruments came at the expense of advances portfolio, which squeezed by 1 percent to Rs.3113 billion resulting in drop in Advances to Deposit Ratio (ADR) by 9 percentage points to 53 percent. Keeping with 9 percent growth in M2 during the first eleven months of CY11 (as per latest available data), the industrys deposit base expanded by 6 percent during the same period. However, the growth in promissory notes in circulation, at a slightly higher rate: close to around 8 percent during the period under review, suggests that there is a sizable room for the financial institutions to accelerate growth in deposits. The overweening expansion in the risk-free instruments would most likely tamp down growth in Non-Performing Loans (NPLs) down the line. It is ironic, that improvement in asset quality is stemming from declining exposure in private sector lending. Although NPLs data for December 2011 is not available yet, the combined non-performing loans for the group of twenty-eight banks grew by 16 percent during the first nine months of CY11 to Rs.493 billion at the end of September 2011. The toxic loans had swelled by 25 percent in CY10. With advances level virtually stagnant, the industrys infection ratio stood at 14.5 percent at the end of September 2011, nearly 2 percentage points higher compared to December 2010. However, the cheery on the top is improvement in the industrys average spreads. The industry clocked in an average monthly spread of 7.63 percent in CY11, a notch above the last years average spared of 7.46 percent. For shareholders, CY12 started on a positive note. With the BR commercial bank index up by 12 percent since the start of the current year, the banking sector outperformed KSE-100 index, which inched up by 5 percent during the same period. Improvement in share prices in symptomatic of the industrys improving profitability, adding that the relaxation in CGT disclosure requirement provided a room for market efficiency. This marks significant improvement compared to the last year since the BR commercial bank index, which had fallen by 16 percent in CY11, largely underperformed the KSE-100 index, which had inched down by 6 percent in CY11. Fad for sovereign instruments will continue to support the banking industrys financial health. But, the monetary easing could exert pressure on the industrys spreads in CY12, since financial institutions assets are tied to floating rate, when interest payments on liabilities are either fixed or have lower cap rate. However, the decline in interest rates will likely to improve the quality of assets down the line.