MSCI euphoria gains price in potential synergies with NIB

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MCB bank has rallied by a massive 19% during the current month.

outperforming the benchmark index by a considerable 13pp where we attribute the same to MSCI euphoria kicking in. This has led to in our view for potential synergies with NIB to be priced in.

MCB reported 1Q2017 earnings at PKR5.30/sh, down 4% YoY with net interest income declining by 14% YoY as yields on investment continued its slide owing to re-pricing of higher yield PIBs at lower rates coupled with pressure on spreads on advances amidst increased liquidity in the banking space.

MCB’s repo borrowings as of 1Q2017 end, surged considerably on QoQ basis by 201% which we believe marks a shift in management’s view on interest rate outlook.

The management of MCB now expects formal amalgamation with NIB by July-2017. Subsequently we have revised our investment case by upgrading our Dec-17 PT by 10% to PKR254/sh and our earnings estimates for 2017/18/19 by 12/10/10%. Improvement in investment case emanates from potential synergies pertaining to gradual NPL recoveries and higher asset base.

MSCI euphoria gains price in potential synergies with NIB; Maintain Market weight: MCB bank has rallied by a massive 19% during the current month, outperforming the benchmark index by a considerable 13pp where we attribute the same to MSCI euphoria kicking in as its other peers that are MSCI EM constituent (i.e. HBL and UBL) have also gained 13/10% respectively during the same period.

While our initial sectoral investment theme of rerating of EM constituents in the banking space (given sizable weightage in excess of 50%) has largely played out, we believe upside potential for MCB emanating from NIB amalgamation has also been priced-in in the MSCI led euphoria. We revise up our Dec-17 PT by 10% to PKR254/sh after amalgamating NIB into MCB, offering total potential upside of 7% with the bank currently trading at a PBV of 2.0x. Maintain market weight.

1Q2017 financial results; saved by capital gains and provision reversals: MCB reported 1Q2017 earnings at PKR5.30/sh, down 4% YoY with net interest income declining by 14% YoY as yields on investment continued its slide owing to re-pricing of higher yield PIBs at lower rates coupled with pressure on spreads on advances amidst increased liquidity in the banking space.

Overall performance of core operations remained lackluster with pre-provisioning and ex-capital gains profit before tax falling by a massive 27% YoY. Core fee income on the other hand was the major positive during the quarter where after continuously trending down in 2016, was up 12% YoY during 1Q2017.

Bottom line was largely salvaged through higher capital gains (up 12.3x YoY) where the bank booked significant gains on its equity book (~PKR2.0bn) and provision reversals amounting to PKR878mn (relative to PKR431mn in SPLY). While overall asset book expanded by a massive 19% QoQ, this was largely financed by increased borrowings (+201% QoQ).

Deposit growth on the other hand chugged along, rising by 14/5% YoY/QoQ with CASA profile being maintained at around 92%.

Higher repo borrowings – back in the arbitrage game: MCB’s repo borrowings as of 1Q2017 end, surged considerably on QoQ basis by 201% which we believe marks a shift in management’s view on interest rate outlook.

Previously MCB’s borrowing levels (3Q and 4Q2016) were quite low relative to industry levels where the bank’s treasury was eying interest rate lift-off by early 2017.

However with subsequent inflation readings continuously surprising on the downside, the management now expects only a marginal chance of 25bps hike in 2017 with the view on interest rate liftoff now shifted to 2018.

We thus believe that leverage levels of the bank would remain elevated in rest of 2017 as the bank would likely opt to earn money market arbitrage (8-10bps) in a bid to support Net interest income.

NIB Amalgamation – Finally Happening: Subsequent to the announcement by both MCB and NIB for amalgamation, a former employee of the NIB Bank obtained a legal injunction to prevent NIB from holding its EOGM which was called for shareholders’ approval of bank’s merger into MCB.

However, the plaintiff withdrew the petition, leading NIB to hold its EOGM on 11th May, 2017 where the majority shareholders approved the merger.

The management of MCB now expects formal amalgamation with NIB by July-2017. Subsequently we have revised our investment case by upgrading our Dec-17 PT by 10% to PKR254/sh and our earnings estimates for 2017/18/19 by 12/10/10%. Improvement in investment case emanates from potential synergies pertaining to gradual NPL recoveries and higher asset base.

Our case for gradual NPL recoveries (amalgamating 1Q2017 accounts of NIB, results in sizable uptick in NPL ratio of 4.5pp to 9.9%) is firmly rooted in MCB’s.