UBL: What Remains a Hidden Gem in Banks · UBL: What Remains a Hidden Gem in Banks Commercial Banks Hubco Company to Outperform Due to Analyst REP 300 United Bank Limited UBL - BUY

Current Price as of June 29th, 2016

July 12, 2016

UBL: What Remains a Hidden Gem in Banks

Commercial Banks

Hubco Company to Outperform Due to Analyst

United Bank Limited REP 300

UBL - BUY

Our Dec’16 Target Price of PKR 203/share offers a 15% upside potential. The stock

currently trades at 1.35x book value (CY16E), which compares well to an average of

1.42x for Big-5 peers (ex NBP). Our Dec’16 Target Price implies a CY16F P/Bx of 1.45x,

P/E of 9.4x, with a DY of 7.3%, and an EPS CAGR of 14% - CY15-20F (Total Return of

22.3%).

Key Strengths to Drive Profitability and Balance Sheet Growth

UBL has been our top pick based on a few key strategic strengths that, coupled with

macroeconomic triggers, we expect, should provide the bank with double digit growth in

its deposit base (CY15-20F CAGR 13%) along with a substantial growth expected in its

loan book (CY15-20F CAGR 10%), and an accelerated growth in profitability in the next

five years (CY15-20F CAGR of 14%). The key strengths of UBL we would like to highlight

in this report include; its (i) cornerstone retail segment (rural/urban market), (ii) rebuilding

its SME business model, (iii) increased focus on becoming a major player in Islamic

banking industry, and (iv) robust fee & commission income.

Perfect Timing for UBL to Expand its Share of Advances in the Industry

These strengths are expected to position the bank perfectly given the recently accelerated

demand for credit in the private sector (up 15% YoY on average); especially in the long

term loans with an average growth of 19% YoY which is anticipated to be followed with

an overall higher credit demand in private sector. The scenario is propped with record low

interest rates (PR 5.75%) and over a decade low inflation (FY16 2.9%) that should furnish

a protracted double digit growth in overall loans. Not to forget the cherry on top; big

ticket financing directly under the banner of CPEC, where UBL is expected to serve as one

of the few primary lenders, and the concomitant spillover throughout the economy.

Ready for Future Credit Growth with All Bases Covered

In preparation of strategically positioning itself for the anticipated upcoming credit

growth, UBL has taken stringent measures to limit its exposure to possible risks and to

improve its overall asset quality. Alongside implementing a more strict lending approach

(infection ratio stagnant at 9.0% vs. peer avg. 11.3%), UBL booked hefty provisions worth

PKR 3.8bn in CY15 (up 186% from CY14) and an additional PKR 1.8bn in 1QCY16 boosting

its coverage ratio to 91.7% (peer’ avg. 87.0%). While UBL’s CAR that improved from 14.3%

(CY14) to 14.7% (CY15) may seem relatively lower compared to some of its peers’ (avg.

19%), it is due to a relatively smaller padding in IEAs (i.e. greater proportion of loans/IEAs).

Exhibit. 1 Key Financial Highlights

Year End (PKR mn) CY13 CY14 CY15 CY16E CY17F

Net Income 19,731 24,025 27,100 27,107 29,835

Earnings growth (%) 17.1 21.8 12.8 1.1 10.1

EPS diluted (PKR) 15.8 19.3 21.4 21.6 23.9

BVPS (Tier II) 90.9 112.3 127.1 139.4 152.6

P/B (x) 1.3 1.5 1.2 1.3 1.2

P/E (x) 7.4 8.6 7.1 8.2 7.4

DPS (PKR) 10.0 11.5 13.0 13.0 13.5

Dividend Yield (%) 8.6 6.5 8.4 7.3 7.6

CAR (%) 14.2 14.3 14.7 14.6 14.7

Source: Company Financials, AHL Research

BUY

203.0

176.3

15.1

Shares (mn) 1,224

40.0

2,056

3M 6M 12M

18.5 18.6 11.8

1392.6 1169.5 1099.2

184.5 184.5 184.5

147.6 137.5 137.5

Source: Bloomberg

Analyst:

Syed Shiraz Zaidi

F:+92 21 3242 0742

D:+92 21 3246 2589

UBL PA

Free float (% )

Upside (% )

Current Price

Target Price (Dec'16)

Recommendation

Market Cap. (USD mn)

www.arifhabibltd.com

E: [email protected]

UAN: +92 21 111 245 111, Ext: 248

215,860

– Bestway Group

Price Performance

Major Shareholders

Price Performance

Avg. Volume (000)

High Price - PKR

Low Price - PKR

Return (% )

Market Cap. (PKR mn)

Best Domestic Equity House – 2016

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UBL KSE100

United Bank Limited Page 2

July 12, 2016

UBL - Commercial Banks

Business & Management Overview

The Bank

A subsidiary of the renowned Bestway (Holdings) Ltd. (UK)

Third largest deposit base at PKR 1.1tr (asset base at PKR 1.5tr) – Mar’16

Third largest footprint in industry with 1,338 branches in four continents

Recently collaborated with IFC to rebuild its SME business model

Representative office in Beijing – China to support CPEC financing

United Bank Limited (UBL), headquartered in Karachi, is the third largest bank (second

largest private bank) in Pakistan with asset base in excess of PKR 1.5tr, that provides a

full range of financial solutions to individuals, corporations, institutions, and

governments through a broad spectrum of products and services, including

commercial, corporate and investment banking, consumer banking and credit,

securities brokerage, commercial, small and medium sized enterprises, agri-finance,

and Islamic and asset financing.

UBL also has the third largest footprint of 1,338 branches, and a much larger network

of ATMs both within Pakistan and internationally, including 41 Islamic branches, with a

noticeable presence in other developed and emerging markets; United Arab Emirates,

Bahrain, Qatar, United States of America, and Yemen. In addition, UBL has subsidies and

associated companies in United Kingdom (United Bank), Switzerland (UBL Switzerland),

Tanzania (UBL Bank Tanzania Ltd.), and Oman (Oman United Exchange Co.), and a

representative office in China (Beijing Rep. Office). A subsidiary of the renowned

Bestway (Holdings) Ltd. (UK), UBL maintains a deposit base in excess of PKR 1,138bn

along with PKR 480bn in advances.

Senior Management

UBL resides under the umbrella of Bestway Group; spearheaded by Sir Mohammed

Anwar Pervez, Chairman of the Board of Directors of UBL, since December 2013. Mr.

Pervez has played a pivotal role in driving Bestway Group as the seventh largest family

business in the UK.

Leading from the front, UBL’s current CEO and President, Mr. Wajahat Husain brings

with him banking expertise spanning over three decades, both domestic and

international. He chairs other key positions with the bank such as the Chairman – UBL

Switzerland and UBL Tanzania, and Director of United Bank UK. Under his stewardship,

and in line with its core values, UBL has witnessed strategic expansion of its international

business in Middle East, China, and Africa.

Along with Mr. Pervez, and Mr. Husain, UBL is maneuvered with the help of highly

experienced board of seven directors that have served as executive chairs within UBL

and other elite financial organizations of Pakistan. We view the exceptional mix of UBL

senior management and their decades of experiences within financial industry to drive

the bank to accomplish its goals and objectives by using available resources both

effectively and efficiently going forward.

Exhibit. 2 Company Snapshot - Dec'15

Head Quarters Karachi

Sponsors Bestway (Holdings) UK

Branches 1,338

Deposit Market Share 12.0% (3rd largest)

Asset Base (PKR bn) 1,506

Loan Book (PKR bn) 480

Equity (PKR bn) 160


Exhibit. 3 Asset Mix by Region - 2015

Domestic Ops 75%

International Ops 25%

Middle East 19%

United States of America 1%

Europe 6%

Africa 0%

EPZ 0%

Source: Company Presentations


July 12, 2016


Shareholders’ Pattern (UBL)

Exhibit. 4 Aggregate Shares Held Figure. 1 Aggregate Shares Held

No of Shares % of Shares

Bestway Group (BG 752,406,007 61.5%

General Public 391,410,020 32.0%

Banks, DFIs, & NBFIs 33,616,240 2.7%

Modarabas & MFs 22,352,467 1.8%

Insurance Companies 18,613,586 1.5%

International GDRs 5,021,054 0.4%

NIT 758,599 0.1%

Privatization Commission 1,714 0.0%

1,224,179,687 100.0%

Source: Company Financials, AHL Research Source: Company Financials, AHL Research

Exhibit. 5 Aggregate Shares Held (as of Dec'15) Figure. 2 Aggregate Shares Held

No of Shares % of Shares

Associated Companies, Undertakings & Re

Bestway Holdings 631,728,895 51.6%

Bestway Cement 93,649,744 7.6%

NIT

CDC NIT 758,599 0.1%

Modarabas & MFs 22,352,467 1.8%

Public Sector 4,106,907 0.3%

Banks, DFIs, NBFIs 52,229,826 4.3%

Directors & CEO 17,536,633 1.4%

Executives 2,407,557 0.2%


61%

32%

3%4%

Bestway Group (BG) General PublicBanks, DFIs, & NBFIs Others

0.1%

0.2%

0.3%

1.4%

1.8%

4.3%

7.6%

51.6%

0.0% 20.0% 40.0% 60.0%

CDC NIT

Executives

Public Sector

Directors & CEO

Modarabas & MFs

Banks, DFIs, NBFIs

Bestway Cement

Bestway Holdings


July 12, 2016


Key Strengths to Drive Profitability and Balance Sheet growth

UBL’s core values and progressive approach to embrace innovation and technology in

the banking and financial sector has enabled the bank to more than double its assets

and profitability in the last five years (CY10-15). Based on our analysis, we project the

bank to continue to excel in key segments of the market with a competitive edge over

its peers and provide impetus for double digit growth in balance sheet along with a

parallel shift in loan growth and profitability (CY15-20F).

Robust

Retail Business

Rebuilding SME Business Model

Increased Focus on Islamic Banking

Strong hold on Remittances to feed Fee & Commission

Income

Double Digit growth

in Balance Sheet,

Loan Book & Profitability


July 12, 2016


1. Strong Retail Business – UBL’s cornerstone - its Retail business grew by a

staggering 14% in CY15 with its asset base inching up to the trillion mark (PKR 985bn

Mar’16), followed by Trading and Sales (PKR 836bn), and Commercial banking (PKR

452), respectively. The management has been taking a stride in improving its services

by continuously renovating and relocating its vast network to areas with more business

potential and by offering competitive products in order to capture bigger share of the

retail market, both urban and rural.

With approximately 20% share in the overall economy, agriculture sector continues to

remain the largest employer and pivotal towards economic growth of the country and

a major segment for local banks to offer various banking products and services.

Historically, UBL has maintained its presence in the stated segment offering various

tailored development and crop-production financing solutions making up about

11.00% of its gross advances in CY14 (9.32% CY15), however, it may not have been the

leader due to the lack of a stronger outreach as one of the factors.

Figure. 3 Agriculture Growth Expected to Accelerate With GDP


Considering that the growth in GDP is expected to accelerate from FY17 onwards

(upwards of 5.5%), especially from an expected bottomed out demand in FY16 due to

bad harvesting season, we estimate the bank could benefit from an accelerated credit

demand in the agribusiness. In addition, the low banking penetration within these areas

provides a fruitful opportunity to tap into the untapped market via improved network.

Besides its rural products and services, UBL facilitates various popular products and

services such as Omni-Branchless Banking, Merchant Payment, Employee Banking

Salary Account (payroll), UBL Pay Partner (payroll SME), Free Insurance Coverage, and

Signature Lounges, geared towards corporates, high net-worth individuals and other

urban clientele that are expected to continue augmenting its advances growth.

3.8% 3.7%4.0% 4.2%

4.7%

5.7%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

FY

12A

FY

13A

FY

14A

FY

15A

FY

16F

FY

17F

GDP Agriculture

According to the SBP, Agribusiness witnessed a

growth of 20% in CY15 alone with a modest

10.3% infection ratio.

Moreover, under the proposed FY17 Budget, GoP

will provide unprecedented relief measures to the

farmers’ community along with up to 50%

guarantees on small farmer loans.

Such initiatives by GoP should furnish ample

encouragement for the local banks to lend more

freely to agribusinesses.


July 12, 2016


2. Rebuilding SME Business Model – A key component of UBL’s Commercial

Banking segment remains the SME market. Recently, UBL teamed up with

International Finance Corporation (IFC), a member of the World Bank Group, which

will serve as an advisor to the Bank on rebuilding its business model and supply chain

finance program targeting the ever growing SME market.

The objective of the yearlong project is to expand UBL’s outreach to SMEs, with IFC

assisting the bank in developing a strategy and business model for SMEs á la Bank

Alfalah Limited (ex any capital injection). During the project, IFC will review UBL’s

existing credit and risk policies and provide recommendations to help improve

efficiencies and reduce turn-around time.

In addition, IFC will also help UBL with setting up a number of Value Chain Finance

Products that should be a value added service for its existing and prospective clients.

IFC holds the view that UBL can leverage its extensive branch network and existing

digital banking platform to rapidly increase its outreach to SMEs, so much so it has

estimated to invest USD 550,000 on this project.

It is not that SME banking is unknown to UBL. Based on our estimates and

categorization of SME by Small and Medium Enterprises Development Authority

(SMEDA) – an institution by GoP under Ministry of Industries and Production, UBL

lending to the SME segment accounted for 4%-8% (~PKR 20bn to 40bn) of its total

advances, during CY15.

Going forward, IFC advisory and the resultant innovative products and services

tailored for the various factions of SME segment could take the segment’s share on

UBL loan book to 8% - 10% in the near term, we believe. On the other hand, in the

medium to longer term (CY20F) where the spillover from CPEC is expected to push

the credit demand in the SME segment to new highs, its share in UBL’s book could

add up to 12% - 15% of its total advances, we believe.

Nonetheless, this project should translate into an improved topline (net interest

income) due to relatively higher yields on SME loans, in turn compensating for the

subdued interest rate environment, and accelerated growth in advances while still

managing a comfortable infection rate within set parameters.

Figure. 4 Infection Ratios on Corporate, SME, and Agri Loans


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Corporate SME Agri(x)

According to SBP, infection ratio for sectors such as

Textile, Leather, Others, and Sugar average out at

14.5%, whereas for Textile, which remains a major

component of SME, has the highest infection ratio of

26.3%. As it is apparent from this, most of the

conservative local financial institutions keep their

distance from the segment all together.

In order to find a resolution to this problem, SBP has

stressed over and over again on the need for local

banks/ DFIs to strategically position themselves by

appropriately aligning their business strategies with

the specific needs of SME sector, which UBL’s

collaborative effort with IFC should furnish.

In addition, recently passed ‘Credit Bureau Bill’ and

‘Corporate Restructuring Bill’ should assist banks in

the long term with making well informed lending

decisions and limiting exposure to credit costs.

SME sector witnessed modest credit growth in CY15

of 4%, same as CY14, whereas in CY16TD it has shed

a hefty 8%, offering a potential for upswing. SME’s

share in the total borrowing by private sector has

averaged 9% in the last 18 months.

Value Chain Finance

It refers to financial products and services that

flow to or through any point in a value chain that

enables investments to increase that units returns

and the growth and competitiveness of the whole

chain.


July 12, 2016


Figure. 5 Slight YoY Decline in SME Lending, Even with Substantial Cut in its Infection Ratio

Source: SBP, AHL Research

3. Increased Focus on Islamic Banking - Given the sheer size of the still mostly

untapped market, we believe UBL has been positioning itself aggressively to target the

Sharia led market with a focus on penetrating across segments in the society where

there is clear preference for Islamic products.

In terms of competition, amongst Big 5 banks, peers like MCB have already setup

dedicated Islamic subsidiaries, whereas from mid-tier banks Meezan Bank (largest

Islamic commercial bank) and Bank Alfalah Ltd have a strong presence in the domestic

market. As of Dec’15, UBL managed an extensive network of 141 Islamic window

operations (via conventional branches), whereas, its Islamic Banking branches reached

a total of 41. Its Sharia led Islamic banking segment comprises of PKR 32.8bn which is

a meager ~2% of its total assets, and thus opens up a window of opportunity for UBL

to capture the rising demand for Islamic credit facility via expansion.

UBL is already in process of converting its conventional branches into fully functional

Islamic branches in targeted key areas with 13 such branches converted in CY15 alone.

In addition, the bank has been diligently training its staff (from both conventional and

Islamic businesses) on basic concepts of Islamic banking, Islamic banking products and

services, and Islamic Branch operations throughout the year.

Besides opening up credit opportunities through CPEC projects, given part of the rural

(lower strata) and SME markets’ inclination towards Islamic banking, an improved

dedicated Islamic banking network should position UBL for the anticipated post-CPEC

boom in SME market. Furthermore, it should support the cornerstone of UBL; its retail

banking segment with the increasing auto ijarah (auto financing) products.

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Advances NPLs Infection (RHS)(PKR bn) (%)

According to data published by SBP (Mar’16),

Islamic Banking segment consists of a low PKR

1.0 tr in assets compared to a whopping PKR

14.3 tr under conventional banking. However,

the segment witnessed a substantial 27% YoY

growth in net financing (advances) in Mar’16.

One setback for the Islamic banks has remained

the lack of asset-side products such as GoP

Sukuks. While conventional banks enjoy the

easy access to SBP PIBs at a favorable yield

spread, GoP Sukuks, paying KIBOR or lower,

have not been able to meet the sector’s

liquidity (apparent from the increasing bid-

cover observed at well over 2.0x in recent Ijarah

Sukuk auctions). The new target set by GoP for

FY17 is PKR 87bn compared to PKR 250bn in

FY16.

However, this will propel banks to lend more

aggressively (substantiated with an increasing

Financing to Deposits) where banks like UBL

with larger network, better turn-around-time,

and more thorough credit risk policies should

benefit most.


July 12, 2016


Figure. 6 Substantial Pickup in Islamic Financing While NPFs* Decline – A Win Win Scenario For Islamic Banks

Source: SBP, AHL Research (*) Non Performing Finances

4. Strong Hold on Remittances to Feed Fee & Commission Income – UBL has

enjoyed a healthy growth in Fee & Commission income with a CAGR of 15% from CY10-

15, with major components driven by core banking such as commission on trade,

remittances, general banking charges, and corporate services.

UBL is a market leader in remittances with over 25% share, where, in conjunction with

the initiative to capture regional remittances, Fee income should witness a higher single

digit growth in the medium to longer term. Whereas, in the shorter term we anticipate

the bank to maintain its current lower double digit growth nonetheless.

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Financing To Deposit Net NPF / Capital (RHS)(x) (x)

Figure. 7 Fee & Commission Income Breakup (Mar’16)


19%

5%

26%

29%

4%5%

13%

Trade

Consumer Loan

Remittances

Service Charge

Cash mgmt

Bancassurance

Others


July 12, 2016


Figure. 8 UBL Enjoys an Increasing Fee Income Supported By Over 25% Share of Home Remittances*

Source: SBP, Company Financials, AHL Research (*) Remittances Industry share based on UBL Analyst Briefing

Leading Big 5 in Deposit Growth

UBL has managed to lead the Big5 with a staggering growth in its deposit base (read:

balance sheet expansion) over the period of last four years (CY11-15) with a CAGR of

15% compared to an average of its peers of 12%. In CY15 alone, UBL posted an 18%

growth compared to its big 5 peers’ average of only 9% (industry grew deposits at an

average of 12%), while UBL’s 5Y CAGR (CY10-15) also stands high at 15% against peer

average of 13%.

Speaking of aggressive strategies, UBL has been paving its own path in booking fixed

deposits (thanks to its new product lines such as UBL Mahana Aamdani Term Deposits)

instead of herding with its peers in solely focusing on CASA accounts. While in the short

term, fixed deposits’ pile up (FDRs up by 17% in CY15, 5Y CAGR of 13%) might have

hurt bank’s topline and net interest margins (NIMs), down 70bps in 1QCY16 to 4.12%

(annualized), relative to other banks (peer avg. 4.05%), we believe, it may very well be

the best strategy in building up its resource base and meeting its year round fixed

deposits target at current cheaper rates.

Figure. 9 Cost & Breakdown of Deposits Figure. 10 NIMs Expected to Improve in the Long Run


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1Q16

Remittances Fee Income (RHS)(USD mn) (PKR mn)

28% 29% 30% 30% 28%

35% 35% 34% 34% 34%

35% 35% 36% 36% 38%

0.0%

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0%

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120%

CY14 CY15 CY16E CY17F CY18F

Fixed Saving Current CoD (RHS)

3.0%

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4.5%

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5.5%

6.0%

6.5%

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Fixed Deposits NIMs (RHS)(PKR bn)


July 12, 2016


With that said, bank’s management has continuously voiced its preference for

CASA accounts over the last few quarters and which, based on the results, it

seems to be on track of (CAs – non remunerative – up by 17% in CY15, 5Y CAGR

of 16%).

Going forward, we estimate an annual average growth in deposits of 13%, with

a probable upward shift in CY17-18 incorporated. While the cost of funds for

the bank is still relatively cheaper at 3.13% (1QCY16 annualized) in comparison

to its peer’s 3.56%, we believe, in the shorter term, it may notice a slight uptick

of 10-15 bps from a possible further pile up of FDRs but should be manageable

at current levels for CY16 (lower than 3.4% from CY15).

Management is also very confident it will be able to successfully manage NIMs

around current levels (at 4.12% on an annualized 1QCY16), through various

high yield projects and upcoming aforementioned strategic initiatives.

Perfect Timing to Expand its Share of Advances in the Industry

We also see UBL’s aforementioned strategic strengths perfectly fitting in the

overall macroeconomic picture. The recent pickup in demand for credit in the

private sector (up ~10% YoY on average), especially in long term loans with

average growth of ~18% YoY (since May’15), is anticipated to be followed by

an overall higher credit demand in private sector via short-term & working

capital financing.

Figure. 12 LT Credit Offtake to Indicate Upcoming Credit Demand Growth

Source: SBP, AHL Research

The scenario is propped with record low interest rates (Policy Rate at 5.75%), over a

decade low headline inflation (FY16 recorded at 2.85% | FY17E at 4.0%), as well as

several relief measures provided under FY17 Budget, that could provide for a protracted

high single digit to low double digit growth in overall loans. Not to forget the cherry

on top; big ticket financing directly under the banner of CPEC, of which UBL is expected

to serve as one of a few primary lenders, and the concomitant spillover throughout the

economy, and in the years to follow.

Similar to the deposit growth, UBL has led the big 5 group in loan book expansion over

the past five years with a CAGR of over 7% (CY10-15) compared to peer average of 5%,

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

19.0%

21.0%

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SMEs LT WCF YoY LT growth (RHS)(PKR bn)

Figure. 11 UBL Deposits’ Categorization


Fixed29%

Savings 33%

Current38%

Fixed Savings Current


July 12, 2016


even in CY15 where advances growth remained lackluster for the bank at a little over

4% compared to peer average of under 2%.

Exhibit. 6 Major Sectors of Loan Book with Respective Coverage and Infection Ratios (Dec'15)

PKR bn Advances % of Advances % Δ YoY Coverage Infection Ratio

Energy 113,321,701 21% 16% 59% 6%

Individuals 64,599,561 12% -11% 62% 11%

Agribusiness 49,398,812 9% -12% 79% 1%

Textile 56,538,633 11% -12% 96% 24%

Financial 30,808,904 6% 14% 99% 6%

Wholesale Trade 28,067,454 5% 18% 79% 6%

Food 21,400,575 4% 77% 85% 4%

Construction 20,894,566 4% -16% 93% 17%

Others 144,884,403 27% 6% 75% 8%


For CY16 onwards, management is eyeing a loan book expansion of over 10% triggered

by i) secure SME lending with assistance from IFC, ii) aggressive lending to financial

institutions (both government and corporate entities), iii) excellent retail business, and

iv) an increased focus on Islamic banking.

While into the medium-long term (CY17-20), bank is expected to capture a consistent

loan growth of higher single to double digits supported by CPEC (both directly and

indirectly).

UBL - Ready for the Future Credit Growth with All Bases Covered

On the provisional front, UBL continues with its conservative approach with cautious

lending and maintaining a healthy buffer for possible infections. UBL wrote-off a

significant PKR 7.9bn during CY15 subsequently declining a substantial PKR 9.0bn in

NPLs, with a net infection ratio of 9%.

Figure. 13 Substantial Coverage To Lend Aggressively Figure. 14 Improved Infection Coupled With Prudent Provisions


Source: Company Financials, AHL Research SP – Specific Provisioning GP – General Provisioning

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July 12, 2016


Furthermore, during 1QCY16 management booked another hefty PKR 2.0bn of general

provision out of prudence towards possible uptick in non-performing loans (both from

domestic and international book). Based on discussion with management, as UBL

stands at a premium coverage level of 91% (1QCY16), it expects only nominal

provisioning throughout the rest of the CY16.

While leverage for the Big 5 banks has stayed around 10x since last five years, increasing

investments in the sovereign bonds have provided for rather too good to be true CARs.

In the meanwhile, UBL has been pacing itself to achieve a comfortable CAR (14.6%

CY16E) to successfully position itself for the anticipated private sector credit offtake.

Here it is pertinent to note that while most of its peers (ex NBP) held much higher CARs

than UBL, they also maintained IDRs in the 70% range. Whereas, UBL’s CAR on average

stood at 14.6% against a much lower IDR average of 56% (CY12-15), exhibiting a much

smaller padding in its IEAs (i.e. greater proportion of loans/IEAs). As a result, the

upcoming PIB maturity and future lending should pose but only a relatively smaller

impact on its CAR.

Strong Investment Portfolio Continues to Feed into the Topline

During the 1QCY16, an industry wide accumulation of PIBs was witnessed. Similarly, UBL

Treasury accumulated on PIBs making it the largest PIB portfolio in the sector crossing

PKR 524bn mark. Consequently, UBL enjoys the largest bond-driven investment surplus

of PKR 21.5bn, even after realizing the largest capital gain on sale of securities for PKR

3.9bn during 1QCY16 alone (total capital gain realized in CY15 was PKR 3.2bn).

One key risk to banking sector earnings in CY16 is the PKR 1.4tr PIB maturity during

3QCY16 (Jul’16). While some of its Big 5 peers (e.g. MCB and ABL) may take noticeable

hit on their NIMs during the 3QCY16, we expect UBL to considerably mitigate the

reinvestment risk via i) continuous re-profiling of its PIB portfolio, ii) expanding its

balance sheet, and ii) substituting with other high yielding avenues (primarily loans),

resulting in a drop of ~40bps to 4.2% expected by end of CY16 compared to 4.6% in

CY15.

Going forward, with PIB maturity due in 3QCY16, under the current lower yield

environment and expectation of interest rate hikes, we expect UBL Treasury to split

reinvestment in both PIBs and MTBs with yields ranging from 6.2% up to 7.5%. Just to

give a perspective, UBL’s end of 1QCY16 PIB portfolio yields stood around 10% (based

on management guidance), however, the decline in yields should be cushioned with

concurrent increase in investments driven by balance sheet expansion.

Figure. 16 Capital Gains and PIBs In Tandem Figure. 17 Banks Expected to Reinvest in PIB MTB mix


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Figure. 15 Interest Earning Assets (CY10-20F)


Cash with Banks Lendings to Fis INV ADV

CY10 CY20F


July 12, 2016


Figure. 18 Relatively Lower Yield Due to Re profiling Figure. 19 Second Largest Total Surplus*

Source: Company Financials, AHL Research Source: Company Financials, AHL Research (*) UBL holds the largest bond surplus

Other Significant Items

Capital Gains on Sale of Investments & Risks to Our Estimates

Historically, UBL had the least reliance on capital gains in providing for its bottom line.

In the past three years (CY13-15), where its peers’ booked gains on an average of 5%-

10% of their total revenue, UBL’s realized capital gains stood on an average of 4% of its

total revenue.

However, in the wake of current low interest rate and small yield spread environment,

there is a higher possibility for the entire banking sector to capture hefty capital gains.

Recently, UBL has enjoyed a very effective treasury function in providing lofty earnings

support. As of Mar’16, it booked the largest capital gain of PKR 3.95bn and yet it held

the largest PIB surplus of PKR 21.5bn that could be used to support the missing bottom

line, if needed (to compensate for scenarios such as the continuation of Super Tax).

In our earnings’ forecasts, we have maintained a moderate-to-conservative approach

towards possible capital gains to smoothen our estimates. We have assumed capital

gains at PKR 5.25bn for CY16 (PKR 3.95bn already booked in 1QCY16), followed by an

average of PKR 4.6bn for the next two years (CY17-18). It is, however, pertinent to note

that the capital gains pose the highest risk (both upside and downside) to our bottom

line estimates.

7.0%

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July 12, 2016


International Loan Book – Stable Outlook

One of the primary concerns surrounding UBL has been its international loan book.

While UBL enjoys the largest international operations amongst top tier local banks,

~20% of its total deposits with an infection ratio of 10% (compared to HBL/NBP at

12%/19%), its diversifying international portfolio, ironically, is heavily anchored in the

Middle East markets (specifically in the United Arab Emirates).

Of the total (unconsolidated) international net advances portfolio of PKR 148bn (USD

1.42bn), 72% or PKR 107bn is booked in UAE, whereas; another 4% (PKR 6bn) of the

total international loan book belongs to the stressed operations in war torn Yemen.

Pertaining to its UAE loan book, management is confident with an overall financially

sound clientele that consists of ex-oil corporations (predominantly trade related) and

that have maintained healthy relationships with the bank over the years. UBL

management holds a stable outlook for its Gulf operations yet remains prudent with

enhanced due diligence processes on fresh underwritings and more strengthened risk

surveillance on existing credit portfolio.

With regards to its Yemeni operations, based on our discussion with the management,

it has a clear short term strategy of reducing the risk exposures and maintaining

sovereign risk investments. We note that the clean exposure to its Yemen loan book

has been on a continuous declining trend, noted at USD 7mn as of Mar’16.

Given the recent ample provisioning aforementioned (Coverage ratio of 91%), we view

the risk exposure to UBL’s international loan book mostly accounted for. While building

our estimates of future provisioning (CY16-20F annual average of PKR 3.2bn), we also

acknowledged the conservative approach taken by the management with no

substantial fresh loans to be added to its international credit portfolio of PKR 148bn

during CY16 or not without stringent due diligence.

‘Brexit’ and Possible Impact on the Subsidiary; UBL UK

In light of recent global development where Britain decided to exit European Union

(popularly known as ‘Brexit’) based on a surprising result of the referendum conducted

in Jun’16, we performed preliminary analysis of possible impact on UBL via its 55%

owned subsidiary; UBL UK.

While, due to the high degree of ambiguity surrounding ‘Brexit’ and its implications on

the financial institutions functioning in the UK it is too early to calculate anything

concrete, we note that UBL UK makes up for an insignificant portion of the parent

company’s topline.

Furthermore, the subsidiary substantiates only a small portion of total business with an

asset base of GBP 463mn, and GBP 11.75mn in PAT (around 3% of parent company’s

PAT), it should not pose a material risk to the parent company in near term.

More can be asserted on this topic as the details of post-Brexit policies surface. Possible

risks to subsidiary may come via (i) interest rate cuts, (ii) restricting trade terms with the

EU, and (iii) under-performing capital markets.

Figure. 20 Net International Advances Breakdown


12%

10%

4%2%

72%

Bahrain Qatar Yemen New York UAE


July 12, 2016


Expenses

Historically, UBL has managed its C/I average at industry levels of 45%-50%, especially

post expansionary phase witnessed from CY11-13 where the bank added over 150

branches. However, since CY13 UBL has successfully trimmed down its operating

expenses considerably bringing down C/I from 50% (CY13) to 41% (1QCY16) compared

to peers’ average of 47%.

In CY16, where we expect the recent slow paced network expansion to continue, there

may be a slight push in C/I upwards to 43%-44%. Whereas, the recent conversion of

conventional to Islamic branches as oppose to setting up new ones (that in the normal

course take up to 18 months to break even) should assist in keeping the operating

expenses lower bound.

In the longer term, where cost benefits from limited branch expansion and further

automation should curb operating expenses, factors such as (i) anticipated pickup in

inflation, and (ii) cyclical rise in salaries and premises lease renewals may put upward

pressure on the same. We anticipate UBL’s C/I to sustain at 40%-43% for the period

CY17-20F.

Figure. 21 C/I Expected to Improve Further… in LT Figure. 22 Well Managed OpEx – Both Salary & Branch Costs


Taxes – Continuation of Super Tax in CY16

In an effort to provide for the military offensive in progress against extremists, GoP has

decided to continue the imposition of a 4% Super Tax (to be based on CY15 PBT).

Similar to CY15, we expect UBL to book the entire charge in the 2QCY16 estimated at

PKR 1.7bn (PKR 1.42/share). In comparison to its peers that booked hefty capital gains

in CY15, UBL’s exposure to a Super Tax continuation is expected to be around 6% of

CY16E earnings.

For the entire CY16, we expect the effective taxation to settle around 39% compared to

38% booked in CY15.

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Admin expenses Branch Cost (% of OpEx) RHS

Salary (% of OpEx) RHS

(PKR bn)


July 12, 2016


Profitability

Profitability to show a +14% CAGR over CY16-20F

We estimate United Bank Limited to achieve an earning CAGR of 14% over CY16-20F

based on a) focusing on its key strengths that can not only provide high yielding

avenues but also boost balance sheet expansion to enable a larger investment base, b)

a strong investments portfolio, and c) well managed operating expenses. It is also

pertinent to note that UBL’s largest bond surplus of PKR 21.5bn (total surplus of PKR

26.4bn) poses a substantial upward risk to our earnings estimate.

Based on an estimated annual pay-out of 60%, we estimate UBL to maintain its ROE

(Tier II) at an average of 18.8% from CY16-20F, with a slight decline to 16.6% in CY16;

mostly due to continuation of Super Tax (additional 4% of CY15 PBT ~ PKR 1.7bn). With

that said, UBL offers an attractive 7.3% dividend yield, providing a robust 22.3% Total

Return.

Recommendation & Valuation

We value United Bank Limited using a Justified Price to Book ratio with our estimated

average ROE of 18.8% (Tier II) for the five year period CY15-20 (risk-free rate 8.0%,

equity risk premium 6.0%, and beta factor 1.2x). We estimate a sustainable growth in

earnings through a retention rate kept at 42.3% (pay-out ratio of 53.7%) and ROE-g

and COE-g kept at 10.8% and 7.4%, respectively.

In addition, we use our CY16 estimated book value per share of PKR 139.4 (Tier II). With

the stated, our justified P/B multiple comes out to be 1.45x with a healthy dividend yield

of 7.3% (providing a potential Total Return of 22.3%). This compares favorably in the

context of trailing P/E high of 10.9x. Hence we rate the stock as Buy!

Figure. 23 UBL - Price to Book Band Figure. 24 UBL – Price to Earning Band


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P/E 7.4x P/E 9.1x P/E 10.8x


July 12, 2016


Rating

Based on its latest rating issued, JCR-VIS Credit Rating Company Ltd. has upgraded the

entity rating for UBL to ‘AAA/A-1+’ (Triple A/A-One Plus) from an earlier ‘AA+/A-1+’

(Double A Plus/ A-One Plus), with a ‘Stable’ outlook on the scrip.

The upgrade was announced on the back of sustained improvement across key

performance areas including asset quality, liquidity, capitalization, and profitability.

Another key rating driver was UBL’s diversified revenue streams and operations. JCR-

VIS also reiterated our stance on UBL’s overseas operations with a stable outlook and

less susceptibility to oil related exposure.

Exhibit. 7 Entity Rating

Long Term AAA Stable

Source: Company Financials


July 12, 2016


Risk Factors

Based on empirical evidence, United Bank Limited is exposed to two major risks while

performing its intermediary function in the economy; a) Credit Risk, and b) Interest Rate

Risk. While Credit Risk arguably remains the most obvious risk to banking sector in

general, United Bank Limited has adequately estimated the price and created more than

sufficient provisioning for possible credit losses, as was discussed earlier in this report.

Based on our discussions with the management, the possible threat from the Middle

East operations is relatively low due to stringent lending framework and stable financial

condition of all its major clients.

Secondly, in our view, interest rates going forward should stay relatively stable at

current record low levels for the shorter term with a reversal anticipated as soon as

1QCY17 and latest during 2HCY17. Considering which, we believe, meagre Interest Rate

changes should not have a drastic impact on the bank’s business model or on its

earnings. With that being said, our performed analysis yielded the following results:

Exhibit 8 below, illustrates the changes in NIMs, EPS, and our CY16 Target Price with

+/- 50bps change in Policy Rate. For our base case, annual average Policy Rates for

CY16-19, come out at 5.9%, 6.1%, 6.9%, and 7.6%.

Exhibit. 8 Changes in Policy Rate* (CY16E)

Scenarios -50bps 5.90% +50bps

NIMs (%) 4.2 4.2 4.2

EPS (PKR) 21.5 21.6 21.6

EPS %Δ 0% 0% 0%

TP (PKR) 202 203 204

TP %Δ 0% 0% 0%

ROE (%) 16.6 16.6 16.7

ROE %Δ 0% 0%

Source: AHL Research, * With changes only in CY16.

In addition to Interest Rate Risk, we believe, a further slowdown in advances growth

could also potentially hurt UBL’s earnings. Exhibit 9 illustrates the changes in NIMs, EPS,

and our CY16 Target Price with +/- 100bps change in Policy Rate for CY16. Our original

estimate for growth in Advances for UBL during CY16 stands at 6.9%.

Exhibit. 9 Changes in Loan Growth* (CY16E)

Scenarios -100bps 6.90% +100bps

NIMs (%) 4.2 4.2 4.3

EPS (PKR) 21.4 21.6 21.8

EPS %Δ -1% 0% 1%

TP (PKR) 202 203 204

TP %Δ 0% 0% 0%

ROE (%) 16.5 16.6 16.7

ROE %Δ -1% 1%

Source: AHL Research, * With changes only in CY16.


July 12, 2016


Financial Highlights

Profit & Loss (PKR mn) 2014A 2015A 2016E 2017F 2018F CAGR & Avg

Net interest income 46,914 57,859 60,019 64,752 78,673 13.8%

Non-Interest Income 21,356 23,687 27,458 27,535 29,329 8.3%

Fee and Commission 13,045 14,239 15,976 16,331 17,835 8.1%

Capital Gains 2,063 3,195 5,250 4,510 4,630 22.4%

Income from FX Contracts 3,092 2,043 1,622 1,745 1,942 -11.0%

Other Income 1,366 1,299 1,197 1,203 1,274 -1.7%

Operating expenses 32,712 35,137 39,846 43,849 48,178 10.2%

Pre-provisioning earnings 36,953 47,271 48,280 49,283 60,703 13.2%

Provisions 1,336 3,823 3,560 3,235 2,735 19.6%

Pre-tax income 35,616 43,447 44,720 46,048 57,968 12.9%

Taxes 11,592 16,348 17,614 16,209 20,869 15.8%

Net income 24,025 27,100 27,107 29,839 37,100 11.5%

EPS (PKR) 19.3 21.4 21.6 23.9 29.7 23.2

DPS (PKR) 11.5 13.0 13.0 13.5 17.0 13.6

Dividends 14,078 15,326 15,937 16,522 20,869 10.3%

Key Balance Sheet Items (PKR bn) & Capital Ratios CAGR & Avg

Total assets 1,182 1,486 1,652 1,831 2,109 15.6%

Interest Earning Assets 1,046 1,330 1,499 1,671 1,934 16.6%

Interest Bearing Liabilities 1,015 1,298 1,448 1,609 1,865 16.4%

Non-performing loans 57 48 51 54 57 -0.2%

Allowance for loan losses 45 38 42 44 46 0.7%

Loans 467 487 520 570 637 8.0%

Deposits 952 1,120 1,256 1,445 1,678 15.2%

NIMs * (%) 4.6 4.9 4.2 4.1 4.4 4.4

Tier-1 Ratio (CAR) * (%) 14.3 14.7 14.6 14.7 14.9 14.6

Shareholders' equity 138 156 171 187 207 10.8%

* Averages

Valuation Ratios & Profitability Measures Average

P/E x 9.1 7.3 8.2 7.4 6.0 7.6

P/B x 1.6 1.2 1.3 1.2 1.0 1.3

Dividend yield % 6.5 8.4 7.3 7.6 9.6 7.9

Dividend Cover x 1.7 1.6 1.7 1.8 1.7 1.7

ROE % 19.3 18.5 16.6 16.7 18.8 18.0

ROA % 2.1 2.0 1.7 1.7 1.9 1.9

Payout Ratio % 59.5 60.8 60.2 56.5 57.2 58.9

Shares Outstanding PKRmn 1,224 1,224 1,224 1,224 1,224 1,224

Deposits/Branch PKRmn 725 842 927 1,051 1,194 948


July 12, 2016


Credit quality ratio 2014A 2015A 2016E 2017F 2018F Average

Infection ratio % 11.1 9.1 9.1 8.8 8.2 9.3

Coverage ratio % 78.5 80.0 81.0 81.4 81.4 80.5

Loss/Gross NPL % 81.9 79.8 79.8 79.8 79.8 80.2

Reserves /NPLs % 65.3 86.6 89.8 95.1 103.4 88.0

Growth Rates and Key Ratios Average

Net Interest Income % 18.7 23.3 3.7 7.9 21.5 15.0

Fee & Commission % 14.0 9.2 12.2 2.2 9.2 9.4

Non-Interest Income % 10.0 10.9 15.9 0.3 6.5 8.7

Total Revenues % 15.7 18.3 6.9 5.7 16.9 12.7

Operational Expenses % 10.3 7.4 13.4 10.0 9.9 10.2

Provisions % 0.7 (14.2) 8.3 6.2 4.4 1.1

Advances % 12.5 4.3 6.8 9.5 11.7 9.0

Investments % 13.2 43.9 15.1 15.8 19.4 21.5

Other Assets % 40.0 1.8 2.0 2.0 2.0 9.6

Deposits % 7.0 17.7 12.2 15.1 16.1 13.6

Borrowings % 29.6 208.4 7.1 (17.8) 16.1 48.7

Other Liabilities % 21.7 1.4 3.0 3.0 3.0 6.4

Non-financial information

Employee No. 13,382 14,623 14,228 14,438 14,753

Branches No. 1,313 1,330 1,355 1,375 1,405


July 12, 2016


Analyst Certification: The research analyst(s), is (are) principally responsible for preparation of this report. The views expressed in this research

report accurately reflect the personal views of the analyst(s) about the subject security (ies) or sector (or economy), and no part of the

compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by

research analyst(s) in this report. In addition, we currently do not have any interest (financial or otherwise) in the subject security (ies).

Furthermore, compensation of the Analyst(s) is not determined nor based on any other service(s) that AHL is offering. Analyst(s) are not subject

to the supervision or control of any employee of AHL’s non-research departments, and no personal engaged in providing non-research services

have any influence or control over the compensatory evaluation of the Analyst(s).

Equity Research Ratings

Arif Habib Limited (AHL) uses three rating categories, depending upon return form current market price, with Target period as December 2015

for Target Price. In addition, return excludes all type of taxes. For more details kindly refer the following table;

Rating Description

BUY Total return of subject security(ies) is more than +10% from last closing of market price(s)

HOLD Total return of subject security(ies) is between -10% and +10% from last closing of market price(s)

SELL Total return of subject security(ies) is less than -10% from last closing of market price(s)

Equity Valuation Methodology

Following valuation technique is used to arrive at the target price of subject security (ies);

Justified Price to Book Value (JPBV)

Risks

The following risks may potentially impact our valuations of subject security (ies);

Market risk

Interest Rate Risk

Exchange Rate (Currency) Risk

Disclaimer: This document has been prepared by Research analysts at Arif Habib Limited (AHL). This document does not constitute an offer or solicitation for

the purchase or sale of any security. This publication is intended only for distribution to the clients of the Company who are assumed to be reasonably sophisticated

investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources

believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be

relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given

in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information

is subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time.

However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to

its client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance.

This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes

the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent

evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his or her own

advisors to determine the merits and risks of such investment. AHL or any of its affiliates shall not be in any way responsible for any loss or damage that may be

arise to any person from any inadvertent error in the information contained in this report.

© 2016 Arif Habib Limited: Corporate Member of the Karachi, Lahore and Islamabad Stock Exchanges. No part of this publication may be copied, reproduced,

stored or disseminated in any form or by any means without the prior written consent of Arif Habib Limited.


July 12, 2016


Contact Information

Shahid Ali Habib Chief Executive Officer [email protected] +92 -21-3240-1930

Shahbaz Ashraf, CFA Head of Research [email protected] +92-21-3246-2589

Tahir Abbas AVP- Senior Investment Analyst [email protected] +92-21-3246-2589

Syed Fawad Basir AVP- Investment Analyst [email protected] +92-21-3246-2589

Rao Aamir Ali Investment Analyst [email protected] +92-21-3246-2589

Syed Shiraz Zaidi Investment Analyst [email protected] +92-21-3246-1106

Muhammad Waleed Rahmani Investment Analyst [email protected] +92-21-3246-1106

Misha Zahid Investment Analyst [email protected] +92-21-3246-1106

Arsalan M. Hanif Management Trainee [email protected] +92-21-3246-1106

Muhammad Hasnain Madni Officer- Database [email protected] +92-21-3246-1106

Azhar Javaid VP- International Sales [email protected] +92-21-3246-8312

Usman Taufiq Ahmed AVP- International Sales [email protected] +92-21-3246-8285

M. Yousuf Ahmed SVP- Equity Sales [email protected] +92-21-3242-7050

Syed Farhan Karim VP- Equity Sales [email protected] +92-21-3244-6255

Farhan Mansoori VP- Equity Sales [email protected] +92-21-3242-9644

Afshan Aamir VP- Equity Sales [email protected] +92-21-3244-6256

Atif Raza VP- Equity Sales [email protected] +92-21-3246-2596

Furqan Aslam AVP- Equity Sales [email protected] +92-21-3240-1932

Research Team

Equities Sales Team

Documents

UBL: What Remains a Hidden Gem in Banks · UBL: What Remains a Hidden Gem in Banks Commercial Banks Hubco Company to Outperform Due to Analyst REP 300 United Bank Limited UBL - BUY