Sectorial Analysis of Commercial Banks in Nepal

This article was originally published in NEPSEWATCH; the weekly newsletter from Smart Wealth Pro.

The article attempts to analyze the commercial banking sector listed in NEPSE primarily based on the 3rd Quarter reports. The various key financials and ratios have been presented, compared and analyzed. The investment perspective has also been provided based on the analysis. Most of the data analyzed and presented below are extracted from Smart Wealth Pro.

1. Commercial Banks in Nepal: The Overview

There are 26 listed commercial banks in Nepal. They are regulated by Nepal Rastra Bank and have to comply with all the regulations and requirements on Bank and Financial Institution Act, 2073 (2017). Following this, the minimum paid-up capital requirement is 8 Arba which has been compiled by all the commercial Banks.

1.1 Market Cap and Price

Based on the latest market data, the LTP ranges between Rs 1265 and Rs 236. NABIL is the most expensive banking stock followed by NICA whereas CBL is the cheapest Banking stock followed by CCBL.

The majority of the banking stocks are trading between Rs. 300-500.

Fig: Stock-Wise Price & Market Cap (as of Baisakh end)

2. The Balance Sheet Analysis based on Q3, 2077/78

Fig: Balance Sheet Items as of Q3 reports, 2077/78

 2.1 Commercial Banks: Capital and Reserve

The Balance sheet analysis will give us an overview of the financial position of the companies in the sector.

2.1.1 Reserve & Surplus

• Industry Average: 7.83 Arba
• Bank with Highest Reserve: Nepal bank Limited (NBL) 21.51 Arba
• Banks with reserve above the industry average (ranked):    NBL, NABIL, ADBL, NIB, EBL, GBIME, SBL & NICA

Nepal Bank Limited (NBL) has the highest reserve with a reserve of 21.51 Arba followed by NABIL and ADBL. The high reserve is the indication of a strong financial position and the company can withstand times of crisis as well as of the dividend stocks like NABIL the good reserve is the signal that the company could keep up the momentum in terms of its dividend distribution.

2.1.2 Paid Up Capital

As the Nepal Rastra Bank is encouraging Mergers and Acquisitions among financial institutions especially commercial banks, the companies with huge paid-up capital may already be an advantage whereas the companies with lower paid-up capital will need to go for mergers and acquisitions with other companies. This can have company-specific both positive and negative aspects. If the company are unable to generate returns in line with their capital, it could be viewed in a negative light by the investors.

 GBIME has the highest paid-up capital with 21.63 Arba which is likely to change as the NIB and HBL have now started the process of merger to form a bank with a paid-up of 26.14 Arba; the biggest in number.

2.2 Commercial Banks: Loans & Deposits

Fig: Balance Sheet Items based on Q3 reports, 2077/78

2.2.1 Business Model of Banks

Collect deposits: Pay lower interest.

Issue loans: Charge higher interest.

In other words, banks give loans, earn interest (revenue). Accept deposits, pay interest (cost). Earned interest minus paid interest is profit. Therefore, to analyze the banking stocks it is vital to analyze the key parameters: Loans and Deposits.

The industry average loans to customers and deposits to customers based on Q3 in 1.25 Kharba and 1.38 Kharba respectively.

• Bank with the highest loan issued amount: NICA
• Bank with the highest deposits collected: NICA

This is followed by GBIME and NABIL.

• Banks above the industry average loans to the customers (ranked):  NICA, GBIME, NABIL, NIB, SBL, NMB, ADBL, PRVU, MEGA, KBL, PCBL, NBL
• Banks above the industry average deposits collected from customers (ranked: NICA, GBIME, NABIL, SBL, NIB, PRVU, EBL, NMB, NBL, ADBL, PCBL

 3. The Income Statement Analysis based on Q3, 2077/78

 Fig: Income Statement Items based on Q3 reports, 2077/78 

3.1 Core Revenue and Net Profit

GBIME, NICA and NABIL record the highest core revenue as well as highest net profits for the commercial banks. When viewed relatively the income and interest income generated on the total capital utilized NICA seems to be outperforming the overall banking sector

4. Some Ratios as per the NRB Directives;

Ideally, the low cost of funds and high spread rate is favorable for the banks’ profitability. The cost of fund ranges between 3-6% and the spread rate ranges between 3-4%. The huge cost of fund results in an increased spread rate.

NBL has the lowest cost of funds. On the other side, NICA & PCBL has the highest interest spread.

Fig: Ratios based on Q3 reports, 2077/78

 4.1 Credit to Deposit Ratio (CD Ratio)

CD ratio helps in assessing a bank's liquidity and indicates its health - if the ratio is too low, banks may not be earning as much as they could be. If the ratio is too high, it means that banks might not have enough liquidity to cover any unforeseen fund requirements, which may affect capital adequacy and asset-liability mismatch. A very high ratio could have implications at the systemic level.

• The average CD ratio for the banks is 78.74. The NRB's threshold for the CCD ratio is 85%.
• The commercial banks with a CD ratio above 80% are: (ranked) NICA, MEGA, SANIMA, PCBL, KBL, BOKL, NMB, NABIL, MBL, CBL

 5. The Profitability Ratios and the Management Effectiveness

We will be reviewing DPS, ROE and EPS as the management effectiveness ratios. 

• NABIL, NICA, SANIMA & PRVU has the highest EPS (annualized) indicating the companies have better profitability as compared to other companies in the same sector.
• Likewise, NABIL, SANIMA & PRVU has the highest Distributable Profit per Share (DPS). Generally, good dividends can be expected from companies with good DPS.
• Similarly, NICA, SANIMA & PRVU has the highest ROE among the banks indicating the greater management efficeincy.

Fig: Ratio Analysis based on Q3 reports, 2077/78

5.1 Search for the Undervalued Stocks (PE & PB)

Fig: Ratio Analysis based on Q3 reports, 2077/78 

Based on PE and PB ratio, the most undervalued stocks are SANIMA, NBB and NBL. However, it is important to note that these valuation ratios take net profit into accounts and doesn’t take account of the types of earning and whether the earnings are recurring. Therefore, it is important to analyze from various standpoints to find the best scripts.

 5.2 Sectoral Ratio Analysis: The Lowest, Highest and the Average

L= Lowest value in the Sector

A= Average value in the sector

H= Highest Value in the sector

Fig: Ratio Analysis based on Q3 reports, 2077/78

6. Quarter 3: Special Highlights

SANIMA & NBB: Increase in Profitability

SANIMA and NBB recorded excellent net profits and NBB growth. The companies’ earnings were resulted from impairment reversals and other operating income respectively rather than the increase in the core revenue (net interest) as the company’s core revenue has not increased significantly. It is important to note that such earnings could be non-recurring

 EBL and SCB: Behind in the Competition

The once blue-chip companies have not been able to improve their performances recently and the same was observed from the recent quarters as these companies were outperformed by the peers which were way behind some time back.

EBL has not been able to expand the loans at the same pace as its closest peers. The company seems conservative as evident from the least non-performing loan in the overall industry. The 75% CD ratio which is way below the industry average suggests the bank is not earning as much as it could be.

SCB in the same way has not been able to compete and expand the business and the appetite for its stocks in the market seems to be decreasing. These factors are reflected in their stock price.

Industry Leaders: Setting the benchmark

NICA & NABIL; the two banking giants are the undisputed leaders in the sector.

Likewise, GBIME, PRVU, SBL, NBL, KBL, PCBL are outperforming the others in major key ratios and metrics.

 7. Other Stories

The biggest bank in the History of Nepal

Nepal Investment Bank and Himalayan Bank Ltd have concluded their MOU for the merger. The merger between them will lead to the formation of the biggest ever bank in Nepal with the paid of the capital of 26.14 Arba.

Nabil Bank Limited to Acquire United Finance Limited

A merger and acquisition agreement has been signed to maintain the share swap ratio of 35 shares of Nabil Bank equating to 100 shares of United Finance.

8. Causes for Concern in the Banking Sector

• A saturated market and cut-throat competition in the BFIs limiting the business growth.
•  Likewise, the regulatory body is pushing the banks into mergers. Although M & A could be good in some aspect like synergy; however, as the BFI's business size increase, the business growth could further be limited.
• Changing regulatory landscapes could affect growth and economies of scale.
• The stock market return from the majority of the banking stocks has underperformed the returns from other sectors leading to a decreased interest/confidence of investors in the sector. Lesser confidence corresponds to decreased demands, especially in the short runs.

9. The Investment Perspective

9.1 Minimum Fundamental Criteria for Investing in Banking Stocks

The minimum criteria that could be set for picking the banking stock for the long run could be:

1) PE and PB lower than the industry average.

2) ROE greater than 12%

3) EPS greater than Rs. 25

4) Gross Profit Margin above 35%

5) Good Dividend History & Distributable Profit per Share above the industry average.

6) NPL below industry average; in decreasing trend. Zero to extremely low slippage.

7) Year on Year steady and consistent growth on Loans, Deposits, net interest income, reserve and net profit.

8) Banks with honest management and strong promoter groups.

9) Focusing on growth, innovation, digitalization and competition.

10) Competitive Advantage: Low Cost of Fund, low cost of deposits, strong CASA proportion.

Technical Analysis of BANKING (chart from Smart Wealth PRO)

Sectoral Analysis of Commercial Banking Sector (As of March 08, 2021)

The banking sector is trading at 1778.71 as of 6th May 2021. It has broken the strong/historic resistance of 1779 as seen in the chart and has retested twice as seen in the weekly chart with the decline in volume indicating the sellers are less interested in selling at lower prices.

The surge in volume with bullish price action should push the index higher and the buy decision could be executed accordingly. However, the break below the support line could signal the opposite and the consolidation can extend for quite some time.

Key levels Summary:

Support: 1770-1800

Resistance: 1930-1970

Trend-based Fib extension provides the following top 3 targets if the resistance level is broken.

Target 1: 2119.22

Target 2: 2454.87

Target 3: 2855.78

Watch out for companies with good fundamentals, consistent core revenue, profits and ratios above peers and industry average for good returns. You can detailly analyze the companies using Smart Wealth Pro’s ratio analysis, stock screener and key financial section. Traders are advised to strictly adhere to their risk profile while setting stop-losses.

The Banking sector, along with other sectors in Nepal, mimics the NEPSE and no company escapes the fall in NEPSE's fall. Currently, the market gave a handsome return of over 120% in less than a year with no major correction meaning the significant correction is still overdue which could be time or price correction. Likewise, the PE of bank and NEPSE are in some of the highest ever levels and therefore, caution and adequate entry-exit strategy especially for fresh buy positions have to be in place.

10. Conclusion

To conclude, the bank’s performance improved since the last few quarters that was deteriorated because of the COVID pandemic. From the investment perspective, while some banking stocks can yield promising returns, the sector could also be used to optimize and diversify the portfolio as the banking sectors are relatively low risks as evident from the majority of the stocks with weekly BETA below 1. Similarly, regular dividends can be expected from the banks. It is highly advisable to perform due diligence and research for a safe and sound investment.

 Sources:

1) https://www.nrb.org.np/

2) https://smartwealthpro.com/

3) https://www.nepalipaisa.com/

Other Articles from Ujjwal Ghimire

Corporate crises/failures and Financial Reporting Standards in the Subsequent Period

Role of Capital Markets in Rapid Development of Country (award-winning article)