Wednesday, September 9, 2009

National Bank of Pakistan (NBP) - Winner of week 36 with a return of +14.59%

Introduction
We will with respect to our portfolio strategies write little presentations about the Winners of the Week. It will be interesting for the readers to see that it is definitely not right to believe that our winners will be fantastic stories about solid, low-risk firms in economies that are doing well. Quite often the winners are recovery stories amidst economic and political turbulence. And our introductory story is quite indicative of this.


Winner of Week 36, 2009: National Bank of Pakistan
 
The best performing stock in our Emerging Markets portfolios during our first week of operation (week 36, 2009) was National Bank of Pakistan (NBP), with a weekly return that would be considered a nice annual return for an emerging market stock!  We don’t want to get excited too quickly of course, but it is a nice sign when one of the stock picks is off to such a good start in what was actually a poor week for the average emerging market stock (see also our previous blog entry). And it was quite a remarkable performance to be honest, because it was also announced a couple of hours earlier that rating agency Fitch downgraded 4 Pakistani banks and NBP was one of them! But as so often we don’t exclude that the well-known behavioral phenomenon that ‘people panic most of the time after the fact - and then take the ‘right’ ex-ante action at the wrong time (ex-post) - is playing a role here.  To what extent is the weaker credit rating already priced into the share prices? We should not panic and analyze carefully before seeing the Fitch rating downgrade as something indicative of excess risk.
Let’s start by Wikipedia. They do have an entry for NBP, but warn us that it is written as an advertisement. Once again we have to be careful though, and if necessary, help Wikipedia re-write the piece.  NBP is by far the largest commercial bank in Pakistan. The former state-owned entity with head quarters in Karachi underwent a complicated set of changes during its history that started in 1949. It actually started in the jute growing areas in East Pakistan, the later Bangladesh, as a fully state-owned enterprise that represented the government in areas where the Central Bank – the State Bank of Pakistan – did not have offices. Offices in Karachi and Lahore (in West Pakistan) followed already in 1949, and the first 15 years of existence saw expansion with new offices in Jeddah (Saudi Arabia, 1950), London and Calcutta (1955), Baghdad (Iraq, 1957) and Dar-Es-Salaam (Tanganyika, 1962). 

Then the turbulence started:
·         1964: The Iraqi government nationalized the Baghdad branch office
·         1965: The Indian government seized the Calcutta office at the outbreak of hostilities between Pakistan and India
·         1967: The Tanzanian government nationalized the Dar-Es-Salaam branch.
Obviously, these setbacks have cost NBP quite some money. In Pakistan things went better, although the separation of East and West Pakistan into Bangladesh and Pakistan respectively had quite an impact as well. In 1971 NBP acquired 2 branch offices from Bank of China, namely the one in Karachi and the one in Chittagong. The latter one was quickly lost since East Pakistan spun-off not too much later. NPB then merged with two local commercial banks that were also in trouble due to the separation of the two Pakistan’s. That is, it allowed private shareholders in.
And this was not the end of turbulence, since the government of Pakistan fully nationalized the bank (again) in 1974. While doing so it allowed NBP increase in scale through the acquisition of another local bank that also did not survive the nationalization trend of 1974. A relatively quiet period – at least for NBP standards – followed with renewed expansion abroad. At the moment NBP has branches/offices in the USA, Canada, Germany, France, Bahrain, Egypt (its offshore branch there was closed in 2005), Bangladesh (yep, they are back again), Hong Kong, Japan, South Korea, China, Afghanistan, Turkmenistan, Kyrgyzstan, Kazakhstan, Uzbekistan and Azerbaijan. 
In Pakistan itself it has more than 1,200 branch offices through which it serves both retail and wholesale customers. It offers both regular and Islamic Banking products. It is also still maintaining good relationships with public sector clients, albeit that the bank is not a full-fledge state enterprise anymore. And the latest news about how the bank is dealing with pensioners who used to work for the government - and how it is thereby indirectly treating the government is 'more than interesting as well'. Below we address this latest news in a separate paragraph. 
In 2001/02 when the State Bank of Pakistan and the Bank of England agreed to allow only two Pakistani banks to operate in the UK, NBP and United Bank agreed to merge their activities to form Pakistan International Bank, of which NBP would own 45 percent and United Bank 55 percent. Pakistan International Bank later renamed itself as United Bank Limited (UNB). The shareholder structure remained initially the same, but within Pakistan the government undertook a privatization operation in which the government of Pakistan cut its shareholding to 49% with the remaining 51% owned by a joint foreign consortium of Abu Dhabi and private shareholders.
The numbers: relatively profitable, but struggling with the Credit Crisis and Pakistani economic and political turbulence
After this somewhat complicated historical biography of the bank now back to finance. The total assets of the bank have a value of USD 12.29 billion (2007). The bank’s revenues for the calendar year 2007 were USD 815.6 million with a relatively large net income of USD 307 million. The full numbers over 2008 are still not published. The turbulence in the world in 2007-08 and in Pakistan itself have led to these delays. So, buying banking shares with this uncertainty about the numbers: isn’t that suicide? We believe it isn’t. NBP has won prices as one of the top-10 banks in terms of profitability (2003) in the world and with its healthy mix of Islamic Banking and regular products it is quite an interesting bank.
End of August 2009 NBP published its second quarter results which indicated that profits declined by 41.5% after the bank paid higher interest rates on savings accounts while at the same time having to deal with a difficult interbank market. Net income for the quarter fell to USD 24 million. Revenues fell as well (by 11.2%). If you think ‘why pay higher interest rates when you are facing trouble at the other side?’, you should be aware of the fact that the State Bank of Pakistan has directed Pakistani banks to pay at least 5% interest rates on savings accounts irrespective of the balance.
So does that all sound strange? Yes, I am sure you are surprised; and even more so when knowing that NBP - which is part of our EmergingMarketLoser portfolio and our Next11 portfolio - had quite a nice share price movement this year already. But just like quite a few local Pakistani investment analysts we believe that a lot of the bad news was already in the price. The country effect AND the sector effect (banks being in trouble both because of the national government regulations AND the international Global Credit Crisis) went hand in hand. The country effect implies that Pakistan was one of the worst hit countries and that is why we looked for a Pakistani stock for our Loser portfolio in the first place, expecting a mean reversion. And NBP was a great candidate because its recovery was already setting while at the same time somehow lagging behind other banks. Analysts in Pakistan believe that the ‘fair value’ of the shares should be at least around 85 rupees and not 75 like right now.

The graph shows the kind of risky but calculated stock bet we are doing here. NBP was showing price levels around 250 rupees in Q3 2007 and we are now about 70 percent lower. Obviously this is not the type of bet to give too high a weight in a diversified, risk-controlled portfolio but that is exactly why we gave the share a weight of 11.1% in both the Loser and Next11 portfolios. Actually, to be honest, we believe that this is already quite high. However, we have an equally-weighted portfolio consisting of 9 holdings and therefore this weight is just what it ‘had to be’ due to the mechanics of our portfolio. But no worries, by proper diversification the risks are still manageable. And after all: the four Emerging Markets portfolios aren’t primarily created for investors that are mainly focused on ‘risk’. They were built for those that want to go for excess return in Emerging Markets in a structured manner. And with that in mind it is nice to see that NBP was our first weekly ‘winner’ in a week In which its rating was downgraded.
And again: that is how it often goes. In similar fashion: global banks are in disarray, with a lot of the allegedly well-known, safe Western names struggling. Isn’t it surprising that BBC World Service was today broadcasting an item that ‘this would be a good time to start a bank (!) now that main competitors are in trouble
NBP suffered its downgrading already, has tight links with the government in Pakistan – and it is unlikely that they will let them go down – and we know that a large part of the downgrade was related to Pakistan itself suffering. 
NBP and the relationship with the government; about 'friends' that are having an issue and what to do when markets don't function properly
But we need strong nerves, because things are in a mess. The government directive concerning the savings rate led to banking problems as we saw earlier, and the banks need to react. One way is to be slow elsewhere and that is exactly what happened, with another message that reached us today indicating that Pakistani pensioners who used to work for the government should be paid their pensions. Of course! What happened? 
In June this year the State Bank of Pakistan had asked all banks to deal with pensioners via their branch offices.  Private banks in Pakistan – including NBP – do however make their living through the spread between lending and deposit rate. And that spread is quite attractive, whcih is one of the reasons for the relatively high profit margin of the bank. This kind of service work for the government with respect to pensions is only something they would love to do – if and only if – a good contract with the government is worked out. 
But things are quite a mess after Pervez Musharraf had to resign as President in August 2008. Wikipedia's article about Musharraf indicates that the general achieved quite a bit in his period of reign:
  • Pakistan's economy grew by 100 percent between 1999 and 2007
  • Per capita GDP grew a lot as well, albeit that Pakistan is still in the 'poorer' group of Emerging nations. But an important one, since it is populous and as such member of the Next11 group highlighted by Goldman Sachs
  • Foreign Reserves in Pakistan grew by 500 percent
  • Exports grew 100 percent
  • The Karachi Stock Exchange grew by 500 percent
  • Foreign Direct Investments grew by 500 percent
  • The poverty ratio decreased 10 percent
  • Literacy went up 10 percent
  • The World Bank, IMF and Asian Development Bank have praised Pakistan for its achievements

Syed Ali Raza, the Chairman of NBP was one of the first people hired under Musharraf. Ali Raza  (see picture) is a graduate of the London School of Economics who used to work as regional chairman for Bank of America in Pakistan. Under his guidance NBP underwent similarly good developments as the country. Up until 2007-08 that is when the political turbulence translated - combined with the credit crisis - into bad weather for the bank.

Syed Ali Raza - President of NBP
Back to the problem of the new, post-Musharraf government, the State Bank of Pakistan, the Supreme Court, the banks and the pensioners. It is clear that the government has to act. But the government is in a very tight budget situation and so far, only some smaller banks were willing to step in and fulfill this service task. The big banks are still working out an agreement with the government with the pensioners waiting in long humiliating lines outside the branch offices. Is it only a government mistake? Not the total truth, because the pension plans do have their accounts with the national banks. So basically, by being slow the banks cut down interest rates (stretching the payables). The same costs that went out of hand because of the government’s 2008 directive that stated that the minimum rate had to be 5%. Result: a situation in which right now pensioners that worked for the government in the past are paying the price. You cannot disrupt market behavior without in the end somewhere having someone pay the price.  Pakistan is therefore definitely still in the ‘difficult’ economic category, albeit it that it also remains a Next-11 country. We do however not feel that this country factor should be translated one-on-one into problems for NBP that go beyond what is already discounted in the price.
Risky stuff, but right now playing the NBP game at this far, far lower price levels is a controlled game and we therefore are confident that we should stay in it. An indicator of the fundamental quality of the bank and its chairman Syed Ali Raza is that both won quite a lot of awards. We therefore end this blog entry by linking to the webpage that shows that this is ‘not just a bank’, but a well-managed one, especially when judging this by average emerging markets standards.

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