FINAL PROJECT: INTRODUCTION TO ACCOUNTING

COURSE INSTRUCTOR : Mr.MUBEEN KHALID

TITLE : ANATOMY AND ANALYSIS OF ANNUAL FINANCIAL REPORTS OF BANK ALFALAH LIMITTED

MPA/MHA (2009-2011) 2 ND SEMESTER

SUBMITTED BY : Dr.SYED SHAMS HAIDER MHA 06 Mr.ASSAD SAKHAWAT MPA 25

ANATOMY OF THE ANNUAL REPORTS FY 2004-FY 2006 AND HFY 2007 The major nuts and bolts are as follows:

The major nuts and bolts of the financial statements for the years mentioned above are presented in the attached PDF files alongwith this analysis doucement .An alalysis of these reports is presented as follows.

ANALYSIS OF THE ANNUAL REPORTS OF BANK ALFALAH OF FY 2004 - HFY2007

Bank: BANK ALFALAH LIMITED - Analysis of Financial Statements Financial Year 2004 Financial Year 2006 OVERVIEW : Bank Alfalah Limited was incorporated on June 21st, 1997 as a public limited company under the Companies Ordinance 1984. The bank is engaged in commercial banking and related services as defined in the Banking Companies Ordinance, 1962. The bank is currently operating through 195 branches in 74 cities. The bank got privatized in 1997. The Abu Dhabi Group, owner of the bank, has invested in

technology to offer an extensive range of products and services, which broadly include general banking, financial services, Islamic banking, consumer banking, treasury and international banking. Because of its superlative performance over the years the bank has been assigned short-term rating of A1+ and long term rating of AA. Bank Alfalah has expanded its branch network and deposit base. It is also making profitable advances and increasing the range of products and services. The bank has 195 branches of which 23 are Islamic and 5 overseas. Bank Alfalah is the 5th largest bank of Pakistan in terms of its assets which are 6% of the entire banking sector assets. The banking sector has expanded rapidly in Pakistan along with the fast paced economic growth. In the year 2006 banks' market capitalization was 1/3rd of the overall market capitalization of KSE, indicating the large share that the banking sector has in the market. This increased competition in the banking sector has encouraged the Banks to come up with services that could satisfy the needs of a large consumer base. The result has been increased profitability of all banks. PERFORMANCE OF H1FY07 The bank's performance has generally improved in all segments. Profits have increased from 0.81 million in 2Q06 (EPS: 1.38) to 1.2 million in 2Q07 (EPS: 1.89). Deposits increased from 184mn to 239mn, an increase of 30%. The trend of ROD has reversed this year as it has improved from 0.44

in 2QFY06 to 0.52 2QFY07 mainly because of improved control on costs resulting in improved profits. Given bank's eagerness for raising longer term deposits to match their assets maturity profiles, it is expected that the share of fixed deposits in total deposits of the banking system would continue to further increase in days ahead. The comparison between figures for FY07H1 and FY06H2 reveal that NPLs in H1FY'07 are now a higher percentage of assets, while the provision coverage for NPLs has declined significantly. The bank is now making greater efforts aimed at the recovery of NPLs while a tightening of the loan policies is expected. The figures for FY07 show that the bank has further improved its liquidity position through the reduction of the ADR. Advances have grown by 26.8% from 112mn to 142mn during this period. The high growth in advances was fuelled by an even higher growth in deposits. The industry as a whole has also experienced an ease in the liquidity position as a result of slower growth in loans. This slowdown in lending was caused by an increase in interest rates accompanied by less credit capacity in the market. Industry figures also show that banks have shown an increase in investment portfolios somewhat corresponding to the decline in loans, depicting a shift in banks' policy towards lower risks and returns. The half-yearly figures for

2007 show a continuing improvement in the solvency position of the bank as a result of further increases in capital. This conforms with an industry-wide trend of better solvency. In terms of profits the Pakistani banking sector ranks amongst the top ten in the world. Bank Alfalah has had its share in the phenomenal profits growth of the banking sector. Profits have risen largely due to increases in advances, investments and lending to financial institutions (Earning Assets). But this positive growth of deposits has not succeeded in improving the ROD of the bank which has declined in 2006. Long term deposits by both customers and financial institutions have seen a growth, leading to an increased interest expense. Since 2004 there has been a growth of 131% in the bank's deposits which is an indicative of the growth that this bank has seen. Profits have also risen due to increase in advances, investments and lending to financial institutions (Earning Assets). The lending to financial institutions alone grew by 264% in FY06. But ROD has shown a declining trend because the profits for Alfalah have not risen proportionally with the increase in deposits. In the year 2006 deposits grew by 7.7%. This significant increase was the result of the excessive reserve growth in the economy. But the corresponding increase in profits was a meager 3.6% because of a tremendous increase

in the interest expensed amount. In FY04 the ROD was 1.06 that declined to 0.76 in 2006. But the trend has reversed this year where the ROD has improved from 0.44 in 2QFY06 to 0.52 2QFY07. This is because of improved control on costs resulting in better profits for a small rise in deposits. Although the ROA of the bank was better than the industry average, it declined from 0.74 in FY04 to 0.64 in FY06. The total assets of the bank have grown by 11% from Rs 248.31billion to Rs 275.69 billion in 2006. The bank's earning assets have shown a significant increase but the high costs of funding these EA have resulted in low profits. In FY06 EA grew by 8.8% but the resulting profitability growth has only been 3.6%. ROE has had a fluctuating trend for the bank. It rose in the FY05 on the back of high profits for the year but declined in the subsequent year. As the general trend in the banking sector, this bank is also retaining profits and has had fresh capital inflow. One reason for this enhanced capital base is aimed at meeting the minimum capital requirement of the SBP. The ROE of Alfalah is 17.89% which is relatively low compared to the sector average of 25.6%. Yield is an indicative of the profitability of the banks assets. The bank's net interest income (NII) has increased by 18.2% in this year whereas the non interest income rose by 42.1% mainly due to gain on sale of securities. But as in the banking sector the NII contributes the most to income. The

increase in NII is mainly because of the high spreads that Bank Alfalah is taking advantage of like others in the sector. An important observation in the income of the bank is that its earning assets have been generating increasing returns over the years. But overall profitability has not seen great increments because of increasing costs of funding these earning assets. In the year 2006 bank's markup/interest costs rose by 111% as compared to a 73% increase in its earnings. This is also indicated by a declining interest margin which is a ratio of markup/return/interest expensed to the markup/return/interest income. The result is that though the yields are high, overall profits are low and so ROA, ROE and ROD have shown a declining trend. Earnings of Alfalah have been rising on the back of higher profitability over the years. As mentioned earlier banks have been retaining their profits. But the overall boom in the economy and the banking sector has made the investors confident about long term gains. Thus price has been increasing for Alfalah. The price of bank Alfalah's share has fluctuated between Rs 34 and Rs 87 over the past three and a half years. P/E has been on the rise that indicates that investors are looking forward to invest in the stocks of the bank in expectation of better returns in future. Though a multiple of 13.7x makes the share look overvalued, its strong fundamentals and in particular the

success of its subsidiary Warid telecom has kept the investors interested in it. MV to BV has shown a steady trend. Notwithstanding a continuing rise in the book value, MV is almost 2.5x the BV, again indicating investor's confidence generally in the banking sector to do well on the back of high spreads. Dividend yield has been low. The share is being traded at a high value. But the dividend policy of the bank is such that it prefers bonuses rather than cash dividends. Thus there has been retention of profits by the bank as it prefers to reinvest profits rather then giving them out as dividends. The bank plans to use the additional capital to strengthen itself in Pakistan and abroad. Also, it intends to use this capital to meet SBP's future capital adequacy requirements. The future plans have kept the investors interested and resulted in keeping the MV of its share above Rs 50 since February 2007. Dividend cover is given by DPS/EPS. It has had an increasing trend since EPS has been declining more than the DPS. The bank has been inclined towards bonus issues resulting in an increased number of outstanding shares. Since the profits not rising considerably, EPS has been on the decline. The non-performing loans (NPLs) have demonstrated a variable character during the period of analysis, first increasing from Rs 2.845 billion in CY03 to Rs 2.935 billion in CY04, then

decreasing by almost two thirds of that to Rs 1.06 billion in CY05. Thus there was a drastic cut down in NPLs in this year, which was also reflected in industry figures, where NPLs decreased from Rs 211 billion in CY03 to Rs 177 billion in CY05. This was the result of extensive measures by the industry in general and this bank in particular to improve the regulation and monitoring of loans and control defaults through more rigorous screening. The following year, however, once again showed a rapid rise of more than a hundred percent in NPLs to Rs 2.31 billion. This rise in NPLs can be more accurately attributed to the rapid rise in interest rates during this period than to any lapse in the bank's screening procedures, as the State Bank had taken definite measures to tighten its monetary policy. At the same time there was a high level of indebtedness in both private sector and consumer markets. There was a slowdown in the rapid decline in industry NPLs, which stood at Rs 175 billion at the end of CY06. Disaggregated industry analysis revealed that there were plenty of fresh NPLs incurred during this period. However, extensive write-offs and recoveries managed to reduce the overall level of NPLs. The debt management figures show that the assets of the bank have become more leveraged during this period. This was due to the fact that while equity has increased, debts have increased by a greater percentage. Equity increased by

10.58% in CY04, 41.86% in CY05, and 64.01% in CY06. However, liabilities rose by 59% in CY04 and 61% in CY05, and then a relatively modest 9.5% in CY06. Deposits rose from a modest Rs 76.7 billion in 2003 by almost 70% to reach Rs 130 billion in 2004, after which they again rose by more than 70% to touch Rs 222 billion in 2005. Deposits continued to show strong growth, rising by more than 7% in 2006 to cross Rs 240 billion. The major upward trend in deposits throughout the industry has been the result of the heavy economic activity during recent years fuelling the demand of consumers and the private sector for credit. The industry has also shown a trend towards increasing deposits in banks, a major cause of which is, of course, the booming economic activity, apart from higher foreign inflows in the form of worker remittances and FDI, as well as expanding branch networks, product innovation and better efforts at marketing. In fact, deposit growth in the top five banks, including Alfalah, was actually slower than that in the next five banks. However, Local Private Banks have shown the highest deposit growth in the banking sector. Both customer and institutional deposits showed steep growth in 2004 and 2005, while in 2006, growth in customer deposits slowed while institutional deposits showed a decline. Deposit growth had also slowed in the industry as a whole in 2006, declining from 18.3% in CY05 to 13.1% in CY06.

Another marked trend within the deposit structure of the bank was the greater growth shown by fixed deposits as compared to and at the cost of saving deposits. Fixed deposits increased by an absolutely stunning 100% and 300% in CY04 and CY05 respectively, and by a further 11% in CY06, thus attaining a level of almost Rs 89 billion at the end of that year, as compared to Rs 11 billion at the end of CY03. On the other hand, while savings deposits grew by almost 55% in CY04, their growth slowed to around 25% in CY05, and actually turned into a 3% decline in CY06, so that their level changed from Rs 44 billion at the end of CY03 to Rs 79 billion at the end of CY06. This is a good sign for the bank since its long term deposits have risen helping it attain the exemption on the CRR (Cash Reserve Ratio). The ratio of earning assets to total assets for the bank shows remarkable uniformity, suggesting careful management of and investment in interest generating assets. Within earning assets, however, the bank shows a gradual trend of movement of capital into and away from lendings to other financial institutions. The lending to other financial institutions declined from 9% of earning assets in CY03 to 0% in CY04, then increased to 13.3% in CY05, but was again reduced to 6% in CY06. This variation also caused a fluctuation in the percentage of earning assets held as advances, which increased from 58% in CY03 to 71.5% in

CY04, then again declined to 58.5% in CY05, finally increasing to 68.5% in CY06. The trend in investments has been mainly a declining one, from 39% of earning assets in CY03 to about 28% in CY04 and CY05, then again declining to 26% in CY06. Industry figures substantiate this trend to an extent, where in CY06 advances increased to 55.8% of total assets from 54.4% in CY05, while investment portfolio decreased from 21.9% of assets to 19.2% in the same period. In addition, 60% of the growth in banking assets in CY06 was accounted for by growth in advances. The advance to deposit ratio (ADR) on the other hand has shown a decline over this period. The ADR for the industry as a whole had actually increased in 2006, as a result of an aggressive loans policy overtaking the strong growth in deposits. The bank, however, managed to maintain and actually improve its liquidity position. As has been mentioned above, deposits showed a steep upward trend, increasing by almost 70% in CY04 and CY05, and by a further 7% in CY06. On the other hand, although advances increased by almost 80% in CY04, they showed more moderate growth rates of 34% and 26% in CY05 and CY06 respectively, presenting a more moderate and cautious expansion in loans by the bank. Advances have shown a strong upward trend over both the short and long-term categories. The solvency situation for the industry as a whole has shown marked improvement in recent

years, caused by increasing profitability and fresh inflows of capital. The figures for the bank show that there was a decline in the solvency position in 2005 as a result of high growth in deposits. As a result, from financing 4% of

assets in CY04, equity financed around 3% of equity in CY05. This situation, however, has improved in 2006 because of increases in equity, which once again financed almost 4% of assets. However, earning assets in comparison to deposits declined from around 1.03 in CY04 to 0.97 in CY05 and 0.96 in CY06. This is caused by the fact that while deposits have shown tremendous growth over the period under study, the bank has maintained a consistent approach with respect to its earning assets and has not expanded them to the same extent. The increase in MCR by the SBP has also led to banks increasing their capital share.

================================== Financial Ratio ================================== 2004 2005 2006 ================================== Earnings Ratios ROA 0.86 0.84 0.67 ROE 21.80 26.75 17.89 ROD 1.06 0.97 0.76 --------------------------------------------------Asset Quality Ratios --------------------------------------------------NPL (Billions) 2.94 1.06 2.31 NPL to Advances 4.3% 1.0% --------------------------------------------------Market Value Ratios --------------------------------------------------Price to earning 10.50 12.43 13 Market to Book 2.57 2.27 2.4 --------------------------------------------------Debt Management --------------------------------------------------Debt to equity 24.33 30.68 25 Debt to assets 0.96 0.97 0.9 Deposit times capital 20.60 27.67 2 --------------------------------------------------Liquidity --------------------------------------------------Earning assets to assets 0.83 0.81 Advance to deposit 0.67 0.59 Yield on earning asset 5.26% 7.19% Cost of funding earning 2.28% 4.23% --------------------------------------------------Solvency --------------------------------------------------Equity to assets 3.95% 3.16% Equity to deposits 4.85% 3.61% Earning assets to deposits 1.04 0.97 ==================================

================================== Other financials ================================== 2004 2005 2006 20 ================================== Cost of funds 2.10% 3.89% 6.40 Intermediation Costs 2.31% 2.33% 2 Net Profit Margin 0.94% 0.92% 0.7 Interest Margin 0.57 0.41 0.28 Net Interest Margin 1.93 1.97 2.32 ==================================