Bank: STANDARD CHARTERED BANK LIMITED - Analysis of Financial Statements Financial Year 2005 - 2001 Q 2009

Standard Chartered Bank (Pakistan) Limited is a subsidiary of Standard Chartered Plc. which is incorporated in England. Standard Chartered has had a long presence in Pakistan. It opened its first branch in Karachi in 1863. However, until recently, the bank's operations were quite limited. In 2000, Standard Chartered had 7 branches in 3 cities
It was during 2006 that the bank underwent major transformation. Standard Chartered Bank (Pakistan) Limited (SCBPL) was incorporated in Pakistan on July 19, 2006 and it became the first international bank to be incorporated in Pakistan. Standard Chartered acquired controlling stake (95.37%) in one of the best private banks in Pakistan called the Union Bank, through a transaction of US $487 million. Union Bank Ltd was the 8th largest bank in Pakistan in terms of market share of assets and had an extensive customer base with 400,000 retail and SME banking customers. However it had a small but growing wholesale banking business. Now SCBPL's business activities constitute consumer banking, corporate and institutional banking (wholesale banking) and global markets.
The acquisition of Union Bank helped SCBPL to grow at a faster and much promising rate. The bank has invested heavily in its brand and franchise positioning. SCBPL opened 36 new branches during HY08 and by 2008 the bank's branch network has grown to 175 branches in 41 cities. However in move towards cost cutting, SCBPL has rationalised many bank branches. Currently there are approximately 160 branches of SCBPL. According to PACRA, SCBPL's long term and short term ratings are "AAA" (Triple A) and "A1+", showing that the bank has the low credit risk and a strong ability to meets its financial commitments.
Recent performance (1Q09)
There has been a trade loss of 10.2% in the outgoing year 2008 due to commodity and oil price shocks. This led to a foreign exchange crisis and Pakistan had to turn to IMF to plug the widening gap. The first tranche of IMF payments have shown a positive response. IMF has now released the second tranche of dollar 847 million out of dollar 7.6 billion loan. The correction of fiscal and external accounts has resulted in lowering of inflation and strengthening of foreign exchange reserves. The reliance on SBP borrowing will significantly bring inflation down.
Now the focus will shift to growth as economic stabilisation program has severely retarded growth beyond expectations. SBP has thus reduced the policy rate by 1% to 14%. However more policy reforms are required to take the economy back to the growth of the previous years in the form of more cuts in policy rates, resolution of power crisis and public investment programs. The banking sector has remained strong despite these challenges as well those of rising NPLs.

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BALANCE SHEET

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(Rupees in millions)           1Q '09     1Q '08   % Change

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Paid up Capital                38,716     38,716      0.00%

Equity                         44,045     44,010      0.08%

Deposits                      186,234    174,552      6.69%

Advances - Net                123,991    125,601     -1.28%

Investments - Net              59,989     29,587    102.75%

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The equity has shown an increase of 0.08%. The deposits have picked up by 6.69%. However the advances have declined by 1.28%. This is due to low demand for credit which in turn is due to high lending rates and risk averseness by banks to avoid NPLs and meet the stringent SBP requirement. The demand for credit is only triggered by the power sector in view of the circular debt and farmer's as the harvest season of some crops like wheat draws near. Banks continue to build assets through investments and this segment has swelled by 102.75%.

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PROFIT AND LOSS STATEMENT

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(Rupees in millions)           1Q '09     1Q '08   % Change

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Revenue                         5,672      5,650      0.39%

Non- markup expenses            3,285      3,015      8.96%

Operating profit                2,387      2,635     -9.41%

Interest income                 4,290      3,870     10.85%

Provisions                      2,335      1,386     68.47%

Profit before tax                  52      1,249    -95.84%

Profit after tax                   34        818    -95.84%

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There was a negligible change in the revenues for the period under review. The revenue was at Rs 5.7 billion in the first quarter. The operating profit stood at Rs 2.4 billion down by 9.41% due to increase in non-mark-up expenses by 8.96%. The profit after tax has declined significantly by 95.84% to stand at Rs 34 million as against Rs 818 million in the corresponding period last year. The interest income has increased by 10.85%. This was due to increase in wholesale banking. Non-interest income has decreased by 23% due to decrease in derivative transactions given the uncertain and volatile market situation. The application of SCB group policies resulted in more provisions against consumer loans than the prudential regulations. SCB is taking measures in the form of collection teams to increase the recovery rate.
Despite huge inflation and considerable investment in technology and branch infrastructure the mark-up expenses increased by only 8.96%. This was due to exchange variance on the amount paid by branches to Head Office under the Service Level Agreement (SLA). Branches in close proximity of others are being closed. Hence, total network stands at 162 rather than 174 branches as on 31st December 2008. The EPS for the period is Rs 0.01/share.
PACRA has maintained favourable ratings for the bank. The long-term and short-term ratings are AAA and A1+ respectively. Also the ratings of 2 subordinated TFCs of the bank are AAA.
The growth in the banking industry of Pakistan has slowed down after the robust growth experienced during the past four years. The average banking spread declined to 7.07% during January-July'08 as compared to 7.36% recorded in the corresponding period of January-July'07. Credit off-take during 8mths08 grew by 9.4% and amounted to Rs 2.89t as at August-08 as compared to Rs 2.65t in December-07. Credit to the private sector grew despite a slowdown in the economy. The major reasons for the acceleration in the private sector credit growth were the rise in the working capital requirements due to higher input costs; the need for funds by the OMCs and IPPs due to the circular debt and the higher fixed investment in the month of March 2008.
Deposit base of the banking sector showed 6.4% growth and reached Rs3.78t at the end of August-08 as compared to Rs 3.56t in December-07. The demand for credit from the corporate sector increased but since the deposits did not grow at the same pace; banks funded this increasing demand for credit through other liquid assets. This is why the asset composition of the banking industry overall changed and there was a shift from investments to advances in 2008. This was contrary to the trend in 2007 when banks were focusing more on investments than advances. Savings deposits formed a major portion of the banking industry's advances.
The NPLs of the sector continued to increase in 2008 as the economic activity in the country slowed down and tight monetary policy affected the debt servicing ability of the customers. The profitability of the banking sector declined owing to lower spreads.
Standard Chartered recorded a profit before tax (PBT) of Rs 1.093 billion during FY-08 as compared to Rs 4.091 billion posted in FY07. The profit after tax (PAT) earned during FY08 was Rs 630 million as against Rs 2.767 billion earned during FY07. Both profit before tax and profit after tax fell by 73% and 77% respectively.
The bank's profits fell although its interest earned (revenue) during FY08 was Rs 777 million higher than the revenue earned during FY07. At the same time, interest expensed increased by Rs 551 million, causing the net interest income to increase marginally by Rs 226.6 million. The non-interest income for FY08 was 16% lower as compared to that earned during FY07. The bank's fee and dividend income both decreased while the income from foreign exchange dealings increased. However, it was the loss on sale of securities amounting to Rs 345 million that caused the decline in non-interest income earned during FY08.
SCBPL has been investing heavily in expanding its branch network and employing more staff to run its expanding business and utilize its increasing capacity. This has presently increased the expenses of the bank but these investments will be beneficial in the long term. This is important especially since SCBPL has growing competition from foreign banks such as RBS. These investments will develop a favourable brand name for the bank and show its positive results in the future profitability.
The main reason behind lower profit was a substantial (68%) increase in the provisions against non-performing loans and advances. The NPLs of the bank amounted to Rs 10.5 billion during FY08 as against Rs 6 billion in FY07. Most of the NPLs occurred in the unsecured consumer portfolio. Tight monetary policy, rising interest rates and inflation has reduced the debt servicing ability of the consumers.
EARNING RATIOS:
The earning ratios of SCBPL show a declining trend. The bank's return on assets fell from 3.66% in FY06 to 2.12% in FY07 because a 4% increase in assets was accompanied by a 40% decrease in profits in 2007. In 2006 the assets increased by 121% as a result of the acquisition of Union Bank. The assets more than doubled while profits also grew by 122% causing a slight increase in the ROA in 2006. The return on asset ratio declined further in FY'08 due to 88% decrease in profit after taxation and just a 4% increase in total assets.
Return on deposits rose in 2006 because the deposits of the bank increased by around 88% but the profits increased more in proportion to deposits (by 122%). However, the 40% decrease in profit in 2007 led to a decline in the ROD in 2007. In 2008, both the profits and the deposits of the bank fell but a more than proportionate decline in the bank's profits reduced the ROD ratio.
Return on equity fell in both years. In 2006 SCBPL's net assets grew to Rs 41 billion as against Rs 8.8 billion in 2005. Thus the equity of the bank increased 5 times and led to a drastic decrease in ROE. During 2007 the equity base of the bank grew by only 7%. But it was the decrease in profits that mainly resulted in the decline in the ROE ratio in 2007. Again in 2008, the ratio fell further due to decrease in profitability.
As rising NPLs and the provisions against them were the major cause of a decline in the earnings of the bank in 2007, the same condition seems to have persisted during FY08. The overall earnings of SCBPL may be dampened by increased provisioning in the future.
The yield on earning assets has been improving over the years because the bank's interest income has increased at a higher proportion than the increase in earning assets. Advances form the major portion of SCBPL's earning assets. In 2007 advances were 68% of total earning assets and by 2008; the share of advances in total earning assets was 67%. Lending to financial institutions form 17% and investments are 16% of earning assets. The investments consist mostly of T-Bills and PIBs, which are less risky. Investments are an important source of income for the bank.
During 2007 the interest income, earned by SCBPL, increased by 55%. The main contribution toward this substantial increase in interest income came from the growing advances. Interest earned on loans and advances to SCBPL's customers increased by 72% in 2007. Therefore, there was an increase in the yield on earning assets ratio of the bank. However, in 2008 the interest income of the bank increased only by 3% as the advances of the bank grew by only 5%. There was only a slight increase in the interest earned on loans and advances to customers while interest earned on loans and advances to financial institutions declined as compared to in 2007. Thus, the yield on earning assets increased in 2008 as the earning assets of the bank increased more in proportion than the increase in interest income.
The business of SCBPL consists of global markets (GM), corporate and institutional banking and consumer banking. As of December 2008, the consumer banking contributed nearly 60% of the total income, while GM contributed 18% and institutional/corporate banking claimed nearly 23% share in the total income. Expenses associated with consumer banking were the highest and therefore the consumer banking segment of the bank incurred a net loss along with the Corporate and institutional banking. GM on the other hand posted a net income and the reason was lower expenses associated with the GM business.
The cost of funding earning assets has been increasing as the yield on earning assets increase. The bank's interest expensed has been increasing and in 2008 it rose by around 9%. Interest expensed on deposits was 83% of total interest expensed in 2007. The bank has been trying to lower its cost of funds and to achieve this, the bank is increasing the share of low cost current account and saving accounts (CASA) in total deposits. Fixed deposits form 29% of total deposits, current accounts 34% while savings deposits form a major portion of deposits with a 36% share.
However, there was 9.8% increase in fixed deposits of the SCBPL during 2008. Savings deposits fell slightly by 10% while the current accounts declined by 1%. The total deposits of the bank decreased by 1.5% to Rs 174.5 billion in 2008 as against Rs 177.2 billion in 2007. Increase in fixed deposits will increase the cost of funds in the future but it will also enable the bank to meet the growing demand for advances, especially from the corporate sector (instead of funding through other sources).
The individuals contribute a major part to the deposits while the rest of the amount comes from various sectors like textiles, electronic appliances, production and transmission of energy and consumer goods.
LIQUIDITY RATIOS:
The liquidity of SCBPL has been decreasing as the earning assets to asset ratio fell during the years. In 2008, however, there was an improvement in the bank's earning assets to assets ratio. Before 2008 the growth in total assets of the bank was higher than the growth in the earning assets. In 2006 the total assets of the bank had increased by 121% while the earning assets rose by only 85%. In 2006, the bank witnessed such a substantial increase in its asset base because it was the year of the acquisition and the operating fixed assets and intangible assets increased manifold. However, in 2008, the asset base of the bank increased by 4% while the earning assets increased by 6%. The bank's most liquid assets such as cash and balances with treasury banks and balances with other banks declined during 2008. At the same time earning assets increased mainly due to 107% higher lending to financial institutions and 5% increase in advances. The bank's investments declined by 27%.
Advances to deposit ratio had improved in 2006 owing to an unprecedented increase in the advances of the bank as a result of the acquisition with the Union Bank. In 2007 the advances of SCBPL fell while the deposits increased and it was able to maintain its advances to deposit ratio. But in 2008 the advances to deposit ratio fell as a 5% rise in advances was not enough. SCBPL is getting into a slightly tight liquidity position. There is a decrease in the demand for loans from the SME and consumer sectors but the bank must focus on the corporate sector. Rising NPLs and higher provisions against them have also dampened the liquidity of the bank.
However, major portion of the bank's assets is funded by customer deposits. These deposits are diversified by type (including current, savings and other deposits) and maturity and are considered to be a reliable source of funds. SCBPL has maintained specific levels of marketable securities to meet the statutory requirements.
ASSET QUALITY:
The asset quality of the bank has worsened in line with the entire banking industry. Banks had indulged in offering loans and advances in the past four years. Consumer loan portfolios grew substantially. However, as a result of such extensive expansion in the advances portfolios of the bank the number of NPLs also started to increase. The situation was further worsened as the SBP started to tighten the monetary policy. Interest rates rose and many consumers defaulted. Now with rising interest rates, economic downturn in the country and increasing inflation the debt repaying capacity of the customers has been adversely hampered.
Banks have started to be more prudent when giving out advances and have improved their recovery lines and credit management. But so far they are dealing with the outcome of their aggressive loan policies of the past.
SCBPL's NPLs have risen tremendously. There was a sharp incline in the NPLs during 2006. In 2007, there was a 53% increase in the NPLs in the consumer banking segment (from Rs 2.8 billion in 2006 to Rs 4.4 billion). Major NPLs have occurred from the lending to individuals (Rs 3 billion) and textile sector (Rs 3.166 billion). NPLs have again increased during 2008 by 58%.
As the NPLs increased, the provisioning against them also increased. This is reflected in the increase in the provisions to advances ratio. Provision to NPLs increased substantially in 2007 due to the withdrawal of the Forced Sale Value benefit by the SBP. Provision against NPLs was around Rs 1.5 billion and in 2007 this figure increased to Rs 6 billion. In 2008, the provisions against loans and advances amounted to Rs 10.5 billion as compared to Rs 6 billion in 2007. This was despite a reduction in the provision requirement by Rs 318.5 million, ie, 30% of forced sale value (FSV) of all commercial and residential properties held as collateral as allowed by SBP. The said FSV benefit is not available for distribution of cash and stock dividend. Increased NPLs have caused an increase in provisions against them.
The loan portfolio of SCBPL largely ignores the agriculture and SME sector, focusing more on the consumer sector. This slant towards the consumer sector was augmented with the acquisition of Union Bank. SCBPL included many different sectors as its customers, and an increase in lending exposure to the previous ones that it was already engaged in lending to. For example, consumer goods and Telecommunications and IT segment became part of SCBPL's portfolio while its exposure in the textile, cement, sugar, financial, and individuals sector expanded due to the acquisition of Union Bank.
In 2007, textiles accounted for 14.17% of the advances, second only to the individuals category with a share of 42% of the advances. Next in line are chemicals and pharmaceuticals with 6.30% share in the advances while financial and cement sectors bag 3.45% and 3.06% respectively.
DEBT MANAGEMENT:
Due to the acquisition of Union Bank and subsequent injection of additional equity through share issue, the influence of debt in the balance sheet has declined drastically after 2005. In 2006, the Debt to equity, debt to assets and deposit times capital ratio declined greatly. The share capital was increased to Rs 38.7 billion in 2006 from Rs 4 billion only in 2005. Since then the share capital has been maintained. The reserves of the bank have increased and this has placed the bank in a comfortable position.
The falling debt to asset ratio shows that lesser assets are being funded through liabilities each year. During the first nine months of FY08 the assets of the bank increased by 6.7% while the liabilities increased by 2%. Overall the ratios show that the bank has efficient debt management policy. Overall, during 2008, the bank's debt to equity ratio increased while deposit times capital and debt to asset ratio remained at the same level as at 2007.
The capital adequacy ratio of the bank as at September 2008 was 11% (Tier 1 ratio of 9%) against the requirement of 8%.
SOLVENCY RATIOS:
The share of equity has been increasing, indicating that SCBPL has been able to comply with the MCR requirements under Basle II. It is one of the strongest banks with respect to fulfilling the capital requirements. The earning asset to deposit ratio is higher than the industry, because of the sudden increase in the equity. This situation gives the bank adequate leverage to aggressively diversify and expand its business operations. The equity has increased further in 2008, as a result of high retained earnings which can be utilized in future expansion of business.
The share price has responded to the fall in the bank's profits in 2008. The Average share price during 2007 was Rs 51.5/share but during 2008 the average share price fell to Rs 29.4/share. The share price began falling since the start of 2008 and has continued the declining trend since then.
FUTURE OUTLOOK:
SBP has decreased the discount rate from 15% to 14% (a decline of 100 basis points) in an attempt to ease the monetary policy. Since it is a slight decrease, it is expected to have negligible impact on the banking sector profitability or NPLs. Kibor is expected to decline to the level of 12.5 or 12.8%. The Banking spreads have been declining.
The banking spread reached a peak in January 2009 but has spiraled down since then. The decline in discount rates may get reflected in lower lending rates, the minimum PLS floor of 5% on deposit rates will stop the cost of funds for the banking sector to reduce. The asset quality of the banks may improve if there is further decline in discount rates in the future, especially the consumer advances portfolio. Consumer banking has a major share in the total advances of SCBPL. Also highly leverages sectors like textiles will get a relief.
However, recently SBP has allowed banks to avail 30% FSV benefit of collateral for calculating provisioning requirement. 30% FSV is allowed against pledged stocks and mortgaged commercial and residential properties only. This will reduce the provisioning and have a positive impact on the profitability of the banks.
Also SBP increased the minimum deposit rates for banks to 5% in May 2008. This has resulted in an increase in the cost of deposits of the banking industry. SCBPL should lower fixed deposits as compared to low cost savings and current accounts in order to prevent a significant rise in cost of funds Higher proportion of low cost CASA and the introduction of high value wealth management products will prevent the bank's spread from shrinking.
The impact of the 2008-09 Budget on the banking industry is expected to be neutral. The withholding tax on cash withdrawals of over Rs 25,000 has been increased by 0.1% to 0.3%. This increase in WHT is not expected to impact the profitability of banks because the increase is insignificant and will likely be passed on to consumers. FED on banking services has been increased by 10 % but this too in not expected to have any affect as it may be passed on to the consumers.
Banking industry is not growing at the rate it was some time back owing to factors mentioned above. SCBPL, in order to survive, needs to be cost-effective and come up with unique products to cater to the customers. One favourable point was that SCBPL generates considerable income from it global market business. However, the global financial crisis will take its toll on the bank. SCBPL offers various cash and interest risk management products to customers. The products include FX options, FX forwards and interest rate swaps. This diversifies the sources of funds of the bank and makes it less vulnerable to the deteriorating economic conditions and volatile local markets. SCBPL has continued to have growth in revenue in the wholesale banking; however, the slow down in economic growth in the country may impact the performance of this segment of the bank. Bank's advances are not expected to grow as its consumer banking segment is being prudently managed.
COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for Business Recorder.
DISCLAIMER: No reliance should be placed on the [above information] by any one for making any financial, investment and business decision. The [above information] is general in nature and has not been prepared for any specific decision making process. [The newspaper] has not independently verified all of the [above information] and has relied on sources that have been deemed reliable in the past. Accordingly, the newspaper or any its staff or sources of information do not bear any liability or responsibility of any consequences for decisions or actions based on the [above information].