Bank: THE ROYAL BANK OF SCOTLAND LIMITED- -Analysis of Financial Statements CY'02-1Q'09
ABN Amro Bank (Pakistan) Limited (AABPL) was renamed as the Royal Bank of Scotland Limited on 1st August 2008 as it was acquired by a consortium led by The Royal Bank of Scotland in October 2007. Prior to this acquisition on the global front, AABPL became a merged entity resulting from the merger of ABN Amro N.V-Pakistan Branches with and into Prime Commercial Bank Limited effective from September 01, 2007.
ABN Amro N.V-Pakistan branches had been operating in Pakistan since 1948, as a scheduled commercial bank, under a banking license from the State Bank of Pakistan, while Prime Commercial Bank Limited was incorporated in Pakistan on September 30, 1991 as a Public Limited Company. AABPL was a majority owned subsidiary of ABN Amro Bank N.V Amsterdam which held a total of 99.22% share holding of the bank as at December 31, 2007.
After the amalgamation, it became the second largest foreign bank, as it was able to expand its local operations. Now as the Royal Bank of Scotland Ltd. (RBS) the bank has a network of 79 branches (including 3 Islamic Banking branches) in Pakistan and Azad Jammu and Kashmir. The bank is principally engaged in retail banking, corporate banking and treasury related activities. RBS's assets stand at Rs 108 billion and it employs about 5,000 employees. According to PACRA the bank's short term credit rating is (A1+) and long term credit rating is (AA).
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Name of Company The Royal Bank
of Scotland
Ticker RBS
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Advances Rs 67.910 billion
Deposits Rs 79.103 billion
Share Capital Rs 13.474 billion
Market Price (28-05-2009) Rs 18.32
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Recent performance 1Q09
The interest margins remained under pressure due to the higher cost of saving deposits and term deposits. The administration expenses rose by 8% to Rs 111 million over the corresponding quarter of last year mainly due to certain restructuring cost incurred during the quarter. Net interest income after provisions declined by 57.7% to be 326 Rs million due to higher provisioning and writing off of bad debts.
Non-mark-up income showed a marginal incline, due to marginally better performance in all accounts. Loss after taxation was Rs 256 million (LPS Rs 0.17) as compared to a PAT of Rs 142 million in 1Q08 (EPS Rs 0.1). The problem plaguing RBS is bad debts and lower recovery levels. As the accounts age, the downward impact on the PLS statements would be stronger unless strong recovery actions are taken. During 1Q09, the deposits of the bank declined by Rs 4.142 billion from the level in December 2008 with a corresponding decrease in advances by Rs 7.324 billion. Surprisingly investments have also declined while the cash with other banks have increased by Rs 5 billion. During the quarter ended March 31, 2009, interbank borrowings and ERF increased by 984 million over December 31, 2008.
During the recent years, the State Bank of Pakistan (SBP) maintained a tight monetary policy. Since July 2006, there has been a hike of 600 basis points in the discount rate, with an increase of 500 basis points occurring in 2008 alone. The average banking spread of the industry dipped by 31 basis points to reach 7.08% during the first six months of 2008. The average lending rate of banks went up by 14 basis points to 11.43 per cent while deposit rate increased by 45 basis points to 4.35 per cent. It was 3.9 per cent in six months of 2007. However, the banking spread in Pakistan was still the highest in the region. Banking spread also declined by the introduction of a minimum profit rate of 5% per annum on all categories of savings/ PLS saving deposits, including any other profit bearing deposit with no fixed maturity, to all existing and new depositors by SBP. This measure was to keep the banking spreads in check.
The increasing lending rates decreased the debt servicing capacity of borrowers (both corporate and consumers), thus deteriorating the asset quality of the banks' advances. At the same time, SBP withdrew the Forced Sale Value benefit and the banks were required to substantially increase their provisioning against NPLs in the last quarter of 2007. This reduced the profits of the banks for the year ended December 31, 2007. NPLs were the major threat to the industry's profits.
There is also a trend of growing consolidation in the banking sector. Many banks have or are expected to consolidate in order to meet the Minimum Capital Requirement set by the SBP. However, ABN Amro Bank N.V- Pakistan Branches were merged into and with Prime Commercial Bank Ltd. in 2007, not to meet the MCR regulation particularly, but it was a move to enter the middle market which includes private firms, smaller listed companies as well as new and expanding businesses. Prior to this, it had large corporate and consumer business, but lacked in the middle business segment. The bank will face tough competition from other bigger players in the industry and major foreign banks
PROFITABILITY:
During CY08, the Royal Bank of Scotland Limited (formerly AABPL) posted a loss of Rs 518 million which was lower (by Rs 1,047 million or 67%) than the loss registered in CY07 The bank's mark-up/interest earned, during CY08, amounted to Rs 11,489 million as compared to Rs 11,520 million earned during CY07. As the interest earned decreased, the interest expensed increased by 6%, resulting in a lower net interest margin. The net interest margin was Rs 5,842 million in CY 08 as compared to Rs 6,225 million in CY07.
The provisioning against NPLs was lower by Rs 410.836 million during CY08 as compared to CY07. This was because SBP allowed banks to avail the benefit of FSV to the extent of 30% of pledge stocks, mortgage commercial and residential properties held as collateral against all NPLs for three years from the date of classification for calculating provisioning requirement with effect from December 31, 2008. However, total provisioning still increased by around 4% as the provision for decrease in the value of investments amounted to Rs 60 million in CY08 as compared to Rs 1.9 million in CY07). Also, bad debts written off increased by 372% during CY08. Thus, the deteriorating asset quality of the bank is hampering its profitability.
The merger with Prime Commercial Bank Limited had helped the bank in expanding its branch network. As a result the non-interest income of the bank increased. During CY08, the bank earned Rs 3,753 million as non-interest income as it was able to offer additional non-interest services with its larger branch network. The bank earned higher non-interest income from fee, commission and brokerage income and foreign exchange transactions. Income on interest rate derivatives contract increased substantially during CY08 (from Rs 295 million in CY07 to Rs 1,222 million in CY08) and boosted the non-interest income of the bank.
There was an increase in personnel and other costs. Administration expenses rose considerably by 13% because the bank has spent considerably on growth initiatives, integration and alignment processes in the past months. Through a quarter-on-quarter analysis it can be seen that the bank has made a loss of Rs 59.7 million during 2Q08 while it made a profit of Rs 142.8 million in the 1Q08. RBS's net interest margin for 2Q08 was Rs 44 million higher than that of 1Q08. However, the bank provisioned Rs 12.5 million against diminution in value of investments and therefore experienced a lower net interest income after provisioning in 2Q08. The non-interest expenses were higher and dampened the effect of higher non-interest expense that the bank earned during 2Q08. The profit before tax fell by 53% and resulted in a loss during 2Q08.
Before CY08, RBS showed a rising trend of profitability. In 2006, the bank earned a considerable profit of Rs 2.4 billion. However in 2007, the year of the acquisition, the bank made a loss of Rs 1,565 million. The bank went through significant changes and its overall performance was impacted during the process of the merger with Prime Commercial Bank Ltd. The bank had made a loss in CY07 as well and a Q-o-Q analysis shows that its PAT decreased gradually during the whole year, especially in the last quarter of 2007, when the merger became effective, the bank's profits deteriorated because it was in a consolidation phase.
However, the main reason the bank incurred losses for the year 2007 was the huge increase in provisioning in line with the SBP's directions. The Bank was hit hard by the withdrawal of the Forced Sales Value benefit by the SBP and therefore, despite an increase in the net interest margin by 4.82% from CY06 to CY07, the increased provisions caused the net interest income after provisions to decrease by 54% in 2007 compared to 2006. Similarly, during HY08, provisioning against non-performing loans and advances increased by 63% and there were Rs 557 million more bad debts written off during HY08 as compared to HY07.
EARNING RATIOS:
The earning profile of the bank has shown a dismal picture because of the loss made by the bank in 2007. By June 2008 the bank had managed to improve its earning ratios by making a profit during HY08. However, by the end of CY08, the bank posted a loss of Rs 518 million. Despite this the earning ratios depicted slight improvement in CY08 as the bank incurred a lower loss as compared to in 2007. However, the negative earning ratios reflect the unfavorable profitability situation of the bank.
In 2008, the total assets of the bank increased only slightly (by 0.52%) while the loss after tax was 67% lower as compared to that in 2007. Thus, the Return on Asset (ROA) ratio improved. The Return on Deposit (ROD) ratio showed improvement, however, it was due to 12% decline in the deposit base of the bank.
The Return on Equity (ROE) became better due to the lower loss while the equity base of the bank improved by 98% during CY08. The equity of the bank increased due the advance against subscription for right shares (amounting to Rs 3,705 million) and surplus on revaluation of assets (Rs 1,778 million) while the share capital of the bank remained the same at Rs 13,474 million in CY08. Due to the losses during the past two years, the reserves of the bank depleted in CY07 and remained negative during CY08.
In 2007, the bank's total assets decreased by 13% as a result of consolidation and the rationalization of certain investments and advances portfolio. It revised its credit policy and this along with higher provisioning for the year reduced the net advances of the bank by 10%. Investments of the bank decreased by 36% and this reduced the earning assets of the bank considerably. A decrease in the cash and balances with the treasury further lowered the total assets of the bank.
The bank's earning assets increased by 5.34% during CY08 as compared to CY07. The advances portfolio of the bank increased by 5% and the investments rose by 15.5%. However, lending to financial institutions fell considerably by 74.5% as both the call money lending and repurchase agreement lending (reverse repo) declined considerably. Thus, the share of lending to financial institutions declined from 8% in CY07 to 2% in CY08 while the share of advances in total earning assets and investments increased.
The increase in advances came from the textile, cement and communications sectors. The yield on earning assets increased in 2007 because the earning assets had fallen by 13% while interest earned had increased by 17%. Thus, there was a more than proportionate increase in the interest income earned in CY07. At the same time the cost of funding earning asset increased as the interest expense rose. In 2008, performance of earning assets remained unchanged as both the yield on earning assets and cost of funding earning assets were maintained around 0.13 and 0.06 respectively.
ASSET QUALITY RATIOS: The bank's NPLs increased during 2007 and continued to do so during 2008. The total advances for the year 2008 were Rs 67,910 million of which Rs 7,688 million was placed under non-performing advances status. The Non performing advances for 2007 were 122.7% more than the non-performing advances of the year 2006 (2006: Rs 2,016.839 million).
The NPLs to advances also increased during CY08 due to higher rate of increase in NPLs as compared to the growth in advances. However, the bank seems to be working on improving its asset quality as it revised its credit policies and procedures. Provisioning for non-performing advances decreased considerably during CY08 due to the benefit of FSV allowed on of pledge stocks, mortgage commercial and residential properties held as collateral. Due to lower provisioning, the provision to NPLs ratio declined from 74.35% in CY07 to 22.18% in CY08. Also, the provision to advances ratio also fell.
The asset quality of the entire banking industry had been worsening in 2008 due to rising interest rates and the slowing down of the economy. RBS experienced loan losses of Rs 3.602 billion as against Rs 3.635 million during the same period last year. The loan losses occurred in the consumer and SME portfolio of the banks because tight monetary policy, rising interest rates and inflationary pressure has reduced the debt servicing ability of the consumers and small businesses. To manage its asset quality, RBS is making efforts to make its recovery system more efficient.
The bank's deposit base has been declining over the past years and by December 2008 the deposits of the bank stood at Rs 79 billion as against Rs 90.3 billion at December 2007. Fixed deposits rose to Rs 37.81billion during CY08 as against Rs 36 billion in CY07. However the savings accounts and current accounts have fallen by 27% and 22.5% respectively. Thus, the low cost CASA accounts of the bank have fallen. Higher fixed deposits would provide the bank with more loanable funds, but this will also increase the interest expense of the bank in the future.
Although the deposit base of the bank reduced, the bank's borrowings rose by 35%. Interbank borrowings and ERF borrowings increased considerably. Inter bank borrowing increased mainly due to higher interest interbank interest rates prevailing under tight monetary policy and liquidity tightening.
The bank increased its authorized capital (by issuing 800 million ordinary shares of Rs 10 each) as approved by the members in an Extra Ordinary General Meeting held on July 27, 2007. Despite this the equity of the bank decreased due to negative reserves and loss made during the year 2007. In 2008, the equity base of the bank increased by 98%. The share capital of the bank remained the same in CY 08 at Rs 13,474.364 million. The reserves of the bank could not be improved due to the loss in 2008. The bank's equity increased due to the issuance of right shares at 27.50% ie 70,545,006 right shares of Rs 10 each. As at December 31, 2008, ABN Amro Bank N.V., the parent company, held 1,336,926,381 (99.22%) ordinary shares.
LIQUIDITY RATIOS:
The bank's earning assets-to-asset ratio has been increasing. During CY 08, the total assets of the bank increased less (0.52%) in proportion to the earning assets (5.34%). The bank's lending to financial institutions has gone down. The bank's earning assets such as advances and investments had both gone down considerably during CY07, however, till Jun 08 the advances portfolio of the bank rose by 10% owing to increase in Loans, cash credits, running finances, etc in Pakistan by 11% and payables outside Pakistan by 44%. RBS must expand its advances portfolio and consider efficient portfolio diversification. It should also consider investments as a source of income and invest prudently. The advances to deposit ratio has been maintained at a comfortable level as a advances rose and deposits fell it remained quite steady during HY07.
SOLVENCY RATIOS: The bank was unable to maintain its solvency ratios in the immediate post merger period. The earning assets to deposits ratio showed a decline from 1.08 in the CY06 to 0.97 in CY07 because the earning assets of the bank fell, especially investments. This had hampered the income of the bank. However, in CY 08 the earning assets to deposit ratio increased to 1.12. The reason is the decline in the deposit base of the bank while the earning assets increased by 5.34%. Similarly, the equity to deposits ratio increased due to falling deposits during CY08. The equity base of the bank has improved by 98% while assets increased only slightly by 0.52%. Thus the equity to asset ratio of the bank improved.
The price of the bank's share has been constantly falling since 2007. During FY07 the average price per share was Rs 51.52 and it reduced further to Rs 31.24 during the last four months of CY08. The bank had negative earnings per share (Rs 0.38) during 2008 due to the loss that it made that year. This has been reflected in the falling share prices. The average share price during the period Jan-28 May 2009 was Rs 14.73/share.
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's 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. Also highly leveraged sectors like textiles will get a relief.
The spread of banking sector is also expected to take fall in the coming months. In March 2009, the lending rates of the banking sector declined by 20bps to 14.38%, but this decline in lending rates did not fully reflect the recent downward trend in KIBOR. The lending rates are therefore expected to decline in the future months due to the declining pattern in KIBOR. Also SBP has increased the minimum deposit rates for banks to 5% in May 2008. This may result in an increase in the cost of deposits of the banking industry. Since RBS has high composition of fixed assets (48%), it may experience a significant rise in cost of funds. Thus, the profitability of RBS and the banking sector in general will further deteriorate due to lower banking spreads. Higher proportion of low cost CASA and the introduction of high value wealth management products will prevent the bank's spread from shrinking.
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.
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. RBS, in order to survive, needs to be cost-effective and come up with unique products to cater to the customers. One favorable point was that RBS generates considerable income from it Global market business. However, the global financial crisis will take its toll on the bank.
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The Royal Bank of Scotland Limited.
formerly ABN Amro Bank (Pakistan) Limited.
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Key Financial Ratios
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Earning Ratios 2006 2007 2008
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Return on Assets 1.93% -1.46% -0.48%
Return on Deposits 2.55% -1.73% -0.65%
Return on Equity 27.80% -30.89% -5.15%
Net Interest Margin 5.88% 7.08% 6.59%
Asset Quality Ratios 2006 2007 2008
NPL to Advances 2.81% 6.96% 11.32%
Non Performing loans 2,016,839 4,489,049 7,688,318
Provisions to NPLs 36.34% 74.35% 22.18%
Provisions to Advances 1.02% 5.18% 2.51%
Liquidity Ratios 2006 2007 2008
Advance to deposit 0.77 0.71 0.86
Earning assets to assets 0.82 0.82 0.82
Yield on earning assets 0.11 0.13 0.13
Cost of funding earning assets 0.05 0.06 0.06
Solvency ratios 2006 2007 2008
Equity to Assets 0.07 0.05 0.09
Equity to deposits 0.09 0.06 0.13
Earning assets to deposits 1.08 0.97 1.12
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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].
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