Bank: MEEZAN BANK LIMITED - Analysis of Financial Statements Financial Year 2003 - Financial Year 2008

Meezan Bank Limited (MEBL) is a publicly listed company, first incorporated on January 27, 1997. It is pioneers of Islamic banking in Pakistan, started its operations from March 2002. It started operations as an investment bank in August of the same year. In January 2002, in a historic initiative, Meezan Bank was granted the nation's first full-fledged commercial banking licence dedicated to Islamic banking, by the State Bank of Pakistan.
The banking sector is showing a significant paradigm shift away from traditional means of business, and is catering to an increasingly astute and demanding financial consumer who is also becoming keenly aware of Islamic banking. This Islamic banking industry has surpassed the growth rates of conventional banks. Rapid growth of the industry has been accompanied by good financial performance and specific industry niche. The capital to risk-weighted ratio has invariably remained significantly above the 8 percent required level, and NPLs ratios have been considerably low.
That places the bank at the top of the industry, a long-term entity rating of A+, and a short-term entity rating of A1. The bank's main shareholders are leading local and international financial institutions, including 'Pak-Kuwait Investment Company', the only AAA rated financial entity in the country, the 'Islamic Development Bank of Jeddah', and the renowned 'Shamil Bank of Bahrain'.
The bank has an internationally renowned, very high caliber and pro-active Shariah Supervisory Board presided over by Justice (Retd.) Maulana Muhammad Taqi Usmani. MEBL has achieved a strong balance sheet with excellent operating profitability, including a capital adequacy ratio.
The total number of branches increased from a total of 28 in January 2006 to over 160 in December 2008 of which 66 online branches are added last year. This comprehensive branch network offers a comprehensive range of retail and wholesale banking products to large customer base spread all over Pakistan. The branch network is supported by real time on-line banking, a network of over 120 ATMs, a 24/7 Call Centre and Internet banking.
ISLAMIC BANKING 5-YEAR PERFORMANCE
In Pakistan, Islamic banking emerged as a response to both religious and economic needs. Efforts for economy-wide elimination of Riba started during 1970s and most of the significant and practical steps were taken in 1980s. The mid-80s attempt was a significant step in the evolution of Islamic banking system in the country.
In a technical sense it was the most advanced model compared to any other model being practiced anywhere in the world at that time. However, that system fell apart as it did not adequately address issues such as putting in place an effective Shariah compliance mechanism, giving emphasis to capacity building, and opting for a flexible and evolutionary approach.
The initiative to re-introduce Islamic Banking in Pakistan was launched back in 2001 when the government decided to promote Islamic banking in a gradual manner and as a parallel and compatible system that is in line with best international practices. Following the decision of the government to shift interest-free economy in a phased manner without causing any disruptions, the effort was envisaged on a market-driven and flexible approach.
The Islamic financial services segment is an increasingly important constituent of the financial sector in Pakistan and has grown in size and diversity in just a few years. The participants of the Islamic banking industry are all strong players with a sound capital base, compliant with SBP's MCR requirements uniformly applied to both conventional and Islamic banks, which restricts entry into the sector without the requisite sound financials. They have increased their share of assets in the overall banking system to 4.9% up to December 2008. The growth is also reflected in increased share of deposits and financing and investment that stood at 4.8% and 4.4% respectively at the end of December 2008.

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Description                    Dec-03  Dec-04  Dec-05  Dec-06  Dec-07  Dec-08

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Total Assets                       13      44      72     118     276     276

% age of Banking industry         0.5%    1.4%    2.1%    2.9%    4.2%   4.9%

Deposits                            8      30      50      83     202     202

% age of Banking industry         0.4%    1.2%    1.9%    2.8%    4.1%   4.8%

Financing. & Invest.               10      30      48      72     186     187

% age of Banking industry         0.5%    1.3%    1.8%    2.4%    3.6%   4.4%

Conventional Banks with Islamic

Banking Branches                    3       7       9      12      12      12

No  of Branches (Including Sub

Branches)                          17      48      70     150     289     514

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Currently, there are six full-fledge banks and 12 conventional banks, offering Islamic-banking products, through their Islamic banking branches. Hence, branch network of IBIs (Islamic Banking Institutions) comprises of around 514 branches as on December 31, 2008.
Total assets of the Islamic banks have been increasing significantly and the market share of Islamic banking assets in the overall banking system rose to 4.9% at the end of December 31, 2008 which was 4.2% in December 2007.
Deposit base also posted impressive growth in terms of share of banking industry to 4.8% though the absolute numbers of deposit remained unchanged in FY08. Financing and investment portfolio grew 50% in FY06 and 60% in FY05. The growth momentum continued in FY07 as well as FY08 the total financing and investment reached at Rs 187bn at the end of December 2008.
FINANCIAL PERFORMANCE (FY03- FY08)
MEBL realized a profit after tax (PAT) of Rs 621 million, which is 36% lower compared to previous year's profit of Rs 963 million. Net income from financings, investments and placements registered a 75% growth as a 49% increase in income was not matched by 26% increase in returns on deposits. Compared to conventional banks MEBL did not show any massive increases in NPLs and is within the margin of safety.
The decrease in profits is attributable to lower "Other Income" this year. On a general observation we see that unlike conventional banks, MEBL has been relying on other income unlike to make up its total profits but this year the picture didn't appear to be favorable as it had many losses from sale of securities and investments. All in all other income fell by 47% while other expenses rose by 54% thus reducing profit before tax by 22% and PAT by 36%.
The profits decoded into an EPS of Rs 1.26 while last year EPS was Rs 1.96 per share. Meezan Bank's profitability saw a promising growth of 60% in the year 2007. The growth was driven by a high net spread income of Rs 1.2 billion, an increase of 71.7% from the previous year. Over the years, ROA had shown a mixed trend despite persistent increase in profits.
This might be true due to changing industry dynamics and rapid increases in assets. For instance, last year the total assets grew by 26% and before that they grew by 45% thus resulting in lower ROAs as the profits do not rise proportionately. In FY08 the ROA fell to 0.73% as compared to 1.43% last year for the reasons quoted before like lower profitability and increases in Total Assets.
Another probable reason for lower ROA is that in year FY08 the whole economy was going through a down turn therefore nothing better could be earned as newer assets in FY08 comprised of earning assets like financings (advances), investments and due from financial institutions (lendings to financial institutions). The ROA of the bank, which had seen a slight dip to 1.30% in FY06 (2005: 1.37%) surged to 1.43% in FY07.
The bank's assets have been on average being fuelled by growths in investments and fixed assets. The bank's assets at the end of 2006 were Rs 67 billion. The bank has been following a policy of expansion to cater to a large number of people who are attracted from Islamic banking. An increased investment by 266% and the overall growth in earning assets promises higher profitability in the years to come.
Also the ROA is above that of the other Islamic Banking Institutions (IBIs) which is 0.9%. Overall the deposits posted 29% increase in FY08 as compared to previous year to an amount of Rs 70.233 billion. Major growth of 35% is seen in customer deposits while financial institutions' deposits reduced to almost a quarter of FY07 deposits.
A probable reason could be the liquidity strain prevailing in FY08, which led to deposit drains coupled with competitive return rates from NSS (National Savings Scheme). For the same reason in FY08 remunerative accounts grew by 17% while Non-remunerative surged up by 68% establishing that other banks were providing better returns on deposits.
An important finding is that the deposits of Islamic banks increased as a share of Banking Industry to 4.8% showing increasing confidence of depositors in Islamic banks disregard the rate of returns. The deposits of the bank have grown remarkably well in FY07 around increasing by 58.4%. The deposits of the bank were Rs 54billion at the end of 2007. The bank's deposits are mainly comprised of long term fixed and savings deposits comprising around 72% of the deposits.
During the FY07 period, the deposit structure depicts some changes; wherein the share of fixed deposits and saving deposits increased from 38 percent and 29 percent last year to 39 percent and 32 percent in FY07 respectively, thus increasing the term deposits from 67% to 71% respectively. Corollary to this, the share of financial institutions and current-non remunerative deposits have decreased from 10 percent and 23 percent in FY06 to 6 percent and 22 percent respectively in FY07.
The shifting deposits mix is indicative of customers' continued growing trust in the Islamic banking products as they are becoming more eager to engage in long-term relationship with Islamic banks. Just like other profitability ratios lower profits resulted in lower ROD, which is apparent from the graphs given. The falling profitability trend is in line with industry but is likely to improve in coming quarters.
The ROD of the bank has seen a slight decline in 2006, being 1.84% in 2006 as against 1.75% in 2005 but rose in FY07. The bank's equity has been rising. It issued more capital in 2006 worth Rs 1.7 billion. The bank's reserves also grew substantially by 29.7% to Rs 721m in order to meet the SBP's liquidity requirements.
As with ROD and ROA, ROE which had declined in 2006 (because the profits did not match the growth in the bank's equity), it improved in FY07. The bank's ROE is too low compared to the sector's average of 23.8%. The administration need to get their act together to rectify the situation as the time is ripe for the growth of Islamic financial institutions.
An impressive 15% growth is witnessed in financings (advances) from FY07 to an amount of Rs 39.768Billion with major contributions from Ijarah (23%), istisna (5 folds) and diminishing Musharakah (182%). Along with this it is important notice that Non performing loans increased by 63% highest recorded for this bank but still it's significantly lower than industry averages which actually gives an edge to Islamic banks over others.
In FY07, financings (advances) have seen a growth of almost 500% since 2003. The break-up of financing as per various Islamic modes shows the continuous predominance of Murabaha and Ijara financing, having their share of 45 percent and 22 percent respectively. When compared with the last year, the share of Murabaha has increased and that of Ijara has remained at the same level.
Diminishing Musharaka has also started to increase its share, which shows the eagerness on the part of to diversify their financing portfolio. Net finances in Q3'07, however increased only by 30% compared to 58% robust increase in deposits. Because of the slower growth of financing, the finance to deposit ratio dropped to around 82 percent and 69% in FY06 and FY07 from 92 percent in FY05.
Earnings assets have shown an increase over the years showing strong liquidity position of the bank. The assets seem to experience some shift away from financing to the investments and other assets since the share of these two has increased over the year. This is line with overall banking industry where the assets mix has shifted more towards investments than advances.
On evaluating the performance of Meezan's earning assets we see that yield (Yield as calculated by Net spread income/earning assets) has shown on overall rising trend till FY08 coupled with increasing gap between the Cost and the yield on the Earnings assets. Moreover, 'Cost of Funding Earning Assets' has also followed an escalating trend. A slight increase in 'cost of assets' coupled with returning higher profits is a good sign for any business and signifies its potential to produce/earn in future.
On the performance side, markup income experienced a robust growth of 49 percent during FY08 Net markup income after provisioning also witnessed healthy growth of 78 percent. Moreover, as the yield is still higher then costs of funding, we hope that Meezan continues future expansion through low cost funding sources. With the growing operations and fast expanding financing portfolio, the occurrence of non-performing financing is inevitable.
The NPLs of the bank have been continuously augmented till FY08
The NPL has increased by 122.7% in 2006 to became Rs 408 million followed by a nominal growth of 35% in FY07 and excessive growth of 272% in FY08, highest recorded for this bank. The rise in NPL is because of the increase in defaults and substandard loans. NPL form 1.6% of the finances in FY'07 but drastically increased to 5.2% of finances as the NPLs grew by 272%. Unlike industry in FY07 the bank shows a reduction in NPLs. Meezan's ratios have on the other hand shown improvement in FY07. These ratios are still very low and do not carry significant threat to the financial soundness of Meezan.
However, it will have to exercise extra safety measures for the financing portfolio, keeping in view the fact that Shariah-based modes of financing require that any late payment fee recovered from clients could only be used for charitable purposes. The bank needs to monitor defaults and must lend cautiously after having studied the credit worthiness of the borrower, as SBP has allowed for only 30% FSV benefit to the banks. 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. In Meezan's case, here was a decline in the solvency position over the years as a result of high growth in deposits. Therefore, the earning assets as a percentage of deposits declined in FY07.
Since the capital of the Islamic banking system grew at a lower rate as compared to the assets growth, the capital to total assets ratio decreased to 9.2 percent from 16 percent. Yet, the ratio is comfortably more than double the generally accepted benchmark of 5 percent. Moreover, the capital adequacy ratio of the bank at 11.63 percent is also well above the regulatory benchmark of 8 percent. Equity/deposits also showed a falling trend due to aforementioned reasons. The bank has been following a conservative dividends policy, as the last cash dividend came in the year 2003. The bank is more inclined on bonuses and rights, to increase its equity whereby conserving its profits for investment in expansion. From this, we hope that it will improve its solvency position in the coming years.
The price of Meezan Bank's share has been fluctuating between Rs 13 and Rs 38.5 from 2004 to December 2007. Same rapid fluctuation is seen in FY08 as well between Rs 6 and Rs 40 due to market conditions. Management may not be held responsible for the share price volatility, as the market remained closed for last quarter of FY08.
Since 2005, the share price has risen by 69% and has gone up to Rs 38.5. As has been the case, the bank's profitability has not been too high. But investors feel an upwards pressure in the share of the bank and with the expectation of Islamic banking occupying around 25% of the market share by 2010 there is bright possibility of growth for Meezan Bank. Also given the bank's policy of increased investments and expansion, the bank is likely to get more profitable in the coming years. The share operated at a P/E multiple of 15.2 in 2007 mainly because of high share price but later in improved further more on the pretext of lower average share price. MV was 2.0x in FY07 of BV indicating a strong investor demand for the share. The overall performance of the Meezan Bank remained encouraging and the key indicators depicted healthy trends in FY06 and FY07 and continued to be satisfactory in FY08.
FUTURE OUTLOOK The Islamic financial assets are expected to cross $1 trillion by 2010 in other words 12% of domestic banking industry share by 2012. The Islamic Banking industry continues to grow in Pakistan and six-full fledged Islamic Banks are now in operation. It is interesting to note that the conventional banks are increasingly realizing the huge potential market backed by the untapped and steadily growing appetite for Islamic banking products; hence the drive for entering this market is based on business considerations in addition to religious considerations. As the level of awareness and understanding of Islamic Banking remains very low, this might pose as a threat to the credibility to the full-fledged Islamic banks like Meezan. For this reason, there is a need for all banks to act in concert and help build awareness of Islamic Banking throughout the country.
However, the bank will have to manage its growing expenses in addition to following the stringent appraisal and monitoring standards. This along with the strengthening systems and building capacities of the human capital will add to the efficiencies of its system and thus proving it a comparable alternate financial system.
Despite the turbulent condition of the international financial markets in FY08, Noor Financial Investment Company, Kuwait (Noor), the major shareholder of the Bank increased its shareholding in the Bank from 34.6% to 45.5% reflecting the confidence it has on the future prospects of Meezan Bank. The Shareholders of the Bank have reaffirmed their respective in-principle commitment to meet the increased capital requirements of the Bank over the next five years. This bodes well for MEBL in a scenario where small banks are merging to meet SBP's enhanced MCR requirements.
Meezan Bank plans to continue its strategy of maintaining a conservative policy and ensure that sufficient liquidity is maintained at all times to meet all eventualities. Moreover, the exposure of the Bank to the equity stock market is only 6% of its total investment portfolio and has a limited impact on the profitability of the Bank. In the light of above scenario it could be said that Meezan Bank is well poised to meet the challenges of the future and will continue to play its leadership role in the Islamic banking industry.
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.
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Copyright Business Recorder, 2009