The banking sector has had an exceptional run since the last few years as profitability has risen by 76% on an annual basis due to both rapid economic growth and prevailing macroeconomic conditions. Economic growth has led to a surge in consumer spending and banks have cashed in on this trend by expanding their consumer product portfolio.
With the increasing significance of consumer spending in economic growth, the banking sector presents a very attractive investment opportunity. Unlike other industries, bank presents an exposure to a diversified consumer segment base, thus reducing the risk associated with a single industry. In 2006-07, total number of branches of domestic banks was 7747 as compared to 7415 in 2005-06; there has been an increase of 332 branches in the first nine months of FY07.
Assets of all banks showed a net contraction of Rs 275.8 billion in the first nine months of FY07 as compared to same period of FY 06. A deceleration in private sector credit and higher contraction in Other Items Net (OIN) contributed to slowdown of scheduled bank's assets. Growth in credit has decelerated during July-February 07 by Rs 124.3 billion, the slowdown primarily stems from deceleration in fixed investment loans as the working capital requirements have actually accelerated. Credit growth is expected to accelerate as structural factors are resolved and the infrastructure projects come online.
The total deposit during July-March FY 07 showed a decline of Rs 238 billion as compared with the same period of last year. A dis-aggregation of deposit mobilization within the banking groups shows that most of the slowdown is registered in domestic private banks due to mergers and acquisitions activities in the whole year. The deposit mobilization of foreign banks and the large privatized banks, on the other hand, has remained higher. It is interesting to observe that returns offered by private sector commercial banks on deposits were the lowest among banking groups during July-February 06. During Jul-February FY 07, these banks raised deposit rates by 256 basis points and now operating with the highest deposit rates. Despite this sharp increase in deposit rates, the deposits of public sector banks registered a net decline.
Faysal Bank started operations in Pakistan in 1987, first as a branch set-up of Faysal Islamic Bank of Bahrain and since 1995 as a locally incorporated Pakistani bank under the present name of Faysal Bank Limited. On January 1, 2002, Al Faysal Investment Bank Limited another group entity in Pakistan merged into Faysal Bank. Faysal Bank Limited is a full service banking institution offering consumer, corporate and investment banking facilities to its customers. The Bank's widespread and growing network of branches in the four provinces of the country and Azad Kashmir, together with its corporate offices in major cities, provides efficient services in an effective manner. Presently, it has 75 branches nationwide.
The strength and stability of Faysal Bank Limited are evident from the Credit Rating assigned by JCR-VIS Credit Rating Company Limited of AA (Double A) for long to medium term and A-1 (A one) for short term.
BUSINESS SEGMENTS
Faysal Bank caters to the following business segments:
-- Corporate Finance
-- Trading and Sales
-- Retail banking
-- Commercial banking
In terms of assets, FABL ranks 9th amongst the major banks of Pakistan. In percentage terms FABL holds 3% market share. As of FY'06, FABL has a share of 2.6% in the total deposits of the industry. The break up of these deposits in FY'06 is as follows:
1. Fixed deposits-50%
2. Current deposits-20%
3. Savings deposits-27%
4. Margin deposits-3%
Like other banks, FABL has consistently increased its reliance on fixed deposits over the years. This augurs well for FABL since a large proportion of term deposits/time deposits signify constant stream of income and better ability to match loans and deposits, thus lowering the credit risk for FABL. Furthermore, the liquidity risk for FABL is also on a lower side as only 27% of the total deposits are savings deposits, thereby posing lesser risk for the bank.
Being a smaller bank as compared to others under consideration (MCB, UBL and NBP) FABL offers higher deposit rates to augment its deposits base. Thus, the cost of borrowing for FABL is relatively on a higher side. Presently, the rate on savings deposits hovers around 7.5% per annum on average while the Faysal Izafa term deposit scheme offers as attractive rates as 9.5% per annum.
A significant portion of assets is allotted to the investment portion while 6% goes to cash amount. Thus, FABL has a strong liquid portfolio with a continuous stream of income as evident from the investment portion of the analysis. Even the five years' trend shows greater inclination towards the investment side, which shows efficiency on part of the company to utilize its idle cash while keeping an adequate amount of cash to fulfill daily cash transactions. Also, the trend in advances has been increasing while the investment portion remained more or less constant.
Although FABL has a small market share in terms of assets (3%), it is constantly increasing its deposit rate to attract customers. Further innovation in product line is needed for the market share enhancement.
FABL has around 3.2% of the total loans of the sector. The following was the composition of the loans (Financing) in 2006:
-- 41% Bills discount (less than 3mth) 21% Short-term loans (greater than 3mth and less than 1 yr)
-- 33% Medium term loans (greater than 1 yr and less than 5 yr)
-- 5% Long term loans (greater than 5 yr)
42% share of Bills discount is in line with the industry trend. Larger Bills discount signify lower default risk in case of loans along with lower liquidity related issues. Advances for FABL are not typical loans that most of other banks offer. Instead FABL offers financing such as margin financing, reverse repo agreements, Ijara financing and lending to financial institutions.
FABL portfolio of consumer loan comprises the following:
1. Mortgage Loans- offered at floating rate of 1 yr KIBOR+5%
2. Auto Loans- offered at a fixed rate of as low as 14.99%(3 yr) to as high as 15.99% (5-yr)
3. Personal Loans with the following options:

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Secured (floating rate)
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Against property             7% plus 6 month KIBOR
Against cash collateral      4% plus 6 month KIBOR
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Considering the tight monetary policy and the political factors into consideration, auto loans are by far the most attractive loans amongst the loans offered by FABL. This is because FABL offers car financing at a fixed rate with three flexible options. From the point of view of the bank, mortgage loans are favourable to offer as they offer floating rates and with SBP's tight monetary policy in place, FABL can derive higher interest income through these loans.
But, a tight monetary policy stance has also been a little unfavourable to FABL as non-performing loans have increased since a very large number of consumers defaulted mainly to high interest rates. As a result, loan loss provisions have also increased in 2006.
Government securities form the major portion of investment portfolio for FABL. This shows lesser volatility in the bank's income with a continuous stream of payments. Asset composition is gradually shifting to investment side, which means that idle cash is being utilized efficiently while generating investment incomes as well.
Surprisingly, Net Interest Revenue (NIR) forms a smaller part of the FABL's revenue account as opposed to other players in the industry. However, that is not a major concern for the bank since its Net Interest Margin (NIM) has been improving. Lower NIM in 2005 can be attributed to the larger provisions made for NPLs which significantly depressed the Net Markup Income for the bank. Net Interest Margin (NIM) is also on a lower side as compared to the industry owing to a smaller branch network and higher deposit rates that FABL has to offer, thereby increasing the mark-up expense.
Lower NIR can be attributed to the high trading income for the bank. Amongst the largest four banks ie MCB, NBP, HBL and BOP - FABL has the highest trading revenue. Subsequently dividend income from NIT investment is the largest component of FABL's Non-interest Revenue. On the other hand, fee income contributes around 11% while capital gains on equity are insignificant.
Trading gains have decreased over the years as FABL's interest income started increasing. Thus, FABL is relying more on spread income than the trading as most of the loans are at a floating rate. Thus, a tight monetary policy has been favourable to the bank so far as it has spurred growth in spread as well as profit margins.
Being a smaller bank with a small network, the costs for FABL are on a lower side. The administrative and operating expenses are the lowest amongst the top 5 banks, which includes salaries of employees (major constituent), charges related to branch operations.
The overall risk profile of the company has increased as Non-performing Loans have decreased. Also, the interest coverage ability of FABL is very weak as the rates on deposits are higher. Furthermore, the asset quality of the bank has a relatively less risk exposure as FABL opts for investment in its asset portfolio unlike loans found in other major banks. Although, the capital adequacy ratio improved for FABL, it hovers around 13%, which is still below the Minimum Capital Requirement consideration. Due to its smaller size, FABL has been a borrower in the interbank market. The proportion of funding for FABL is highest amongst NBP, MCB, UBL and HBL.
The return on assets has depressed over the years as FABL is constantly struggling to increase its deposits base. As a result, the bank has to offer higher rates to attract customers, thereby increasing its costs and decreasing its overall profit. Moreover, the high base effect has also played a significant part in lowering the ROA. ROE has followed the same trend and has declined considerably in 2006.
Future outlook: SBP stressed further tightening of monetary policy in its recent statement by raising the discount rate by 50bps to 10%. This has increased KIBOR and T-bills rates which in turn pushed the banks lending rates upward. Therefore, a rise in lending rates is also expected to cause a slowdown in credit demand.
Zero rating of CRR for all deposits of one-year and above maturity (to encourage greater resource mobilization of longer tenor) and 7% CRR for other demand and time liabilities is the second major provision of the recent monetary policy. This move is in line with SBP's previous efforts to encourage longer-term deposits and gives an incentive to banks to seek deposit growth in longer tenors. Such deposit growth will have the consequence of higher deposit costs. The two measures are expected to have a balancing impact on the banking sector. The discount rate change is likely to be favourable for banking spreads whereas CRR change is expected to squeeze spreads.
Export Finance Scheme has been modified to allow for a phased transformation. SBP shall allow 70% refinance against such limits while the balance 30% shall be funded by the banks out of their own resources. This move is expected to put further pressure on banks especially smaller banks such as FABL to raise deposits.
All banks are now required as a minimum to open 20% of their new branches in rural/underserved areas. This move is likely to hamper deposit growth rather than increase outreach in rural areas. Most urban-centered small banks lack the capacity to open branches in rural areas and this move will limit their growth in urban areas as well.