ABN Amro Bank (Pakistan) Limited (AABPL) is a newly 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 licence from the State Bank of Pakistan.
While the Prime Commercial Bank Limited was incorporated on September 30, 1991 as a public limited company. On March 5, 2007, ABN Amro N.V entered into an agreement to buy 93.4% stake in Prime Commercial Bank Limited, later it offered to purchase the remaining stake in the bank. AABPL is a majority owned subsidiary of ABN Amro Bank N.V., Amsterdam. ABN Amro Bank N.V. held a total of 99.22% shareholding of the bank as at December 31, 2007.
After the amalgamation, AABPL became the second largest foreign bank as it was able to expand its local operations with a network of 82 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.
The last quarter of 2007, brought about more significant changes in the ownership structure of the bank as on the global front, ABN Amro Bank N.V was acquired by a consortium led by The Royal Bank of Scotland. ABN Amro Bank (Pakistan) Limited would be renamed as 'The Royal Bank of Scotland Limited' in the next few months.
BANKING INDUSTRY (FY07) The banking industry witnessed a volatile movement in 2007 in terms of profitability, with every quarter depicting a different picture as shown in the graph below. The total profitability improved from first quarter to the second, but after amendment in the SBP's regulation regarding NPLs and FSV, the banks became more prudent in lending and total profitability declined in the following two quarters. Likewise, AABPL also revised its credit policy.
Non interest income grew significantly by 43% during the period under review. The net interest income earned by the banking sector in FY07, also posted a growth of 17.4% and reached at Rs 203 billion as compared to Rs 173 billion in FY06. The major reason for this growth was the high level of spreads throughout the year, which remained at 7.29% on average, despite further tightening of the monetary policy by the SBP in July 07. The SBP raised discount rate by another 0.5% in January 2008, raising its benchmark policy rate to 10.5%. The lending rates increased while the banks maintained the deposit rates.
The increasing lending rates not only deteriorated the debt servicing capacity of borrowers (both corporate and the consumers) but also subdued the credit demand by the private sector resulting in slower advances growth. Also, the country's large scale manufacturing activity slowed down. Due to this, the banks are shifting from advances to investments as the key source of funds/income for the bank. On the flip side, the asset quality of the banks has been improving through strict policies and effective credit management.
There is also a trend of growing consolidation in the banking sector, in order to meet the Minimum Capital Requirement set by the SBP. However, ABN Amro Bank N.V- Pakistan merged into and with Prime Commercial Bank Ltd. not to meet the MCR regulation but as a move to enter the middle market which includes private firms, smaller listed companies as well as new and expanding businesses. Prior to the acquisition, the ABN Amro had large corporate and consumer business but lacked in the middle business area. AAPBL, however, will face tough competition with other big players in the industry
FINANCIAL STATEMENT ANALYSIS (FY02-FY07) ABN Amro Bank (Pakistan) Ltd. showed a rising trend of profitability over the years and in 2006, the bank earned a considerable profit of Rs 2.4 billion. However in 2007, the acquisition year, the bank made a loss of Rs 1.56 billion. The bank went through significant changes during the year and its overall performance was impacted during the merger.
The merged entity's loss before tax for FY07 was Rs 1.37 billion (including the PBT of ABN Amro N.V-Pakistan Branches reported up to 31 August 07 and LBT (of Rs 2.8 billion) of the new merged entity - ABN Amro Bank (Pakistan) Ltd for the year ended 31 December 2007).
A quarter-on-quarter analysis reveals that AABPL's PAT decreased gradually during the whole year and during the last quarter of 2007, when the merger became effective, the bank made a colossal loss. The deteriorating profits of the bank can be attributed to the changes in the bank's consolidation and the management's preoccupation with it.
However, the main reason the bank incurred losses for the year 2007 was a huge increase in provisioning in line with the SBP's directions regarding FSV. AABPL made adequate provisioning against its advances portfolio. Due to this specific loan loss amounting to Rs 3.78 billion against non-performing loans was recognised as against Rs 861 million in the year ended December 31, 2006. The total provisions increased by 350% amounting to Rs 1,358.226 million. Therefore, despite an increase in the net interest margin by 4.82% from 06 to 07 the increased provisions caused the net interest income after provisions to decrease by 54% in 2007 compared to 2006.
Also the total non-interest income decreased, resulting mainly from a Rs 298 million loss on sale of the government securities - Pakistan Investment Bonds (PIBs) - and some listed shares.
As the total income decreased in 2007, an increase in total expenses by 51% surpassed the income earned by ABN Amro Bank (Pakistan) Ltd resulting in a loss for the year 2007. Major increase was seen in the administration expenses mainly because the bank was newly merged and had to spend considerably on growth initiatives, integration and alignment processes.
All the earning ratios of the newly merged entity- ABN Amro Bank (Pakistan) Ltd. show a dismal picture because of the loss made by the bank in 2007. As a result, the earning per share for the year-ended fell from Rs 1.78 to Rs (1.16).
Taking into account the ongoing consolidation and rationalisation of certain investments and advances portfolio, the net advances and investments of the bank witnessed a 10% and 36% decline respectively, thereby reducing the earning assets of the bank considerably. This has hampered the income of the bank and the bank was unable to maintain its solvency ratios in the post merger period. It is not clear whether the solvency situation will be improved.
This decline in earning assets coupled with a decrease in cash and balances with the treasury further lowered the total assets of the bank in 2007 by 13%. The bank has increased its authorised capital (by issuing 800 million ordinary shares of Rs 10 each) as approved by the members in an EOGM held on July 27, 2007. Despite this the equity base of the bank decreased by 41%, due to negative reserves and loss made during the year 2007.
Deposits of the bank decreased by Rs 3.453 billion in 2007 compared to 2006 despite an 8% growth in deposits witnessed during the Q3'07. The fixed deposits and saving deposits fell by 3.8% and 0.25% respectively, while the current accounts increased by 1.7% in 2007. With total advances of Rs 64.468 billion, Rs 4.49 billion were placed under non-performing advances status in FY07, which were 122.7% more than the previous year of Rs 2,016.839 million.
Thus, due to the increased NPLs, provisioning and reduced advances, there was a significant increase in all the asset quality ratios of the bank. The average NPL to advances ratio of the top 5 firms is 0.01 while that of AABPL is 0.07. This shows that AABPL needs to manage its credit risk tactfully. On the flip side, the bank seems to be already working on improving its asset quality as it revised its credit policies and procedures (which is also believed to have resulted in the decrease in advances for the year 2007).
The debt management of AABPL seems to have worsened as the debt ratios have increased. Even though the liabilities of the bank have decreased due to reduced borrowings and deposits by 11%, the equity and assets base of the bank have also deceased during the same time period for above mentioned reasons. The net assets have decreased (by 41%) more than the deposits (4%) explaining the rise in deposit times capital.
The bank has been able to maintain its earning assets-to-asset ratio at 0.82 in 2007 in line with the industry trend. However, the main driver is declining assets base rather than increase in earnings assets. AABPL's advances form 73% of the total earning assets. Investments are 19% and lending to financial institutions constitute just 8% of the total earning assets. AABPL must expand its advance portfolios and consider efficient portfolio diversification. It should also consider investments as a source of income.
The ADR was went down from 0.77 to 0.71 from 06 to 07, as the declining deposits (3.7%) lagged the declined in advances (10%). This shows that AABPL's liquidity position has gone down when compared to its liquidity position in the prior years. However, with ADR above that of the industry (0.68 in FY07), it is still in a comfortable situation to guard against any credit risks. The yield on earning assets was 0.02 in 2006 but has become negative (-0.02) in 2007 due to a loss incurred by the bank.
BUDGETARY IMPACT The "accumulated loss" of an amalgamating banking company could be set-off or carried forward against the business profits and gains of the amalgamated company up to a period of six tax years. This is expected to bode well for the M&A activity in the sector. Tax treatment of provisions for classified advances and off balance sheet items, allowing deduction on account of NPLs as per prudential regulation shall induce banks to either improve their recovery process or write-off the NPLs. Though the said change won't impact accounting earnings, it shall increase the cash taxation of banks from next calendar year.
Availability of Govt. Commercial Paper for maturities of 3 months, 6 months and 1 year, from commercial banks along with a 2% upward adjustment and quarterly revision in NSS rates shall further increase the attractiveness of these competing instruments and could significantly enhance competitive pressures and suck liquidity from the banking system. It might result in disintermediation of resources by attracting low cost current and savings deposits. It will drive up yield on short-term saving account deposits. It could also cause shifting of current deposits to savings deposits, especially if yields get very attractive. The burgeoning competition would further result in narrowing spreads and slower deposit growth.
The enhanced rate of FED from 5% to 10% on banks' fee-based services is largely neutral as the same shall be passed on to the end-customers. Similarly, WHT on cash withdrawal from banks enhanced from 0.2% to 0.3% is likely to have a neutral impact.
FUTURE OUTLOOK The recent DR hike to 13% and 100bps increase each in CRR and SLR to 9% and 19% respectively would firmly restrain credit expansion while making banks to struggle for liquidity, which had already started to become scarce. Despite the contractionary monetary policy stance of SBP, gross advances of the banking sector during 1HCY08 have shown a growth of 11%.
The persistent rise in inflation witnessed due to exogenous and endogenous shocks have meant that despite a rise in nominal interest rates, real lending rates in the economy have been negative. Another factor of the rise in advances is the increase in working capital financing due to rising input costs. Moreover, the latest data reveals that the banking spread has increased by 20bps to 7.34% in May 2008 compared to 7.14% in December 2007. However, the imposition of 5% minimum deposit rates on interest bearing checking accounts from July-08 onwards could squeeze NIM and result potentially higher credit costs (due to asset quality deterioration), thereby potentially trimming net interest income and reducing banking sector's profitability.
The bank is in the final stage of merger and the process of integration and alignment has reached near completion. The bank made a loss this year, but it expects to make future gains from its new vast network of branches and improved products and services. The bank is expected to diversify its advances portfolio and intends to enter the Pakistan's fast growing SME segment. It will be greatly helped by Prime Commercial Bank Limited's strength and established client base in the SME segment.
The bank is expected to use its expanded branch network to increase its deposits. It will focus on increasing current and saving deposits because they are low cost deposits and the bank needs to improve its overall cost structure. Another positive sign for the bank is the decision of the Royal Bank of Scotland to retain ABN Amro's operations in Pakistan. The credit rating of the bank has also increased and this shows the strengthened position in the local banking industry.
The bank can expect better results in the future by focusing on its Islamic banking as the Islamic banking sector is experiencing robust growth. AABPL has three Islamic branches and it intends to open more. In 2007, the bank's NPLs resulted mainly from the advances portfolio of Prime Commercial Bank Limited and the consumer loans of ABN Amro N.V Pakistan Branches. However, the bank has made a provision of more than 88% against total NPLs. Thus, the future profitability of the bank will not be impacted so greatly in the future. COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for Business Recorder.
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