HBL was the first commercial bank established in Pakistan in 1947. Over the years, the bank has expanded its branch network and has become the largest private sector bank. Its customer base currently exceeds five million. HBL also has a presence in 25 countries with subsidiaries in Hong Kong and the UK and affiliates in Nepal and Nigeria.
HBL's major area operations encompass product offerings and services in retail banking and, recently, consumer banking as well. HBL has the largest corporate banking portfolio in the country with a dynamic investment banking side. SME and agriculture lending programmes and banking services are offered in both urban and rural centres. HBL is expanding its presence in international markets such as the UK, UAE, South and Central Asia, Africa and the Far East.
THE BANKING INDUSTRY FY08
In the last quarter, the banking system successfully weathered a liquidity stress. The stress emerged in usual timeframe, ie, withdrawals on Eid-ul-Fitr and a number of global, domestic and industry specific factors further compounded it. Major dampening factors like global financial turmoil, economic slowdown and contractionary monetary policy were compounded by an unusual liquidity stress during October-November 2008. The current account deficit was quite high and the real exchange rate had significantly appreciated to unsustainable levels which ultimately put pressure on PKR/US$ exchange rate and led to capital outflows.
On top of it, breakdown of capital market in Pakistan and the series of news on the financial meltdown in the advanced markets raised general public doubts about the financial strength of some Pakistani banks. By this time, due to relatively higher growth in advances, the liquidity profiles of the banks had already been burdened. In this backdrop, the usual post-Eid liquidity pressure in interbank market led to rumour mongering about the banks. The impact was severe in some banks especially the small banks with the constrained liquidity profile in terms of ADR.
The reduction in Cash Reserve Requirements (CRR) and Statutory Liquidity Requirements (SLR) requirements in early weeks of October 2008 to manage the liquidity stress resulted in a significant decline in cash and treasury bank balances by the end of Dec-08 quarter, thus releasing funds for financing the growth of advances. However, strong capacity developed by the banks and regulators over the years and the offsetting measures taken by the State Bank of Pakistan enabled the system to avert this transitory stress from converting into a financial crisis.
INVESTMENTS
The investments, especially the Government papers, which declined in both absolute rupee terms as well as a proportion of total assets during the first nine months of CY08, registered a slight increase during the last quarter. Actually, the heightened credit risk on account of deterioration in macroeconomic fundamentals and already constrained liquidity profile induced the banks to shift their preference towards risk-free Market Treasury Bills (MTBs).
The banking system is marked with a high concentration as a fewer number of banks hold a major share of the system's total assets and deposits. This concentration has been following an overall declining trend as the medium sized banks gradually gained market share. However, due to unusual liquidity stress that affected mainly the small and medium sized banks, the market share of five large banks inched up to 52.4 percent (51.3 percent in Sep-08).
DEPOSITS
The deposit component, which used to witness a strong growth in last quarter, registered a slow growth of Rs 153 billion (3.8 percent) this year. Incidentally, foreign remittances, a key factor behind the recent year's strong growth in deposits, maintained the momentum and grew by 17 percent over the CY08. The industry has been witnessing a gradual shift in deposits from savings to term deposits for quite some time.
This trend emerged largely in response to SBP's policy incentives to encourage the mobilization of long term deposit so as to reduce the maturity mismatches. Consequently, fixed deposits gained a significant share of savings deposits since 2004. However, the SBP's policy drive to increase the CRR and SLR in last week of Jun-08 and exemption of long-term deposits also from SLR requirements during the last quarter seem to have considerably invigorated this trend (Other factors like general rise in interest rates and innovative deposits scheme have also augmented depositors preference for terms deposits)
ADVANCES
During the quarter under review, advances witnessed a significant slowdown in sharp contrast to industry's established patterns for the last quarter. The worsening business and economic environment somewhat increased the credit risk, which compelled the banks to adopt cautious lending strategy, particularly in consumer sector where the advances have been decreasing since the start of CY08, some new loans have been issued of which a significant portion was disbursed to public sector enterprises (PSEs).
CY08 however observed a deviation in the growth pattern of advances. Slackness in the demand for bank credit during CY07 coupled with slowdown in economic activities and tightening of monetary regime, forced the banks to reposition their lending strategy and asset profile. The asset mix of the banking system gradually shifted from lending to investments during the first three quarters of CY07.
PROFITABILITY
Currently, the cumulative profit of 22 listed commercial banks has declined by 21% to Rs 50.3bn in 2008 as compared to Rs 63.6 billion in the same period in 2007, mainly due to higher provisions for non-performing loans (NPLs) and impairment loss. The full year profits of CY08 were lower than the profits of the last couple of years but still it remained profitable.
The overall profitability was neutralizing due to more than proportionate increase in operating expenses and provisioning for loan losses. In absolute terms, expenses increased by 33.4 percent to Rs 235.8 billion in CY08, which affected the overall profitability of the system. In addition to higher provisions, enhanced branch network with increased human resource base has soared the expense of the system during the last quarter under review. Moreover, stock market crash in the second half of 2008 resulted in bank recognizing impairment loss of Rs 12 billion as against only Rs 287 million recognized in 2007.
High spreads of 7.29% in 2008 and strong advances growth of 19% supported the net interest income, while non-interest income increased by 11% on the back of surge in exchange gain as rupee remained volatile against the dollar. The annual audited results of the top five banks for the year 2008 show that their profitability on average has remained at the previous year's level. The assets distribution on the basis of ROA shows that 16 banks, holding 67.9 percent market share, have ROA of one percent and below.
The banking sector in Pakistan has remained somewhat insulated from the global financial turmoil and has maintained its profitability albeit the slower growth. The prevailing global economic downturn nevertheless has the potential to impair corporate and business profitability that may ultimately heighten the credit risk and may affect the earnings of the banking sector in the quarters ahead.
NPLS
This rise in NPLs observed across all the banking groups except specialized banks, where NPLs have actually decreased. NPLs have been on the rise mainly due to poor economic performance of the economy and the FSV benefit therefore resulting in worsening of asset quality ratios. Total provisions for NPLs surged to Rs 53 billion in 2008 as against Rs 42 billion in 2007, an astounding growth of 27% largely due to slowdown in economic growth. The composition of segment wise NPLs of the banking system shows that infection ratio of all the segments except agriculture have increased.
The infection ratio of consumer finance portfolio increased in CY08 (2.3 percent over the year). Rising inflation and contained disposable incomes coupled with increasing lending rate have reduced consumers' appetite for credit as well as their repayment capacity, resulting in increasing defaults rate in the consumer finance. Interestingly, in the wake of economic slowdown, banks seem to facilitate the businesses through rescheduling/restructuring of loans, the textile sector being the major beneficiary.
Latest banking industry numbers show an effort to keep balance sheets clear of NPLs by recognizing and providing for NPLs on criteria that are more stringent. This approach might look costly in the meantime but in the long run it will definitely benefit banks by providing a cushion to withstand losses.
RECENT PERFORMANCE
In FY08, year ending December 2008, the bank realized an income (profit after tax) of Rs 15.614 billion which is 55% higher than previous year of Rs 10.084 billion in FY07. The profits before tax grew by 45% over previous year. The difference of percentage points in growth between before tax (45% growth) and after tax (55% growth) is due to deferred taxation.
The interest income earned during this time was Rs 65.305 billion which is 25% higher than the previous year. But to match this, interest expense was higher this time as there has been a minimum floor of 5% return on all types of deposit accounts.
This measure has added to costs of interests so much so that interest expense has been 38% higher this year. Previously banks have saved a lot due to no protection of consumers on the returns. Furthermore, the returns on NSS (National Savings Schemes) have also increased as part of tight monetary policy. These higher rates on NSS gave strong competition to deposits and also huge drains from the system. The net mark-up has grown up by 17% this year, shows a positive indication despite the below average economic performance in FY08. The total provisions were 13% higher this year, details are discussed later.
Non-interest income was up by a significant 63% owing mainly to fee and commission and income from dealing in foreign currencies. Both categories of non-interest income experienced 32% and 63% growth respectively. Another notable non-interest income was from investments in associate firm namely Platinum Habib Bank in which the bank has almost 6.28% holding. The gain from this associate company amounted to Rs 4 billion owing from dilution. The non-interest expenses swelled up by 21% in total chiefly due to increases in administrative expenses and other charges. Administrative expenses (increased by 17%) were high as the economy faced double digit inflation rates so its adjustments in salaries of employees add to costs.
ANALYSIS OF FINANCIAL PERFORMANCE - DECEMBER 2005 - DECEMBER 2008
The earnings profile of the bank shows a declining trend. Up to 2006 the profitability of the bank was slowly increasing and gained momentum in FY08 after a dip in FY07. However, with the coming in of SBP's rule for full provisioning of the NPLs and removal of the benefit of the forced sales value in 2007, the provisions expenses of the bank increased that lowered its profitability. The provisions of the bank increased by almost massive 4 times in this year.
In FY08 the profitability as a percentage of assets and equity has been on the rise due to base effect; the profitability rose by more than proportionate than assets and equity thus increasing the ROA and ROE ratios. It has to be borne in mind that there has been numerous factors at play which drastically changed the industry dynamics over the years with NPLs and the SBP's policies on top of the list.
Nevertheless, in FY07 the interest earnings of the bank have been increasing throughout the years and so have been its mark-up interest expenses. Interestingly, the mark-up interest expenses of the bank have been quite less as compared to its interest earnings, thus accentuating its net interest earnings. The main contribution to the profit of the bank comes from its net interest earnings although the non-interest earnings are also quite a significant contributor. Of these, the fee, commission and brokerage income takes the highest share. The company launched its credit card at the end of 2007.
Since the potential in the market for credit cards is very high, the company may be expected to compete successfully in the market, especially seeing its large customer base. This source may become an important and potent source of revenue for the bank. Hence, the profitability of the bank may improve in the future, especially as the banking industry starts absorbing the effect of the full provisioning requirement and starts recovering in the near future. However, this may not be so quick a process as the NPLs of the industry are on the rise. Unless these are contained, the provisions may continue to reduce the profitability of the banks.
This graph suggests well-managed assets. The NPLs of the bank have been declining till FY07; a significant surge is seen in FY08. The bank has been stringent in its policies indicating that it's protecting itself from exposures to poor customer. In the year under review the bank experienced the highest ever NPLs growth of 45%. Industry (top 5 banks) wide NPLs growth has been close to 34%. With the right policies in place bank is likely to recover from this daunting problem.
The above graphs compare two types of advances in 2007 and 2008. The composition of short term advances has increased whereas that of the long term advances has decreased once again, this trend has continued since FY06. More short term advances in turn mean that the returns of the bank come in quickly and they are recovered much earlier than long term advances. With prudent policies in place and earlier advances recovery translates into lesser NPLs and hence a better asset quality. However, the bank may be advised to be cautious, as short term is riskier than long term due to interest rate fluctuations. Another trend was seen industry wide that in order to avoid NPLs banks are helping troubled borrowers by re-scheduling their loans.
The liquidity profile of the company shows good signs as most of the ratios have been increasing. Earning assets (advances, lendings to financial institutions and investments) of the company have been within a safe range over the years. In FY07 the lendings to financial institutions of the bank have been decreasing whereas the investments have witnessed a major increase that has led to an overall increase in the earning assets of the bank. The reverse repo transactions of the bank have decreased tremendously by about 75%. This has injected liquidity into the bank. Moreover, the investments have been made mostly in the government securities.
Keeping in mind the current downward trend of the stock market, investment in the government securities would protect the bank from the fluctuations being experienced by the stocks. It's also important to note that advances increased and contributed more to earning assets in FY08 with a little share from lendings to financial institutions. As can be seen, the cost of funding the earning assets is much below that of the yield on the earning assets, leaving a large net interest margin for the bank. The cost of funds rose due to a minimum 5% deposit rate at all types of accounts. This means a pure addition to the cost of funds. The bank has maintained an ADR of 76%, which is in line with the guidelines of the SBP.

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                                                               Growth  % of total
DEPOSITS                                                        since    deposits
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Customers                                   2007         2008    2007      (2008)
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Fixed deposits                       142,718,688  186,206,978     30%         31%
Savings                              194,299,616  198,303,889      2%         33%
Other savings account                 72,663,620   72,936,177      0%         12%
Current Account Remunerative           1,672,810    2,739,417     64%        0.5%
Current Account Non-Remunerative     109,089,044  130,326,871     19%         22%
Fin.Inst - Remunerative deposits       6,477,822    2,368,970    -63%        0.4%
Fin Inst - Non-Remunerative deposits   4,376,527    4,208,243     -4%          1%
                                     531,298,127  597,090,545     12%
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The deposits form an important part of funds for the banks which later pass on to other consumers in the form of advances and investments. The deposit policies used to be monopolized for last few years where depositors were never protected against increases in inflation or any given any other benefit accruing from competition. It was due to State bank of Pakistan's stance that confirmed a minimum of 5% of returns on all types of deposits. This move was important as competing forms of deposits like National Savings Schemes were offering better rates and they did drain huge chunks from banks.
In FY08 the deposits of HBL grew by 12%. This year it's apparent that fixed deposits (30% growth) were on the lead after current accounts growth of 64% over previous year. On a close analysis we see that only fixed, savings and Non-remunerative current account forms a major part of the deposits. The solvency profile of the bank shows bright long run growth prospects for the bank. All the ratios are on the rise. The earning assets to deposits ratio is increasing which means that the earning potential and revenue generation of the bank are increasing. Since the yield on the earning assets has been increasing, the increasing earning assets mean even more revenue generation. Moreover, this may also indicate that the bank in case experience a run on its deposits, it has cover and protection available to manage itself under such a condition.
Since the bank became public only this year, its market value is as shown. Since the IPO was oversubscribed and investors had the confidence in HBL, a good market price was achieved. In FY08, the market crashed down and remained closed for most of the time in last quarter. The price of share is lower as compared to previous year but it does not reflect any of the management's performance.
FUTURE OUTLOOK
The global financial crisis has its effects trickling down to our banking systems. The financial sector is facing its lows but still on a comparative basis its better than other neighboring countries owing to regulations and the role of SBP to take timely corrective measures. Measures include relaxation of CRR and SLR in phases. The banking sector's spread continues its rising trend after witnessing a dip to the level of 6.78% in June 2008 that has being taken as an after effect of minimum profit payment of 5% on saving accounts. The profits show that long term investment in Pakistani banking system will be lucrative as the assets quality is quite satisfactory.
As against the worldwide trend of low interest rates even zero-rated, Pakistan continued to follow stance of tightening of the monetary policy using the high interest rate as a tool to contain inflationary pressures at the cost of stalled economic activities. It can be noted that SBP already charging lower mark-up rate from exporters against export refinance facility under EFS in order to enable them to become competitive in the international market. The trade and industry however feels in order to ignite a spark in the dull and dreary economic conditions and to come out of the persisting recession the incentive of low interest should have been given to all stakeholders across the board to achieve the desired results.
Some market expectations were that current discount rate at 15% is too high and we recently saw a reduction of 100 basis points. In fact, the cut in the interest rate was long overdue as done by other economies elsewhere as well as in the face of stability returned into macro situation under the IMF program. Trade experts feel that in current times low cost credit is vital to stimulate the economy and international trade. Pakistan exports have a combination which can be well suited to the current world economic situation, ie low value added goods have Income elasticity's and are least likely to be affected the economic slowdown.
Challenges faced by the economy, in general, and banking sector, in specific, include restrained liquidity, slow down of economic activity, and high inflation. Despite of these issues HBL has been able to maintain its profitability and only concern is of the higher NPLs growth, which has to be checked as it has surpassed to alarming levels. Besides this, the bank is equipped to face challenges with its dynamic management and trained workforce.
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].