analysis of capital structure and dividend policy of bank al

8/4/2019 Analysis of Capital Structure and Dividend Policy of Bank Al

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SUBMITTED BY:

MARYA QURESHINIDA FAREED

SAADIA BAIG

BBA VI-I

DATE OF SUBMISSION: 11

APRIL 2010

5/10/2010

ANALYSIS OF CAPITALSTRUCTURE AND DIVIDEND

POLICY OF BANK AL-FALAH2005-2009


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ANALYSIS OF CAPITAL STRUCTURE AND DIVIDEND POLICYOF BANK AL-FALAH 2005-2009

2

Table of Contents

Table of Contents ....................................................................................................... 2

ABOUT BANK ALFALAH ............................................................................................... 4

PART I: Capital Structure of Bank Alfalah ....................................................................5

MINIMUM CAPITAL REQUIREMENT: .......................................................................... 5

CAPITAL ADEQUACY: ............................................................................................... 7

OPTIMALITY OF CURRENT CAPITAL STRUCTURE (MCR & CAR) .................................9

Part II: Financing Sources ......................................................................................... 10

WHAT ARE THE FINANCING SOURCES FOR BANK ALFALAH ................................... 10

FACTORS IMPORTANT BEFORE DECIDING FINANCING SOURCE FOR

PROJECTS/ASSETS ................................................................................................. 10

ADVANCES/ DEPOSITS IN THE LAST 5 YEARS ........................................................ 11

PART III: Dividend Policy ........................................................................................... 11

DIVIDEND POLICY ................................................................................................. 11

FACTORS IMPORTANT FOR DIVIDEND PAYOUT: ..................................................... 12

DIVIDEND PAYOUT IN THE LAST 5 YEARS ............................................................. 12

REASONS FOR INCONSISTENT PAYOUT ................................................................. 12

LOW PAYER OF DIVIDEND: ..................................................................................... 13

OPTIMAL DIVIDEND PAYOUT STRUCTURE: ............................................................. 14

PART IV: COMPARISON WITH COMPETING FIRMS ...................................................... 14

a) CAPITAL STRUCTURE POLICY: ............................................................................ 14

b) DIVIDEND POLICY:............................................................................................. 15

PART V: SUGGESTIONS AND RECOMMENDATIONS ................................................... 17

APPENDIX ................................................................................................................. 18


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ACKNOWLEDGMENT

We offer our thanks to Mr.Ghulam Qadir, Deputy General Manager

(Finance)at Bank Alfalah for giving us valuable interview timeand answering the questions related to our assignment.

Moreover, we would like to thank Ms Sana Tauseef whose

encouragement, guidance and support at all levels enabled us to

develop an understanding of the subject and make this

assignment possible.

Lastly, we offer our regards and blessings to all of those who

contributed data over the internet and made them publicly

available.


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ABOUT BANK ALFALAH

Bank Alfalah Limited was incorporated on June 21st, 1992 as a public limited

company under the Companies Ordinance 1984. Its banking operations commenced

from November 1st, 1997. The bank is engaged in commercial banking and related

services as defined in the Banking companies ordinance, 1962. The Bank is

currently operating through 195 branches in 74 cities, with the registered office atB.A.Building, I.I.Chundrigar, Karachi.

Since its inception, as the new identity of H.C.E.B after the privatization in 1997, the

management of the bank has implemented strategies and policies to carve a

distinct position for the bank in the market place.

Strengthened with the banking of the Abu Dhabi Group and driven by the strategic

goals set out by its board of management, the Bank has invested in revolutionary

technology to have an extensive range of products and services.

This facilitates employees commitment to a culture of innovation and seeks out

synergies with clients and service providers to ensure uninterrupted services to its

customers. They perceive the requirements of their customers and match them with

quality products and service solutions. During the past five years, they have

emerged as one of the foremost financial institution in the region endeavoring to

meet the needs of tomorrow today1.

1 www.bankalfalah.com.pk


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PART I: Capital Structure of Bank AlfalahThe capital structure of banks are analyzed and maintained through Minimum

Capital Requirement (MCR) & Capital Adequacy Ratio (CAR). This is according to

State Bank of Pakistans requirement.

MINIMUM CAPITAL REQUIREMENT:

The Minimum Capital Requirement is the minimum level of security below which the

amount of financial resources should not fall. When the amount of eligible basic own

funds falls below the Minimum Capital Requirement, the authorization of insuranceand reinsurance undertakings should be withdrawn, if those undertakings are

unable to re-establish the amount of eligible basic own funds at the level of the

Minimum Capital Requirement within a short period of time.2

During the last few years, the MCR requirement of the bank has been subject to

change. Following is the MCR requirement as per that particular year and the MCR

maintained by the bank.

(Figures are in 000)

This can be shown in the graph below

2http://www.minimum-capital-requirement.com/

Year 2005 2006 2007 2008 200

MCR Rs2,000,000

Rs3,000,000 Rs4,000,000 Rs5,000,000 Rs7,000,00

CapitalMaintained

Rs6,738,063

Rs10,572,605

Rs13,776,673

Rs14,608,523

Rs19,770,26
http://www.minimum-capital-requirement.com/http://www.minimum-capital-requirement.com/


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It can be analyzed from the graph above that Bank Alfalah fulfilled its

Minimum Capital Requirement by State Bank of Pakistan.

Capital growth was maintained from 2005 to 2007 at a constant rate.

In 2007, the growth rate was slowed down because of SBPs requirement of

only Rs 5 Billion in the next year whereas the bank had already achieved Rs

13.77 Bn. Hence the growth rate was slowed down in 2007.

In 2008, because of financial meltdown across the globe, SBP wanted to

strengthen the solvency of banks. Therefore, a new notification was sent toall banks. This is as follows (BSD Circular No.19)

Minimum Paid up Capital Deadline by which to beincreased

Rs 5 Billion 31-12-2008

Rs 6 Billion 31-12-2009

Rs 10 Billion 31-12-2010

Rs 15 Billion 31-12-2011

Rs 19 Billion 31-12-2012Rs 23 Billion 31-12-2013

According to this list, all banks were required to increase their minimum capital by

Rs 23 Billion by Dec 2013. Bank Alfalah was equally affected by this notification and

in order to meet up that requirement, Bank Alfalah drastically increased its Capital


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through issue of bonus shares and rights issue, increasing the shareholders equity

by 1.499 Billion and 3.9975 Billion respectively.

CAPITAL ADEQUACY:

Capital adequacy ratio also known as capital to risk (weighted) assets ratio

(CRAR).It is a ratio of banks capital to its risk. This ratio is used to ensure that bank

can absorb a reasonable amount of loss and they comply with their statutory capital

requirements.3

For the last five year period, CAR maintained by Bank Alfalah is mentioned in the

following table:

2005 2006 2007 2008 2009

Total EligibleRegulatoryCapital held

Rs10,652,551

Rs14,823,448

Rs18,309,208

Rs18,178,362

Rs26,700,764

Total RiskWeightedassets

Rs122,982,888

Rs156,446,378

Rs185,836,940

Rs226,321,210

Rs214,250,634

CapitalAdequacy 8.66% 9.48% 9.85% 8.03% 12.46%

All figures in 000

As according to the regulations by State Bank of Pakistan, the following CapitalAdequacy Ratio has to be maintained:

Year 2005 2006 2007 2008 2009

CARrequirement

8% 8% 8% 9% 10%

CARmaintained

8.66% 9.48% 9.85% 8.03% 12.46%

This can be shown in the graph below:

3 www.wikipedia.com


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Bank Alfalah was able to maintain the Capital Adequacy Ratio during the last

five years except in 2008.

The reason as to why Bank Alfalah had a decrease in Capital Adequacy Ratio

in 2008 was:

o From 2007 to 2008, the advances given by bank increased from Rs

171,198,992,000 to Rs 192,671,169,000. This is approximately an

expansion of Rs 20 Billion. Therefore the risk weighted assets of the

company increased. This was positive for the bank as it implies that

the bank expanded.

o From 2007 to 2008, the regulatory capital held almost remained

constant from 18,309,208,000 to Rs 18,178,362,000.

o Therefore regulatory capital as a percentage of Risk weighted assets

declined from 9.85 to 8.03 %

Bank Alfalah was allowed to have Capital Adequacy Ratio less than the

requirement because

o In 2008, the bank also had a rights issue of Rs 10/- per share, bringingin Rs 399,750,000. However, this cash was announced in 2008 but the

money was received in March-April 2009. Due to this difference of

timing, the CAR of 2008 remained at 8.03 % although the effective

CAR was 10.5 %. SBP allowed Bank Alfalah with 8.03 % because the

bank had already announced Rights issue by then. SBP granted an

extension to Bank in meeting the Capital Adequacy Ratio up to March

2009.


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In 2009, the bank had received the money from the rights issue as the CAR

jumped to 12.46 % in that year.

OPTIMALITY OF CURRENT CAPITAL STRUCTURE (MCR & CAR)

Minimum Capital Requirement:

In August 2009, SBP issued another notification which is as follows (BSD Circular

No. 07 of 2009)

Minimum Paid up Capital Deadline by which to be

increasedRs 6 Billion 31-12-2009

Rs 7 Billion 31-12-2010

Rs 8 Billion 31-12-2011

Rs 9 Billion 31-12-2012

Rs 10 Billion 31-12-2013

According to this notification, all the banks in Pakistan have to only maintain Rs 10

Billion by 2013. Earlier on, it was Rs 23 Billion by 2013. Bank Alfalah was increasing

its Capital by heavy proportion but after this new Minimum Capital Requirement, its

current shareholders capital of Rs 19,770,260,000 is more than adequate to meetRs 10 Billion Requirement by 2013.

Capital Adequacy Ratio:

With respect to Capital Adequacy, the current CAR maintained by the bank is 12.46

% whereas the SBP requirement is to maintain 10 %. This is also in its optimal

condition.

SBP can increase the CAR for different banks depending on their operating

standards. It can be increased to 12 % or maximum 14 %. However, Bank Alfalah is

maintaining those standards effectively and even in the worst scenarios, if SBP

increased the CAR for Bank Alfalah, it would not cross 12 %. Even in that situation,

Bank Alfalah would be able to meet the CAR, having 12.46 %. Hence, it can be said

that Bank Alfalahs Capital Adequacy Ratio is currently optimal.


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Bank also foresees expansion in the future which will increase its Risk Weighted

Asset in the future. However, expansion brings profitability as well which will

increase its Capital in a similar trend. Hence, it can be reaffirmed that bank ismaintaining an optimal Capital Adequacy Ratio

Part II: Financing Sources

WHAT ARE THE FINANCING SOURCES FOR BANK ALFALAH

The major financing source for a bank is its deposits. This is because this is the

prime function for which a bank is created. This is the prime source through which

any bank carries out its operation.

The other sources through which the bank finances its activities are Subordinated

loans, borrowings and bills payable etc.

At Bank Alfalah, deposits form the biggest proportion of the liabilities. In the year

2009, out of the total Rs 366,936,635,000, Rs 324,759,752,000 was made up of

deposits and other accounts. Borrowings formed Rs 20,653,921,000 while sub

ordinate loans and Bills Payable were Rs 7,570,181,000 & 3,766,144,000

Respectively.

FACTORS IMPORTANT BEFORE DECIDING FINANCING SOURCE FOR

PROJECTS/ASSETSA bank does not have to primarily consider where it is getting money from to

finance its assets because its financing sources is primarily deposits. Where and

how the deposits are being invested is more important question.

In Pakistan, when a customer deposits his or her money to a bank, the bank has to

deposit 5 % to the bank. With the remaining 21 % out of the 100 %, the bank has to

buy securities from SBP. This leaves 74 % for the operation. With this 74 % Cash,

the bank gives advances which are its prime source of earning income. Also, the

expenses of the bank are undertaken within the 74 % cash. Banks have to

therefore maintain an Advances/ Deposit Ratio.

An Advances/ Deposit ratio of 70 % is considered maximum by Bank Alfalah. State

Bank of Pakistan also keeps a check on this advances/deposit ratio so that it does

not cross a certain limit. Therefore, Bank Alfalah has to consider this before

financing its assets.

Other factors which determine the Advances/Deposit ratio of Bank Alfalah is the

economic condition of the country. If the country is in boom, the bank will be willing


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to give more advances because the profitability on giving advances becomes high

and chances of loan default becomes very low. However, if the country is in a

recession, a low Advances to Deposit ratio is maintained as the demand for loans

decreases and profitability decreases & default rate increases.

Similarly, Bank Alfalah also undertakes a market study of where the competitors are

putting resources and which industry needs the most investment. For example,

these days electricity generation needs the most investment and most banks are

investing in this industry, therefore Bank Alfalah is also investing in this sector.

ADVANCES/ DEPOSITS IN THE LAST 5 YEARS

Bank Alfalah has had the following Advances to Deposit Ratio in the last 5 years:

2005 2006 2007 2008 2009

Advances

Rs118,864,010

Rs149,999,325

Rs171,198,992

Rs191,790,988

Rs188,042,438

Deposits

Rs222,345,067

Rs239,509,391

Rs273,173,841

Rs300,732,858

Rs324,759,752

Advances/Deposits 53.46% 62.63% 62.67% 63.77% 57.90%

According to the Deputy Manager Finance, the bank has maintained an optimalAdvances/Deposit ratio throughout. In 2009, the bank deliberately reduced the

advances/deposit ratio since the economy is in slump. However, as the economy

will recover in the near future, the bank will also increase its Advances to Deposit

Ratio

PART III: Dividend Policy

DIVIDEND POLICY

When asked what the dividend policy of the company is, the Deputy General

Manager replied that when there is adequate profit, there will be dividend

The company gives out a dividend in the form of cash and stock like its competitors

in the market. However, Bank Alfalah has had a greater emphasis on stock

dividends in the past years due to government policies discussed below. Most of the


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banks have to follow this policy of giving out stock dividends to maintain their

minimum capital.

Another thing to be kept in mind here is that the Bank declares the dividends in one

year and distributes them the next year.

FACTORS IMPORTANT FOR DIVIDEND PAYOUT:

For Bank Alfalah, the factors that it considers before declaring a dividend are its

profits for the year and most importantly the minimum capital requirement

imposed on it by the State Bank of Pakistan.

For cash dividends, profits are the most important determinant especially since the

firm is in its expansion phase and continuously needs to reinvest.

In the years 2005-2009, stock dividends have been paid in four out of the five yearsbecause of the need to increase the Banks Minimum Capital Requirement as

pertaining to the State Banks regulations whereas Cash Dividends have been paid

only once.

DIVIDEND PAYOUT IN THE LAST 5 YEARS

The following chart presents the Net income of the company and the dividend

announced in the last five years:

2005 2006 2007 2008 2009

Net income

Rs1,702,09

4

Rs1,762,69

1

Rs3,130,22

9

Rs1,301,30

1

Rs

897,035

Cash Dividend (as

according to year

declared)

Rs

-

Rs

-

Rs

975,000

Rs

-

Rs

-

Dividend payout

(Cash) 0.00% 0.00% 31.15% 0.00% 0.00%

(Figures in000)

It can be seen above that only once in the last five years did the company declare

dividends which was 31.15 percent of the Net income. It can be observed that the

payout is inconsistent in the last 5 years

REASONS FOR INCONSISTENT PAYOUT

There are two reasons for an inconsistent payout:


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i. Firstly, the profit in the last five years has not been adequate enough to giveit in the form of cash dividends except for in 2007. In 2007, Bank Alfalah hada one time windfall income as it sold securities of Warid Telecom worth Rs1788,514,000. Therefore, Bank Alfalah had a comparatively very high overallprofit of Rs 3130,229,000 in 2007 which was nearly double than other years.Rest of the years, the profit was very less to be given in the form of cashdividends.

ii. Secondly, the bank was focusing on raising its shareholders equity in the lastfive years. There were only two ways of doing it. Either through rights issueor through bonus shares. The company cannot ask money from shareholdersevery year so it was increasing the shareholders equity through bonusshares by transferring the net income to its reserve and then issuing bonusshares.

2005 2006 2007

2008 2009

The bank had to focus on increasing shareholders capital mainly due to the

change in the capital adequacy ratio (CAR) and Minimum Capital

Requirement (MCR) by the State Bank in the last 5 years.

LOW PAYER OF DIVIDEND:

Bank Alfalah is a low payer of dividends. They have only paid Rs 1.5 per share in

2007. This is because, after meeting State Banks requirement for minimum Capital,

the bank also has to reinvest as they are still in their expansion phase with another

65 branches planned for next year. This expansion has a high cost for the Bank as

it is still very new and it has only been 12 years to its birth. Hence the land they

acquire will have a higher rental rate or purchase cost as compared to Allied Bank

which is more than 32 years old. Also, the government policies are a tad bit tight

on this relatively new bank hence their payouts have been low for the past years so

as to help them survive the market.

Stock Dividend -

33.33

%

30.00

%

23.00

%

12.50

%


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OPTIMAL DIVIDEND PAYOUT STRUCTURE:

Bank Alfalah considers this dividend policy of cash dividend when profits are

available and the rest stock dividends to maintain minimum capital to be optimal

as it satisfies SBP as well as the investors who do require cash dividends on and off

to be faithful long term investors of this Bank

Till last year the Bank had a minimum capital

ratio of 12.46% against the benchmark of

10% and does not feel the need to give out

stock dividends this year. It plans to give out

cash dividend in the upcoming year since it

has more than adequate capital structure

now.

Also, although the competing firms such as

Allied Bank has been paying dividends to its

investors on regular basis, Bank Alfalah does not consider this comparison valid as

the bank is only 12 years old whereas Allied Bank is almost 45 years old and other

banks are much more older. Those banks have real estate properties at much lower

price and hence their overall expenditure is much low too.

Those banks have branches in optimal locations whereas Bank Alfalah is only in its

growth stage. However, the bank foresees that within 3-4 years, it will be able to

surpass Allied Bank in ranking. Hence, the current dividend policy is optimal

according to the bank.

PART IV: COMPARISON WITH COMPETING FIRMSa) CAPITAL STRUCTURE POLICY:

The following graphs present the capital structure of the biggest 6 banks in Pakistan

including Bank Alfalah from 2005-2009. The Capital structure policy of the

competing firms will be analyzed through past trend. (Data sheet attached in the

appendix).


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From the graph, it can be seen that the Shareholders equity of Bank Alfalah has

been the least as compared to the other top 5 banks of Pakistan therefore Bank

Alfalah must increase its shareholders capital in the future. However, all the firms

have increasing minimum share capital policy as it can be observed from the

positive linear trend.

From the ADR graph, it is evident that the biggest banks in Pakistan have been

maintaing a much higher percentage of Advances to Deposit ratio than bank

Alfalah, specially in 2009 where the ADR maintained by Bank Alfalah has been the

least. Even ABL, with which Bank Alfalah competes directly, has had a much higher

ADR indicating that the policy of Bank Alfalah is not optimal when it comes to

Advances to Deposit ratio.

The Capital Adequacy Ratio maintained by

the top 5 banks of Pakistan in the past was

much higher than what was being

maintained by Bank Alfalah. However, from

2009 onwards, Bank Alalah has had a much

higher Capital Adequacy Ratio and the

difference between Bank Alfalah, United

Bank Ltd and Habib Bank Ltds CAR have

shrinked. Hence, it can be said that

BankAlfalahs policy with respect to CAR is

optimal.

b) DIVIDEND POLICY:

The following graph presents the dividend

yield of the top 6 banks of Pakistan in the

last 4 years. On the basis of the past trend of

competing, Bank Alfalahs dividend policy isanalyzed. (Data Sheet in appendix)

Dividend yield of top 6 banks of

Pakistan


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From the chart above, it can be seen that the top all the banks except for Bank

Alfalah have pursued a policy of paying dividends in the last 4 years. Bank Alfalah

only paid dividends in 2007.

Although, the major bank paid the same amount of dividend all throughout the four

years, the dividends as a percentage of the price increased in 2008 for all the top 5

banks because of a decrease in share prices overall in the market. This implies that

(possibly) profitability of the top 5 banks must have decreased but even in that

scenario, the banks continued to give dividends to the shareholders. Bank Alfalahs

current dividend policies of paying dividend only when there is adequate profit is

not optimal as the competing firms give dividends every year and in order to

survive the competition, Bank Alfalah must alter its dividend policy


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PART V: SUGGESTIONS AND RECOMMENDATIONSAfter an analysis of the banks Capital structure, Advances to Deposit ratio and

dividend policy with the companys Deputy Financial Manager, we came to

conclusion that the bank considered its capital structure to be highly optimal and

didnt find need for improvement in its Advances to deposit ratio or dividend policy

either.

However, after an analysis of the banks ratios with competing firms, we came to

conclusion that

(i) Although, the bank is meeting State Banks requirement of Minimum Capital

Requirement over and above the required standards, yet the Shareholders

capital must continue to grow at a similar pace in the future in order to

compete with top 5 banks of Pakistan

(ii) Capital Adequacy Ratio is optimal and must be maintained in the future.

(iii) Bank Alfalah must increase its advances to deposit ratio as all the competing

firms have a much higher percentage. It is through Advances that the Banks

make profit, so if the bank has to increase its profitability, it must increase its

Advances to Deposit Ratio

(iv) Bank Alfalah must focus on paying cash dividends to its shareholders in the

upcoming years as the top 5 banks of Pakistan have been continuouslypaying over the last few years. Although, the bank had been concentrating

on increasing its CAR and shareholders capital in the last few years but from

now on, it should focus on dividends as it is essential that shareholders get

cash from the company since it is their money. Either the Bank should revise

its policy of paying dividends only when there is adequate profit or should

try to increase its profitability (by increasing ADR, for example)

However, the limitations of these recommendations is that the comparison of a

twelve year old bank is being made with banks which are around fifty year old thathave much advantages in terms of cheaper real estate properties in ideal locations

etc. Hence, Bank Alfalahs current ranking of number 6th can be considered

milestone in itself with the capital structure and dividend policies it has pursued in

the past.


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APPENDIX

analysis of capital structure and dividend policy of bank al

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