Bank Alfalah Limited was incorporated on June 21, 1997 as a public limited company under the Companies Ordinance 1984. The bank is engaged in commercial banking and related services as defined in the Banking Companies Ordinance, 1962. The bank was privatised in 1997.

The Abu Dhabi Group, owner of the bank, has invested in technology to have an extensive range of products and services. They broadly include general banking, financial services, Islamic banking, consumer banking, treasury and international banking. Because of its superlative performance over the years, the bank has been assigned short term rating of A1+ and long term rating of AA.

Currently, it is operating with a network of 199 branches. This includes 23 Islamic banking branches and 7 foreign branches in Bangladesh, Afghanistan and one wholesale banking unit in Bahrain. Bank Alfalah has expanded its branch network and deposit base, along with making profitable advances and increasing the range of products and services. Bank Alfalah is the 5th largest bank of Pakistan in terms of its assets that are 6% of the total banking sector.

The banking sector has expanded rapidly in Pakistan along with the fast paced economic growth. The increased competition has encouraged the banks to come up with services that could satisfy the needs of a large consumer base. The result has been increased profitability of all banks.

BAFL's PAT is up by 51% (QoQ) at Rs 998 million (EPS: Rs 1.25) during Q1'08 on account of 34% Net Interest Income improvement coupled with a healthy non-interest income growth and 17% balance sheet growth. While the addition of 36 branches during FY07 have resulted in an upsurge in operating expenses which stood higher by 27% (QoQ), the total cost has nonetheless been contained by lower NPL provisioning (most likely on account of provisioning reversals).

The expansion in branch network undertaken last year has resulted in upsurge in administrative expenses which increased to Rs 2.3 billion (Mar'08), up by 27% over Mar'07. The rise in total cost was nonetheless contained by lower provisioning charges despite Rs 589 million increase in NPLs (Mar'08) vis-a-vis increase of Rs 502 million (Mar'07) and stricter provisioning requirements.

FINANCIAL PERFORMANCE (FY04-FY07) The bank's performance has generally improved in all segments in FY07. Bank Alfalah Limited (BAFL) declared profit after tax of Rs 3.1 billion with earnings per share of Rs 4.82 in FY07 compared to profit after tax of Rs 1.7 billion with earnings per share of Rs 2.71 in FY06. A significant growth of 77.6% has been registered during FY07 on back of the capital gain of Rs 1.7 billion on sale of Warid Telecom (Pvt) Limited. The bank also declared a cash dividend of Rs 1.50 per share for FY07 and 23.0% bonus share.

Net interest income of the bank registered a growth of 53.8% to Rs 9.1 billion in FY07 compared to Rs 5.9 billion in FY06 mainly due to the interest earned on deposits to customers. (Total deposits of the bank grew by Rs 33.6 billion during FY07).

In FY07, the bank sold 48.8 million of its holdings in Warid Telecom (Pvt) Limited out of 316.7 million to Singapore Telecommunication Limited (Singtel) at a price of US $37.67 million. Due to this, the bank earned Rs 1.7 billion of capital gain during FY07, which resulted in a growth of 87.3% in non-interest income. Non-interest income climbed to Rs 6.0 billion in FY07 as compared to Rs 3.2 billion in FY06

In terms of profits the Pakistani banking sector ranks amongst the top ten in the world. Bank Alfalah has had its share in the phenomenal profits growth of the banking sector. There has been a change in composition of earnings assets with a shift from advances to higher investments in FY07. This shift is in line with the overall industry trend.

A positive growth in deposits somewhat succeeded in improving the ROD of the bank, which had declined in 2006. The deposits of Bank Alfalah have shown an increase over the years largely due to increase in fixed deposits by customers. Deposits by both customers and financial institutions have seen a growth. The most prominent factor behind this was increase in the market's liquidity due to increased FDI and remittances inflow. Since 2004, the bank witnessed a 131% growth in its deposits, which is an indicative of the growth that this bank has seen.

Profits have also risen due to increase in advances, investments, and lending to financial institutions (earning assets). Only lending to the financial institutions grew by 264% in FY06. But ROD has shown a declining trend. This has been the case because the profits for Alfalah have not risen proportionally with the increase in deposits. In the year 2006 deposits grew by 7.7%. This significant increase was the result of the excessive reserve growth in the economy. But the corresponding increase in profits was a meagre 3.6%. In FY03 the ROD was 2.77 that has declined to 1.28 in 2007.

Deposits increased from 239 million to 273 million, an increase of 14% in FY07. The trend of ROD has reversed this year as it has improved from 0.55 in FY06 to 1.28 in FY07 mainly because of improved control on costs resulting in improved profits. Due to banks' eagerness for raising longer term deposits to match their assets maturity profiles, it is expected that the share of fixed deposits in total deposits of the banking system would continue to further increase in days ahead.

Whereas the ROA of the banking system has further improved to 1.07 in FY07 from 0.48 in FY06, Bank Alfalah's ROA had shown a significant decline in FY06. Though still better than the industry average the ROA declined from 2.15 in FY03 to 1.07 in FY07. The total assets of the bank have grown by 19% from Rs 248.31 billion to Rs 329 billion in 2007. In FY06 EA grew by 8.8% but the resulting profitability growth has only been 3.6%.

ROE has had a fluctuating trend for the bank. It rose in FY05 due to high profits for the year but declined in the subsequent year. As the general trend in the banking sector, this bank is also retaining profits and has had fresh capital inflow. One reason for this enhanced capital base is for meeting the minimum capital requirement of the SBP. The ROE is 21.62% which is low compared to the sector average of 25.6%. This way the bank also meets the Basel II requirements for risk exposures by keeping higher capital in hand.

Yield is an indicative of the profitability of the bank's assets. The bank's net interest income (NII) has increased by 53.8% in 2007 whereas the non-interest income rose by 87.3% due to capital gains on sale of Warid Telecom. But as in the banking sector the NII contribute the most to the income. The increase in NII is mainly because of the high spreads that Bank Alfalah is taking the advantage like others in the sector.

An important observation in income of the bank is that its earning assets have been generating increased returns over the years. But overall profitability had not seen great increments because of increasing costs of funding these earning assets. In the year 2006 bank's markup/interest costs rose by 111% as compared to a 73% increase in its earnings. This was also indicated by a declining interest margin which is a ratio of markup/return/interest expensed to the markup/return/interest income. The result is that though the yields are high, overall profits are low and so ROA, ROE and ROD have shown a declining trend in 2006. However the situation improved in FY07 as shown by trend below:

The non-performing loans (NPLs) have shown variable character during the period of analysis, first increasing from Rs 2.845 billion in FY03 to Rs 2.935 billion in FY04, then decreasing by almost two-thirds to Rs 1.06 billion in FY05. Thus there was a drastic cut down in NPLs in this year, which was also reflected in industry figures, where NPLs decreased from Rs 211 billion in FY03 to Rs 177 billion in FY05. This was the result of extensive measures by the industry in general and the bank in particular to improve the regulation and monitoring of loans and control defaults through more rigorous screening.

The following year, however, once again showed a rapid rise of more than a hundred percent in NPLs to Rs 2.31 billion. This rise in NPLs can be more accurately attributed to the rapid rise in interest rates during this period than to any lapse in the bank's screening procedures, as the State Bank had taken definite measures to tighten its monetary policy. At the same time there was a high level of indebtedness in both private sector and consumer markets. There was a slowdown in the rapid decline in industry NPLs, which stood at Rs 175 billion at the end of FY06. Disaggregated industry analysis revealed that there were plenty of fresh NPLs incurred during this period. However, extensive write-offs and recoveries managed to reduce the overall level of NPLs. The bank is now making greater efforts aimed at the recovery of NPLs, and a tightening of the loan policies is expected.

Provisioning against NPLs grew phenomenally during FY07 and amounted to Rs 2.3 billion over Rs 697.6 million in FY06. The bank made incremental provisioning of Rs 1.0 billion during the year due to withdrawal of FSV benefit which was the major reason behind the upsurge in the provisions.

Due to increasing number of non-performing loans, car financing by the bank has declined by 42.3% in FY07. The car financing covers the major portion of total consumer financing of the bank. The total number of cars financed during FY07 was 12,058 which were of Rs 5.7 billion as compared to 20,012 cars financed during FY06 equal to Rs 9.9 billion.

The debt management figures show that the assets of the bank have become less leveraged during the current period. This was due to the fact that the debt has increased but equity has increased by a greater percentage in recent years. Equity increased by 11% in FY04, 42% in FY05, 64.01% in FY06 and 32% in FY07. However, liabilities rose by an astounding 57% in FY04 and a further stunning 60% in FY05, and then a relatively modest 11% in FY06 and 19% in FY07. The steep increases in debt in FY04 and FY05 were due to a spectacular rise in deposits in both years.

Deposits rose from a modest Rs 76.7 billion in 2003 by almost 70% to reach Rs 130 billion in 2004, after which they again rose by more than 70% to touch Rs 222 billion in 2005. Deposits continued to show strong growth, rising by more than 14% in 2007 to cross Rs 270 billion. The major upward trend in deposits throughout the industry has been the result of the heavy economic activity during recent years fuelling the demand of consumers and the private sector for credit. The industry has also shown a trend towards increasing deposits in banks, a major cause of which is, of course, the booming economic activity, apart from higher foreign inflows in the form of worker remittances and FDI, as well as expanding branch networks, product innovation and better efforts at marketing.

In fact, deposit growth in the top five banks, including Alfalah, was actually slower than that in the next five banks. However, local private banks have shown the highest deposit growth in the banking sector. Deposits showed consistent growth in both local and foreign currencies. Both customer and institutional deposits showed steep growth in 2004 and 2005, while in 2006, growth in customer deposits slowed while institutional deposits showed a decline. Deposit growth had also slowed in the industry in 2006 as a whole, declining from 18.3% in FY05 to 13.1% in FY06.

Another marked trend within the deposit structure of the bank was the greater growth shown by fixed deposits as compared to and at the cost of saving deposits. Fixed deposits increased by an absolutely stunning 100% and 300% in FY04 and FY05 respectively, and by further 11% in FY06, thus attaining a level of almost Rs 89 billion at the end of that year, as compared to a mere Rs 11 billion at the end of FY03. On the other hand, while the savings deposits grew by almost 55% in FY04, their growth slowed to around 25% in FY05, and actually turned into a 3% decline in FY06, so that their level changed from Rs 44 billion at the end of FY03 to Rs 79 billion at the end of FY06. This is a good sign for the bank since its long term deposits have risen.

The ratio of earning assets to total assets for the bank shows remarkable uniformity, suggesting careful management of and investment in interest generating assets. Within earning assets, however, the bank shows a gradual trend of movement of capital into and away from lendings to other financial institutions. These declined from 9% of earning assets in FY03 to 0% in FY04, then increased to 13.3% in FY05, but were again reduced to 6% in FY06. This variation also caused a fluctuation in the percentage of earning assets held as advances, which increased from 58% in FY03 to 71.5% in FY04, then again declined to 58.5% in FY05, finally increasing to 68.5% in FY06. The trend in investments has been mainly a declining one, from 39% of earning assets in FY03 to about 28% in FY04 and FY05, then again declining to 26% in FY06. Industry figures substantiate this trend to an extent, where in FY06 advances increased to 55.8% of total assets from 54.4% in FY05, while investment portfolio decreased from 21.9% of assets to 19.2% in the same period. In addition, 60% of the growth in banking assets in FY06 was accounted for by growth in advances.

The advance to deposit ratio (ADR) on the other hand has shown a decline over this period. The ADR for the industry as a whole had actually increased in 2006, as a result of an aggressive loans policy overtaking the strong growth in deposits. The bank, however, managed to maintain and actually improve its liquidity position. As has been mentioned above, deposits showed a steep upward trend, increasing by almost 70% in FY04 and FY05, and by a further 7% in FY06. On the other hand, though advances increased by almost 80% in FY04, they showed more moderate growth rates of 34% and 26% in FY05 and FY06 respectively, showing a more moderate and cautious expansion in loans by the bank. Advances have shown a strong upward trend over both the short and long-term categories.

The figures for FY07 show that the bank has further improved its liquidity position. The ADR remained flat in FY07. Advances have grown by 14.13% from 150 million to 171 million during this period. The high growth in advances was offset by an equally higher growth in deposits. The industry as a whole, has also experienced an ease in the liquidity position as a result of slower growth in loans. This slowdown in lending was caused by an increase in interest rates accompanied by less credit capacity in the market. Industry figures also show that banks have shown an increase in investment portfolios somewhat corresponding to the decline in loans, showing a shift in banks' policy towards lower risks and returns.

The solvency situation for the industry as a whole has shown marked improvement in the recent years caused by increasing profitability and fresh inflows of capital. The figures for the bank show that there was a decline in the solvency position in 2005 as a result of high growth in deposits. As a result, from financing 4% of assets in FY04, equity financed around 3% of equity in FY05.

This situation, however, has improved in 2006 because of increases in equity, which once again financed almost 4% of assets. However, earning assets in comparison to deposits declined from around 1.03 in FY04 to 0.97 in FY05 and 0.96 in FY06. This is caused by the fact that while deposits have shown tremendous growth over the period under study, the bank has maintained a consistent approach with respect to its earning assets and has not expanded them to the same extent. The increase in MCR by the SBP has also led to banks increasing their capital share.

The figures for FY07 show a continuing improvement in the solvency position of the bank as a result of further increases in capital. This follows an industry-wide trend of better solvency.

Banks have dominated the capital markets of Pakistan because of their superlative performance. They comprise one-third of the total capitalization of the KSE.

Earnings of Alfalah have been rising on back of the higher profitability over the years. As mentioned earlier, the banks have been retaining their profits. But the overall boom in the economy and the banking sector has made the investors confident of long term gains. Thus price has been increasing for Alfalah. The price of bank Alfalah's share has fluctuated between Rs 34 to Rs 87 over the past three and a half years P/E has been on the rise that indicates that investors are looking forward to invest in the stocks of the bank in expectation of better returns in the future. A multiple of 12.04x makes the share look overvalued but its strong fundamentals have kept the investors interested.

MV to BV has shown a steady trend. Though the book value has been on the rise MV is almost 2.6x the BV again indicating investor's confidence generally in the banking sector to do well on the back of high spreads.

Dividend yield has been high in FY07. The share is being traded at a high value. The bank also declared a cash dividend of Rs 1.50 per share in FY07 and 23.0% bonus share. But the dividend policy of the bank is such that it prefers bonuses rather than cash dividends. Thus there has been retention of profits by the bank as prefers to reinvest profits rather then giving them out as dividends. The bank plans to use the additional capital to strengthen itself in Pakistan and abroad. Also it intends to use this capital to meet SBP's future capital adequacy requirements. The future plans have kept the investors interested and has resulted in keeping the MV of its share above Rs 50 since February 2007. Dividend cover is given by DPS/EPS. It has had an increasing trend since DPS has been increasing more than the EPS. The bank has been inclined towards bonus issues resulting in increased number of outstanding shares.

FUTURE PROSPECTS: In its MPS (3Q Y'08), the SBP announced substantial tightening of monetary policy with added measures of minimum return of 5% on savings accounts and mandatory margin on import L/Cs. A 150bp DR hike to 12% and 100bp 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. Aiming to enhance the efficiency of monetary policy transmission mechanism, SBP has also set minimum return of 5% on interest bearing checking accounts. Squeeze in net interest margins and potentially higher credit costs (due to asset quality deterioration) shall reduce banks' profitability.

After the current tightening, average deposit rates are also expected to increase. This might impact BAFL's high margins, despite moderate deposit growth and improved earnings quality. Future expansion through low cost funding sources might help in near future. The operating expenses are likely to continue the upward trend as the bank plans to expand its network further by 49 branches during the current year, while net provisioning is also expected to increase given lower NPL coverage (against specific provisioning) as of Mar'08.

Recently, SBP has raised the upper limit of retail exposure to Rs 75 million in case of consumer loans and small business loans. Moreover, the exposure limit should not be more than 2% of total (gross) retail portfolio of the bank. Penetration in Small and Medium and Enterprises (SME) segment and expansion in the Middle East markets are some of the opportunities that BAFL can tap.