Analysis of Capital Structure and Dividend Policy of Bank Al

ANALYSIS OF CAPITAL STRUCTURE AND DIVIDEND POLICY OF BANK AL-FALAH 2005-2009
SUBMITTED BY:
MARYA QURESHI NIDA FAREED SAADIA BAIG
BBA VI-I
DATE OF SUBMISSION: 11 APRIL 2010
5/10/2010
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
ACKNOWLEDGMENT
We offer our thanks to Mr.Ghulam Qadir, Deputy General Manager (Finance) at Bank Alfalah for giving us valuable interview time and 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.
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 at B.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.
www.bankalfalah.com.pk
PART I: Capital Structure of Bank Alfalah

The 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 insurance and 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. Year MCR Capital Maintained (Figures are in 000) This can be shown in the graph below 2005 2006 2007 2008 2009 Rs2,000,00 Rs3,000,000 Rs4,000,000 Rs5,000,000 Rs7,000,000 0 Rs Rs Rs Rs Rs 6,738,063 10,572,605 13,776,673 14,608,523 19,770,260
http://www.minimum-capital-requirement.com/
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 to all banks. This is as follows (BSD Circular No.19)
Minimum Paid up Capital Rs Rs Rs Rs Rs Rs 5 Billion 6 Billion 10 Billion 15 Billion 19 Billion 23 Billion
Deadline by which to be increased 31-12-2008 31-12-2009 31-12-2010 31-12-2011 31-12-2012 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
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 Eligible Regulatory Rs Rs Rs Rs Rs Capital held 10,652,551 14,823,448 18,309,208 18,178,362 26,700,764 Total Risk Rs Rs Rs Rs Rs Weighted 122,982,88 156,446,37 185,836,94 226,321,21 214,250,63 assets 8 8 0 0 4 Capital Adequacy 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 Capital Adequacy Ratio has to be maintained: Year CAR requirement CAR maintained 2005 8% 8.66% 2006 8% 9.48% 2007 8% 9.85% 2008 9% 8.03% 2009 10% 12.46%
This can be shown in the graph below:
www.wikipedia.com
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. From 2007 to 2008, the regulatory capital held almost remained constant from 18,309,208,000 to Rs 18,178,362,000. 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, bringing in 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.
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 Rs Rs Rs Rs Rs 6 Billion 7 Billion 8 Billion 9 Billion 10 Billion
Deadline by which to be increased 31-12-2009 31-12-2010 31-12-2011 31-12-2012 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 meet Rs 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 is maintaining 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/ASSETS

A 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:
Advances Deposits Advances/Depo sits
2005 Rs 118,864,01 0 Rs 222,345,06 7 53.46%
2006 Rs 149,999,32 5 Rs 239,509,39 1 62.63%
2007 Rs 171,198,99 2 Rs 273,173,84 1 62.67%
2008 Rs 191,790,98 8 Rs 300,732,85 8 63.77%
2009 Rs 188,042,43 8 Rs 324,759,75 2 57.90%
According to the Deputy Manager Finance, the bank has maintained an optimal Advances/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

banks have to follow this policy of giving out stock dividends to maintain their minimum capital.
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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 years because 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 Rs 1,702,09 4 Rs 0.00% 2006 Rs 1,762,69 1 Rs 0.00% 2007 Rs 3,130,22 9 Rs 975,000 31.15% 2008 Rs 1,301,30 1 Rs 0.00% 2009 Rs 897,035 Rs 0.00%
Net income Cash Dividend (as according to year declared) Dividend payout (Cash) (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:

i.
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Firstly, the profit in the last five years has not been adequate enough to give it in the form of cash dividends except for in 2007. In 2007, Bank Alfalah had a one time windfall income as it sold securities of Warid Telecom worth Rs 1788,514,000. Therefore, Bank Alfalah had a comparatively very high overall profit 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 cash dividends. Secondly, the bank was focusing on raising its shareholders equity in the last five years. There were only two ways of doing it. Either through rights issue or through bonus shares. The company cannot ask money from shareholders every year so it was increasing the shareholders equity through bonus shares by transferring the net income to its reserve and then issuing bonus shares. 2005 2006 2007
ii.
2008
2009 33.33 % 30.00 % 23.00 % 12.50 %
Stock Dividend
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.

OPTIMAL DIVIDEND PAYOUT STRUCTURE:
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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 FIRMS

a) 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 is analyzed. (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 RECOMMENDATIONS

After 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 Capital Adequacy Ratio is optimal and must be maintained in the future. 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 Bank Alfalah must focus on paying cash dividends to its shareholders in the upcoming years as the top 5 banks of Pakistan have been continuously paying 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)
(ii) (iii)
(iv)
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 that have 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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ANALYSIS OF CAPITAL STRUCTURE AND DIVIDEND POLICY OF BANK AL-FALAH 2005-2009