Financial Analysis of Commercial Banks Your Facilitator: Altaf Noor Ali Chartered Accountant
Day 1: Financial Analysis of Commercial Banks • Session scope • Case study 1: Financial analysis of an international commercial bank • Case study 2: Basic financial analysis of a commercial bank on per share basis • For data based on last 2 years • For data based on more than 2 years • Case study 3: Basic financial analysis of multiple commercial banks
Session Scope • This program is about a concrete approach towards conducting a financial analysis of commercial banks. • Financial analysis of commercial banks requires understanding about how banks operate. A bank is unlike any business entity engaged in say, trading or manufacturing. • Financial analysis is based on the information made available by commercial banks. Unavailability of information impairs the quality of financial analysis. We will tell you about it.
Financial Analysis : 5 Objectives • Update our understanding about financial and other disclosures made by commercial bank in annual reports: they form the bedrock of financial analysis. • Learn how to transform data into meaningful information. • Locate and link fragmented pieces of information to create an overall picture of a commercial bank. • Compare metrics with competitors to reach to a conclusion: provides deep insights. • Identify areas of relative strengths and weaknesses: conclusion.
A word about training methodology Each session divided in learning modules of 45-60 minutes each. • Opening statement: Introduce basic concept and principles = 5 minutes • Interactive on the spot group feedback in Q&A form about the salient features = 20 minutes • End of session individual T/False test = 20 min Target retention = 50%.
Case Study 1: CitiGroup on valueline format • We will first learn how financial analysis of an international commercial bank is carried out. • For this, we will use a very respectable source of financial information – the Valueline [www.valueline.com]. • As an example, we will use Citi Group, which is a Dow Jones Industrial Index component. • Refer to the one-sheet analysis of valueline for CitiGroup, provided to you as a part of course material.
CitiGroup: Lesson 1 • Refer to the only diagram/graph in the valueline. • Say in few words, how the data presented in the form of a diagram compares with the one provided in numeric form (as an example, study data in the row ‘Earnings per share’ and create an imaginary graph).
CitiGroup: Lesson 2 • Refer to first three rows, right after the diagram, for which numerical data is stated from 1992 to 2009, starting from ‘earning per share’. • Specifically, what is common between the first three rows? • Why is it important to us to learn?
CitiGroup: Lesson 3 • Refer to the row entitled ‘Total Assets ($mill)’ and six row following it. • Our second learning is in these seven rows. • The ‘data’ stated in seven rows have one common feature. What is it? • Clue: The same is true for two more rows titled ‘Long-term Debt ($mill)’ and ‘Shr. Equity ($mill)’.
CitiGroup: Lesson 4 • Refer to the ‘text’ part of the valueline starting from ‘Business’ to the point where the name of the analyst is given. • The text here is an example of ‘non-financial information’. • What is the most important lesson that one can draw when comparing non-financial information to financial information?
CitiGroup: Review • Visual (one glance understanding) • Numerical (per share) • Numerical (absolute) • Text (non-financial information) We will now go to Exercise 1…
What is ‘financial analysis’? • Financial analysis is a systematic process of evaluating the financial position, performance and cash flows of a business entity. • Financial analysis is supported by financial and non-financial information. The non-financial data at times assumes more importance than financial information. • Financial analysis is about forming appropriate opinion (about past and prospective) based on limited time and resources.
What should be the starting point of an ‘effective’ financial analysis? • Annual Report • Summary of past financials • Balance sheet • Profit and loss account • Cash flow statement • Statement of changes in equity • Notes to the account • Consolidated financial statements • Directors’ report • Company literature
Annual Report Summary of past financials Balance sheet Profit and loss account Cash flow statement Statement of changes in equity Notes to the account Consolidated financial statements Directors’ report Company literature All the sources mentioned in left panel are important. Annual report is an official document that contains the information mentioned. ‘Summary of past financials’ provides some bare analysis. No where else you will find any further analysis. Apart from ‘summary’ the data is there but not its analysis. You have to do it An analyst skill is to translate data to information. For example, balance sheet data may be entered in an Excel sheet and the difference in amount and percentage computed for every item of balance sheet. Data may be easily be converted into ‘per share’ basis. What should be the starting point of an ‘effective’ financial analysis?
What should be the starting point of an ‘effective’ financial analysis? • Imagine ‘financial analysis’ as a ‘potrait’ – a financial picture of an entity. • Imagine a ‘financial analyst’ as a painter artist who does his utmost to create a masterpiece everytime he gets down to work. • Think of a blank Excel Sheet as a blank paper sheet available to an artist. Think of features available in the software as the brush and paint palette available to the artist.
Case Study 2: Financial Analysis of a local commercial bank • We will expand the lessons learned from the Value Line to study a local commercial bank. • Our focus in this segment will be to prepare the balance sheet at 31-12-07 and income statement for the year ended 31-12-07 of allied bank for further analysis. • You must be having allied bank annual report 2007 to proceed further. • I will now refer to the excel sheet in which I have done the ground work.....
Case Study 2A: Allied BankBasic 2 year Analysis • Werefer to the excel file containing balance sheet of allied bank. [BankFinancialAnalysis.xls] • Review each item of balance sheet line by line and state in few words, what has changed from the previous year.
Case Study 2A: Allied BankBasic 2 year Analysis • Werefer to the excel file containing income statement of allied bank. [BankFinancialAnalysis2.xls] • Review each line item of income statement and say in few words, what has changed from the previous year.
Case Study 2A: Allied BankBasic 2 year Analysis Steps to follow for preparing a 2-year analysis in Excel: • Enter basic data line by line. The source of data will be the balance sheet. Prepare separate sheets for balance sheet, income statement and cash flow statement. • Compute ‘change’ for each item (line) by deducting the latest year from previous. • Compute ‘percent’ of change in each item. For each line, take change and divide by previous period. • Enter number of shares outstanding for each year • Compute ‘per share’ for each item by taking the amount and dividing it by number of shares for latest year. Repeat the same exercise for the previous year. • Save your sheet. • Recheck and review. We will now refer to the excel sheet to explain it….
Case Study 2A: Allied Bank 2 year Analysis • We will now refer to Exercise 2….
Case Study 2B: Allied BankMultiple Year Analysis • We will now refer to the excel file containing balance sheet and income statement of allied bank for the period 2002-07. [BankFinancialAnalysis.xls and BankFinancialAnalysis2.xls] • Review each line item of balance sheet and income statement and say in few words, what has changed from the previous year.
Case Study 2B: Allied BankMultiple year Analysis by Pivot Table • Set up a pivot table for multiple year analysis. • Once a pivot table is set, use pivot chart. • Review and check. • Refer to the excel sheet for further analysis.
Case Study 2B: Allied BankMultiple Year Change Analysis • Supplementary analysis of change from 2002 to 2007 can also be very useful in understanding the strategic emphasis. • Refer to the worksheet…
Case Study 2B: Multiple Year Analysis: Steps Steps to follow for preparing a multiple year analysis in Excel: • Enter basic data line by line. The source of data will be the performance highlighs on p.16. Prepare separate sheet for balance sheet and income statement. Data for cash flow statement may not be available. • Enter number of shares outstanding for each year. • Compute ‘average’ for each line item in a separate column. • Compute ‘per share’ for each item by taking the amount and dividing it by number of shares for latest year. Repeat the same exercise for the previous year. • Compute ‘average per share’ for each line item in a separate column. • Save your sheet. • Recheck and review. We will now refer to the excel sheet to explain it….
Case Study 2: Allied BankReview • For allied bank, we should be familiar with how financial analysis is initiated for the balance sheet and income statement. • So far, we have covered a basic 2-year (case 2A) and multiple year (case 2B) analysis for balance sheet and income statement. • Foundation is now laid to proceed to compare one bank with the other to gain some additional insights for our financial analysis.
Case Study 3: Multiple Bank Financial Analysis • Comparing apples to apples and banks to banks provide very useful insights for financial analysis. • We will now demonstrate this approach by including in our study, in addition to the allied bank, the following: • MCB • HBL • Askari • Soneri
Case Study 3: Multiple Bank Balance Sheet Analysis • We will now refer to our excel sheet in which we have done analysis of five commercial banks for the year ended 31-12-07. • Our purpose here would be to learn about how allied bank is different from others in terms of its financial position. • Pivot table and pivot table chart is used.
Case Study 3: Multiple Bank Income Statement Analysis • We will now refer to our excel sheet… • The purpose is to learn about how allied bank is different from others in terms of its financial performance. • Pivot table and pivot table chart is used.
Case Study 3: Multiple Bank Cashflow Analysis • Here we will also introduce comparison of cash flow statements of banks. • Cash flows of a commercial bank are classified in three ways: • Operating • Investing • Finance • The most critical issue in cfs of banks is that its operating cash flows are derived on indirect method. • Indirect method only considers net changes in balances and conceals a lot of information that would otherwise be available on direct method.
Case Study 3: Multiple Bank Cashflow Analysis We will first consider cashflow statement of allied bank…and our conclusions are… • Allied Bank invested more money than it advanced. • It borrowed more money from financial institution that it lend them. • It recorded healthy growth in its deposits. Can you verify these fact?
Case Study 3: Multiple Bank Financial Analysis: Review • We will now refer to Exercise 3….
Risk-related disclosures • Capital adequacy (n40p85) • Credit risk (n41p88) • Credit risk – Segment Information (n41.1.1p90) • Credit risk – details of non-performing advances (n188.8.131.52p91) • Foreign exchange risk (n41.2.1p93) • Mismatch of interest rate sensitive assets and liabilities (n41.2.3p94) • Maturities of assets and liabilities (n41.3.1p95)
Risk-related disclosures Capital adequacy (n40p85) • What is the purpose of disclosing capital adequacy ratio in the annual report? • What it means? • How is it relevant? • Two components: Regulatory capital base and risk-weighted exposures.
Risk-related disclosures Capital adequacy (n40p85): Regulatory capital base • Why it differs from the net assets stated in the balance sheet?
Risk-related disclosures Capital adequacy (n40p85): Risk-weighted Exposures • Two components: credit risk and market risk.
Risk-related disclosuresCredit Risk (n41.1p88) • Principal sources of credit risk • Sovereign credit risk on its public sector advances • Non-sovereign credit risk on its private sector advances • Counter party credit risk on inter bank limits.
Risk-related disclosuresCredit risk – Segment Information (n41.1.1p90) • Relate to advances (n10p63) • Relate to deposits (n16p70) • Relate to contingencies and commitments (n21p73) • Advances: any observation about Textile and others? • Deposits: any observation about individuals and others? • Contingencies: how it connects with the note?
Risk-related disclosuresCredit risk – details of non-performing advances (n184.108.40.206p91) • Relate ‘specific provisions’ to n10.5.2p65 • Relate to the previous note on segments by class of business n220.127.116.11p90 • Learn to relate how much of the gross advances have ‘specific provisions’ against them.
Risk-related disclosuresMarket risk (n41.2p91) • Foreign exchange rate risk • Interest rate risk • Equity price risk
Risk-related disclosuresForeign exchange (rate) risk (n41.2.1p93) • Risk of loss arising from fluctuations of exchange rates. • Funding policy: learn how mismatches are handled. • Break down of financial assets and financial liabilities: refer to n41.2.3 on p94. • Learn why off-balance sheet amount is not the one on next note.
Risk-related disclosures Equity Position Risk (n41.2.1p93) • Refer to Management Discussion and Analysis on p31. What is mentioned about investments? • Refer to investments n9p61. How much of total investment is in treasury bills? Can you identify by comparison with 2006, where major investments have been parked? What it means in terms of present scenario prevailing at the stock market?
Basic fact: Segregation of ‘on balance sheet’ assets and liabilities as interest or non-interest based. Identify data, and conclude. The most important disclosure in this table is that of ‘Effective Yield / Interest rate’. What it implies? Other important terms to discuss: On-balance sheet gap, Total Yield / Interest Risk Sensitivity Gap’ Sub-ordinated loans: There is an obvious mismatch here. Identify and comment why a bank borrows at a rate lower than it advances. Finally, what is the fun in borrowings at 8.23% and lending it to financial institutions at 9.56%? Risk-related disclosures Mismatch of interest rate sensitive assets and liabilities (n41.2.3p94)
The keyword in preparing this note is ‘liquidity risk’. What are the key conclusions drawn? Advances and investments. A key disclosure is missing in this note. Can you name it? How much can we rely on the information in this statement? How useful is the information provided? Maturity of fixed assets: a closer look Refer to administration expenses (n28p76) The depreciation amortisation for 2007 was Rs. 341,656. Assuming no additions to the fixed assets, the monthly charge will be Rs. 30,264 which for one year works out to be Rs. 363,168. Risk-related disclosuresMaturities of assets and liabilities (n41.3.1p95)
This brings us to the end of our presentation for today. Hope you enjoyed and learned…. Thank you all.