Commercial Islamic Banks' Corporate Financial Analysis - Example

Report On Commercial Bank Qatar, Qatar Islamic bank, al khaliji commercial bank and Barwa Bank corporate financial analysis Presented By (Your name) Subject Date Contents Contents 0 1.1Financing decisions for the Commercial Bank Qatar, Qatar Islamic bank, al khaliji commercial bank and Barwa Bank past year and analysis of their investment pattern 3 1.1Financial analysis of the banks using financial ratios and market valuation 11 1.3 The four banks capital structure and their financial performance 14 1.4: Shares investment options between the four banks 15 1.6 Calculating the rate of return using CAPM and average rate of return 16 Abstract Financial analysis of companies is normally undertaken so that investors, creditors, shareholders and other stakeholders can make decisions about the company (Friedlob and Schleifer, 2003). Best practices suggest that financial analysis is the basis for sustainable and successful companies (CGAP, 2001). Keeping this objective in mind, the paper gives a report on the financial analysis of the banking industry by comparing four banks in Qatar namely Commercial Bank Qatar, Qatar Islamic bank, al khaliji commercial bank and Barwa Bank, and make a comparison in their Corporate Financing as companies within the same industry. The report gives a brief theory of Corporate Financing along with its type and focuses on the financial analysis of the four banks using the financial statements (financial report, balance sheet and income statement) for the past 5 years period. In addition, the report analyzes the financing pattern over this period, financial ratios, and market valuation. Data relating to their performance and profitability have been collected from various sources among them being the companies themselves for the past five years. The report analyzes any co-relation between capital structure and financial performance; if the shares are valued fairly and the company’s stock valuation using capital asset pricing model (CAPM) and average rate of return. In addition, the paper will seek to find which company is more risky to invest in and give reasons why. The results of the report are important to an investor as the bank’s Corporate Financing in terms of performance and profitability of the four banks are compared in financing and investments, and this gives an investor the choice between the four banks in terms of investment. Corporate Financing 1.0 Introduction Corporate financing is a broad term used to describe how Company’s deal with monetary decisions (Friedlob and Schleifer, 2003) that they make and the tools and analysis used in order to make these decisions. Corporate finance takes into consideration maximization of the shareholder value. The strength of a company can be evaluated by the solid balance sheet which is important for investors. Corporate Finance can be evaluated using the company’s working capital adequacy, capital structure and asset performance for the company. The financing of a company relates to its debt-equity relationship where equity consists of common and preferred stock plus retained earnings which collectively are referred to as the shareholders equity. Debt capital for a company consists of short-term borrowings and long-term debt (Friedlob and Schleifer, 2003). A company described as highly leveraged has too much debt compared to the equity which may restrict its freedom of action by its creditors and may have its profitability depleted by high interest costs. Additionally, it may have trouble meeting its operating and debt liabilities. 1.1 Financing decisions for the Commercial Bank Qatar, Qatar Islamic bank, al khaliji commercial bank and Barwa Bank past year and analysis of their investment pattern Financial analysis of companies is normally undertaken so that investors, creditor, shareholders and other stakeholders can make decisions about the company (Friedlob and Schleifer, 2003). Best practices suggest that financial analysis is the basis for sustainable and successful companies (Pyke, 2007). By looking at the figures presented below for Al Khaliji Commercial Bank, we can say that the company is enjoying good liquidity in its combination of assets and liabilities; good profitability; adequate financial leveraging; and good return on investment for its shareholder. Table 1A: Key financial ratio for Al Khaliji Commercial Bank Table 1A: Balance Sheet for Al Khaliji Commercial Bank 2009 – 2011. Source: www.markets.ft.com Table 1B: Income Statement for Al Khaliji Commercial Bank for 2009 – 2011 Source: www.markets.ft.com Table 1C: Cash-flow statement for Al Khaliji Commercial Bank 2009 – 2011 Sources: www.market.ft.com Commercial Bank of Qatar was established in 1975 as the first private bank. It has an estimated asset base of QR 69.9 billion as at 31st March 2012 with consistent growth and profitability paying out dividends every year since its inception. Financial decisions / leverage can is defined as the extent to which a company has used the borrowed money. Companies with high leverage are regarded as a risky or bankrupt, in case, they are unable to repay the debts. Based on the computations below, just as in the case of Al Khaliji Commercial Bank, the Commercial Bank of Qatar Company is enjoying good liquidity in its combination of assets and liabilities; good profitability; adequate financial leveraging; and good return on investment for its shareholder. Table 1A: Statement of financial position - Commercial Bank of Qatar 2008 – 2010 Source: commercial bank of Qatar Inc. 2012 Table 1B: Statement of financial position for Commercial Bank of Qatar 2008 – 2012 Source: commercial bank of Qatar Inc. 2012 Located in Qatar, Barwa bank’s historical corporate financing perspectives are enshrined in its rich, competitive, dynamic, and long-term financial strategies that focus on enhancing its competiveness and common good of the clients and other key shareholders. Barwa Bank is a new Shariah compliant bank that is regulated by Qatar’s central bank. The bank was established in 2008 after which its corporate financial strategy was initiated. Currently, the bank has an authorized capital of QAR 6 billion and an issue capital of QAR 3 billion. The manner in which clients access corporate services have increasingly been simplified through increased innovation and development of new banking strategies. For instance, the emergence of Barwa bank’s internet banking is a total transformation of the bank’s corporate strategy Gulf Business, 2012). Barwa bank has continued to offer very cost effective, reliable, and efficient corporate banking solutions that help in the management of clients’ personal finances and transactions. Barwa bank’s corporate financing has continued to expand (Angus, 2001). The strategy has several banking services that include the use of credit cards, vehicle financing, international services, processing of corporate check and payroll processing among others. Ever since 2008, Barwa bank has continued to win a lot of financial deals. By successfully enhancing a strong financial relationship with key players in the Islamic capital market, the bank has continued to successfully better its financial position. Sadly, Qatar government’s decision to end Islamic financial operations for conventional banks has compelled the bank to re-think and transform its past financial decisions. In fact, the tighter legal capital rules have complicated some of the company’s financial decisions (Demirakos, Strong, & Walker, 2004). The past years have also seen the bank undertake various corporate social responsibilities as well while strictly adhering to Shariah compliant financial strategies. One such aspect of management is outlined in its initiation of IPO on the renowned Doha stock exchange. The company’s financial decision has in the past also worked closely with QInvest, Qatar Holding, as well strong banking of the Gulf state financial success strategies. Major decisions at the bank have focused on developing under developed markets. There is a steady increase in the bank’s income. The bank recorded an increase in its income of 882% at QR244m in comparison to the QR25m rate in the year 2010. This implies that the bank has a financial ability to grow and generate more income for shareholders and other stakeholders. The bank has a very lucrative equity fund of more than QR90m that is fully Shariah compliant. The equity fund is crucial and it leverages both the bank and the shareholders financial capabilities. In 2010, Barwa bank recorded an increase of 143% on its investment thus reaching the QR19 bn mark that had always been desired by the bank’s financial strategists. Over the years, there has been an unmatched level of increased revenue that has led to constant enhancement of revenue generated. The bank also has a favorable rate of increase for the share value. This is the main reason why the share value for the company for the year 2011 was QR1.9bn while the book value for the bank rose to QR16.4. Better still, the bank has been expanding steadily. By July 2012, the bank had already opened 6 branches (Angus, 2001). Qatar Islamic Bank (QIB) is a Qatar based financial institution. The company offers various banking services based on Islamic Sharia principles. QIB conducts its business activities through the Islamic modes of financing, such as Sukuk, Murabaha, Mudaraba, Musharaka, Musawama, Istisna’a and Ijarah (Beder, 2012). The company carries out its business activities through three divisions, namely, Retail Banking Services, Corporate Financing and Private Banking, and Investment Banking and Development. The company operates in the Gulf, the Middle East, Asia, Europe and North Africa. 1.1 Financial analysis of the banks using financial ratios and market valuation According to Drake (2006), financial analysis for companies using ratios assist in financial decision making by evaluation efficiency in financial operations, credit policies, credit worthiness of borrowers and potential investments. The primary source of information required to compute the ratio comprise of the income statement, the balance sheet and statement of cash flows. There are six aspects of operating performance from financial ratios namely: liquidity; profitability, activity, financial leverage, shareholder ration and return on investment. Three different ratios can be used to assess the financial strength of the banks financing / capitalization structure. These are the debt and debt versus equity ratios. The setback with these ratios is that they are too broad in scope which gives equal weight to operational and debt liabilities. The most recognized financial leverage ratio is the debt to equity ratio. Financial leverage indicates the ability of a company to fulfill on its debts in order to operate. According to Drake (2006), if the financial leverage ratio of a company is greater than 2-to-1, it indicates financial structure weakness. High leveraging is considered to be a near bankruptcy status. Also, at this state it might be difficult to secure new capital if it is inept of meeting its current obligations. According to Bloomberg (2012), commercial Bank of Qatar has a debt to equity of 0.3229 which means it has used little or no debt during the period. Using the debt ratio computed in the ratio section of this paper, Commercial Bank of Qatar has made good financing decisions with a debt to equity ratio of 4.7.4, and 4.5 in 2011, 2010 and 2009 respectively. Its current ratio is also favorable computed as 2.6, 2.5 and 1.8 in 2011, 2010 and 2009 respectively which is above 1.0 required for a good performing company. This indicated the bank can cover its short term liabilities without affecting its ability to finance working capital. Table 1c: Statement of financial position - Commercial Bank of Qatar 2008 – 2010 Source: commercial bank of Qatar Inc. 2012 Market valuation of Barwa bank reveals the extent to which Barwa bank is profitable and has a feasible future. Barwa bank’s income statement indicates a steady increase in the value of the bank’s shares. The net working capital and the value of net current asset are indicating that the bank is in a good financial position to sustain its current and future operations. Its high dividend yield levels and earning visibility also reveals that the bank is in a good financial position (Angus, 2001). Indeed a close association between capital structure and the bank’s financial performance does exist. The banks steady expansion could be attributed to its capital structure which allows for investment in other sectors of the economy as well as establishing new banking branches and investment in modern economic platforms. The bank’s capital structure has augmented innovation and creativity. During 2010, through a Sharia compliant Sukuk Financing arrangement, and after getting the Sharia Board approval, the Qatar Islamic Bank, Bank raised a medium term , maturing on 7 October 2015, finance amounting to USD 750 million (QAR 2,713,290,000 netted-off of the related issuance cost of QAR 16,710,000 to be amortized over its period of maturity (5 years). The sukuks are listed in London Stock Exchange (Beder, 2012). The terms of the arrangement include transfer of certain identified assets (“the Co Owned Assets”) including original leased and musharakat assets, Sharia compliant authorized investments and any replaced assets of the Group to a Sukuk company, Qatar Islamic Bank Sukuk financing Limited (L.L.C) – the Issuer, especially formed for the sukuk transaction. The Group controls the assets which will continue to be serviced by the bank. Upon maturity of the sukuks, the Bank has undertaken to repurchase the assets at the exercise price of USD 750 million. The sukuks bear a fixed profit rate of 3.856% payable to the investors on a semi-annual basis (Burke, 2012). The issuer will pay the distribution amount from returns received in respect of the Co-owned Assets Semi-Annually. Such proceeds are expected to be sufficient to cover the distribution amount payable to the sukuk holders on the semi-annual distribution dates. The group’s responsibility is limited to marketing the portfolio without assuming exposures to any risks. The maximum bank risk exposure is limited to the fee and commission receivable in return for the management of the portfolio and the Group does not guarantee the portfolios liabilities other than operational risk represented by the non-compliance with investment conditions as well as reputation risk. The Group has transactions in the ordinary course of business with associates, shareholders, directors, officers of the Group and the entities of which they are principal owners 1.3 The four banks capital structure and their financial performance Financing decisions are critical for success because impact directly on financial performance and capital structuring (Pyke, 2007). The optimal structure of capital is one that minimizes the company’s cost of capital, while in turn maximizing the shareholder’s wealth. Modigliani and Miller (1963) as cited in (Gupta, Srivastava and Sharma, 1999) stated that under capital market imperfections where expenses of interest are tax deductible, the value of a company will increase with higher financial leverage. This model and theory suggest that profitable companies should essentially have more debt because of the need to manage corporations’ tax. The optimal structure of capital is the one that balances bankruptcy cost and benefits of debt finance. Hence, the cost of borrowing is the expected cost of financial anguish in the event of bankruptcy. Pyke asserts that financing decisions are critical to for success because impact directly on financial performance and capital structuring (2007). The optimal structure of capital is one that minimizes the company’s cost of capital, while in turn maximizing the shareholder’s wealth. Modigliani and Miller (1963) as cited in (Gupta, Srivastava and Sharma, 1999) stated that under capital market imperfections where expenses of interest are tax deductible, the value of a company will increase with higher financial leverage. This model and theory suggest that profitable companies should essentially have more debt because of the need to manage corporations’ tax. The optimal structure of capital is one that balances bankruptcy cost and benefits of debt finance. Hence, the cost of borrowing is the expected cost of financial anguish in the event of bankruptcy. Barwa Bank’s capital structure has a very risky yet promising capital structure. Its capital structure is in equity such as corporate bonds and shares while others are in equity investments such as buildings, foreign investments such as offshore shares in countries such as Brazil and the United States of America. The bank’s capital structure enhances performances and also spreads the risk level. Existence of capital bonds ensures that there is a long term return on capital. Indeed, the risk levels are either increased or reduced based on the performance based on the performance of such investments and the continued use of ordinary shares, preferential shares, and ordinary shares that help in the haring of company risks. On 30 December 2009, Qatar Islamic Bank received QR 956 million as advance against share capital for 9,845,550 ordinary shares by way of private placement to Qatar Investment Authority, in accordance with the resolution of the shareholders in their Extra-ordinary General Meeting held on 23 December 2008 (Barnes, 2011). The allotment of shares and transfer of this amount to share capital has been executed during the year 2010. In accordance with QCB law No. 33 of 2006 as amended, at least 10% of the net profit for the year is required to be transferred to legal reserve until this reserve equals 100% of the paid up capital (Barnes, 2011). This reserve is not available for distribution except in circumstances specified in Qatar Commercial Companies Law No. 5 of 2002 and after Qatar Central Bank approval. 1.4: Shares investment options between the four banks Return on assets is one of company’s biggest responsibilities in order to ensure that they bring about a profit using the resources that they have at hand (Pyke, 2007). The formula used in the calculation of the Return on assets is; Return on assets = (Gross profit – operating expense) / Total assets) This is the Returns the percentage of earnings for a company in terms of its total assets (Drake, 2004). The greater the percentage the better management is at managing assets. Return on equity is another essential formula to that can be utilized to analyze viability of investment. It analyzes how a company obtains the funds used to acquire assets (Pyke, 2004). Assets are acquired either by borrowing or by utilizing the retained earnings and capital contributions of the shareholders. Therefore, if the return on equity (ROE) is much larger than the return on assets (ROA), it can be inferred that the firm has funded portions of its operations through debt financing. Rate of Return for Barwa bank is (return – initial investment) / initial investment x 100. The bank’s rate of return for the year 2010 and 2011 is 5% and 9% return. This rates are derived from the below calculations. For the year 2010, the rate of return is calculated as (QAR 300 million – QAR 6 billion) / QAR 6 billion = 5 % while for the year 2011, the rate of return is (QAR 540 million – QAR 6 billion) / QAR 6 billion = 9%. 1.6 Calculating the rate of return using CAPM and average rate of return The capital asset pricing model (CAPM) calculates the required rate of return (ROR) for risky assets. The required ROR is the increase expected based on the inherent risk level of the particular asset (Friedlob and Schleifer, 2003). Analysts use CAPM to decide the price to pay for a particular stock and is calculated as ra = rrf + Ba (rm – rfr) where: rrf = the rate of return for a risk-free security; rm = the broad market’s expected rate of return; Ba = beta for the asset. The return for a risk free security in Qatar as indicated in Bloomberg is 6.75% with beta as 0.7962 and the broad markets expected rate of return for the company’s share is 9.14% as indicated it is financial report for 2011. Hence the CAPM is 6.75 + 0.7962 (9.14 – 6.75) which computes to 3.1574. The average rate of return (AROE) is an investing formula that shows how much an investment accumulated the investment's life. The formula averages the return yearly basis. It is important for investors to compute their average return so they can make better assessments between the returns of different investments. 1.7 Shares investment options between the four banks and which of the company would be suitable for investing and why? A major motivation for an investor to buy a share in a company is the company’s capacity to provide steady returns on moneys invested in the form of regular dividend payments computed using the earning per share. Further, this can be achieved by an investors’ ability to obtain a profit by owning the stock as the market value of its shares increases (Friedlob and Schleifer, 2003). The percentage of market price to its earnings per share is a good indicator of the value of a stock. It points toward a fair stock market price and represents the investors’ collective opinion regarding its risks and prospects (Goodman and Peavey, 1983). The higher the P/E ratio the higher the buyers are willing to pay. A healthy P/E ratio should be 10 to 25. The higher the P/E ratios the higher the buyers are willing to pay; the higher the number the favorable the dec . There are a number of factors and investment decisions that are key and very crucial in determining whether or not one would invest in the banks. The reasons are based on the bank’s investment and financial strategies. According to Bloomberg, the P/E ratio for Al Khaliji is 11.98 with an estimated P/E ratio for the year 2012 been 12.66. Relative P/E ratio versus the DSM is 1.2 with earning per share been 1.4. Based on Al Khaliji Commercial Bank, favorable P/E, this is a good share to buy. Considering other factors, the book value of the share is 1.09 with a price per sale of 5.06 which is also favorable considering the share has a dividend gross yield of 5.93%. The successful launching and continued investment in equity has successful portrayed Barwa bank as an ideal investment opportunity. The existence of very reliable operational and corporate financing structure is very reliable. This reliable structure has proved economically sound in overseeing all the financial and economically sound operations of the bank. The bank has a wide market base and has the potential to expand with a lot of ease that makes me believe that investing in it is a financially sound decision. The bank has endeavored to always employ high competent and professional qualified personnel. As a result, identification of more investment men inventive opportunities has become easier to the top level manager. The bank’s investment portfolio evidently has very competitive investment and management portfolio which ensures that the return on investment is good. Barwa’s company operations are fully compliant with various government policies and regular frameworks that exist in Qatar and other countries in which the company operates. Involvement in constant innovation, constant creative strategies, and market research strategies has continued to ensure that Barwa bank remains competitive. Cash flow value creation that is derived from the analysis of the company’s earnings plays a vital role in revealing the productivity levels of the bank. The fact that many investors have been willing to invest in the Barwa bank proves that the company’s shares are not only fairly priced but that the value is likely to increase. Many investors are very reluctant to sell their shares. The current earnings per the bank’s every share is suitable and very encouraging for any investor interested in the banking industry. Qatar Islamic Bank Group is organized into four operating segments based on business lines and subsidiaries companies which are as follows: Wholesale banking – it includes services offered to institutional investors, corporate, other banks, and investment vehicles such as mutual funds or pensions. Personal banking – includes services that are offered to individual customers through local branches of the bank which includes checking and savings accounts, credit cards, personal lines of credit, mortgages, and so forth. Group function Treasury, Investment, finance and other central functions. Local & international subsidiaries - Local and international subsidiaries include the Groups local and international subsidiaries all of which are consolidated in the group financial statements. Qatar Islamic Bank (S.A.Q.) (Qatar Islamic) is one of the leading Islamic banking companies in Qatar. Hence one would be confidently able to invest in it and expect good returns. Based on the table below, for the Commercial Bank of Qatar 2008 – 2010 period, the percentage of return of a Commercial Bank of Qatar assets has fallen steadily on the years of focus 2008 - 2010. The return on equity (ROE) is much larger than the return on assets (ROA) and it can be inferred that the firm has funded portions of its operations through debt financing. The Commercial Bank of Qatar P/E ratio is way below the industry norm of 10 to 25. However, dividend payout is high but other factors are against investing in this share and so this company may not be the best for a good investment. Fiscal Period  2008 2009 2010 Sales 2 778 2 562 2 864 Operating income (EBITDA) 2 264 1 599 1 794 Operating profit (EBIT) 2 171 1 480 1 681 Pre-Tax Profit (EBT) 1 524 1 480 1 681 Net income 1 524 1 635 1 884 EPS ( QAR) 7,08 7,24 7,71 Dividend per Share ( QAR) 6,00 7,00 6,00 Yield 8,22% 9,59% 8,22%               Table: 1A: Financial ratios – Commercial Bank of Qatar Source: www.4-trader.com 1:8 Conclusions In conclusion, the report has focused on analyzing the financing pattern of the four banks over five years period in terms of financial ratios, and market valuation. The report has also evaluated the co-relation between capital structure and financial performance; and if the shares are valued fairly and stock valuation using capital asset pricing model (CAPM) and average rate of return References Angus, M. (2001). Development Centre Studies The World Economy: A Millennial Perspective, OECD. CGAP. (2001). Financial analysis: The consultative group to help the poorest Barnes, D. (2011). Islamic Banks Operations Management: An International perspective. London: Thomson Learning. Beder, H. (2012).Financial Planning in Gulf States. New York: Pearson Education. Burke, R. (2012). Investment Policies Restructured. Jacksonville: ABC Press. Demirakos, E. G., Strong, N & Walker, M. (2004) What valuation models do analysts use? Accounting Horizons 18, 221-240 Drake, P.P. (2004). Financial ratio analysis. Boston, IIL Lts Friedlob, G.T and Schleifer, L.L.F. (2003). Essentials of financial analysis Hoboken, New Jersey, John Wiley & Sons Inc Gulf Business (2012) Barwa Bank Eyes Potential IPO on Doha Bourse, The Qatari lender, part-owned by Qatar Holding. Goodman, D.A and Peavey, J.W. (1983) Industry relative P/E ratio as an indicator of investment returns. Financial analyst journal Vol.39, No.4. Chartered financial analyst institute Gupta, P. Shrivastava, A. & Sharma, D. (1999). Capital structure and financial performance: evidence from India. Bloomberg (2012) ww.bloomberg.com/quote/KCBK:QD. Retrived on 6th December 2012 Goodman, D.A and Peavey, J.W. (1983). Industry relative P/E ratio as an indicator of investment returns. Financial analyst journal Vol.39, No.4. Chartered financial analyst institute Pyke, C. (2007). Interpreting financial statements. Journals of accounting. ACCA Read More