CRESBANK'S SHARP DROP IN PROFITS
What does this signify for the rest of the sector?
Naween A. MangiThe Crescent Investment Bank, one of the prominent players in the sector reported their results for the eighteen month period ended June 30, 1996 last week. Although the investment banking industry, not having reached a stage of maturity yet, has had several operational difficulties, CresBank, the oldest in the sector, has posted a noticeably sharp decline in profitability.
Sep 07 - 13, 1996
Despite the fact that total income rose 70% in the last 18 months, expenditure was also about 94% higher. As a result of this and provisioning measures, they posted a 59% drop in pre-tax profits from almost Rs 261 million end 1994 to less than Rs 108 million. Profit after-tax also fell sharply by as much as 65% from just over Rs 221 million to just over Rs 78 million.
Stock market exposure
These results, however, are not unique to CresBank; in the early nineties, before 1994, the bull run on the Karachi Stock Exchange provided ample opportunity to realise substantial capital gains. And almost all investment banks, trading on both their own and their clients accounts, invested heavily in the equities market.
When the market began sliding a couple of years ago, (and continues to fall unabated), these banks, largely exposed, began posting larger and larger losses. And because they had concentrated all efforts on this area, ignoring, completely in some cases, the more traditional investment banking activities, such as underwriting, debt and equity placements, debt syndication and other fee-based income, there was little recourse. Of course, as Salman Rasheed, Head of Research at Fortune Securities pointed out, since capital gains are tax exempt, these banks had an added incentive.
With a paid-up capital of some Rs 428 million, CresBank, one of the larger banks, made more than a Rs 165 million provision against diminution in the value of their investments in the period under review. Their gain on the sale of investments for the same period was almost Rs 151 million. Discussing why the year was not a good one for his bank, Nessar Ahmed, President, CresBank, told PAGE that while the primary reason for the fall in profitability was the poor performance of the stock market, divesting in the market was not a viable strategy since most shares had fundamentally good values, and when the market turns around, as it is sure to, perhaps in fiscal 1997 or 1998, they will be able to book higher profits. Mr. Ahmed did think that the market would continue to fall for some time though before we see a correction.
Now, while it is true that the Rs 165 million provision was the principal reason for CresBank's poor results, it is also true that the bank did not concentrate enough on the other more traditional investment banking activities alluded to earlier in this article. In the current eighteen month reference period, income from fees, commissions etc amounted to just Rs 38 million; 33% up from the previous period, but, nevertheless a low contributor to total income.
What is perhaps, most disturbing is that the bank does not even appear to have any concrete strategy to develop these areas and management seems to be hoping for an upturn in the market to solve its profitability problems.
Mr. Ahmed did say that since the difficulties with the central bank have been sorted out and investment banks are allowed to raise foreign currency deposits, the sector is likely to improve.
He also said that since CresBank has access to credit lines from the World Bank, the Asian Development Bank, and the International Finance Corporation, the availability of funds did not pose the kinds of problems for them as for other investment banks.
Of the other investment banks which have reported their results for the current period, Al-Faysal, with a paid-up capital of Rs 783 million, also posted a 11.5% drop in after-tax profits for the half-year. At the end of 1995, Al-Faysal's proprietary and clients investment portfolio in the stock market totalled Rs 1.8 billion; having made a Rs 135 million adjustment against this amount, the bank claims to have built on its fund-based activities. In the six month period ending June 30, 1996, however, "other income", which probably indicates advisory services fees, arrangement fees, underwriting and guarantee commissions amongst other things (as the notes to the accounts in the annual report for 1995 indicate) fell more than 41% over the year to slightly over Rs 37 million.
Citicorp Investment Bank, a much smaller player with a paid-up capital of just Rs 100 million, seems to have preserved against the huge losses other investment banks have incurred from equity investments. They posted very strong growth over the year with after-tax profit rising 172%, and most income coming from demand promissory notes. Income from constancy and corporate advisory fees amounted to Rs 16.65 million for the period ending June 30, 1996.
Mr. Ahmed summed up by saying that the difficult year that CresBank faced was a reflection of the economy and that he hoped for better results in the future.
We would suggest that an active move towards advisory and corporate finance services as well as new financial products such as convertibles and term finance certificates along with underwriting, project financing and other such activities be made in order to reduce the reliance on capital gains from equity investments.
It is also probably fair to say that not only CresBank but the direction of the entire investment banking sector will depend largely on the ability of management to achieve this kind of diversification. So even when the stock market does turn around, the base for earnings is more solid than and less reliant on just capital gains from investments.