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Bank of Baroda public issue: Our view

Jan 16, 2006

Bank of Baroda's second public issue (100% book building) for 71 m equity shares, at a face value of Rs 10 each, will be open for bidding between the 16th and 20th of January 2006. The bank has reserved 7.1 m shares for eligible employees and minimum 22.4 m shares (35% of net issue) for retail investors. Going by the price band of Rs 210 to Rs 230, the bank is expected to mop up Rs 16.3 bn (at the higher end of the band) through the offer. The issue is slated to bring down government's holding in the bank from 67% to 54%.

Bank of Baroda
Bank of Baroda was established in 1908 as a private bank and following nationalisation became a wholly owned government bank in 1969. It had its initial public offering in 1996 during which the government shareholding was diluted to 66.8%. At the end of 1HFY06, Bank of Baroda had 2,694 branches in India spread over 27 states. In addition, the bank has an international presence in 19 countries across the globe. It also has a work force of over 39,170 people serving over 25 m customers. The bank has a larger concentration of its credit portfolio in the corporate segment (71% in 1HFY06). Besides, it is looking at the international operations to have a sizeable contribution to its business in the longer term. In FY05, the bank's international operations contributed 15.5% and 9.3% of its total business (deposits plus advances) and total income respectively, rising from 14.8% and 7.7% respectively, in FY04.

Objects of the issue
  • To increase the Tier I capital adequacy ratio (at present 7.9%) and overall CAR (at present 12.8%) for meeting the Basel II norms going forward. Also, the bank needs to hike its capital base to meet the growth in the corporate and retail credit segment.

  • The bank plans to expand its presence overseas.

Reasons to apply
Well-diversified franchise: Bank of Baroda, though a late starter in terms of capitalising on the retail boom, has well utilised its diversified franchise (2,694 branches in 1HFY06) to accelerate asset growth in the retail segment over the past couple of years. The bank's retail portfolio has grown at a CAGR of 53% over the past 3 years. It has also made an appreciable attempt of trying to shed its 'PSU image' by simplifying and launching dedicated retail product cells (Baroda Moneyplexes). Overhauling its corporate image and focusing on well-diversified asset growth will stand the bank in good stead in the longer term.

Rationalising for efficiency: The bank has witnessed a steady growth in terms of its efficiency parameters over the last 3 years. Although not very lean in terms of number of branches and employees, the bank has made consistent efforts to improve its productivity parameters, by rationalising its franchise and staff strength. The same however, may not be sustainable in the long term unless PSU banks as a sector get government backing to rationalise their operations (i.e. through approvals for branch closure, VRS and the like).

Low cost funding: The bank has successfully reduced its funding costs through a large base of low-cost deposits, with total deposits representing 86% of its funding at the end of FY05. At the end of 1HFY06, low cost deposits constituted 38% of the bank's total deposits. This has helped the bank considerably improve its net interest margins (NIMs 3.4% in 1HFY06) over the last couple of years. Further, the bank believes that it can enlarge its low-cost funding base by leveraging on its extensive branch network and large customer base, particularly in the rural areas where majority of the deposits are in low-cost category. Having said this, with the interest rates keeping an upward bias, we expect some pressure at the NIM levels for the banking sector as a whole in the medium term.

Hedging treasury risks: Bank of Baroda has garnered approximately 50% of its revenues through treasury operations at the end of 1HFY06. Also, 76% of its investments were in the form of GSecs at the end of 1HFY06, the market value of which are subject to interest rate risks being witnessed in the money market currently. Nevertheless, the bank has been reasonably proactive in terms of provisioning and has increased the proportion of investments in the HTM basket from 5% in FY03 to 43% in 1HFY06. It must however, be mentioned that the proportion of investments in the HTM basket are not adequate to see the bank through further spikes in interest rates in the longer term.

Reasons not to apply
Impaired assets: Despite being proactive in terms of provisioning, the bank seems to be unsuccessful in aggressively arresting the incremental delinquencies. The gross NPA to advance ratio stood at 7.3% in FY05 and 6.3% in 1HFY06. At the same time, the net NPA to advance ratios stood at 1.5% and 1.1% respectively. Thus, although the bank's net NPA levels compare quite favourably against its PSU banking peers, given the higher provisioning that the bank needs to make for the same, we believe that impaired asset quality will continue to dampen the return ratios for the bank.

High cost to income ratio: Although Bank of Baroda made some efforts to bring down its cost to income ratio until FY04, the ratio has been steadily rising since then (54% in 1HFY06). This can be attributed to additional expansion overseas and technological upgradation. Once the benefit of these starts filtering into the bank's bottomline, we expect the ratio to improve in the longer term.

Lower fee based income: The bank's 'other income' is heavily relied on treasury income as against fee-based income. Fee based income formed barely 16% of the total other income at the end of 1HFY06. Going forward, the focus on non-fund based revenues may improve the contribution of the same to the bank's revenues. The bank has plans of venturing into asset management and stock broking by FY07 and is also looking at a foreign partner to set up an insurance subsidiary.


    (Rs m)FY03FY04FY051HFY06
    Interest earned 60,976 61,471 64,314 33,673
    Interest expended 39,942 35,755 34,521 18,268
    Net Interest Income 21,034 25,716 29,793 15,405
    Other income 12,617 17,190 13,048 5,183
    Total income 33,651 42,906 42,841 20,588
    Other Expenses 16,484 18,053 19,822 11,078
    Operating profit 4,549 7,663 9,971 4,326
    OPM (%)7.5%12.5%15.5%12.8%
    Provisions 9,538 15,183 16,251 5,349
    Net profit 7,628 9,670 6,768 4,160
    NPM (%)12.5%15.7%10.5%12.4%
    No. of shares (m) 293.0 293.0 293.0 293.0
    EPS (Rs) 26.0 33.0 23.1 28.4
    1HFY06 EPS is annualised

Our view
At the current market price of Rs 241, the bank is trading at 1.3 times its adjusted 1HFY06 adjusted book value. After the issue, the bank is expected to trade at 1.1 times its post issue adjusted book value (assuming the shares get subscribed at the higher end of the band).

Comparitive valuations
1HFY06ROE (%)NIM (%)NPM (%)CAR (%)Net NPA (%)P*/ABV (x)
Bank of Baroda14.5%3.4%12.4%12.8%1.1%1.2
ICICI Bank12.9%2.4%17.9%12.0%1.0%2.4
HDFC Bank14.7%3.9%21.0%12.2%0.3%4.7
* P/ABV has been calculated by considering prices as on 16th January 2006

Though the bank compares favorably against its PSU banking peers, it needs to consolidate its position and derive better efficiency parameters to compete against its counterparts in the private banking space. While margin sustainability is a concern for the sector as a whole, slippages in asset quality and treasury risks may also retard growth for the bank. In terms of valuations, we believe that the bank is very favourably positioned on the risk return matrix and the stock is likely to be remunerative in the longer term.

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