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OBC: Brighter days ahead?

Jan 24, 2006

Performance Summary
Oriental Bank of Commerce declared its results for the quarter ended December 2005, posting an adjusted bottomline growth (less of GTB write-offs), for the first time after the GTB acquisition. Without considering the extraordinary write-off of GTB losses, the bottomline growth has been 60% YoY in 3QFY06. However, for the nine-month period, the bottomline continues to truncate, as do the profit margins. While the bank has done appreciably in terms of asset growth, asset quality and curtailment of operating expenses, stagnation of other income remains a concern.

Rs (m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Income from operations 9,107 10,499 15.3% 26,285 30,443 15.8%
Other Income 1,650 1,263 -23.4% 3,308 3,938 19.0%
Interest Expense 5,383 6,549 21.7% 14,927 18,421 23.4%
Net Interest Income 3,724 3,950 6.1% 11,358 12,022 5.8%
Net interest margin (%)       2.8% 3.0%  
Other Expense 2,485 2,225 -10.5% 5,773 6,863 18.9%
Provisions and contingencies 2,063 309 -85.0% 2,511 1,661 -33.9%
Profit before tax 825 2,679 224.7% 6,382 7,436 16.5%
Tax (451) 633   1,150 2,077 80.6%
Profit after tax/ (loss) 1,276 2,046 60.3% 5,232 5,359 2.4%
Extraordinary item** - 612   - 1,837  
Net profit 1,276 1,434 12.3% 5,232 3,522 -32.7%
Net profit margin (%) 14.0% 13.7%   19.9% 17.6%  
No. of shares (m)       192.6 250.6  
Diluted earnings per share (Rs)*         23.5  
P/E (x)         11.0  
* (trailing 12 months)
** write off of GTB losses

Getting the best out of the worst
OBC has the repute of being one of the most efficient public sector banks in the country. The bank’s credit portfolio is skewed towards corporate segment (81%). Of the retail portfolio (19%), housing loans comprise 75%. As against most of its peers, OBC has not been able to capitalise on the credit boom during FY05 primarily on account of having lower CAR post Global Trust Bank (GTB) acquisition. The bank, which was also the first public sector bank to have zero net NPAs, no longer has the tag to its credit. At the time of amalgamation, erstwhile GTB had 104 branches with 1 m customers and 1,209 employees. It had a negative networth of Rs 8.1 bn, a negative capital adequacy ratio and cumulative losses of Rs 10.8 bn. However, OBC has done its best in using GTB to its advantage and has reduced the effective cost of ‘acquisition’.

What has driven performance in 3QFY06?
Margin improvement – base effect: OBC continues to reap the benefit of lower base effect (of FY05) in terms of net interest margin growth as well as asset growth. Although the bank has divulged no details with respect to growth in advances and breakup of the same, we reckon that the same has grown by around 28% YoY, in line with our estimates. We could substantiate our argument based on the fact that the bank witnessed a growth of 32% YoY in its interest income. The same could also be attributed to the bank’s pan India presence (the GTB branches now having started lending) and better yield on assets. It must be noted that while only 12 of the 104 branches of GTB were disbursing loans, OBC has extended the lending operation to all the 104 branches. Also, the bank has opened new branches in the eastern regions of the country where it did not presence earlier. Resultantly, while players across the sector continue to face margin pressures due to higher cost of funds, OBC has been able to improve its net interest margin over the corresponding quarter of FY05. We have estimated the bank’s FY06 NIM at 3.1%, which is expected to dilute going forward, if the funding pressures continue.

Breakup of interest earned
(Rs m) 3QFY05 % of total 3QFY06 % of total Change
Interest on advances 4,645 51.2% 6,124 58.3% 31.8%
Interest on investments 4,267 47.0% 4,165 39.7% -2.4%
Interest on RBI and inter bank balance 169 1.9% 209 2.0% 23.7%
Total interest earned 9,081   10,498   15.6%

Overheads curtailed: In contrast to most of its PSU banking peers, OBC has successfully curtained its operating costs in 3QFY06. Though it will not be wrong to adjudge the same as being an impact of higher base in the corresponding quarter of FY05, given the bank’s higher employee cost and rental liability due to the GTB branches, it must be noted that the bank has kept its cost to income ratio flat at 41% (lower than PSU banking sector average). It may be recalled that OBC saw its operating overheads amplify post GTB acquisition (GTB employee and rental costs were considerably higher as compared to that of OBC) and since then, it is trying to rationalise the same. Also, the public issue expenses amounting to Rs 223 m are being written off equally over a period of five years and accordingly Rs 34 m has been charged to profit & loss account under the head ‘operating expenses’ during 9mFY06.

Breakup of operating expenses
(Rs m) 3QFY05 % of total 3QFY06 % of total Change
Employee expenses 1,114 44.8% 1,119 50.3% 0.4%
Other operating expenses 1,371 55.2% 1,106 49.7% -19.3%
Total operating expenses 2,485   2,225   -10.5%

Nevertheless, the bank’s initiatives of offering cash management services and tie up with insurance companies for vending third part party products seems to be doing little to improve its fee income. Also, while the bank has not divulged details of investments in the HTM category, we reckon that the same is not above 50% and may lead to treasury losses in the wake of spurt in interest rates. Having said this, it must be noted that the bank has made provisions for rise in bond yields upto 7.8% and any rise beyond this will impact the bank's treasury book

Quality – no compromise: The bank is facing an incremental delinquency rate of approximately 3% on its advance book, which is good considering the expansion in its credit book. OBC has lived up to its commitment of improving its asset quality and has pared its NPAs further (0.6% in 3QFY06). Although, the bank seems to have written back some of its provisioning in the current fiscal, it continues to have a coverage ratio of around 88%. The bank has set the target of reducing its net NPAs to the erstwhile ‘zero’ levels (before taking over GTB) and we believe that it will be successful in doing so. The same will prove benign for the bank’s valuations in the longer term.

Profit margins seesaw: The bank’s profit margin has been very volatile over the past couple of quarters. To add to it, the bank is carrying GTB’s losses of Rs 12.2 bn, which need to be written off equally over 5 fiscals. As a result, the bank has had to partially write off the GTB losses under the head ‘extraordinary item’ in this quarter, thus further eroding its bottomline

What to expect?
Although OBC has shifted part of its G-Secs from the available for sale (AFS) to the held to maturity (HTM) basket during the current fiscal, we reckon that it may have to continue making higher provisions for the same in the coming quarters. On the other hand, the bank has already recovered bad debts worth Rs 4.8 bn, which is expected to reduce the NPA provisioning requirements, once the GTB NPAs go off its books. Also, rationalisation of operating overheads and improvement in asset quality (through higher provisioning), which the bank is working towards, will augur well for the longer term. Nevertheless, growth on the fee income side leaves a lot to be desired. A comfortable capital position (CAR 13% in 9mFY06) supports the bank’s asset growth targets.

At the current price of Rs 259, the stock is trading at 1.1 times our estimated FY08 adjusted book value. We had recommended a ‘Buy’ on OBC in September 2005. We reiterate our view on the stock, as we believe that the bank’s ability to capitalise on its pan-India presence coupled with good quality appraisal, will enable it harness higher asset growth and good asset quality.

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