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IDBI: Diminutive margins!

Jan 25, 2006

Performance Summary
IDBI announced results for he quarter and nine month ended December 2005 late yesterday. The consolidated results are not comparable with that of 3QFY05, as the bank has given the results for the said period only for the standalone entity (IDBI). What however, can be comprehended of the given set of numbers, is that the bank is struggling to keep its net interest margins in the positive. Lower provisioning and tax benefits continue to bail out the bank, as does an extraordinary gain in other income.

Rs (m) 3QFY05 3QFY06 9mFY06
  Solo entity Merged entity Merged entity
Income from operations 10,638 12,517 38,069
Other Income 1,953 2,964 9,102
Interest Expense 10,976 12,524 37,619
Net Interest Income (338) (7) 450
Net interest margin (%)     0.1%
Other Expense 972 1,807 5,569
Provisions and contingencies 62 (69) 392
Profit before tax 582 1,219 3,591
Tax (40) 27 (6)
Profit after tax/ (loss) 622 1,192 3,597
Net profit margin (%) 5.8% 9.5% 9.4%
No. of shares (m)     723.7
Diluted earnings per share (Rs)*     7.1
P/E (x)     13.5
* (12 months trailing)      

Sleeping giant

Merger of IDBI and IDBI Bank was largely anticipated to be a win-win situation for both the entities. The erstwhile IDBI Bank, given its clean assets and impressive fundamentals, has offered valuable growth prospects, access to low cost deposits and extended reach, which in future will enable the consolidated entity to seek a better spread on its infrastructure funding. Post the merger with IDBI Bank, the government holding in IDBI stands at 58%. The bank is currently functioning with two SBUs handling the development finance and banking businesses separately. It currently has two subsidiaries namely IDBI Housing Finance Ltd. and IDBI Capital Services Ltd. Although the merged entity is in the league of the largest banks in the country in terms of asset size, its lackadaisical rate of growth leaves it way behind its peers in terms of performance.

What has driven performance in 3QFY06?
Yet to catch up on growth: IDBI continues to under perform the sector in terms of asset growth despite having a comfortable capital base and wider franchise post merger with IDBI Bank. While the bank’s deposits registered a stellar growth of around 60% YoY (on a low base) advance growth trailed far behind at 14% YoY (sector average 31%). Also, despite access to higher proportion of low cost deposits (low cost deposits accounted for 31% of total deposits in 9mFY06) the bank’s net interest margins continued to truncate further. This is because although the bank is gradually getting rid of the high cost IDBI borrowings, cost of deposits is not getting marginalized due to hardening of interest rates. Also, most of its advances have got re-priced through the CDR mechanism, thus depriving it of higher yields. While we do not expect the NIMs to improve significantly this year, the bank has set a target of 1% NIMs by FY07.

Breakup of interest earned
(Rs m) 3QFY05* % of total 3QFY06** % of total
Interest on advances 8,735 82.1% 10,106 80.9%
Interest on investments 1,639 15.4% 2,153 17.2%
Interest on RBI
and inter bank balance
263 2.5% 238 1.9%
Total interest earned 10,637   12,497  
*Standalone entity
** Merged entity

The breakup of operating costs though not comparable with the corresponding quarter of FY05, clearly shows that the bank has seen an escalation in its employee cost as well as operating overheads during 3QFY06, which can be attributed to franchise and employee accretion. The cost to income ratio stands at 58% at the end of 9mFY06.

Breakup of operating expenses
(Rs m) 3QFY05* % of total 3QFY06** % of total
Employee expenses 232 23.9% 555 30.7%
Other operating expenses 740 76.1% 1,251 69.3%
Total operating expenses 972   1,806  
*Standalone entity
** Merged entity

Business efficiency outperformance: It is nonetheless noteworthy that IDBI, despite being a PSU banking entity enjoys a very lean franchise and employee strength. The bank has 155 branches and 4,500 odd employees at the end of FY05. Resultantly, the bank enjoys the best business efficiency ratios amongst PSU banks. Its business per employee during 3QFY06 stood at over Rs 150 m, which is comparable with some of the most productive banks in the country.

Other income – profit booster: While IDBI’s other income continues to cushion its bottomline, the contribution from NII (net interest income) being negligible, the same was aided by an extraordinary gain in 3QFY06. The bank earned a profit of Rs 546 m on the buy back of its shares by IDBI Capital, a wholly owned subsidiary of the bank, which accounted for 20% of its other income in 3QFY06. Lower provisioning and tax benefit (effective tax rate 3% in 3QFY06) also aided profit margins.

Signs of quality? Although the bank has been able to pare its net NPA levels from 2.4% in 3QFY05 to 1.4% in 3QFY06, the leniency in provisioning is unwarranted, as the bank seems unable to arrest the incremental delinquencies. The fresh slippage despite the marginal growth in assets is a lingering concern. However, the bank has fully written off some provided non-performing assets in 3QFY06, resulting in decline in gross NPAs. No updates have been given by the bank in terms of recovery against SASF (stressed asset stabilisation fund) during 9mFY06.

Capital rich: IDBI has sufficient capital and its capital adequacy ratio (CAR) stood at 16% in 9mFY06. Besides investing in its retail foray, the bank is also embarking on several plans for its subsidiaries.

  1. The bank is likely to finalise details pertaining to its life insurance foray before the end of this financial year.

  2. The bank plans to inaugurate a large corporate branch in Mumbai shortly.

  3. The bank is planning to incorporate an AMC for entry into Mutual Fund business in association with its wholly owned subsidiary - IDBI Caps.

It, however, remains to be seen as to what is the time period within which the benefits of such investments start filtering into the bank’s valuations.

What to expect?
IDBI does not seem to be delivering on any of its promises, be it in terms of asset growth or improvement in net interest margins. The bank’s priority lending and SLR mandation are also proving to be a handicap. Although the bank is now well poised to capitalise on the growth opportunities in the retail and corporate lending space, we reckon that it may continue to remain a laggard.

At the current price of Rs 93, the stock is fairly valued at 1.0 time our estimated FY08 adjusted book value. Although the fundamentals of the merged entity position it on a better ground than before, the concerns regarding its adaptability to the competitive environment in the banking sector and ability to clean up it asset book, diminish the comfort factor.

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