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IDBI: Lower provisioning saves day!

Jan 31, 2005

Performance Summary
IDBI (now a banking entity), on the verge of merger with IDBI Bank (merger ratio 1:1.42), has posted a turnaround in its bottomline growth (33% growth YoY) after 3 quarters. However, a closer look at the figures tells another story! Although on the face of it the bottomline growth looks attractive, what is pertinent to note that the same has been achieved by neither a growth in topline nor in ‘other income'. On the contrary, the entity has tried to sugarcoat its bottomline figures by drastically reducing its provisioning and tax liabilities.

Rs (m) 1QFY04** 1QFY05** Change
Income from operations 12,823 10,637 -17.0%
Other Income 3,821 1,953 -48.9%
Interest Expense 11,602 10,975 -5.4%
Net Interest Income 1,221 (338) -127.7%
Other Expense 627 972 55.0%
Operating profit / (loss) 594 (1,310) -320.5%
Operating profit margin (%) 4.6% -12.3%  
Provisions and contingencies 3,889 61 -98.4%
Profit before tax 526 582 10.6%
Tax 58 (39) -167.2%
Profit after tax/ (loss) 468 621 32.7%
Net profit margin (%) 3.6% 5.8%  
No. of shares (m) 652.8 652.8  
Diluted earnings per share (Rs)* 2.9 3.8  
P/E (x)   28.91  
** 1QFY04 and 1QFY05 both stand for the period of September to December 2004 and 2005 respectively.

The largest DFI becomes one of the largest banks
Industrial Development Bank of India (IDBI) was established in 1964. It was the largest development finance institution (DFI) in the country and it has now been converted into a bank. For many years it played an active role in the creation of institutions like SEBI, Export- Import Bank of India, the National Stock Exchange of India, and Credit Analysis and Research Ltd (CARE). Now with the impending merger with subsidiary IDBI Bank, IDBI is set to become one of the largest banks in the country. The merged entity is set to function with two SBUs thereby retaining its development finance character, as well as catering to the retail segment of the market.

What has driven performance in 1QFY05 (October to December 2004)?
Plunge in earnings:  During the period of April to December 2004, despite a 239% growth in sanctions, the IDBI had a mere 2.8% growth in disbursals. This minimal growth in advances is surprising, and looking at the sanctions even more so, indicating that the company is taking time to disburse loans. The institution does not seem to be managing competition from banks too well and falling yields continue to add to the bank's woes.

Operating margins also take the hit:  IDBI continues to reduce its interest costs and has managed to reduce the incremental cost of its rupee borrowings to 6.2% during April to December 2004 from 6.6% in FY03. This has however not prevented the fall in net interest income (dipped by 127% YoY), as the interest costs of the bank are still very high compared to the banking sector due to its legacy of high cost borrowings. Since the bank has not yet started its retail operations it is not able to tap in to the low cost deposit segment. However, the bank's profitability is likely to improve once it is able to garner low cost deposits, which will happen post the merger with IDBI Bank.

Cut back on provisioning:  After three quarters of aggressive provisioning, the bank seems to have adopted a lenient approach. Despite having NPAs to the tune of 2.4% (much higher than IDBI Bank) IDBI has drastically pared its incremental provisioning in this quarter so as to show a better picture of its bottomline.

Where is the SASF money going?  The government had sanctioned a Rs 90 bn bailout package under the name of “Stressed Asset Stabilisation Fund” to enable IDBI clean up its books before the merger with IDBI Bank. How much of the said funds have been utilised for the intended purpose is still a matter under wraps. The fact that despite having sufficient funds, the entity is being frugal on provisioning, raises doubts as to where is the SASF money being utilised?

What to expect?
At the current price of Rs 110, the stock is trading 29 times its FY05 expected earnings and 1.2 times its December 2004 book value. Given the price to book value band of 0.75x to 1.25x, the current price puts the entity at the higher end of valuation spectrum. Although IDBI's performance (as a standalone entity) is a sure disappointment, we reiterate our earlier view that post merger the merged entity will be able to rectify its current drawbacks i.e. accelerate lending through better retail access and reduce cost of deposits. Moreover, the efforts of the top management to garner a break through in Dabhol Power Project, can become a positive in the long run.

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