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IDBI: Just palatable - Views on News from Equitymaster
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IDBI: Just palatable
Feb 19, 2007

Performance summary
IDBI declared results for the third quarter and nine months ended December 2006, reporting the numbers for the United Western Bank (UWB) SBU for the first time in its books. While the merger has proved to be benign in terms of reducing the average funding and operating costs, UWB’s legacy of poor assets has aggravated IDBI’s provisioning requirements. In terms of advance growth, the bank continues to lag its peers in the sector while the fee income growth has shown no signs of improvement.

Standalone numbers
Rs (m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Income from operations 12,517 16,973 36% 38,068 45,310 19%
Other Income 2,964 1,803 -39% 9,102 6,562 -28%
Interest Expense 12,524 14,854 19% 37,618 40,857 9%
Net Interest Income (7) 2,119   450 4,453 890%
Net interest margin (%)       0.0% 1.0%  
Other Expense 1,806 1,890 5% 5,569 5,732 3%
Provisions and contingencies (69) 496   392 624 59%
Profit before tax 1,220 1,536 26% 3,591 4,659 30%
Tax 27 268 893% (6) 491  
Profit after tax/ (loss) 1,193 1,268 6% 3,597 4,168 16%
Net profit margin (%) 9.5% 7.5%   9.4% 9.2%  
No. of shares (m) 723.0 724.1   723.0 724.1  
Diluted earnings per share (Rs)* 6.6 7.0   6.6 7.7  
P/E (x)         12.8  
* (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 3QFY07?
NIMs spurt: While the integration with the defunct United Western Bank was the mainstay of IDBI’s operational highlights of 3QFY07, the bank also managed to appreciably grow its asset book this quarter. Retail credit, which has been the focus of IDBI, ever since it converted into a banking entity, however, has shown some signs of slowdown with the rise in interest rates and comprised only 16% of the bank’s advance book in 9mFY07. While the deposit growth continues to be healthy, albeit on a lower base, it must be noted that there has been a fall in the proportion of CASA from 31% in 9mFY06 to 25% in 9mFY07. This suggests that the incremental deposits were largely high-cost term deposits. What, however, is enthusing is the fact that IDBI managed to improve its net interest margins to 1% (from 0 in 9mFY06) due to the better NIMs of UWB and by retiring the high cost debts.

Expensive growth
(Rs m) 9mFY06 % of total 9mFY07 % of total Change
Advances 500,760   604,660   20.7%
Retail 80,122 16.0% 94,932 15.7% 18.5%
Corporate 420,638 84.0% 509,728 84.3% 21.2%
           
Deposits 218,840   375,910   71.8%
CASA 68,278 31.2% 92,098 24.5% 34.9%
Tem deposits 150,562 68.8% 283,812 75.5% 88.5%
Credit deposit ratio 228.8%   160.9%    

Of the Rs 90 bn SASF, cases worth Rs 44 bn (settlement amount Rs 51 bn) were resolved until FY06. Of this, Rs 2 bn and Rs 8 bn were recovered in FY05 and FY06 respectively, while Rs 15 bn is expected in FY07. The bank has made cash recovery of Rs 5 bn in 9mFY07.

Fees yet to catch up: The bank’s fee income (18% of total income in 9mFY07) shows little signs of growth. The bank has entered into a life insurance venture with Federal Bank and Fortis Insurance International, in which IDBI will have 48% stake. Also, it is contemplating to start an asset management company. These initiatives will, however, contribute meaningfully only in the longer term.

No blow on costs:Lowering the cost to income ratio from 58% in 9mFY06 to 52% in 9mFY07 has aided the bank’s operating margins. Given the fact that the branch franchise of UWB is largely present in the rural and semi urban areas, the same has not had an adverse impact on the bank’s cost ratio.

Quality takes a backseat: After successfully halving the gross NPAs in this portfolio from 4% (of advances) in 1HFY06 to 2.2% in 1HFY07, the same has once again gone up to 2.4% in 9mFY07 (net NPAs rose from 1.4% to 1.6%). This can be largely attributed to the loss assets of UWB (Rs 49 bn) taken into IDBI’s books. IDBI’s provision coverage, despite rising from 35% in FY05 to 50% in FY06, lies way below that of its peers. This will entail additional provisioning liability for the bank in the coming quarters. Also, any write-back of provisioning may not augur well for the bank in a rising interest rate scenario, as the risk of higher delinquencies loom large.

Benefits of UWB yet to filter in: Although at less than 10% of IDBI’s balance sheet size, UWB offered an extensive franchise and a strong presence in the rural and semi-urban areas of Maharashtra. The benefit of the deal to IDBI is further underlined by the fact that while the net compensation payable by IDBI to UWB shareholders (at Rs 28 per share against book value of Rs 21) was Rs 359 m, the cost of setting up UWB’s franchise (branches and ATMs) would have come to Rs 534 m approximately. Also, IDBI’s employees per branch ratio that was unreasonably high at 27 in FY06 is expected to get rationalised to 18 post integration with UWB.

What to expect?
At the current price of Rs 98, the stock is fairly valued at 0.9 times our estimated FY09 adjusted book value. Our meeting with the management of IDBI earlier this year had convinced us about the fact that while the downsides to the bank’s future prospects are almost negligible, the recovery process will be gradual and time consuming. However, the bank’s merger with UWB, on one hand has given a boost to its balance sheet growth, on the other it has also compensated for IDBI’s shortcomings. This has led us to believe that the recovery process is set to accelerate. Its comfortable capital adequacy position and possible upsides in terms of NIMs and NPA recovery also make the stock attractive from a long-term perspective.

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