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PNB public issue: Our view - Views on News from Equitymaster
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PNB public issue: Our view
Mar 7, 2005

Punjab National Bank’s second public issue (100% book building) for 80 m equity shares, at a face value of Rs 10 each, will be open for bidding between the 7th and 11th of March 2005. The minimum application will be for 15 equity shares and going by the price band of Rs 350 to Rs 390, the bank is expected to mop up Rs 31.2 bn through the offer (at the higher band). The issue is slated to bring down government's holding in the bank from 80% to 57%. The bank has appointed merchant bankers - DSP Merrill Lynch, JM Morgan Stanley, Kotak Securities, I-Sec and Enam Securities to manage the offer. The third largest bank
After initiating operations in 1895, the bank has grown to become India’s third largest bank in terms of assets and second largest bank in terms of number of branches. The bank has gradually extended its operations beyond northern India, to provide services to over 35 m customers across the country through over 4,000 branches. The bank has a capital adequacy ratio of 11.9% with government being the largest shareholder (80% holding).

The bank’s credit portfolio is skewed towards corporate segment (60%), while both retail and food credit have a weightage of 20% each. As the banking sector witnessed a robust credit growth during 9mFY05, PNB has been able to capitalise on the same. It posted a growth of 23% YoY in its loan book during 9mFY05 while the growth in the retail segment was 32% YoY during the same period. The bank has deployed most of its funds in advances and pruned its investment portfolio during the falling interest rate regime.

The bank has the cleanest asset book (net NPAs 0.3% of advances) and one of the highest coverage ratios amongst PSU banks.

Objects of the issue

  • To increase the Tier I capital adequacy ratio (at present 7%) and overall CAR (at present 11.9%) for meeting the Basel norms going forward. Also, the bank needs to hike its capital base to meet the growth in the corporate and retail credit segment.

  • Of the 80 m shares issued, proceeds of 30 m shares will be used to return a part of government capital. After the return of capital, government’s stake in the bank will be to the tune of 57.8%.

  • The bank plans to expand its overseas operations and open representative offices in the emerging markets of Asia.

Capital structure
(Rs m) Pre issue Post issue
Before capital reduction After capital reduction
Equity capital % Equity capital % Equity capital %
Promoter
(Government)
2,122 80 2,122 61.47 1,822 57.8
Public 531 20 1,331 38.53 1,331 42.2
Total 2,653 100 3,453 100 3,153 100

Basis of allocation
Of the 80 m shares to be offered, PNB has reserved 8 m shares for existing small shareholders and an equivalent amount for employees. The remaining 64 m shares are to be sold to the public. Minimum 35% of the net offering has been reserved for retail individual investors who can bid for equity shares up to Rs 0.1m in value. QIBs can bid up to 50% of the net offering whereas minimum 15% has been reserved for non-institutional bidders.

Reasons to apply

Strong corporate exposure:  PNB has a majority of its exposure in the corporate segment (60%) and going forward, the growth of demand in this segment will augur well for the bank’s credit portfolio. Also, the thrust on infrastructure funding may help the bank accelerate its credit growth in this segment.

Low cost funding:  The bank has consistently replaced its borrowings with low cost deposits over the years. Low cost deposits have grown by 25% YoY during 9mFY05 and form 43% of the bank’s total deposit portfolio. This has enabled the bank to reduce its cost of deposits from 6.1% in FY03 to 4.6% in 1HFY05 and has reduced the cost to income ratio from 48% to 42% during the same period.

Mortgage financing fillip:  The bank is a likely beneficiary of the budget provisions, providing impetus to home loan financing, as 41% of its retail exposure is in this segment. A growth of demand in this segment will thus help the bank increase its market share in the retail segment and also yield better returns for it.

Comfortable with agriculture credit:  Budget 2005 has mandated PSU banks to hike their credit exposure to agriculture by 30% and increase the number of rural borrowers by atleast 50 m in FY06.This means that banks need to have minimum 23% of their exposure in this segment, up from the earlier requirement of 18%. As agricultural credit already comprises 21% of PNB’s credit book, we believe that the bank will be very comfortable in complying with this requirement. Also, the bank’s recovery rate in indirect agriculture credit is to the tune of 97% while that in case of direct agri-credit stands at 90%.

Adequate provisioning:  PNB has one of the cleanest asset books in the PSU banking sector with net NPA to advances ratio of 0.3%. Due to conservative provisioning the bank had NPA coverage ratio to the tune of 95% in FY04. During 9mFY05 the bank has also made an adhoc provision of Rs 2.7 bn towards salary arrears payable to employees as per the wage revision settlement.

Assets transferred to HTM:  The bank has accounted for depreciation of Rs 2 bn during 9mFY05 for transfer of government securities from ‘available for sale’ to ‘held to maturity’ category. This has insulated the bank’s bottomline against any further losses on the treasury side due to interest rate volatility.

Autonomy benefits:  Governments recent declaration of granting autonomy to PSU banks has not only facilitated the sector’s consolidation route but also provided better options to the entities for improving their productivity and rightsizing their balance sheets.

Reasons not to apply

Shrinking margins:  Despite the access to low cost deposits, the bank has not been able to augment its net interest margins. Over the years, the bank’s net interest income growth has not been parallel to the growth in average earning assets and also the yields on advances and investments have substantially declined (from 10.4% in FY03 to 8.5% in 9mFY05). This has caused its NIM to subside from 4.3% in FY03 to 3.8% at the end of 9mFY05. As we go forward, we expect some pressure at the NIM levels for the banking sector as a whole (of course, there will be some exceptions).

Overexposed to agri-credit:  While the bank’s retail and agriculture credit have continued to witness a robust YoY growth, it is the corporate segment that seems to lag behind. In contrast to most of its peers, which have benefited by a rising demand for corporate working capital, the bank’s exposure in this segment remains stagnant. On the other hand, exposure towards food credit seems to be unreasonably high. Although the bank has had a reasonable recovery rate in the indirect agri-credit portfolio, the possibility of NPAs resurfacing in the direct credit segment is undeniable. Also, overexposure to this segment may limit the bank’s returns in the long run.

Risk in overseas operations:  The bank has recently opened representative offices in London (UK), Almaty (Kazakhstan) and Shanghai (China) and a branch in Kabul (Afghanistan). Each of these investments are subject to start-up and operational risks and may not be able to generate the desired returns.

Possibility of IFCI merger:  The Government has requested PNB to consider a merger proposal with IFCI. As on March 31st 2004, IFCI had Rs 159 bn of assets, Rs 11 bn of total income and Rs 120 bn of gross NPAs. The Board of Directors of the bank have agreed in principle to consider the proposal subject to certain conditions conveyed to the government. These conditions include the completion of due diligence, the acquisition of only the performing assets of IFCI and several others designed to ensure that the merger does not have any adverse financial or operational impact on the bank. If IFCI is merged with PNB without the conditions being accepted, then the balance sheet of the bank will be adversely affected.

Subsidiary losses:  The bank’s subsidiary PNB Gilts Ltd, has had subsiding profits for the last three years and has posted losses to the tune of Rs 0.87 billion for 1HFY05. The main reason for the loss was trading losses incurred by PNB Gilts as a result of the rise in interest rates during the period. The subsidiary continues to remain exposed to such market risks and this could drain the bank’s bottomline in a rising interest regime.

Financials
(Rs m) FY03 FY04 9mFY05
Interest earned 76,751 79,721 62,752
Interest expended 44,733 42,639 33,405
Net Interest Income 32,018 37,082 29,347
Other income 13,351 19,721 12,983
Total income 45,369 56,803 42,330
Other Expenses 20,736 23,879 20,527
Operating profit 11,282 13,203 8,820
OPM (%) 14.7% 16.6% 14.1%
Provisions 15,478 20,911 11,307
Net profit 9,155 12,013 10,496
NPM (%) 11.9% 15.1% 16.7%
No. of shares (m) 256.4 265.3 265.3
EPS (Rs) 35.7 45.2 39.6
Comparitive valuations
9mFY05# ROA
(%)
OPM
(%)
NPM
(%)
CAR
(%)
Net NPA
(%)
P*/BV
(x)
PNB 1.2% 14.1% 16.7% 13.1% 0.3% 2.7
Canara Bank 1.3% 13.5% 18.2% 12.9% 2.9% 1.8
Bank of Baroda 0.9% 13.5% 12.3% 13.9% 2.1% 1.3
Allahabad Bank 1.4% 12.4% 19.6% 12.1% 1.5% 1.3
# 9mFY05 figures have been annualised
* P/BV has been calculated by considering prices as on 5th February 2005

Our view

At the current price of Rs 475, the bank is trading 2.7 times 9mFY05 adjusted book value. Although the price band of Rs 350 to Rs 390 is at a discount of 13% to the current market price, the valuation accorded to it is 2.2 times its 9mFY05 book value (at the higher end of the band).

We feel that the offer is slightly overpriced for a bank like PNB. Despite its size, the bank does not seem to be able to cash in on the buoyancy in the economy and holds prospects of better future performance only in the event of a merger with a more efficient bank. Meanwhile, with the prospects of a merger with IFCI looming large, the possibility of deterioration in asset quality cannot be ruled out. Apart from listing gains, we do not see a substantial upside to the stock in the long term and would therefore advise serious investors, looking for visible growth stories, to keep aside their funds for better opportunities in the banking sector itself.

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