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OBC: Showing little hope - Views on News from Equitymaster

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OBC: Showing little hope
Apr 23, 2008

Performance summary
  • Interest income grows 33% YoY in FY08.
  • Bottomline remains flat during the fiscal (excluding extraordinary item arising from write-off of GTB losses), declines by 39% YoY including the same. GTB write-offs due in FY09 written off a year in advance.

  • Capital adequacy ratio at 12.1% (12.7% at the end of FY07).

  • Effective tax rate increases from 21.2% to 33.4% in FY08.

  • Gross NPAs pared to 2.3% from 2.7% in FY07.

  • Board recommends dividend of Rs 4.7 per share (dividend yield of 2.4%).

Rs (m) 4QFY07 4QFY08 Change FY07 FY08 Change
Interest earned 14,336 19,105 33.3% 51,649 68,382 32.4%
Interest expense 9,874 14,734 49.2% 34,736 51,561 48.4%
Net Interest Income 4,462 4,371 -2.0% 16,913 16,821 -0.5%
Net interest margin (%)       2.7% 2.3%  
Other Income 1,437 1,606 11.8% 6,033 6,167 2.2%
Other Expense 2,650 2,726 2.9% 9,979 9,941 -0.4%
Provisions and contingencies 1,616 1,001 -38.1% 2,436 428 -82.4%
Profit before tax 1,633 2,250 37.8% 10,531 12,619 19.8%
Tax 462 2,206 377.5% 2263 4,210 86.0%
Effective tax rate 28.3% 98.0%   21.5% 33.4%  
Profit after tax/ (loss) 1,171 44 -96.2% 8,268 8,409 1.7%
Extraordinary item** 622 1,039 67.0% 2,460 4,877 98.3%
Net profit 549 (995)   5,808 3,532 -39.2%
Net profit margin (%) 3.8% -5.2%   11.2% 5.2%  
No. of shares (m)         250.5  
Book value per share (Rs)*         230.6  
P/BV (x)         0.8  
* (Book value as on 31st March 2008)  ** write off of GTB losses

What has driven performance in FY08?
Slow but steady: OBC has managed to marginally outperform our estimates in terms of advance as well as deposit growth despite being short of capital. While restricting its growth in retail credit to single digits, OBC has adopted a more aggressive strategy for growing its corporate and SME portfolios. Having set a target of 17% YoY growth in advances for the FY08, the bank has been able to outperform the same. Having said that the bank was compelled to raise high cost bulk deposits to fund the advances, which took a toll on its net interest margins (NIMs). The bank’s NIMs declined to 2.3% in FY08 from 2.7% in FY07 due to the negative impact of the Rs 70 bn high cost bulk deposits raised in early FY08. The bank is targeting low cost deposits to comprise 35% of deposits in FY09. Nonetheless, inability in re-pricing the loans according to the higher costs may continue to impact the bank’s margins going forward.

(Rs m) FY07 % of total FY08 % of total Change
Advances 441,385   538,048   21.9%
Retail 74,594 16.9% 80,707 15.0% 8.2%
Corporate 366,791 83.1% 457,341 85.0% 24.7%
Deposits 639,960   778,831   21.7%
Credit / Deposit 69%   69%    

Lack of fee income visibility: Fee income (FY08 growth not divulged) has once again slowed down in FY08 and comprised 13% of the bank’s total income. This is, however, higher against 10% in the corresponding period of the previous fiscal. Going forward, the bank hopes to leverage its collaboration with Corporation Bank and Indian Bank (that have a significant presence in the south) to propel its initiatives of offering cash management services, vending insurance products and other third party products The potential risk on the treasury side has also reduced, albeit marginally. The bank had 44% of its investment portfolio in the HTM (held to maturity) basket in FY08. We however, fail to find any visible fee income stream in the near term.

Costs scale up: OBC had successfully re-aligned the costs of the erstwhile GTB’s branches with itself, which led to the marginal decline in cost to income ratio in FY07. The cost to income ratio has increased to 47% in FY08 from 43% in FY07, partially due to the AS-15 provisions. Although the cost to income ratio is amongst the lowest in public sector banks, the same is exerting pressure on the bank’s margins.

Breakup of operating expenses
(Rs m) FY07 % of total FY08 % of total Change
Employee expenses 5,209 52.2% 5,494 50.9% 5.5%
Other operating expenses 4,770 47.8% 5,303 49.1% 11.2%
Total operating expenses 9,979   10,797   8.2%
Cost / Income 43%   47%    

Leaving GTB legacy behind: OBC had to provide Rs 2.5 bn each in FY08 and FY09 to fully write off the GTB losses in its books. However, the bank has chosen to take the entire write off at one go in FY08 itself so as to clean up its balance sheet and avoid providing on this front going forward. Excluding this extraordinary item, the bank’s bottomline has grown by 2% YoY and the net profit margin stood at 12.3% in FY08 against 16% in FY07. With the GTB legacy gone, the bank will show a substantial increase in net profit in FY09. The bank’s net NPAs stood at 1% in FY08 against 0.5% in FY07.

What to expect?
At the current price of Rs 202, the stock is valued at 0.7 times our estimated FY10 adjusted book value. OBC’s performance in FY08 has been broadly in line with our estimates, excluding the impact of the extraordinary item. However, the bank’s low capital adequacy, inability to capitalise on its pan-India presence coupled with poor efforts on the fee income side is stopping it from harnessing higher asset growth and good asset quality. Having said that, efforts at sustaining NIMs, generate fee income and leverage on its franchise may, however, bring better times for the bank going forward.

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