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OBC public issue: Our view - Views on News from Equitymaster
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OBC public issue: Our view
Apr 25, 2005

Oriental Bank of Commerce’s second public issue (100% book building) for 58 m equity shares, at a face value of Rs 10 each, will be open for bidding between the 25th and 29th of April 2005. The applications will be accepted in multiples of 25 equity shares. Going by the price band of Rs 235 to Rs 260, the bank is expected to mop up Rs 15 bn (at the higher end of the band) through the offer. The issue is slated to bring down government's holding in the bank from 66% to 51%. The bank has appointed merchant bankers - DSP Merrill Lynch, Citigroup, Kotak Investment Banking, I-Sec, and Bajaj Capital to manage the offer.

OBC - No longer a zero NPA bank
Nationalised in 1980, OBC is one of the most efficient public sector banks in the country. The bank has close to 1,000 branches that are mainly concentrated in northern India. OBC, like most other public sector banks, has chosen to concentrate on the fast growing retail market, where it has met a reasonable amount of success. The bank, which was also the first public sector bank to have zero net NPAs, no longer has the “zero NPA” tag to its credit. This is because, post the liquidation of the erstwhile Global Trust Bank (GTB), OBC has merged the operations of GTB with itself and is carrying GTB’s poor asset legacy in its books.

The bank’s credit portfolio is skewed towards corporate segment (64%). Of the retail portfolio (22%), housing loans comprise 75%. As against most of its peers, OBC has not been able to capitalise on the credit boom during 9mFY05 primarily on account of having lower CAR post GTB acquisition.

The bank had Net NPA to advances ratio of 1.7% at the end of 9mFY05.

Erstwhile GTB
At the time of amalgamation, erstwhile GTB had 104 branches with 1 m customers and 1,209 employees. EGTB then suffered from a high level of NPAs, inadequate capital for growth of its business, poor corporate governance and risk management systems. As on August 2004, GTB had a negative networth of Rs 8.1 bn, a negative capital adequacy ratio and cumulative losses of Rs 10.8 bn.

Objects of the issue
  • To increase the Tier I capital adequacy ratio (at present 5.7%) and overall CAR (at present 9.4%) 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.

  • The bank plans to expand its operations to have a pan India presence.

Reasons to apply
GTB benefits:  The key rationale behind the merger, as highlighted by OBC, was to expand its presence in south India and lend OBC a pan India presence. GTB had a total network of 104 branches, with a major presence in south India (51 branches). Thus, it has almost doubled OBC’s presence in the south. Further, since GTB and OBC were operating on a common software platform, the technological integration has been hurdle free. GTB also had a young and trained manpower, coupled with a high share of non-interest income. The bank has improved on its cost and efficiency parameters post merger and OBC has projected very optimistic results from the erstwhile GTB branches in the coming fiscals.

Projections for the GTB (standalone)
(Rs bn) 9mFY05 FY05E FY06E FY07E FY08E
Deposits 46.1 48.5 57.0 67.0 80.0
Advances 20.7 25.0 35.0 42.0 50.0
Gross NPA 13.2 11.5 8.7 6.0 4.5
Operating profit/(loss)* (0.7) 0.1 10 17.5 22.5
Source: OBC
* Operating loss figure for 9mFY05 relates to period
between 15th Aug 04 to 31st Dec 04
Post merger scenario…
Aug-04 OBC GTB Merged
entity
Business/Employee (Rs m) 43.5 75.9 44.2
Business/Branch (Rs m) 571.1 642.5 572.6
CAR (%) 16.7 (- ve) 9.4
Cost to Income (%) 34.2 528.1 38.8
Cost of Deposits (%) 5 4.6 4.9
Yield on advances (%) 8.3 6.3 8.1
Yield on Investments (%) 9.2 5.2 9.0
Net NPA (%) 0 27.7 1.7

Prudent on recoveries:  OBC has done extremely well in terms of recoveries from the erstwhile GTB. The management has also upped their expectations of recoveries to close Rs 10 to 12 bn from their earlier expectation of Rs 7 to 8 bn. The higher recoveries, coupled with the tax break, which the bank will be availing of on account of the unabsorbed losses of GTB, would lower the effective cost of acquisition of GTB for OBC. The recoveries from OBC’s NPAs totaled Rs 5.7 bn in FY05 including Rs 0.8 bn of interest recovered, which is likely to add to the interest income of the bank. If OBC succeeds in recovering NPAs worth Rs 10 bn (Rs 8 bn post tax) over the next 15 months, the total cost of the takeover will work out to Rs 4 bn, which will be a profitable bargain for acquisition of GTB.

Transforming the NPAs of erstwhile GTB
Rs bn Dec-04 Mar-05
Cash recoveries of NPA accounts 1.0 2.0
Restructuring of dues in NPA accounts 3.6 4.1
Upgradation of sub standard to standard 0.5 0.6
Total 5.0 6.7
Source:OBC
Total cost of acquisition
  Rs bn
Unabsorbed losses 4.9
Unprovided NPAs 11.0
Total cost 15.8
Less: Tax breaks (@35% of unabsorbed losses) 3.8
Net cost 12.0
Source:OBC

Strong corporate exposure:  OBC has a majority of its exposure in the corporate segment (64%) and going forward, demand growth 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.

Improving efficiency:  The bank has witnessed a steady growth in terms of its efficiency parameters and is in line with the industry benchmarks. This is very unlike most PSU banks and thus a plus for OBC. The bank has established specialized branches for corporate customers to improve productivity further.

Low cost funding:  The bank has consistently replaced its borrowings with low cost deposits over the years. Low cost deposits comprised 93% of the bank’s incremental funding during 9mFY05. Interest free demand deposits and low interest savings deposits constituted 8.7% and 18.8% of the total deposit base at the end of 9mFY05. This has enabled the bank to reduce its cost of deposits from 7.8% in FY03 to 3.7% in 9mFY05.

Reasons not to apply
Integration of GTB:  Although the merger with GTB has offered OBC some potential benefits, the acquisition of the troubled bank has adversely affected the OBC’s financial statements for FY05. During 9mFY05, GTB adversely affected OBC’s financial condition by, among other things, increasing the NPA levels, lowering the NIM, reducing the capital adequacy ratio and operating profit margins. Its negative networth and accumulated losses, as mentioned earlier, have considerably eroded OBC’s networth. GTB employees who have so long received salaries as per their previous pay scale (higher than that of OBC employees) are unhappy with the scheme of realignment of their salaries with that of OBC employees. Once the alignment is done, a high attrition of GTB employees is expected.

Interest rate risk:  As against the government mandate of 25% (of net demand and time liabilities - NDTL) SLR investment, OBC has SLR investments to the tune of 37% of NDTL. This exposes the bank to high interest rate risk in a rising interest rate regime. This is also a concern in view of the fact that only 18% of the investments are in HTM category.

Lower fee based income:  The bank’s ‘other income’ is heavily relied on treasury income as against fee-based income. Fee based income formed barely 16% of the total other income at the end of 9mFY05. Going forward however, GTB’s expertise in garnering fee-based income may improve the contribution of the same to the bank’s revenues.

Margin pressures:  Despite a reasonable growth in loan book and access to low cost deposits, the bank has not been able to augment its net interest margins (NIM). Also, GTB’s poor yielding assets have added to the bank’s NIM woes. Its NIM has reduced substantially from 4.1% in FY04 to 2.7% at the end of 9mFY05. As we go forward, with the interest rates keeping an upward bias, we expect some pressure at the NIM levels for the banking sector as a whole.

Quality of assets… now a concern:  Although OBC is expected to stick to its reputation of maintaining a good asset quality, the addition of GTB’s net NPAs, which has brought the net NPA levels to 1.7% of advances at the end of 9mFY05, remains a concern. This is despite the fact that the bank has a coverage ratio of 84%. Going forward, in the event of no substantial treasury gains, writing off the NPAs will not be an easy task and considerable provisioning will be required.

Financials

(Rs m) FY03 FY04 9mFY05
Interest earned 33,043 33,005 26,285
Interest expended 20,899 18,447 14,927
Net Interest Income 12,144 14,558 11,358
Other income 5,314 7,217 3,308
Total income 17,458 21,776 14,666
Other Expenses 5,827 6,445 5,773
Operating profit 6,317 8,113 5,585
OPM (%) 19.1% 24.6% 21.2%
Provisions 7,061 8,469 3,661
Net profit 4,570 6,862 5,232
NPM (%) 13.8% 20.8% 19.9%
No. of shares (m) 192.5 192.5 192.5
EPS (Rs) 23.7 35.6 27.2
9mFY05 EPS not annualised

Our view
At the current market price of Rs 289, the bank is trading at 2.6 times its adjusted 9mFY05 book value. Post issue, the bank is expected to trade at 2.9 times its 9mFY05 adjusted book value (assuming the shares get subscribed at the higher end of the band). If the cumulative loses and negative networth are accounted for, then the bank trades at 4.8 times its adjusted book value. Considering the vulnerability of the bank’s performance to its ability to turn around GTB, the rich valuations are unjustified.

Comparitive valuations
9mFY05# ROE (%) OPM(%) NPM (%) CAR (%) Net NPA (%) P*/BV (x)
OBC** 26.8% 21.2% 19.9% 9.4% 1.7% 4.8
SBI 14.6% -0.4% 10.6% 13.5% 2.5% 1.8
Punjab National Bank 26.9% 14.1% 19.6% 13.1% 0.3% 2.1
ICICI Bank 21.9% -4.5% 20.4% 13.5% 2.3% 2.3
HDFC Bank 20.6% 22.4% 21.5% 12.2% 0.2% 4.0
** OBC's book value has been calculated after reducing GTB's accumulated losses and negative networth
# 9mFY05 figures have been annualised
* P/BV has been calculated by considering prices as on 19th April 2005

Although OBC traditionally holds a repute of being a fundamentally strong bank, its asset quality and the possibility of a further slippage in GTB’s assets remains a matter of discomfort. However, it is undeniable that with the increment in the CAR the bank certainly holds potential for future growth. As most of the potential upside seems to already factor in the key positives, apart from listing gains, we do not see a substantial upside to the stock in the medium term. We would therefore advise investors, to look for better valuations for their investment in the banking sector itself.

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