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Bank of Baroda: Diversification pays off
May 7, 2007

Performance summary
Bank of Baroda recently announced results for the fourth quarter and full year ended March 2007. While outperforming the sector in its domestic asset growth, access to deposit and advances in foreign shores has also stood the bank in good stead this quarter. Having said that, despite the strong traction in fund-based revenues, the bank has faced pressure on its net interest margins (NIMs). The bank’s other income, however, has helped substitute much of the margin loss. A higher tax incidence has capped the profits emanating from curtailment in operating overheads.

Rs (m) 4QFY06 4QFY07 Change FY06 FY07 Change
Income from operations 19,550 26,720 36.7% 70,499 92,126 30.7%
Interest Expense 10,883 15,674 44.0% 38,750 54,265 40.0%
Net Interest Income 8,667 11,046 27.4% 31,749 37,861 19.3%
NIM (%)       3.3% 3.2%  
Other Income 3,720 2,403 -35.4% 11,274 11,732 4.1%
Other Expense 6,666 7,584 13.8% 23,847 25,443 6.7%
Provisions and contingencies 3,633 3,409 -6.2% 10,905 13,885 27.3%
Profit after tax/ (loss) 2,088 2,456 17.6% 8,271 10,265 24.1%
Net profit margin (%) 10.7% 9.2%   11.7% 11.1%  
No. of shares (m)       293.2 364.3  
Diluted earnings per share (Rs)*       28.2 28.2  
P/E (x)         8.7  
* (12 months trailing)            

A de-risked play
Bank of Baroda is the fifth largest banking entity in the country (in terms of asset size) with 4% share of the total credit disbursals at the end of FY06. Given its geographic concentration in the northern regions, the bank was a laggard in terms of credit growth in the initial years of this decade, which resulted in a loss of market share (from 5.7% in FY02 to 4% in FY06). However, a brand and operating overhaul led to accelerated growth in the last two fiscals, thus helping it stabilise its share and position itself favourably amongst its peers. Adequate capital (CAR 11.8% in 4QFY07), high NPA coverage and hedge against interest rate risks peg the bank amongst the frontrunners in the public sector banking space.

What has driven performance in 4QFY07?
Geographic substitution: Having one of the largest number of offshore branches amongst Indian banks helped Bank of Baroda tide over the liquidity constraints and margin pressures in FY07. In line with its past performance, the bank continued to outdo its peers in public sector banking space in terms of asset growth. The bank’s global business exposure (deposits and advances) nearly doubled from global advances comprising 10% of total advances in FY06 to 20% in FY07, clocking a growth rate of 72% YoY. In terms of profitability, the international operations had contributed 33% of the bank's net profits in FY07 (28% in FY06).

Asset book: Global tilt…
  FY06 % of total FY07 % of total Change
Advances 599,240   836,209   39.5%
Global 95,400 10.0% 163,582 19.6% 71.5%
Domestic 503,840 84.1% 672,627 80.4% 33.5%
           
Deposits 936,593   1,249,159   33.4%
Global 146,124 15.6% 251,903 20.2% 72.4%
Domestic 790,469 84.4% 997,256 79.8% 26.2%

The hike in interest rates in the domestic markets coupled with the shortage of liquidity led to a slower advance growth in the domestic markets.However, on the back of 46% YoY growth in retail credit (21% of total domestic advances), Bank of Baroda registered a 34% YoY growth in domestic advances in FY07, outperforming the sector average of 28% YoY. Over the past 5 years, while the bank’s retail credit portfolio has grown at a CAGR of 52%, the home loan portfolio has grown at a CAGR of 33% and SME credit has grow a CAGR of 32%. A higher share of CASA (39% in FY07 against 42% in FY06) and access to global funds cushioned the drop in the bank’s net interest margins, which dipped by marginal 10 basis points. Nevertheless, the fact that the bank’s NIMs have steadily declined over the past few quarters, remains a cause for concern.

Cashing in on ‘fees’: Bank of Baroda's recent initiatives for improving its non-fund based income resource started yielding results in FY07. The bank’s fee income grew 31% YoY in FY07 (one of the highest amongst PSU banks). It, however, comprised merely 10% of the bank’s total income in this fiscal and has grown at a CAGR of 8% in the last 5 years. Fee income from overseas operations grew by 25% YoY. It may also be recalled that the bank had entered into an MOU with IDFC in FY07 for funding the projects appraised by it. This is expected to ensure good quality lending and big-ticket loans but also fetch the bank proportionate fee income. Although, the investment book of the bank is not a concern (76% of investments are in HTM basket), diminishing fee income will endanger the sustainability of net margins, as the core banking business gets commoditised and more competitive private sector and foreign players cannibalise on its market share.

Costs to even out: The bank has pared its cost to income ratio from 55% in FY06 to 51% in FY07. Also, only 40% of Bank of Baroda's employees (38,774 at the end of FY06) have opted for the pension scheme, which otherwise would have burnt a hole in its reserves as in the case of most other PSU banks. The bank has also clarified that it has been providing for pension related expenses on actuarial basis, thus taking care of future liabilities in its books. Further, in the next 3 to 4 years, around 4,000 employees of the bank will be retiring, thus considerably lightening its wage burden (as most of these employees are in the high salary bracket). For filling the requisite vacancies, the bank will be recruiting around 300 people each year for the next 3 to 4 years, at relatively lower salary levels as compared to the retirees. We expect this to rationalise the bank's overheads and bring down its cost to income ratio at par with that of its peers in the sector. The cost to income ratio in the overseas operations was at a relatively lower 27% in FY07.

Housing slip: While the bank has witnessed a 21% YoY reduction in the absolute value of its gross NPAs (2.4% of total advances from 3.9% in FY06), even at the net NPA level the higher provisioning has brought down the same from 0.9% of advances in FY06 to 0.6% in this quarter. In the international operations, gross NPAs are at 0.7% while the net NPAs are zero. While higher recoveries and an adequate coverage ratio of 78% for NPAs dilute some concerns on this front, the NPA level in homes loans (3.5% in FY07) remain a peril. At the end of FY07, 10% of the bank’s corporate credit exposure was categorised in the ‘high risk’ category in terms of ratings.

What to expect?
At the current price of Rs 245, the stock is attractively valued at 1.0 time our estimated FY09 adjusted book value. The bank has marginally outperformed our FY07 asset growth and margin estimations and we will need to upgrade our forward estimations to that extent. Adequate capital, a high provisioning cover, exposure in overseas markets and reasonable consistency in net interest margins makes it a de-risked play in the PSU banking space. The interest rate risk due to excessive dependence on fund-based revenues is the only downside to the prospects of the bank. We maintain our positive recommendation on the stock from a long-term perspective.

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