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IDBI: A ray of hope! - Views on News from Equitymaster
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IDBI: A ray of hope!
May 9, 2006

Performance summary
IDBI announced results for the fourth quarter and full year ended March 2006 last week. While the annual (FY06) results are not comparable with that of FY05 (the latter being for a 6 month period), there has been a visible improvement in the fourth quarter performance. However, what can be comprehended of the given set of numbers is that the bank has appreciably controlled its funding costs to keep its net interest margins in the positive. Lower tax outgo and operating leverage continues to bail out the bank. The result analysis includes the excerpts of the bank’s analyst meet.

Rs (m) 4QFY05 4QFY06 Change FY05 FY06
6 months 12 months
Income from operations 13,573 15,739 16% 26,557 53,807
Other Income 3,520 3,703 5% 6,271 12,804
Interest Expense 12,426 12,390 0% 24,678 50,008
Net Interest Income 1,148 3,349 192% 1,879 3,799
Net interest margin (%)       0.8% 0.5%
Other Expense 2,685 3,026 13% 4,539 8,594
Provisions and contingencies (562) 1,733   725 2,125
Profit before tax 2,544 2,293 -10% 2,886 5,884
Tax 651 281 -57% 188 275
Profit after tax/ (loss) 1,893 2,012 6% 3,073 5,608
Net profit margin (%) 13.9% 12.8%   11.6% 10.4%
No. of shares (m)       721.7 723.7
Diluted earnings per share (Rs)*       4.3 7.7
P/E (x)         12.3
* (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 4QFY06?
NIMs – bottomed out: Despite a slower deposit growth (20% YoY) as compared to the past few quarters, IDBI continued to garner a handsome proportion of retail assets. The bank’s retail loan book grew by 50% YoY in FY06, a rate comparable with private sector banks, albeit on a lower base. Nonetheless, the average asset growth of 16% YoY was an underperformance vis-à-vis its peers. What, however, is enthusing is the fact that IDBI managed to grow the incremental assets with negligible rise in funding costs, despite the rising interest rates. This has been achieved by paying off the high cost debts. The bank repaid debts to the tune of Rs 200 bn in FY06, of which Rs 160 bn were high cost (with interest rates of 12% per annum and above). Resultantly the NII grew by 192% YoY in 4QFY06. At the end of FY06, 55% to 60% of the bank’s borrowings were priced at interest rates of 8% per annum and above, Rs 50 bn were ‘restructured debts’ under the CDR mechanism and the balance were at rates between 4% to 8% per annum. Given this, Rs 190 bn and Rs 70 bn high cost debts will be repaid in FY07 and FY08 respectively.

Retail advances leapfrog…
(Rs m) FY05 % of total FY06 % of total Change
Advances 454,140   525,180   15.6%
Retail 56,935 12.5% 85,163 16.2% 49.6%
Corporate 397,205 87.5% 440,017 83.8% 10.8%
           
Deposits 151,030   181,580   20.2%
Credit deposit ratio 300.7%   289.2%    

Although the NIMs of 0.5% in FY06 are not only the lowest in the sector but also lower than the bank’s previous quarters’, the same seem to have bottomed out. The bank has offered sufficient rationale for this. Of the Rs 90 bn SASF, cases worth Rs 44 bn (settlement amount Rs 51.3 bn) have been resolved until FY06. Of this, Rs 2 bn and Rs 8.1 bn were recovered in FY05 and FY06 respectively while Rs 15 bn is expected in FY07. G-Secs of equivalent value on getting freed from IDBI’s books will be available for productive usage. It must be further noted that for every rupee transferred to the SASF, IDBI is to receive Rs 1.14 on settlement. Also, the profit on sale of stakes in companies (hitherto booked as other income) is now available for lending purposes. These will shield any further downsides to the bank’s NIMs. The bank has been able to maintain a margin of 300 to 400 basis points between the incremental loans taken in its books and the debts repaid. With this, while the average yield on advances was 8.9%, the average cost of funds was 6.7%, thus leaving a healthy spread of 1.8%.

Cost-push: In terms of operating costs, although the bank has been able to control its staff costs at 5% of total operating costs, the cost to income ratio continues to expand (52% in FY06). Also, the staff costs have grown by 113% YoY due to the additional recruitments (employee turnover 17% in FY06). It is interesting to note that while IDBI has the highest average business per branch in the sector (due to its lean franchise), it also has the highest number of employees per branch. This can drain the bank’s profitability going forward unless it expands its franchise at a faster pace (FY08 target - 500 branches vis-à-vis 177 in FY06).

Quality- at par with the best: Despite the relatively faster pick up in retail disbursals, the bank has been able to cap the net NPAs in this portfolio at 0.2% (of advances). Also, post SASF, we do not see the overall average net NPA levels shooting higher than the current levels of 1% of advances. With the current NPA levels (gross NPA at 2%), IDBI’s asset quality can be pegged as one of the best amongst PSU banks. The bank also has floating provisions to the tune of Rs 20 bn in its books. To that extent, quality and valuations remain well guarded.

Valuations impacted: With a slower asset growth and low spread IDBI’s valuations have been considerably impacted over the past few quarters. However, going forward, we see the bank showing improvements on both these grounds. Its recent initiatives to garner additional fee income and expand its revenue stream (foray into the insurance business with Fortis) will also stand in good stead going forward.

(FY06) Nov'04 - Mar'05 FY06
Return on assets (RoA) 0.8% 0.7%
Return on equity (RoE) 9.9% 9.0%
Yield on assets 8.3% 7.8%
Cost of funds 7.4% 6.8%
NIM 0.8% 0.5%
Low cost funds/total funds 38.3% 28.5%
Cost to income ratio 56.0% 52.0%

What to expect?
At the current price of Rs 94, the stock is fairly valued at 1.0 time our estimated FY08 adjusted book value. While there is definitely a marked improvement in the bank’s operating parameters, we do not see the potential upsides making any immediate impact on its numbers. For instance, we do not see the bank achieving NIMs of 1% until FY08. Nevertheless, investors with a long-term perspective (3 to 4 years) can definitely hold on to the stock.

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