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OBC: Short of delivery! - Views on News from Equitymaster
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OBC: Short of delivery!
May 11, 2007

Performance summary
Oriental Bank of Commerce (OBC) recently declared its results for the fourth quarter and fiscal ended March 2007. While the bank has marginally outperformed our estimation in terms of bottomline growth, the net interest margin and other income growth are largely in line with estimates. While lower provisioning requirement (due to NPA recoveries) and operating expenses have lent buoyancy to the bank’s net profit margins, the bank continues to remain exposed to treasury risks. In terms of fee income growth, the bank has grossly fallen short of delivering its promises.

Rs (m) 4QFY06 4QFY07 Change FY06 FY07 Change
Income from operations 10,745 14,335 33.4% 41,189 51,649 25.4%
Interest Expense 6,717 9,874 47.0% 25,138 34,735 38.2%
Net Interest Income 4,028 4,461 10.7% 16,051 16,914 5.4%
Net interest margin (%)       2.8% 2.7%  
Other Income 1,589 1,437 -9.6% 5,527 6,032 9.1%
Other Expense 2,795 2,650 -5.2% 9,658 9,978 3.3%
Provisions and contingencies 610 1,615 164.8% 2,271 2,435 7.2%
Profit before tax 2,212 1,633 -26.2% 9,649 10,533 9.2%
Tax (459) 462 -200.7% 1,617 2,263 40.0%
Effective tax rate -20.8% 28.3%   16.8% 21.5%  
Profit after tax/ (loss) 2,671 1,171 -56.2% 8,032 8,270 3.0%
Extraordinary item** 623 623 0.0% 2,460 2,460 0.0%
Net profit 2,048 548 -73.2% 5,572 5,810 4.3%
Net profit margin (%) 19.1% 3.8%   13.5% 11.2%  
No. of shares (m) 250.5 250.5   250.5 250.5  
Diluted earnings per share (Rs)* 32.7 8.8   22.2 23.2  
P/E (x)         8.3  
* (trailing 12 months)
** write off of GTB losses

Getting the best out of the worst
OBC has the repute of being one of the most efficient public sector banks in the country. The bank’s credit portfolio is skewed towards corporate segment (81%). Of the retail portfolio (19%), housing loans comprise 75%. As against most of its peers, OBC has not been able to capitalise on the credit boom during FY05 primarily on account of having lower CAR post Global Trust Bank (GTB) acquisition. The bank, which was also the first public sector bank to have zero net NPAs, no longer has the tag to its credit. At the time of amalgamation, erstwhile GTB had 104 branches with 1 m customers and 1,209 employees. It had a negative networth of Rs 8.1 bn, a negative capital adequacy ratio and cumulative losses of Rs 10.8 bn. However, OBC has done its best in using GTB to its advantage and has reduced the effective cost of ‘acquisition’. At the end of December 2006, the bank had 1,233 branches and 601 ATMs.

What has driven performance in 4QFY07?
Reticent retail: While its repute of being risk averse is appreciated, OBC merely managed to toe in line with the sector growth this fiscal due to its conservative stance on retail assets, especially housing loans. As a result, while the overall credit disbursals clocked a growth of 29% YoY, the growth in retail credit was restricted to single digits and the share of the latter to total credit was brought down from 20% in FY06 to 16% in FY07. At the same time, the growth in the bank’s home loan portfolio was 12% YoY, less than half the rate of growth clocked by the sector (30% YoY). Nevertheless, the bank is over-exposed to mortgage loans in its retail portfolio, as the same comprise nearly 78% of its retail book. This may be one of the reasons for its reticence to avoid slippages on this book.

The bank has set a target of 25% YoY growth in advances for the current fiscal. Low cost deposits (comprising 30% of total deposits) grew by 18% YoY in FY07 and the bank is targeting the same to comprise 35% of deposits in FY08. Also, despite the bank’s cautious approach towards accepting high cost bulk deposits in early FY07, the same comprised 41% of term deposits in FY07 and squeezed the bank’s NIMs by 10 basis points to 2.7%. The bank sees 10 basis points improvement in NIMs in FY08.

Cautious on retail
(Rs m) FY06 % of total FY07 % of total Change
Advances 355,490   456,950   28.5%
Retail 70,430 19.8% 74,515 16.3% 5.8%
Corporate 285,060 80.2% 382,435 83.7% 34.2%
           
Deposits 501,970   639,960   27.5%
CASA 162,910 32.5% 192,870 30.2% 18.4%
Term deposits 339,060 67.5% 447,090 69.9% 31.9%
           
Credit deposit ratio 70.8%   71.4%    

Gaping treasury risks: Fee income (grew by 33% YoY) has once again slowed down in 4QFY07 and comprised 13% of the bank’s total income in FY07. This is, however, higher against 10% in the corresponding period of the previous fiscal. This has helped it circumvent losses in other income due to poor results on the treasury front. 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 FY07 and a tolerance level (provisions for rise in 10 year G-Sec yield) upto 8.0% (10 year G-Sec yield is currently at 8.2%) in the AFS portfolio. Of the AFS portfolio, 44% is to be marked to market.

GTB costs evened out: OBC seems to have successfully re-aligned the costs of the erstwhile GTB’s branches with itself, as is evident in the marginal decline in cost to income ratio. The cost to income ratio has stabilised at 42% as per the bank’s expectations. This will be amongst the lowest in public sector banks.

Breakup of operating expenses
(Rs m) FY06 % of total FY07 % of total Change
Employee expenses 5,004 51.8% 5,208 52.2% 4.1%
Other operating expenses 4,654 48.2% 4,774 47.8% 2.6%
Total operating expenses 9,658   9,982   3.4%
Cost / Income 44%   42%    

Provisioning bliss: OBC has lived up to its commitment of improving its asset quality and has pared its gross NPAs further (3.2% in 4QFY07 from 5.9% in 4QFY06). This has been aided by recoveries to the tune of Rs 10.4 bn made in this fiscal. The total cash recovery was to the tune of Rs 5 bn. The bank expects further recoveries by the end of FY07. We have not factored these in our estimations. The said recoveries have considerably reduced the provisioning requirements for the bank.

What to expect?
At the current price of Rs 192, the stock is attractively valued at 0.8 times our estimated FY09 adjusted book value. OBC’s performance in FY07 has been broadly in line with our estimates. The bank’s comfortable capital adequacy (CAR 12.5%), ability to capitalise on its pan-India presence coupled with good quality appraisal will enable it harness higher asset growth and good asset quality. While the provision write backs on account of NPA recoveries may continue to aid margins, propensity to interest rate risks on the treasury books continues to be high. Inability to generate fee income and leverage on its franchise may, however, lead to loss of market share for the bank.

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