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OBC: Slow takeoff… - Views on News from Equitymaster
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OBC: Slow takeoff…
May 23, 2006

Performance summary
Oriental Bank of Commerce declared its results for the fourth quarter ended March 2006, posting a marginal adjusted bottomline growth (less of GTB write-offs). The full year profits were, however, lower by 23% YoY, due to the impact of higher operating expenses, tax incidence and margin pressures. While the bank has done appreciably in terms of asset growth and asset quality, stagnation of other income remains a concern.

Rs (m) 4QFY05 4QFY06 Change FY05 FY06 Change
Income from operations 9,434 10,746 13.9% 35,719 41,189 15.3%
Other Income 1,744 1,590 -8.9% 5,052 5,528 9.4%
Interest Expense 5,554 6,717 20.9% 20,482 25,138 22.7%
Net Interest Income 3,880 4,029 3.8% 15,237 16,051 5.3%
Net interest margin (%)       3.2% 2.8%  
Other Expense 2,184 2,795 28.0% 7,957 9,659 21.4%
Provisions and contingencies 1,491 610 -59.1% 4,002 2,271 -43.3%
Profit before tax 1,949 2,213 13.5% 8,330 9,649 15.8%
Tax (2,541) (459)   (1,391) 1,617  
Profit after tax/ (loss) 4,490 2,672 -40.5% 9,721 8,032 -17.4%
Extraordinary item** 2,460 623 -74.7% 2,460 2,460 0.0%
Net profit 2,030 2,049 0.9% 7,261 5,572 -23.3%
Net profit margin (%) 21.5% 19.1%   27.2% 19.5%  
No. of shares (m)       192.6 250.6  
Diluted earnings per share (Rs)*         23.5  
P/E (x)         11.0  
* (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’.

What has driven performance in 4QFY06?
GTB still haunting: Although OBC seems to have caught up with its peers in the sector in terms of asset growth (29% YoY), lower deposit mobilisation and pressure on margins (due to GTB’s poor asset legacy) have restricted the bank’s growth. It must be noted that while only 12 of the 104 branches of GTB were disbursing loans, OBC had extended the lending operation to all the 104 branches in FY06. While the bank has been able to improve the yield on its loan assets (as is evident from the 32% YoY growth in interest from advances), the spurt in G-Sec yields has taken a toll on its investment income. More so because the bank’s treasury book was not adequately hedged.

Also, while we expected OBC to be better off than its peers in the sector in terms of NIMs, OBC has grossly under-performed our expectations (low cost deposit growth has been slower than our estimates). The net interest margins have contracted by 400 basis points from the levels of FY05 (3.2%).

Breakup of interest earned
(Rs m) 4Q05 % of total 4Q06 % of total Change
Interest on advances 4,973 52.7% 6,567 61.1% 32.1%
Interest on investments 4,194 44.5% 3,686 34.3% -12.1%
Interest on RBI and inter bank balance 267 2.8% 493 4.6% 84.6%
Total interest earned 9,434   10,746   13.9%

What also remain to be seen is whether OBC can leverage its pan-India presence to capture the retail opportunities. The retail portfolio still comprises less than 20% of the bank’s credit book, of which the mortgage portfolio is 15.5% (grew 33% YoY). Nevertheless, a healthy low cost deposits composition (32% in FY06) will aid the bank’s NIMs going forward.

(Rs m) 4QFY05 % of total 4QFY06 % of total Change
Advances 274,968   355,485   29.3%
Retail 51,255 18.6% 70,430 19.8% 37.4%
Corporate 223,713 81.4% 285,055 80.2% 27.4%
Deposits 478,503   501,975   4.9%
Credit deposit ratio 57.5%   70.8%    

Overheads weigh heavy:As against the past few quarters, wherein OBC successfully curtained its operating costs, increase in operating expenses on account of payment of wage arrears, higher outgo towards rent and depreciation booked on investments in the AFS basket (Rs 1.7 bn) have drained the bank’s profit margin in 4QFY06. The bank’s cost to income ratio has shot up from 39% in FY05 to 45% in FY06. It may be recalled that OBC saw its operating overheads amplify post GTB acquisition (GTB employee and rental costs were considerably higher as compared to that of OBC) and since then, it is trying to rationalise the same.

Breakup of operating expenses
(Rs m) 4Q05 % of total 4Q06 % of total Change
Employee expenses 958 43.9% 1,359 48.6% 41.9%
Other operating expenses 1,226 56.1% 1,436 51.4% 17.1%
Total operating expenses 2,184   2,795   28.0%

Fee improvement: Although the bank’s non interest growth has grown at a tepid 9% YoY, its initiatives of offering cash management services and tie-up with insurance companies for vending third part party products have helped improve its fee income by 36% YoY. The potential risk on the treasury side, however, cannot be ignored. While the bank has not divulged details of investments in the HTM category, we reckon that the same is not above 70% and may lead to treasury losses in the wake of spurt in interest rates. Having said this, it must be noted that the bank has made provisions for rise in bond yields upto 7.8% and any rise beyond this will impact the bank's treasury book

Quality – on track: OBC has lived up to its commitment of improving its asset quality and has pared its NPAs further (0.5% in 4QFY06 from 1.3% in FY05). Although, the bank seems to have written back some of its provisioning in the current fiscal, it continues to have a coverage ratio of around 88%, which is very comforting. The bank has set the target of reducing its net NPAs to the erstwhile ‘zero’ levels (before taking over GTB) and we believe that it will be successful in doing so. The same will prove benign for the bank’s valuations in the longer term.

Profit margins seesaw: The bank’s profit margin has been very volatile over the past couple of quarters. To add to it, the bank is carrying GTB’s losses of Rs 12.2 bn, which need to be written off equally over 5 fiscals. As a result, the bank has had to partially write off the GTB losses under the head ‘extraordinary item’ in this quarter, thus further eroding its bottomline

What to expect?
At the current price of Rs 208, the stock is trading at 0.9 times our estimated FY08 adjusted book value. We reiterate our positive view on the stock, as we believe that the bank’s ability to capitalise on its pan-India presence coupled with good quality appraisal will enable it harness higher asset growth and good asset quality.

As far as the treasury risk is concerned, the bank is working towards shifting a higher component of its investments from the available for sale (AFS) to the held to maturity (HTM) basket in every quarter and a higher composition of fee income will also hedge the risks to some extent. Nevertheless, rationalisation of operating overheads and improvement in net interest margins are two factors that will be necessary to support the bank’s growth targets.

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