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OBC: Feeling the heat!

May 28, 2005

Performance Summary
Oriental Bank of Commerce (OBC) announced its 4QFY05 and FY05 results recently. While the same are not very enthusing (bottomline growth 4% YoY), one needs to note the fact that the results are not comparable to the previous fiscal due to the inclusion of erstwhile GTB's figures. Also noteworthy is the fact that the bank has not hesitated to prune its bottomline performance to clean its books (the GTB NPA legacy). While operating expenses have mounted (26% YoY), the tax benefits that the bank has received due to GTB losses have marginally cushioned the net profit margins.

Rs (m) 4QFY04 4QFY05 Change FY04 FY05** Change
Income from operations 8,533 9,434 10.6% 33,005 35,719 8.2%
Other Income 1,648 1,744 5.8% 7,217 5,052 -30.0%
Interest Expense 4,585 5,554 21.1% 18,447 20,482 11.0%
Net Interest Income 3,948 3,880 -1.7% 14,558 15,237 4.7%
Other Expense 1,736 2,184 25.8% 6,445 7,957 23.5%
Operating Profit 2,212 1,696 -23.3% 8,113 7,280 -10.3%
Operating profit margin (%) 25.9% 18.0% 24.6% 20.4%
Provisions and contingencies (90) 1,491 1756.7% 3,874 4,002 3.3%
Profit before tax 3,950 1,949 -50.7% 11,456 8,330 -27.3%
Tax 1,664 (428) -125.7% 4,595 722 -84.3%
Profit after tax/ (loss) 2,286 2,377 4.0% 6,861 7,608 10.9%
Net profit margin (%) 26.8% 25.2% 20.8% 21.3%  
No. of shares (m) 192.6 192.6   192.6 192.6  
Diluted earnings per share (Rs)* 47.5 49.4   35.6 39.5  
P/E (x)         6.7  
* (annualised)
** includes the erstwhile GTB figures

Enduring the GTB hit 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 (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 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 "zero NPA" 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.

What drove performance in 4QFY05?
Catching up on asset growth: The bank's advances have grown by 29% YoY in FY05 (of which retail segment has grown by 27% YoY) while the deposits have been augmented by 34% YoY. Despite a reasonable growth in loan book and access to low cost deposits (93% of the incremental deposits are 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 FY05. As we go forward, with the interest rates keeping an upward bias, we expect NIM pressures to continue for the bank, which holds true for the other entities in the sector as well.

Segmental revenue
FY04 % of total FY05 % of total Change
Retail & wholesale banking
Revenue 32,621 60.6% 35,514 65.2% 8.9%
Profit from banking operations 3,859 33.7% 5,203 62.5% 34.8%
Profit margin 11.8%   14.7%    
Treasury income
Revenue 21,225 39.4% 18,984 34.8% -10.6%
Profit 7,597 66.3% 3,126 37.5% -58.9%
Profit margin 35.8%   16.5%    
Revenue 53,846   54,498   1.2%
Profit * 11,456   8,329   -27.3%
Profit margin 21.3%   15.3%    
* Profit before tax          

Lower fee based income:The bank's other income (reduced by 30% YoY in FY05) 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 FY05. The bank has not disclosed the growth in standalone fee based income during FY05. Going forward however, GTB's expertise in garnering fee-based income may improve the contribution of the same to the bank's revenues.

Overheads swell: The overheads of the bank have primarily bolstered (26% YoY) due to the higher remuneration cost of the erstwhile GTB employees. The bank has worked up a scheme of realignment of the salaries of GTB employees with that of OBC employees. However, the same has not gone well with the GTB employees and once the scheme materialises, a high attrition of GTB employees is expected.

Prudent on recoveries: OBC has done extremely well in terms of recoveries from the erstwhile GTB. The management has also increased their expectations of recoveries to 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 has availed of on account of the unabsorbed losses of GTB, have lowered 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 has added to the interest income of the bank. However, the asset quality of the bank has deteriorated from zero NPA levels (in FY04) to 1.3% (net NPA to advances) and the coverage ratio has dipped from 100% to 53% in FY05.

Short in capital: The inclusion of GTB's negative networth of Rs 8.1 bn and cumulative losses of Rs 10.8 bn has considerably condensed the bank's CAR (capital adequacy ratio), ROA (return on assets) and book value. Despite the follow on public issue of Rs 15 bn (in 4QFY05), the bank's CAR stands at 9.2% at the end of FY05, which is insufficient for meeting future credit growth and Basel norms. Also, since the government's stake in the bank has come down to 51% (minimum permissible limit in a PSU bank), the bank cannot go in for any subsequent public issues. It is however, considering Tier II and preference issues to meet its capital requirements.

What to expect?
While OBC (prior to merger with GTB) had a regional concentration in the north, GTB's branches have lent the bank the desired access to the prosperous south and western markets, therein giving it a pan-India presence. GTB's technical expertise and portfolio of over 1 m retail customers is also expected to bring synergies in the coming quarters. Also, the bank is expected to shed the poor asset legacy that it has inherited from GTB and regain its zero NPA level.

At the current price of Rs 264, the bank is trading 7 times its FY05 earnings and 3 times its FY05 adjusted book value, which has been calculated by reducing GTB's negative networth and losses. Although the current negative impact of GTB merger was well anticipated, going further, we expect the bank to benefit from the same. However, we would like to reinstate our earlier view that the positives of the merger will become "visible" only in the longer term.

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