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IDBI: Growth at the cost of margins - Views on News from Equitymaster
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IDBI: Growth at the cost of margins
Jul 18, 2007

Performance summary
  • Interest income grows by 30% YoY despite slower growth in advances.
  • Deposit growth buoyant at 61% YoY aided by UWB franchise.
  • Net interest margins languish below 1%.
  • Higher other income due to profit on sale of investments.
  • Bottomline remains flat due to higher provisioning.

Standalone numbers
Rs (m) 1QFY07 1QFY08 Change
Interest income 13,837 17,928 30%
Interest expense 12,866 17,299 34%
Net Interest Income 971 629 -35%
Net interest margin (%) 0.6% 0.7%  
Other Income 2,846 4,002 41%
Other Expense 1,899 2,060 8%
Provisions and contingencies 292 857 194%
Profit before tax 1,626 1,714 5%
Tax 121 183 51%
Effective tax rate 7.5% 10.7%  
Profit after tax/ (loss) 1,505 1,531 2%
Net profit margin (%) 10.9% 8.5%  
No. of shares (m) 723.7 724.4  
Book value per share (Rs)*   85.6  
P/BV (x)   1.4  
* (Book value as on 30th June 2007)

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 and IDBI Capital Services. 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 1QFY08?
No attempt to improve NIMs: After the integration with the United Western Bank (UWB) in FY07, which had a positive impact on IDBI’s flagging margins and operational efficiencies, the latter does not seem to be doing much to sustain or improve the same. IDBI managed to grow its advance book merely by 14% this quarter, in line with our FY08 estimates, albeit much lower than the sector average. Retail credit, which has been the focus of IDBI, ever since it converted into a banking entity, however, has been showing signs of slowdown since the last quarter itself with the rise in interest rates and comprised only 15.7% of the bank’s advance book in 1QFY08. Home loans, which comprise 87% of retail loans, are expected to be the main cause of the slowdown in this segment. While the deposit growth continues to be healthy (61% YoY), albeit on a lower base, it must be noted that there has been a fall in the proportion of CASA from 31% in 1QFY07 to 21% in 1QFY08, suggesting that the bank is targeting growth at the cost of margins. The incremental deposits garnered by the bank this quarter were largely high-cost term deposits. While IDBI had managed to improve its net interest margins to 0.8% (from 0.5% in FY06) due to the better NIMs of UWB and by retiring the high cost debts, we do not see the same being sustained due to its lack of cost consciousness. We expect the bank’s NIMs to remain below 1% until FY10E.

Assets…chugging ahead
(Rs m) 1QFY06 % of total 1QFY07 % of total Change
Advances 526,370   597,720   13.6%
Retail 84,219 16.0% 93,842 15.7% 11.4%
Corporate 442,151 84.0% 503,878 84.3% 14.0%
Deposits 290,960   467,570   60.7%
CASA 90,780 31.2% 98,190 21.0% 8.2%
Tem deposits 200,180 68.8% 369,380 79.0% 84.5%
Credit deposit ratio 180.9%   127.8%    

The bank has divulged no further details with regard to the recoveries from the Rs 90 bn SASF, suggesting little effort on this aspect as well.

Fees yet to catch up: IDBI’s fee income (18% of total income in FY07) shows little signs of growth. The bank has entered into a life insurance venture with Federal Bank and Fortis Insurance International, in which IDBI will have 48% stake. Also, it is contemplating to start an asset management company. IDBI and India Infrastructure Finance Company (IIFCL) have recently entered into a Memorandum of Understanding (MoU) for pooling in their resources and expertise to assist infrastructure projects, which typically have elongated payback periods, with funds on competitive terms. These initiatives will, however, contribute meaningfully only in the longer term.

Low cost advantage: Thanks to UWB’s relatively lower cost operations, the lowering of the blended cost to income ratio from 50% in 1QFY07 to 44% in 1QFY08 has aided the bank’s operating margins. Given the fact that the branch franchise of UWB is largely present in the rural and semi urban areas, the same has not had an adverse impact on the bank’s cost ratio.

Although at less than 10% of IDBI’s balance sheet size, UWB offered an extensive franchise and a strong presence in the rural and semi-urban areas of Maharashtra. The benefit of the deal to IDBI is further underlined by the fact that while the net compensation payable by IDBI to UWB shareholders (at Rs 28 per share against book value of Rs 21) was Rs 359 m, the cost of setting up UWB’s franchise (branches and ATMs) would have come to around Rs 534 m.

Quality takes a backseat: After successfully reducing its net NPAs that had gone up to 1.6% in 9mFY07 due to the loss assets of UWB (Rs 49 bn) taken into IDBI’s books, to 1.1% in FY07, the same have again slipped to 1.2% in 1QFY08 due to rising delinquencies. IDBI’s provision coverage, despite rising from 35% in FY05 to 42% in FY07, lies way below that of its peers. This will entail additional provisioning liability for the bank in the coming quarters. Also, any write-back of provisioning may not augur well for the bank in a rising interest rate scenario, as the risk of higher delinquencies loom large.

Sale of stake in NSE: IDBI has sold 0.9 m equity shares of NSE, constituting 2% of the latter’s issued and paid up capital to MS Strategic (Mauritius) for an aggregate sum of US$ 50 m (Rs 2 bn) in 1QFY08. The profit from the same has been booked under other income.

What to expect?
At the current price of Rs 115, the stock is valued at 1.0 time our estimated FY10 adjusted book value. The bank will float a US$ 1.5 bn Tier II borrowing programme in FY08 for funding international banking business. It also plans to open two offshore banking units in Singapore and Bahrain. With a comfortable CAR of 14.4%, while the downsides risks to the bank’s future prospects are almost negligible, the recovery process will be largely dependant on the bank’s efforts to accelerate growth and improve margins at the same time. Further, the bank also needs to exercise caution on the NPA front.

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