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OBC: Not enthusing enough - Views on News from Equitymaster
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OBC: Not enthusing enough
Aug 1, 2007

Performance summary
  • Interest income grows 35% YoY on the back of 19% YoY growth in advances.

  • Other income falls 13% YoY due to treasury losses and low fee income contribution.

  • Net interest margins improve to 2.7% against 2.6% in 1QFY07.

  • Bottomline grows 48% YoY, due to provision write backs, despite higher tax outgo.

  • Net profit margins improve from 8.3% in 1QFY07 to 9.1% in 1QFY08. Excluding the GTB write-offs, the same are however, 13.7% and 13.1% respectively.

Rs (m) 1QFY07 1QFY08 Change
Income from operations 11,353 15,341 35.1%
Interest Expense 7,244 10,910 50.6%
Net Interest Income 4,109 4,431 7.8%
Net interest margin (%) 2.6% 2.7%  
Other Income 1,686 1,462 -13.3%
Other Expense 2,286 2,642 15.6%
Provisions and contingencies 1,476 506 -65.7%
Profit before tax 2,033 2,745 35.0%
Tax 480 741 54.4%
Effective tax rate 23.6% 27.0%  
Profit after tax/ (loss) 1,553 2,004 29.0%
Extraordinary item** 612 612 0.0%
Net profit 941 1,392 47.9%
Net profit margin (%) 8.3% 9.1%  
No. of shares (m) 250.5 250.5  
Book value per share (Rs)*   223.6  
P/BV (x)   1.0  
* (Book value as on 30th June 2007)  ** 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 1QFY08?
Reticent growth: OBC toed in line with its larger peers in 1QFY08 in terms of slowing down its incremental advance growth. While its repute of being risk averse is appreciated, OBC merely managed a 19% growth in advances due its conservative stance on retail assets, especially housing loans. As a result, while the growth in retail credit was restricted to single digits, the share of the latter to total credit was brought down from 18.5% in 1QFY07 to 16.3% in 1QFY08. 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. 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 17% YoY growth in advances for the current fiscal, which is again below the sector target, despite adequate capital. The bank’s deposit growth of 17% YoY, despite the rise in interest rates, is also not enthusing enough. The bank is targeting low cost deposits to comprise 35% of deposits in FY08. Also, despite the bank’s cautious approach towards accepting high cost bulk deposits in 1QFY08, the same comprised 29% of term deposits in 1QFY08. Having said that, the re-pricing of loan helped the bank improve its NIMs by 10 basis points to 2.7%.

Cautious on retail
(Rs m) 1QFY07 % of total 1QFY08 % of total Change
Advances 364,494   433,748   19.0%
Retail 67,431 18.5% 70,701 16.3% 4.8%
Corporate 297,063 81.5% 363,047 83.7% 22.2%
Deposits 545,063   637,724   17.0%
Credit deposit ratio 66.9%   68.0%    

Lack of fee income visibility: Fee income (1QFY08 growth not divulged) has once again slowed down in 1QFY08 and comprised 13% of the bank’s total income. This is higher against 10% in the corresponding period of the previous fiscal. This has however, been insufficient in helping the bank circumvent losses in other income due to shift to HTM (held to maturity) basket. 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. We however, fail to find any visible fee income stream in the near term.

Costs scale up: OBC had successfully re-aligned the costs of the erstwhile GTB’s branches with itself, which lead to the marginal decline in cost to income ratio in FY07. The cost to income ratio has increased to 45% in this quarter, partially due to the AS-15 provisions. Although the cost to income ratio is amongst the lowest in public sector banks, the same is exerting pressure on the bank’s margins.

Breakup of operating expenses
(Rs m) 1QFY07 % of total 1QFY08 % of total Change
Employee expenses 1,331 58.2% 1,439 54.5% 8.1%
Other operating expenses 955 41.8% 1,202 45.5% 25.9%
Total operating expenses 2,286   2,641   15.5%
Cost / Income 39%   45%    

Provisioning bliss: OBC has lived up to its commitment of improving its asset quality and has pared its gross NPAs further (3.3% in 1QFY08 from 5.6% in 1QFY07). The bank has not divulged the details of cash recovery in this quarter. The net NPA to advance ratio has, however, marginally moved up to 0.7% in 1QFY08 from 0.5% in 1QFY07 due to the provisioning write backs.

What to expect?
At the current price of Rs 222, the stock is valued at 0.9 times our estimated FY10 adjusted book value. OBC’s performance in 1QFY08 has been broadly in line with our FY08 estimates. The bank’s comfortable capital adequacy (CAR 13.8%), ability to capitalise on its pan-India presence coupled with good quality appraisal will enable it to harness higher asset growth and good asset quality positions it favourably. Nonetheless, lack of aggressiveness in terms of asset growth, 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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