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OBC: Truncating margins

Aug 8, 2005

Performance summary:
OBC’s margin woes post amalgamation with GTB do not seem to be abating, as the bank despite registering a strong asset growth and better asset quality, posted a marginal 4% growth in bottomline in 1QFY06. This is also because of the fact that the bank has had to amortise depreciation on investments transferred to HTM category and the losses of GTB (that OBC is carrying in its books). Higher operating overheads have also contributed to the margin erosion.

Rs (m) 1QFY05 1QFY06 Change
Income from operations 8,653 9,876 14.1%
Other Income 998 955 -4.3%
Interest Expense 4,881 5,845 19.8%
Net Interest Income 3,772 4,031 6.9%
Other Expense 1,631 2,136 31.0%
Operating profit / (loss) 2,141 1,895 -11.5%
Operating profit margin (%) 24.7% 19.2%  
Provisions and contingencies 222 1,028 363.1%
Profit before tax 2,917 1,822 -37.5%
Tax 1,112 775 -30.3%
Profit after tax/ (loss) 1,805 1,047 -42.0%
Extraordinary item** - 612  
Net profit 1,805 435 -75.9%
Net profit margin (%) 20.9% 4.4%  
No. of shares (m) 192.5 250.0  
Diluted earnings per share (Rs)* 37.5 7.0  
P/E (x)   39.7  
* (annualised)   ** Extraordinary item is the partial write off of GTB losses

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 (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 “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 has driven performance in 1QFY06?
Cashing in on corporate credit:  The bank has achieved an appreciable 35% YoY growth in advances during 1QFY06, which is comparable to the best in the industry. However, what is disturbing is the fact that despite having more retail access (due to presence in the southern region through GTB branches) the bank continues to rely on the corporate segment (81% of advance book). While the retail credit book has grown by 16% YoY, the corporate book has swelled by 40% YoY. Also, the bank has failed to marginalize its deposit costs with the same remaining stagnant over the year (at 5%) despite 22% YoY growth in deposits. At the same time, the yield on advances have declined to 7.9% in 1QFY06 from 8.2% in 1QFY05 thereby paring the net interest margins to 2.9% against 3.4% in 1QFY05. However, in all fairness we must also consider the fact that the same has been the result of takeover of GTB’s poor yielding assets.

(Rs m) 1QFY05 % of total 1QFY06 % of total Change
Advances 203,904   275,074   34.9%
Retail 43,922 21.5% 51,223 18.6% 16.6%
Corporate 159,982 78.5% 223,851 81.4% 39.9%
Deposits 366,753   447,976   22.1%

Other income growth,...
(Rs m) 1QFY05 1QFY06 Change
Fee income 595 875 47.1%
Treasury income 403 80 -80.1%
Total non interest income 998 955 -4.3%
Fee cushion:  OBC’s bottomline continues to bleed due to consistent losses on the treasury side. However, the fee income (comprising 91% of other income) that has grow by 47% YoY has to some extent compensated for the treasury losses. It was well anticipated that the bank will stand to gain in terms of fee income post GTB merger due to the latter’s expertise in garnering fee revenue. Also, with the investment book now being partially hedged, treasury losses are expected to be lower going forward.

Overheads and provisions swell:  Operating overheads continue to weigh heavy on the bank’s margins as the employee costs and other operational overheads of the erstwhile GTB branches are considerably higher as compared to that of OBC. Also, the amortisation of depreciation charged on investments transferred to HTM basket (21% investments are in HTM category) has been charged to provisioning account. The booking of depreciation of Rs 1.7 bn has thus swelled the bank’s provisioning in this quarter, although mitigating the interest rate risks.

Margin hit:  The bank’s profit margin has been very volatile over the past couple of quarters. To add to it, the bank is carrying the erstwhile GTB’s losses of Rs 12.2 bn, which needs 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?
Given the fact that OBC has had to bear the brunt of taking over the defunct GTB during FY05, the bank has done its best to try and utilise the latter’s assets to its advantage. It also made a good effort in recovering GTB’s loss assets. During 1QFY06, recoveries of Rs 2.1 bn have helped the bank prune its gross NPA to advance ratio to 8.8% (9.1% in 4QFY05) and net NPA to advance ratio to 1.1% (1.3% in 4QFY05). The bank is also aiming at becoming a zero NPA bank by FY06. However, the bank’s risk exposed treasury portfolio and inability to use GTB branches to garner retail assets leaves a lot to be desired.

At the current price of Rs 275, OBC’s stock is trading at 1.4 times our estimated FY07 adjusted book value. Although we reiterate the fact that our outlook for the bank remains positive from the long-term perspective, we believe that the current valuations already factor in the growth prospects.

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