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OBC: Provisioning woes

Oct 21, 2005

Performance summary
Oriental Bank of Commerce has declared its results for quarter and half year ended September 2005. The bank has posted a decline of 23% YoY in its bottomline. Paradoxically, the same is not so much of a concern, as without considering the extraordinary write-off of GTB losses, the bottomline growth has been 5% YoY in 2QFY06. While the bank has done appreciably in terms of growing its net interest income and other income, higher provisioning has weighed heavy on the margins.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 8,526 10,069 18.1% 17,179 19,945 16.1%
Other Income 660 1,720 160.6% 1,659 2,675 61.2%
Interest Expense 4,664 6,027 29.2% 9,545 11,872 24.4%
Net Interest Income 3,862 4,042 4.7% 7,634 8,073 5.8%
Net interest margin (%)       3.2%  2.9%   
Other Expense 1,657 2,503 51.1% 3,288 4,639 41.1%
Provisions and contingencies 226 324 43.4% 448 1,352 201.8%
Profit before tax 2,639 2,935 11.2% 5,557 4,757 -14.4%
Tax 490 670 36.7% 1,602 1,445 -9.8%
Profit after tax/ (loss) 2,149 2,265 5.4% 3,955 3,312 -16.3%
Extraordinary item** - 612   - 1,224  
Net profit 2,149 1,653 -23.1% 3,955 2,088 -47.2%
Net profit margin (%) 21.3% 19.4%   23.0% 16.6%  
No. of shares (m)       192.5 250.6  
Diluted earnings per share (Rs)*       41.1 26.4  
P/E (x)         9.4  
* (annualised)            
** 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 2QFY06?
Strong traction in asset growth: Although the bank has divulged no details with respect to growth in advances and breakup of the same, we reckon that the same has grown by around 28% YoY, in line with our estimates. The same is substantiated by the fact that the bank witnessed a growth of 30% YoY in its interest income from advances. Also, while the sector continues to face margin pressures due to higher cost of funds, OBC has been able to sustain its net interest margin over the previous quarter (1QFY06).

Breakup of interest earned
(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Interest on advances 4,299 50.4% 5,593 55.5% 30.1%
Interest on investments 4,054 47.5% 4,154 41.3% 2.5%
Interest on RBI and inetr bank balance 173 2.0% 322 3.2% 86.1%
Total interest earned 8,526   10,069   18.1%

Operating overheads – the dampener: Operating overheads continue to weigh heavy on the bank’s margins as employee costs (grew 56% YoY) and other operational overheads of the erstwhile GTB branches are considerably higher as compared to that of OBC. Also, the public issue expenses amounting to Rs 223 m are being written off equally over a period of five years and accordingly Rs 22 m has been charged to profit & loss account under the head ‘operating expenses’ during 1HFY06.

Breakup of operating expenses
(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Employee expenses 922 55.6% 1,438 57.5% 56.0%
Other operating expenses 735 44.4% 1,064 42.5% 44.8%
Total operating expenses 1,657   2,502   51.0%

However, the higher growth in other income (161% YoY) has helped in partially setting off the expenditure blues. This suggests that the bank’s initiatives in improving its fee income contribution seem to finally paying off. It may be recalled that the bank has launched cash management services and has started vending third party insurance products (through alliances with LIC and Oriental Insurance) from its branches in FY05.

Asset quality improves: OBC has lived up to its commitment of improving its asset quality and has pared its NPAs further (0.8% in 2QFY06) at the cost of taking a higher provisioning hit. 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 249, the stock is trading at 1.0 time our estimated FY08 adjusted book value. We had recommended a ‘Buy’ on OBC in September 2005. We reiterate our view on the stock as we believe that strong performance on asset growth and other income side will help the bank tide over margin pressures. Its comfortable capital position (CAR 13.7% in 1HFY06) puts it in a favourable position to sustain its credit growth. Also, rationalisation of operating overheads and improvement in asset quality (through higher provisioning), which the bank is working towards, will augur well for the longer term.

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