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Bank of Baroda: Risks ironed out - Views on News from Equitymaster

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Bank of Baroda: Risks ironed out

Nov 2, 2007

Performance summary
  • Interest income grows by 35% YoY in 2QFY08, on the back of 27% YoY growth in advances.

  • Other income grows by 41% YoY.

  • Net interest margins improve to 3.2% from 3.0% at the end of September 2007.

  • Provisions fall by 8% YoY.

  • 77% YoY growth in cash recoveries saves NPA blushes.

Rs (m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Interest income 21,334 28,798 35.0% 40,487 54,802 35.4%
Interest Expense 12,952 18,983 46.6% 24,329 35,944 47.7%
Net Interest Income 8,382 9,815 17.1% 16,158 18,858 16.7%
NIM (%)       3.0% 3.2%  
Other Income 3,217 4,541 41.2% 5,993 8,784 46.6%
Other Expense 5,968 7,983 33.8% 11,484 14,825 29.1%
Provisions and contingencies 1,068 981 -8.1% 3,599 2,395 -33.5%
Profit before tax 4,563 5,392 18.2% 7,068 10,422 47.5%
Tax 1,679 2,120 26.3% 2,551 3,842 50.6%
Profit after tax / (loss) 2,884 3,272 13.5% 4,517 6,580 45.7%
Net profit margin (%) 13.5% 11.4%   11.2% 12.0%  
No. of shares (m) 365.5 365.5   365.5 365.5  
Book value per share (Rs)*         230.8  
P/BV (x)         1.3  
* (Book value as on 31st March 2007)

A de-risked play
Bank of Baroda is the fifth largest banking entity in the country (in terms of asset size) with 4% share of the total credit disbursals at the end of FY07. Given its geographic concentration in the northern regions, the bank was a laggard in terms of credit growth in the initial years of this decade, which resulted in a loss of market share (from 5.7% in FY02 to 4% in FY07). However, a brand and operations overhaul led to accelerated growth in the last two fiscals, thus helping it stabilise its share and position itself favourably amongst its peers. Adequate capital (CAR 12.9% in 1HFY08), high NPA coverage and hedge against interest rate risks peg the bank amongst the frontrunners in the public sector banking space.

What has driven performance in 2QFY08?
Going global: Having one of the largest number of offshore branches amongst Indian banks continued to help Bank of Baroda tide over the liquidity constraints and margin pressures in 1HFY08. While the bank has continued to outdo most of its public sector peers in terms of advance growth, the cost benefit due to global presence has also started filtering in into the bank’s margins. It may be recalled that the bank’s global business exposure (deposits and advances) increased from 20% of total advances in 1HFY07 reaching levels of 22% in 1HFY08, thus clocking a growth rate of 41% YoY. While the proportion of domestic advances to global advances reduced to 78% in this quarter (80% in 1HFY07), its international operations contributed 21.3% of the bank's net profits and 19.5% of the bank’s total business.

Global presence adds value
  1HFY07 % of total 1HFY08 % of total Change
Advances 709,570   902,120   27.1%
Domestic 567,656   702,184   23.7%
% of total 80%   78%    
Agriculture 80,872 11.4% 114,030 12.6% 41.0%
Retail 114,077 16.1% 144,650 20.6% 26.8%
SME 75,410 10.6% 102,180 14.6% 35.5%
Deposits 1,076,820   1,313,730   22.0%

The hike in interest rates in the domestic markets coupled with the shortage of liquidity led to a slower advance growth in the domestic markets. However, on the back of 26.8% YoY growth in retail credit (21% of total advances) and 41.0% YoY growth in its agri portfolio, Bank of Baroda registered a 23.7% YoY growth in domestic advances in 1HFY08, marginally outperforming the sector average in terms of domestic growth. A higher share of CASA (39% in FY07) and access to global funds cushioned the bank’s net interest margins. Also, the bank has been proactive in re-pricing its lending rates along with the hike in deposit rates. The NIMs for the overseas business at 3% were relatively lower than the domestic business (3.2%) in 1HFY08. Nevertheless, the risks to the banks NIMs continue to loom large due to the pressure on the domestic cost of funds.

‘International’ benefit: Bank of Baroda's recent initiatives for improving its non-fund based income resource started yielding results in FY07. The bank’s fee income, however, comprised merely 10% of its total income in FY07 (1HFY08 figures not divulged) and has grown at a CAGR of 8% in the last 5 years. While we know that the bank’s fee income from overseas operations grew by 25% YoY, it has not divulged the growth in overall fee income in this quarter. It may also be recalled that the bank had entered into an MOU with IDFC in FY07 for funding the projects appraised by the latter. This is expected to ensure good quality lending and big-ticket loans but also fetch the bank proportionate fee income. Further, we believe that increased access to businesses across the world will enable the bank to fetch a higher volume of fee income going forward.

The bank’s proactive provisioning for its investment portfolio has yielded good results this quarter as the bank was able to write back a substantial proportion of the provisioning due to fall in the benchmark G-Sec yields. Although, the investment book of the bank is not a concern (76% of investments are in HTM basket), diminishing fee income will endanger the sustainability of net margins going forward, as the core banking business gets commoditised and more competitive private sector and foreign players cannibalise on its market share.

Costs to even out: The bank’s cost to income ratio scaled up to 54% in 1HFY08. This was primarily because the employee costs grew by 28% YoY. The bank has also clarified that it has been providing for pension related expenses on actuarial basis, thus taking care of future liabilities in its books. Further, in the next 3 to 4 years, around 4,000 employees of the bank will be retiring, thus considerably lightening its wage burden (as most of these employees are in the high salary bracket). For filling the requisite vacancies, the bank will be recruiting around 300 people each year for the next 3 to 4 years, at relatively lower salary levels as compared to the retirees. We expect this to rationalise the bank's overheads and bring down its cost to income ratio at par with that of its peers in the sector. The cost to income ratio in the overseas operations was at a relatively lower 27%.

Cash recoveries buoy bottomline: While Bank of Baroda has witnessed a 14% YoY reduction in the absolute value of its gross NPAs over the last 12 months (2.8% of total advances from 3.9% in 1QFY07), the same are sequentially higher than the previous quarter, suggesting incremental delinquencies in the quarter under review. At the net NPA level, the higher provisioning has brought down the same from 0.8% of advances in 1HFY07 to 0.6% in this quarter (0.6% in 4QFY07). More importantly, the 77% YoY growth in cash recoveries substantially reduced the provisioning requirement for the bank in 1HFY08.

In the international operations, gross NPAs are at 0.7% while the net NPAs are zero. While higher recoveries and an adequate coverage ratio of 78% for NPAs dilute some concerns on this front, the NPA level in homes loans (3.5% in FY07) remain a peril. At the end of FY07, 10% of the bank’s corporate credit exposure was categorised in the ‘high risk’ category in terms of ratings.

What to expect?
At the current price of Rs 359, the stock is valued at 1.1 times our estimated FY10 adjusted book value. The bank has marginally outperformed our broad asset growth and margin estimations and we will need to upgrade our forward estimations if the same continues in the forthcoming quarters of this fiscal. Adequate capital, a high provisioning cover, exposure in overseas markets and reasonable consistency in net interest margins makes it a de-risked play in the PSU banking space. The interest rate risk due to excessive dependence on fund-based revenues is the only downside to the prospects of the bank. We maintain our positive recommendation on the stock from a long-term perspective.

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Mar 25, 2019 (Close)


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