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OBC: Hinging on firm yields - Views on News from Equitymaster

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OBC: Hinging on firm yields
Nov 16, 2007

Performance summary
  • Interest income grows 28% YoY on the back of higher yields on advances.
  • Other income grows by 25% YoY due to higher fee income contribution.
  • Net interest margins improve to 2.8% against 2.7% in 2QFY07.
  • Bottomline falls 11% YoY, due to higher costs, despite provision write backs
  • Net profit margins drop from 19.5% in 2QFY07 to 10.6% in 2QFY08. Excluding the GTB write-offs, the same are however, 20.8% and 14.4% respectively.

Rs (m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Income from operations 12,822 16,456 28.3% 24,175 31,798 31.5%
Interest Expense 8,694 12,461 43.3% 15,938 23,372 46.6%
Net Interest Income 4,128 3,995 -3.2% 8,237 8,426 2.3%
Net interest margin (%)       2.7% 2.8%  
Other Income 1,136 1,425 25.4% 2,113 2,887 36.6%
Other Expense 2,565 2,698 5.2% 3,699 6,492 75.5%
Provisions and contingencies (737) (190) -74.2% 739 315 -57.4%
Profit before tax 3,436 2,912 -15.3% 5,912 4,506 -23.8%
Tax 770 550 -28.6% 1,252 1,291 3.1%
Effective tax rate 22.4% 18.9%   21.2% 28.7%  
Profit after tax/ (loss) 2,666 2,362 -11.4% 4,660 3,215 -31.0%
Extraordinary item** 170 612 260.0% 1,225 73 -94.1%
Net profit 2,496 1,750 -29.9% 3,435 3,142 -8.5%
Net profit margin (%) 19.5% 10.6%   14.2% 9.9%  
No. of shares (m)         250.5  
Book value per share (Rs)*         223.6  
P/BV (x)         1.2  
* (Book value as on 31st March 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 2QFY08?
Lagging the sector: While its repute of being risk averse is appreciated, OBC continued to lag way behind its larger peers in 1HFY08 in terms of incremental advance growth. The bank has not disclosed the figures for its advance and deposit growth in the second quarter of FY08. However, we reckon that the same has not crossed our estimated numbers of approximately 16% to 18% YoY given the overall slowdown in the sector. OBC has managed a slower 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 in the past 6 months has been 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 is targeting low cost deposits to comprise 35% of deposits in FY08. Also, despite OBC’s cautious approach towards accepting high cost bulk deposits in 1HFY08, the same comprised 29% of term deposits in 1HFY08. Having said that, the re-pricing of loan helped the bank improve its NIMs by 10 basis points to 2.8%.

Lack of fee income visibility: Fee income (1HFY08 growth not divulged) has once again slowed down in 1HFY08 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.

Employee 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 50% 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) 1HFY07 % of total 1HFY08 % of total Change
Employee expenses 1,312 51.2% 1,445 53.6% 10.1%
Other operating expenses 1,252 48.8% 1,251 46.4% -0.1%
Total operating expenses 2,564   2,696   5.1%
Cost / Income 49%   50%    

Provisioning bliss: OBC having lived up to its commitment of improving its asset quality, has faltered in this quarter as although its gross NPAs reduced further (2.9% in 1HFY08 from 4.8% in 1HFY07), the net NPA level has gone up due to lower provisioning. The bank has not divulged the details of cash recovery in this quarter. The net NPA to advance ratio has marginally moved up to 0.6% in 1HFY08 from 0.5% in 1HFY07 due to the provisioning write backs.

What to expect?
At the current price of Rs 268, the stock is valued at 1.1 times our estimated FY10 adjusted book value. OBC’s performance in 1HFY08 has been broadly in line with our FY08 estimates. The bank’s comfortable capital adequacy (CAR 13.6%), 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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