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BOI: Margin starved! - Views on News from Equitymaster

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BOI: Margin starved!

Nov 17, 2005

Performance summary
Despite a decent credit outgo, Bank of India (BOI) reported an uninspiring performance for the quarter ended September 2005. Although the bottomline growth of 168% YoY suggests otherwise, one must note that the same can be purely attributed to a lower base and lower provisioning. Although asset quality has improved over the corresponding quarter of the previous year, the bank continues to face capital crunch. We also attended the analyst meet of the bank and our results analysis includes extracts of the same.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 15,219 16,614 9.2% 29,306 32,259 10.1%
Other Income 2,597 3,031 16.7% 5,347 5,975 11.7%
Interest Expense 9,263 10,827 16.9% 17,965 20,883 16.2%
Net Interest Income 5,956 5,787 -2.8% 11,341 11,376 0.3%
Operating profit margin (%) 8.6% 1.6%   7.4% 3.1%  
Other Expense 4,643 5,516 18.8% 9,170 10,384 13.2%
Provisions and contingencies 3,137 1,521 -51.5% 4,469 2,912 -34.8%
Profit before tax 773 1,781 130.4% 3,049 4,055 33.0%
Tax 279 458 64.2% 926 1,015 9.6%
Profit after tax/ (loss) 494 1,323 167.8% 2,123 3,040 43.2%
Net profit margin (%) 3.2% 8%   7.2% 9.4%  
No. of shares (m)       487.4 487.4  
Diluted earnings per share (Rs)*       8.7 12.5  
P/E (x)         9.6  
* (annualised)            

The under performer!
Bank of India (BOI) is the sixth largest bank in India, both in terms of market share (5.3%) and asset size. The bank has a network of 2,600 branches inclusive of 19 foreign branches, and 250 ATMs. It has a large reach in the rural and semi-urban areas with more than 31% of aggregate deposits coming from these regions. Despite having a reasonable asset size, the bank, unlike its peers, has not been able to capitalise on the buoyancy in the sector during FY05. The fact that it has a significant amount of non-performing assets (NPAs) is also one of the crucial concerns regarding the bank.

What has driven performance in 2QFY06?
‘Amortisation’ heavy: As against the general practice amongst banks to book amortisation for depreciation on investments (mark to market for investments in the AFS category) under ‘provisioning’, the bank has booked the same under ‘interest expended’. As a result, this ‘extraordinary’ expense (to the tune of Rs 690 m) has bloated the bank’s interest cost and pruned its net interest margins (NIMs). While the NIMs stood at 2.6% at the end of 1QFY06, the same has contracted further to 2.2% in 1HFY06. This is despite a 50 basis point improvement in interest spread on a YoY basis. The share of retail credit improved to 26% of advances credit due to 29% YoY growth in this segment, while the corporate segment also grew at 18% YoY. Growth in the bank’s advance portfolio continues to be lower than the industry average.

Credit deposit ratio improves…
(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Advances 374,593   450,913   20.4%
Retail 92,150 24.6% 118,590 26.3% 28.7%
Corporate 282,443 75.4% 332,323 73.7% 17.7%
Deposits 756,370   858,560   13.5%
CASA 291,959 38.6% 348,575 40.6% 19.4%
Term deposits 464,411 61.4% 509,985 59.4% 9.8%
Credit deposit ratio 49.5%   52.5%    

What also restricts the bank’s margin expansion is the over-allotment of assets to the ‘priority’ (defined as farm loans, loans to small scale industries, home loans upto Rs 1 m, education loans etc.) and agriculture segments. The minimum mandate for the same (as per RBI norms) is 40% and 18% of the advance book respectively. However, Bank of India has more than 50% of its net credit in the priority sector and has disbursed 20% to the agricultural sector. This is despite the fact that priority loans are typically low yielding and the bank has an average gross NPA to advance ratio of 8% to 8.5% in the agri loans basket.

De-risked investment portfolio: It must however be noted that BOI has one of most well hedged investment portfolios in the sector. The same can be said not only in terms of percentage of investments in the HTM (held to maturity) category, but also the duration of investments in the AFS (available for sale) category. BOI has 78% of its investments in the HTM category and one of the lowest durations (1 year) in the AFS category. Both of these facts suggest that the bank stands very well hedged with respect to interest rate risk if the rates are to head northwards, going forward.

Fee cushion: Not only have the bank’s treasury losses shown signs of abating, but the same has also been substituted by growth in core fee income (grew 16% YoY). The share of fee income in total income has also grown from 12% in 2QFY05 to 14% in 2QFY06.

Better asset quality: Incremental provisioning has improved the bank’s provision coverage ratio from 43% in 2QFY05 to 53% in 2QFY06. This is also due to the fact that the bank has successfully pruned its high net NPA levels (4.2% in 2QFY05) to 2.2% in 2QFY06. All said, the bank continues to persist at the bottom of the league when it comes to asset quality. Reduction in gross NPA levels (4.6% in 2QFY06) also suggests arrest of incremental delinquencies.

What to expect?
At the current price of Rs 117, the stock is trading at 1.8 times our estimated FY07 adjusted book value. Not only has the bank been under-performing its peers in terms of asset growth, the lower margins and erosion of net worth have pared the returns per share. Deterioration in operating efficiency (cost to income ratio increased from 55% in 1HFY05 to 60% in 1HFY06) also calls for concern. The bank has already indicated its plans for a public issue to prop up its capital, which is inevitable given the requirements of credit growth and Basel II compliances. With its proposed merger with Union Bank of India going under wraps (due to staff opposition), the bank needs to hunt for suitable alliances to complement its weaknesses. However, the treasury book being well hedged, BOI now has better chances of improving its profitability. All said, given the slow momentum in the bank’s growth, the current price does not position the stock favorably on the risk return matrix.

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