Bank of India: Diversified gains

A diversified loan book, branch network, prudent lending practices and stable margins make Bank of India a good pick in the banking space.

Over the past few years, Bank of India has taken various steps which have helped improve its productivity, maintain high profit margins, create a balanced asset portfolio as well as sustain healthy growth rates. In the midst of a weak macroeconomic environment the bank has increased focus on maintaining asset quality and follows better provisioning norms.

A proof of this is its performance, which on the back of a robust growth in advances to corporates and SMEs, has helped the bank to increase its net income by 57.5 per cent Y-o-Y in Q3FY09. Net profits too were up by 70 per cent Y-o-Y to Rs 872 crore aided healthy non-interest incomes. The bank has a well-balanced portfolio across corporate, SMEs, retail and agriculture in the domestic space as well as foreign international exposure. 

A BALANCED LOAN PORTFOLIO

Bank of India has seen its advances grow at a faster pace than the industry, recording an average growth of 25 per cent over the last five years and a growth of 35 per cent in H1FY09. Even in the Q3 the growth in advances was ahead of the average industry growth. Even in Q3 growth was 31.3 per cent, which is much ahead of the average industry growth.

The growth in advances has been led by lending to the corporates. The tight liquidity conditions prevailing abroad coupled with drying sources of funding (IPO market, private equity etc) has meant that more corporates are looking at the domestic banking industry for funding. This has helped BOI grow its bank loan book faster.

A proof of this is the significant 73 per cent Y-o-Y increase in Q3 advances to corporates, which account for about 40 per cent of the bank’s loan book. However, besides maintaining high growth in advances, the banks has been has been particular in preferring quality and safer assets. Although a shade riskier, SMEs segment offers an attractive opportunity to Bank of India due to the increasing reluctance of private banks to lend to smaller companies.

While the bank has been able to grow its SME portfolio by 25 per cent in the December quarter and the segment provides higher returns, the bank is adopting prudent lending practices as there is a high level of asset risk in deteriorating market conditions. Positively, the exposure to the SMEs segment is not high and currently account for the 16-18 per cent of the loan book.

DEPOSIT GROWTH

While deposits have grown by 21 per cent on an average in the last five years, it has been higher at 26 per cent for Q3 as PSU banks became the first choice for depositors preferring safe options. Also the higher rates on term deposits in Q3 has led to some slippage in CASA deposits; the share of CASA deposits as a percentage of the total deposit fell to 30 per cent in Q3 as compared to 32.2 per cent in Q2.

The third largest branch network (around 2,900 branches) among PSU banks with 55 per cent of the branches in the rural and semi-urban areas would ensure higher volumes from growing rural economies. The bank’s higher penetration in the rural areas would be a distinct advantage over its private peers.
 

STEADY PERFORMANCE
in Rs crore	FY08A	FY09E	FY10E
Net Interest Income	4229.0	5534.0	6639.0
Other Income	2117.0	2523.0	2516.0
Total Income	6346.0	8057.0	9155.0
Operating profit	3701.0	5287.0	5732.0
Net profit	2009.0	2800.0	3195.0
P/E (x)	6.0	4.3	3.8
P/BV (x)	1.4	1.1	0.9

The bank has been wiring up its network with core banking solution being implemented 75 per cent of the bank's branches (covering over 85 per cent of the bank’s business). Operational efficiencies are also best among the PSU banks have helped improve its cost-to-operating income ratio from 57 per cent in FY 05 to 44 per cent in FY08. In the first nine months this ratio has further fallen, albeit marginally, to about 42 per cent.

NON-INTEREST GAINS

Even on the non-interest income front, which comprises fee based, treasury and forex income, the bank has consistently reported healthy growth. For nine months ended December, the growth rates were higher by 55 per cent.

The rapid decrease in yields has led to a 275 per cent jump trading income in Q3, doubling its share in non-interest income to 40 per cent compared to the previous corresponding quarter. Along with trading income, fee-income has also seen a jump of 55 per cent and is attributed to higher credit volumes.

The bank plans to add more branches which would improve fees from the sale of third party products such as insurance. Overall, expect the fee income to grow at robust rates in the coming years.

HIGHER MARGINS

Strong advances and control on costs has helped the company report higher net margins in the recent past. For the Q3 quarter the bank managed a 38 per cent growth in the net interest income which improved by 30 bps Y-o-Y to 3.4 per cent in Q3. The reduction in prime lending rates effective from January onwards, lowering deposit rates twice on various maturities along with decline in bond yields would help the bank to maintain the current margins.

While the bank has been focussing on profitable volumes; there is an overhang of asset deterioration. Creditably, gross and net NPAs at 1.6 per cent and 0.5 per cent have not shown any deterioration over the last one year. Going ahead, given the weakening macroeconomic conditions, expect NPAs to increase.

More importantly, the aggressive provisioning stance and the coverage level at about 69 per cent, is above what most other PSU banks have provided and is comforting. For example, BOI provided fully for its exposure to assets related to Lehman Brothers.

INVESTMENT RATIONALE

The business mix (deposits and advances) and net profits have grown by 22.5 per cent and 19 per cent, respectively in the last five years. While historically, BOI specialised in lending to high-margin retail and SMEs ensuring higher profitable growth, the focus has now shifted to prudent risk lending, decreasing its exposure to the retail segment in light of the current scenario.

The CBS rollout, branch expansion and wage revisions could put some pressure on the operating expenses front. Going forward, a weakening demand would put the expansion plans of the corporates on hold, thus lowering corporate demand. Nonetheless, credit demand should grow at healthy rate of 18-20 per cent for the industry. And Bank of India should do better.

The government’s stake (at 64 per cent) would ensure room to raise capital in the future. Improving return ratios, a well balanced asset portfolio, prudent risk management systems and low cost to income ratio would help the bank sustain NIMs. All of this put in the top league of the PSU bank space. At Rs 230, the stock trades at a PE 3.8 times FY10 earnings and P/BV of 0.9 and can deliver 20 per cent over a one year time.