Buy rating on Bank of Baroda; One-off provisions mar quarter

By: | Published: May 23, 2016 7:33 AM

Bank of Baroda is laying emphasis on quality and stable business, with focus on average rather than period-end numbers

Bank of BarodaBank of Baroda is laying emphasis on quality and stable business with focus on average than period-end numbers. (Photo: Reuters)

Bank of Baroda’s Q4FY16 performance was marred by one-off provisions. Key highlights: (i) slippages were higher than anticipated (>6%, albeit lower than Q3FY16); (ii) however, higher recoveries and improved coverage led to lower NNPLs; consequently stressed assets (NNPLs plus restructured book) came off to 8.2% (9.7% in Q3FY16); (iii) BoB is laying emphasis on quality and stable business with focus on average than period-end numbers. We have already factored in higher credit costs. Ergo, our estimates remain broadly intact. Further, able management at helm, strong capital position, and government support (structural reforms) lend comfort. Maintain ‘BUY’

Slippages elevated, superior recoveries aid performance

Slippages were elevated at Rs 59 bn (R10 bn of AQR being related accounts). However, impressive recoveries at R32 bn (versus Rs 16 bn cumulative in 9mFY16) restricted GNPL rise to Rs 405 bn (up 4% q-o-q). Looking qualitatively: (i) higher focus on granularity (highest exposure <Rs 20 bn, average of top-3 exposure in stressed segments <Rs 20 bn); and (ii) relatively lower SMA-II accounts at Rs 132 bn (<3.5% of loans) suggests lower pain and uncertainty henceforth. BoB highlighted watch-list of Rs 138 bn (comprising restructured and SMA-II accounts) and expects credit cost of 70bps (best case)-to – 155bps. We have already factored in credit cost for FY17/18e at >170/165bps, therefore our estimates remain broadly intact.

GR

Profitability dented by one-offs and higher coverage

BoB reported loss of R32 bn, largely driven by one-off provisions. The one-off items were: (i) additional provision on account of employee cost of R15.6 bn, as the bank changed mortality assumptions; (ii) it provided R2.9 bn (@15% at one go versus industry practice of two quarters) towards Punjab food credit; (iii) R1.5 bn provision towards SEB exposure not converted to bonds and diminution in fair value of loans/discom bonds.

Outlook & valuations: Business re-engineering key; maintain ‘BUY’

Performance was hit by dismal asset quality and one-off provisions, leading to loss in FY16. Despite high credit costs, owing to business re-engineering (focus on granularity) BoB will still generate near-term RoE of 9-10%. Further, even though BASEL III requirements are increasing we see dilution risk for BoB being much lower. Considering valuations of 0.9x FY18E P/BV even factoring in higher stress and given focused granularity and strong capital position, we maintain ‘BUY/SP’ with a target price of R170.

Loan consolidation continues, focus on retail

Advances continued to decline, which came in at R3.8 tn (down 10.3% y-o-y/flat q-o-q), following dip in both domestic and international books. Management highlighted that while end period numbers optically looked lower, growth in domestic advances on average basis was up >5%, albeit still lower than industry growth of ~11%. When looked at on segmental basis, corporate book saw y-o-y decline of >15% (against run-rate of ~2.5% y-o-y growth over past 5 quarters)/up 3.7% q-o-q. Within retail, housing and auto segments clocked good traction, up 10.8% and 6.5% y-o-y, respectively. The bank highlighted that focus on consolidation and rebalancing will continue and growth will be driven by retail. We, therefore, expect BoB to grow its loans at lower than industry average for the next 18-24 months.

Better domestic NIMs feed into rise in global NIMs

Global NIMs inched up to 2.15% (up 43bps q-o-q, albeit on low base on account of interest income reversals in Q3FY16), largely aided by 59bps jump in domestic NIMs (~30bps on account of one-off items). Domestic yields fell by 55bps, though partially offset by 16bps decline in domestic cost of deposits. With a 25bps inch-up in overseas yields during the quarter, global NIMs too were up 5bps q-o-q and came in at 92bps. Stepping into FY17, management expects domestic NIMs to be in the range of ~3%, primarily led by retail lending and shift towards adopting RWA-based lending.

Core fee remains missing link

Non-interest income stood at R17.7 bn, primarily led by strong forex, trading and recoveries. Core fee though came in at R6.8 bn (up 8.1% y-o-y/21.8% q-o-q); inch-up is more of a seasonal in nature. However, core fee on annual basis was up just 6.7%—a trend which needs to be monitored. Other line items of non-interest income saw healthy growth: forex came in at R4.8 bn (up > 98% y-o-y and q-o-q), trading profits stood at ~R5 bn (up 41.3% y-o-y/76.1% q-o-q) and recoveries from written-off accounts stood at R1 bn (as against run-rate of R425m in past 5 quarters). Management has identified this as a potential area of improvement and expects some traction going forward with renewed emphasis on BoB Caps, etc. The bank has increased focus on transaction banking and expects that to lead to improved fee traction. We await improvement in this line item as it will be critical for RoA improvement.
Other highlights
* Total bank’s exposure to 7 stressed sectors constitutes 20% of its fund-based exposures and ~45% of overall NPAs.
* Overall slippages were Rs 59 bn, of which domestic slippages were R49.5 bn and international at Rs 9.8 bn.
* Maximum exposure to single borrower is at R20.4 bn; maximum exposure to single Iron & Steel borrower is R14.4 bn and to single power sector borrower it is Rs 18.6 bn.
* The bank did not undertake any sale to ARCs during the quarter.

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