CMP Rs335, Target Rs292, Downside 12.8%
Our recent meeting with BOI further confirmed our cautious view on the sector and on the bank. BOI’s advances are likely to grow behind the system in FY12 given marginal contraction in Q1 FY12 and structurally weak loan book profile. NIM is expected to recover sharply from a multi-quarter low mainly led by improved loan yield. Asset quality outlook remains grim with slippages expected to remain high in ensuing quarters driven by system based NPL recognition, substantial restructured book and deteriorating macro. Resultantly, credit cost would remain elevated restricting material improvement in RoA. With Tier-1 ratio at 8%, low capitalization is also an issue.
Even at sharply lower price (down 30% since April), BOI does not provide any comfort to investors due to relatively vulnerable loan portfolio, deteriorating asset quality, lower capitalization and alarmingly high NPL risk (net NPL/Networth at 17%; highest amongst PSBs). RoA, the key valuation driver, is estimated to remain subdued over the medium term. We cut BV estimates and now assign a lower valuation multiple (0.95x FY13E P/adj. BV) to arrive at our reduced 9-month price target of Rs292. Downgrade BOI to Sell and expect continued underperformance.
Loan book likely to grow behind system
After growing its advances significantly ahead of the system in the past two years, BOI targets to grow in-line with the system in the current fiscal. Over FY09-11, while the domestic loan book grew at brisk 20% CAGR, bank’s international advances (25% of total) witnessed robust 32% CAGR. Driven by a weak loan demand and conscious shedding of lower yielding LC discounting (~Rs40bn at near Base Rate), BOI’s advances de-grew by 0.6% in Q1 FY12 with the yoy growth momentum moderating to 21%. The bank’s intent to match the system growth (18% projection by RBI) in FY12 appears to be a tall ask given the required strong 5.5-6% CQGR amidst weakening credit demand. BOI has also turned cautious with respect to lending to mid-corporate, SMEs and rural segments due to their higher sensitivity to interest rate in general. Deposits of the bank are likely to grow behind advances during the year as the bank would continue to drop some of the high-cost CDs (was seen in Q1 FY12). We estimate 17% loan CAGR for BOI over FY11-13.
As per the bank, FY13 credit growth would be determined by GDP growth and its composition. Generally, the credit growth multiplier has been 2.5x. Bank expects corporate capex freeze, improved working capital management and softening commodity prices to impact credit demand negatively. Inflation trajectory and interest rate response would be the key macro variables influencing credit growth.
~64% of the domestic loan book is floating
According to the bank, 63-64% of the domestic loan book is floating - ~35% linked to the Base Rate and ~29% linked to BPLR. 100% of the international advances are at floating rate linked to the LIBOR. The international book is funded through inter-bank deposits, customer deposits, corporate deposits and deposits of Indian companies (subsidiaries, others or ECBs pending utilization).
Yield on advances to spike-up in Q2 FY12
BOI’s yield on advances (YoA) improved only by 20bps in Q1 FY12 on sequential basis despite the bank having hiked lending rates by 125 bps since April 2011. With system-based NPL recognition driving higher slippages, the bank had to reverse interest income of ~Rs1.75bn recognized earlier on the new NPL accounts thereby restricting YoA improvement. In our recent meeting, BOI expressed its intentions to follow a different accounting treatment from Q2 FY11 wrt to interest de-recognition on NPLs. This would imply bank not reversing interest but providing fully for it below the NII level. With this adjustment likely to be retrospectively implemented (from Q1 FY12), the reported YoA in the current quarter is expected to be materially higher (~60-80bps) on qoq basis, also supported by the higher lending rates.
Cost of deposits to increase modestly on the other hand
With a modest CASA at 25% of global deposits (30% of domestic deposits), BOI’s funding profile is relatively weak when compared to some of the other large/mid sized PSU Banks. Wholesale term deposits comprising about 24% (~Rs580bn) of domestic deposits has been driving the overall cost of deposits (CoD) higher along with the rate hikes on retail term deposits. BOI’s domestic CoD increased by substantial 80bps qoq during Q1 FY12. The maturity of wholesale deposits vary between 3-12 months therefore the re-pricing for shorter term deposits has been positive (by 50-70bps) while the re-pricing for longer term deposits has been negative. Since June, the bank has not increased retail term deposits rates with deposits mobilization improving. Overall, BOI expects a marginal 10-20bps increase in CoD during Q2 FY12.
NIM has bottomed out; to recover significantly over the next three quarters
BOI’s domestic NIM hit a multi-quarter low of 2.4% in Q1 FY12, declining steeply by 100 bps on sequential basis. The margin fall was caused by the sharp increase in the deposits cost. Bank expects NIM to recover strongly to 2.7% in Q2 FY12 aided by strong improvement in loan yield. Further margin improvement is expected in H2 with the full-year NIM anticipated at 2.6-2.7%. As per the bank, further lending rate hike would be a function of monetary actions by RBI and liquidity. However, additional interest rate increase would impact asset quality especially affecting borrowers having high leverage.
System recognition of NPLs driving elevated slippages
BOI has been consistently reporting higher slippages over the past 7-8 quarters. In the aforesaid period, asset quality has deteriorated substantially with the GNPL ratio increasing from 1.9% to 2.7%. Over the past couple of quarters, slippages have been lofted by the implementation system based NPL recognition. As per RBI guideline, all the banks need to complete system based NPL recognition by October 31st. The new system based on CBS which replaces the manual recognition has been throwing up higher NPLs especially in granular credit segments. Of the Rs17bn slippage reported by BOI in Q1 FY12, Rs8bn was on account of adoption of the new system. Bulk of these slippages mainly came from the smaller accounts (accounts <Rs1mn in size) which were left unrecognized in the manual system. With full implementation of the new system to compete by September, BOI expects slippage in Q2 FY12 to be as high as Q1 FY12.
Asset quality outlook remains grim; credit cost would continue to be elevated
Against bank’s expectation of annual slippages at 1.6-1.7%, we forecast materially higher delinquency ratio for BOI at 2.3% in FY12. Though slippages in H2 would be lower than H1 (estimated Rs33-34bn) with no additional impact of system NPL recognition, the normal slippages are likely to increase significantly on deteriorating macro. We believe that higher interest rates and income slowdown would hurt loan servicing and repayment capacity of borrowers in general. Further, BOI has significant restructured assets at Rs111bn, 5.2% of net advances. This portfolio has grown by 11% over the past three quarters. It is highly likely that in the current environment, some of restructured accounts could turn NPLs and add stress to the asset quality. Within its loan portfolio, the bank has significant exposure (Rs210-250bn including SEBs) to the beleaguered power sector. We anticipate strong quarterly run-rate wrt absolute GNPL growth over the next three quarters with the ratio remaining elevated at 2.8-2.9%. Resultantly, the credit cost is expected to be high throughout the year at 0.9-1%.
RoA recovery would be gradual; capital raising after some time
Saddled with sharp margin contraction, lower fee income growth and high NPL/investment provisioning, BOI earned a disappointing RoA of 0.6% in Q1 FY12. Though margin improvement trajectory makes a case of sharp RoA improvement in ensuing quarters, estimated high credit cost would moderate the pace of RoA recovery. We believe that the respectable 1% RoA mark would remain elusive for the bank till FY13. Though the Board has approved the capital raising plan (via issue of up to 18mn equity shares), the bank is not in hurry to raise capital. It is confident of growing at 15-16% over the next two years with the current capital adequacy (Tier-1 capital at 8%).
Still no comfort; Downgrade to Sell with revised TP Rs292
Even at sharply reduced price (down 30% since April), BOI does not provide any comfort to investors due to relatively vulnerable loan portfolio, deteriorating asset quality, lower capitalization and alarmingly high NPL risk (net NPL/Networth at 17%; highest amongst PSBs). RoA, the key driver of valuation, is estimated to remain subdued over the medium term. Post recent meeting with the management, we have further cut BV estimates and now assign a lower valuation multiple (0.95x FY13E P/adj. BV) to arrive at our reduced price target of Rs292 (earlier Rs325). We Downgrade the stock to SELL and expect continued underperformance.