Indian Overseas Bank - asset quality woes continue; Hold:: Edelweiss

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Indian Overseas Bank (IOB) reported NII of INR 9.6 bn (up 22% Y-o-Y, 6% Q-o-Q),
in line with our estimates, supported by 4% Q-o-Q growth in loan book. NIMs
improved marginally by 8bps, to 3.02%. PAT came in at INR 2 bn, ahead of our
estimate of INR 1.65 bn on account of lower staff expenses. Other income (ex
treasury) grew 17% Y-o-Y and 49.4% Q-o-Q. Asset quality woes continue as
incremental slippages, after declining to 1.8% in Q1FY11 again rose to 3.7% in
Q2FY11 (4.1% in FY10). Headline asset quality improved with gross and net NPLs
declining 7% and 1.6%, to 3.8% and 2%, Q-o-Q, respectively- largely a function of
INR 5 bn write-off effected by the bank. Provision coverage (with write offs) stood at
60%. Staff expenses declined sequentially as the bank made lower second pension
provisions (on account of downward revision of overall second pension liability).


􀂃 High slippages: A key concern
After declining to INR 3.5 bn (1.8%) in Q1FY11 (4.1% in FY10), incremental
slippages rose again to INR 7.59 bn (3.7%), which is a key concern. Loans under
agricultural debt waiver accounted for INR 1.6 bn of slippages; the bank
provided INR 1 bn against these loans. Headline asset quality improved as gross
NPLs declined 7% Q-o-Q to INR 33 bn (3.8%) due to higher write offs (INR 5 bn)
and robust upgrades/recoveries (INR 5 bn). The bank has recovered INR 5.27 bn
YTD; management expects recoveries to touch INR 13 bn by end of FY11. The
company is, however, seeing stress in commercial real estate (11.8% of GNPA)
and infrastructure (28% of GNPA) sectors. On account of higher provisioning
(LLP at 132bps; 124bps in FY10), net NPAs declined 1.6% Q-o-Q, to INR 17.6 bn
(2%). Provision coverage, adjusted for write offs, stood at 60% (management
has to shore up provision coverage to 70% by end of FY11). Restructured book
grew 6% Q-o-Q, to INR 73 bn (8.45%). Slippages in the restructured book
during the quarter came in at INR 1.3 bn (INR 4.3 bn in H1); total slippages in
the restructured book touched INR 15 bn (21%).

􀂃 Outlook and valuations: maintain ‘HOLD’
Asset quality woes continue as incremental slippages stood high at 3.7% for the
quarter. We believe higher-than-industry-average gross NPLs and restructured
asset pool, together with lower provisioning coverage, will keep credit cost at
relatively higher levels. However, the bank showed improvement on the income
front, as reflected in robust NIMs and core fee income. We are revising our EPS
estimates up 7% for FY11 and 6% for FY12. The stock is currently trading at
1.3x FY12E adjusted book and 8.5x FY12E earnings. We maintain ‘HOLD’ on the
stock and rate it ‘Sector Underperformer’ on relative returns.