Asset quality pain likely to continue
Action: Downgrading to Reduce, TP cut to INR590
We downgrade BOB to Reduce from Neutral, and cut our TP to INR590
from INR820, as we believe asset quality risks will continue to derail
BOB's earnings trajectory over the next several quarters. We are
increasing our delinquency forecast for FY13F to INR50.6bn from
INR41.7bn (FY12F loan delinquency: INR34.4bn) and expect loan loss
provisions to increase to 97bps from 72bps in FY12
We estimate delinquency ratio at 1.76% for FY13F, 1.51% for FY12F
Asset quality pain will continue for BOB, in our view. We raise our
delinquency ratio estimate from 1.17% in FY10 to 1.51% for FY12F; in
1QFY13, the annualised delinquency ratio was 1.8%. We note, a slowing
economy is leading to widespread deterioration across several sectors
and we believe BOB's NPL book is still beginning to build up (given NPL
ageing) and hence we expect the delinquency ratio to increase to 1.76%
by FY13. A key risk event coming up is the expected change in top
management later in CY12 and this transition is likely to reiterate the asset
quality risk to earnings, in our view.
Catalysts: Continued slowdown in corporate capital spending and
increasing delinquency
Valuation: Our TP implies 0.83x FY13F ABV and 5x FY13F EPS
BOB currently trades at 0.88x FY13F ABV of INR715, 1SD below its
historical mean of 1.1x one-year forward ABV. At our TP of 590, BOB
trades at 0.83x FY13F ABV and 5x FY13F EPS of INR118 for an FY13F
ROA of 1% and adjusted ROE of 17.7%.
Further deterioration in asset quality
likely
Asset quality will continue to be a drag for BoB, in our view. We raise our incremental
delinquency ratio estimate from 1.17% in FY10 to 1.51% in FY12F; in 1QFY13 the
annualised delinquency ratio was 1.8%. We believe slowing economic growth will
continue to exert pressure on asset quality and we estimate incremental delinquency
ratio at 1.76% for FY13F.
BoB has cumulative restructured loans of INR195bn (outstanding restructured loans are
at 6.8% of the loan book) and the delinquency ratio from these restructured loans is
currently trending at 25% and, we believe, the loans restructured in FY12 are yet to show
up in the delinquency numbers reported so far. We are factoring in a delinquency ratio of
1.76% for FY13F. As detailed in the chart below, the loans restructured and classified as
'standard' have increased significantly in FY12. We believe this further highlights the
continued deterioration in asset quality over the next few quarters.
PSU banks have seen a 48% increase in the CAGR of restructured loans outstanding
and classified as 'standard'. Given the slowing economy, high interest rates and also
global headwinds, we expect asset quality in sectors like textiles to deteriorate further.
Based on information released by the Press Information Bureau of the Government of
India, as of August 13, 2012, the government has issued directives to nationalised banks
to restructure textile industry loans on a case-by-case basis in accordance with the
Reserve Bank of India (RBI)'s prudential guidelines. The Press Information Bureau
reported that loans of INR360bn need to be restructured. Bank of Baroda has a fundbased
exposure of 2.4% (as a percentage of its FY12 loan book) to the textiles sector. Its
delinquency ratio has been on a steady climb since FY09 – increasing from 0.94% in
FY09 to 1.8% in 1QFY13. Loan loss provisions have not kept pace though, as BoB has
cut back on provision cover from 72.5% to 65.3% during the period
Management guides for strong recoveries and upgrades from non-performing loans over
the next few quarters. The chart below shows the incremental delinquency ratio (as a
percentage of the average loan book) and the incremental recovery ratio (recoveries and
upgrades as a percentage of the average loan book) for BoB for the past eight quarters.
As seen below, the gap between incremental delinquencies and incremental recoveries
has been widening over the past four quarters and, we believe, it is too early to conclude
that this gap may have peaked. While we expect delinquencies will continue to increase
due to slowing growth, incremental recoveries, upgrades especially are likely to take
longer to close the gap with the delinquencies. With the gap between recoveries and
fresh delinquencies widening, risks to the downside exceed the possible upside potential
risks in our view.
Expect loan growth of 18.5% for FY13F
We are factoring in loan growth of 18.5% y-y for FY13F – with growth contribution
coming from (all y-y) - domestic corporate loans of 15.9%, international loans 24.5%,
mortgages 18.6%, other retail loans 15.6%, SMEs 17.6% and rural / agri loans 14.3%.
We expect core fee income growth of 8.4% for FY13F. We estimate the GNPL ratio to
inch up to 2.24% in FY13F from 1.84% in 1QFY13. We expect BOB to clock FY13F NIM
of 2.8% and expect non-interest income to remain weak on the back of slower fee
income growth.
Key 1QFY13 results highlights and takeaways from the
analysts’ meeting
• Net interest income came in 5.5% below our estimates, on the back of loan growth of
23% y-y (flat q-q) and a 23bps decline in NIM to 2.73%. Non-interest income grew 20%
y-y but declined 14% q-q (21% below Nomura estimates) as fee income remains muted
y-y and lower than expected trading income. The cost-income ratio improved by 80bps
y-y to 36.9%.
• Loan book remained flat sequentially despite strong 41% y-y international book growth
(helped by INR depreciation) as retail loans declined 7.7% q-q (up 6.4% y-y). Corporate
loans grew a strong 28% y-y and SME loans grew 21% y-y.
• CASA deposits grew 14.4% y-y, with savings deposits growing 15.1% y-y and current
account deposits growing 12.3% y-y. Blended CASA ratio declined 83bps q-q to
26.07%.
• GNPLs increased 19% q-q, with the GNPL ratio inching up 31bps to 1.84%. This was
on account of higher slippages of INR12.6bn (INR13.2bn in 4Q) and lower write-offs of
INR1.96bn (INR5.3bn in 4Q). The bank restructured loans to the tune of INR7.7bn
during the quarter, thus taking restructured loans as a percentage of total loans to
6.82% vs. 6.48% in 4Q. LLPs came in higher at 1.14% vs. our expectation of 0.94%.
Provision cover, including technical write-offs remains stable at 79%.
• BOB expects to grow 1.0-1.5% higher-than-the-sector average in FY13F. Management
guides for blended NIM of 2.7- 2.75% for FY13F (FY12 blended NIM was 2.96%).
• The bank has cumulatively restructured loans to the tune of INR194.91bn, of which
INR7.7bn was restructured in 1QFY13 and INR52.8bn was restructured in 4QFY12
(stripped off a large aviation ac/ & SEB exposures, loans restructured in 4QFY12 would
be INR8.8bn).
• While management did not give any guidance on fresh delinquencies, it has indicated
that it expects recoveries and upgrades to pick up in 2QFY13F and 3QFY13F. We
currently factor in an incremental delinquency ratio of 1.3% for FY13F (which is the
annualised run-rate for this quarter approximately).
Valuation methodology
We downgrade BOB to Reduce from Neutral, and cut our TP to INR590 from INR820, as
we believe asset quality risks will continue to derail BOB's earnings trajectory over the
next several quarters.
Our target price of INR590 is based on a three-stage residual-income valuation method
which assumes the following: 1) 18.8% CAGR for interest-earning assets over FY12-15,
9.7% CAGR over FY15-20 and a terminal growth rate of 4% beyond that, 2) average
ROE of 15% over FY12-20 and a 9.3% terminal value ROE, and 3) discount rates
ranging from 14.9% (current cost of equity) for FY12-15, 12.8% for FY15-20 and a 11%
terminal rate. At our TP, BOB would trade at 0.83x our FY13F ABV and 5x FY13F EPS
for an ROE of 17.7%. We show key changes to our valuation assumptions below.
Fig. : Key changes in our residual income valuation assumptions
Assumptions changes Old New
Interest earning asset (FY12-20 CAGR) 12.2% 13.0%
Terminal NIM 2.23% 2.18%
Terminal cost to asset Ratio 1.1% 1.2%
Terminal P&L provisioning as % of interest earning assets 0.6% 0.8%
Source: Nomura estimates
Risks
Key upside risks include stronger-than-expected recoveries and slowing delinquencies,
higher-than-expected economic growth, accelerated monetary policy easing and
government policy intervention to revive corporate investment spending. Global liquidity
rushing into Indian equity markets is another key upside risk to our thesis.
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