Bank of India -Margin and asset quality shocks:: Macquarie Research,

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Bank of India
Margin and asset quality shocks
Event
 Downgrade to Neutral. BOI reported 1Q12 PAT down 29%YoY and 25%
below our estimates. We cut our earnings and target price sharply, to Rs415
from Rs530, and downgrade the stock to Neutral from Outperform.
Impact
 Delinquencies show no sign of abating. Delinquencies were a hefty
Rs16bn in the quarter or 3% of loans. High delinquencies have been a
persistent issue with the bank and even including for NPLs from automatic
recognition of NPLs, the 3% slippage is disappointing. NPLs from automatic
recognition were Rs7.6bn. A significant chunk (10% of loans) is to come
under automatic recognition in 2Q12 and management is guiding for a similar
NPL figure from this source in 2Q. With provision coverage at ~67%, the bank
does not have any cushion on the provisioning front.
 Stress on the portfolio continues with fresh restructurings amounting to Rs9bn
in 1Q12 compared to Rs5bn in 4Q11- with management indicating a large
power exposure of Rs6bn has been restructured. Another restructured road
exposure of Rs1.8bn has slipped this quarter.
 Margins collapse. NIMs were down sharply by 75bp QoQ to 2.19%. There
were three key drivers: (i) Deposit costs moved up 70bp QoQ as the deposits
repriced. The pressure from this is likely to continue. (ii) Asset yields were up
only 8bp QoQ- hampered partly by the interest income of Rs1.8bn foregone
on agri NPLs slipped resulting from automatic recognition. The impact of the
interest income foregone would be ~20-25bp on NIMs. (iii) Yield on
investments were down by 67bp QoQ. Management was not clear on the
exact reason why this is so.
 Fees were sluggish, down 21% QoQ and up only 9% YoY. A key reason is
that disbursals of sanctioned infrastructure loans is slow and fees are booked
when the loan is actually disbursed.
Earnings and target price revision
 We have cut our earnings estimates sharply for FY12, FY13 and FY14 by
18%, 13% and 15% respectively driven by cut in NIM estimates and increased
provisioning expenses. We have cut our TP by 21% from Rs530 to Rs415.
Our sustainable ROE is lower as a result of higher credit costs, driving lower
PBV multiple even as we roll forward valuations to FY13E from FY12E.
Price catalyst
 12-month price target: Rs415.00 based on a Gordon growth methodology.
 Catalyst: Pressure on asset quality and margins
Action and recommendation
 While valuations are reasonable, earning headwinds remain and we expect
FY12E earnings growth to be modest at ~9%. We downgrade the stock to
Neutral from Outperform and lower TP to Rs415 from Rs530.



Asset quality disappoints- again!
 Asset quality has been a major disappointment at the bank. This quarter delinquencies again
printed a hefty number of Rs16bn or 3% of loan book. About Rs7.6bn came from automatic
recognition of NPLs. Management is guiding for a similar number in 2Q12 given that almost 10%
of the book is yet to be covered by automatic recognition in 2Q12. Even excluding that the
Rs8.4bn delinquency number was a disappointment and management commentary indicated that
pressures on asset quality remain significant. This quarter a large power exposure of ~Rs6bn was
restructured and a ~Rs1.8bn previously restructured road exposure slipped into NPL.
 The high slippage is impacting the P&L both in the form of interest income foregone and higher
provisioning.


Margins under pressure on all fronts
NIMs were down sharply by 75bp QoQ to 2.19%. There were three key drivers:
(i) Deposit costs moved up 70bp QoQ as the deposits repriced. The pressure from this is likely to
continue in the next quarter as well.
(ii) Asset yields were up only 8bp QoQ hampered partly by the interest income of Rs1.8bn
foregone on agri NPLs slipped resulting from automatic recognition. The impact of the interest
income foregone would be ~20-25bp on NIMs. Many of these agri loans were accruing
interest over past two years so the income reversed was significant. Management has also
indicated that it has refrained from raising loan rates because of competitive pressures.
(iii) Yield on investments were down by 67bp QoQ. This was a surprise as bond yields have
moved up this quarter. Management was not clear on the exact reason why this is so.
We have cut our NIM estimate to 2.5% from 2.7%. As a result of this sharp decline, our forecast net
interest income growth is only 6%Yoy for FY12E.


Valuations and TP change
We have cut our TP to Rs415 from Rs530. The cut in TP is primarily driven by cut in P/adj BV
multiple- its 1.2xFY13E now compared to 1.8x FY12E earlier. This has offset the 17% growth in book
value as we roll over from FY12E to FY13E.
We value Bank of India on a two-stage Gordon growth model:
P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)} where g=growth rate
for the first n (high-growth period) years, p=payout ratio in the first n years, gn=perpetual growth rate,
pn=perpetual payout ratio.

 Bank of India valuation methodology
r (cost of equity) 13.9%
Blended RoE estimate 16.8%
Computed P/BV – two stage Gordon growth model 1.2x
FY12E adj book value (INR) 336
Target Price (Rounded off) 415
Source: Macquarie Research, July 2011