Bank of India

Investors can consider buying the Bank of India stock with at least a two-year horizon. Valuations are quite attractive, but the stock can be re-rated only when sentiment towards the banking sector improves on a rend reversal in interest rates.

At the current market price of Rs 275, the stock trades at 1.6 times its June 30, 2008 book value and 6.8 times its FY-08 earnings; 5.5 times FY-09 earnings.

Despite outperforming its peerls in the last three years, the stock trades at a discount to larger public sector banks, except Canara Bank .

Given that the broader markets might be volatile in the medium term investors can accumulate the stock during declines.

Bank of India is the sixth largest in terms of balance-sheet size and has superior profitability ratios, a diversified loan book, a de-risked bond portfolio, robust non-interest income and healthy levels of low-cost deposits. It created 50 SME centres and 20 retail hubs for focussed lending to these sectors.

The loan book, which has the ability to weather the current interest rate regime with relatively lower slippages, constitutes 13 per cent agriculture credit, 20 per cent retail credit, 21 per cent SME credit and 47 per cent corporate credit.
Financials

Bank of India’s balance-sheet and earnings have each grown at 18 per cent compounded annual growth rate (CAGR) in the last five years. The net NPA/advances have come down dramatically from 5.5 per cent to 0.5 per cent during the same period.

In the June quarter, a troubled period for most banks, Bank of India posted a 78 per cent growth in earnings thanks to strong growth in net interest income (25 per cent) and non-interest income (45 per cent), even as operating expenses remained flat.

The major boost to ‘other income’ came from forex transactions, commission, exchange and brokerage income and write-back of loans.

Trading profits remained flat due to underperformance of the capital markets. The bank’s cost:income ratio of 38.6 per cent is the lowest among the larger banks and shows good operating efficiency.

Advances grew by 37 per cent in the tough market conditions but at the cost of shrinking net interest margins (NIM).

The bank’s Indian operation’s NIM (3.3 per cent) is strong but the international operations pulled down the overall margins to 2.9 per cent. The NIM contracted as the bank’s cost of funds increased, even as yields remained flat on the back of a lending rate (PLR) cut of 25 basis points. Low-cost deposits form 34 per cent of the total, which is above the industry average, but does not give the bank an advantage vis-À-vis other banks (PNB, SBI, BOB).

Bank of India’s capital adequacy ratio (CAR) stands at 12.39 per cent, well above the RBI’s stipulated limit. The Government holds 64 per cent stake in the bank which is higher than most of the PSB peers. This gives the bank adequate room to raise capital to fund aggressive advances growth.

The bank made Rs 129 crore mark-to-market provision for available for sale (AFS) investments, but it may see some write-backs this quarter, on the softening of bond yields.

For AS-15 retirement benefit, the bank had provided Rs 70 crore for the current quarter (this provisioning will be recurring in all quarters for the next four years).

The bank has to provide for the employee wage revision. It has exposure to risky investments overseas which might lead to losses or higher provisioning.

The bank had also taken a hit of Rs 54.6 crore as the premium on held-to-maturity (HTM) bonds was amortised from interest income. Prudent risk management helped the bank to limit slippages in asset quality. The Gross NPA/advance has come down from 2.29 per cent to 1.64 per cent over the year. Net NPA/advance stands at 0.5 per cent. The provision coverage at 80 per cent will cushion the bank in adverse conditions.
Outlook

The bank has one of the highest return on equity (28 per cent) and return on assets at 1.25 per cent, which places it among the better banks; the credit deposit ratio is also the highest among nationalised banks.

The bank has displayed robust growth in advances and earnings in a challenging environment. Though it may be hard to replicate the same growth rates going forward, healthy growth rates are still expected.

The management expects 20 per cent growth in advances this fiscal. Given the high corporate exposure, any sharp slowdown in the corporate capex cycle will be a key risk. An increase in PLR by 125 bps is likely to help the bank maintain its NIM at healthy levels in the coming quarters. A core earnings growth at about 19 per cent in FY-09 appears possible; trading profits and forex gains have the potential to boost growth rates further.

Going forward, the bank may have to choose between growth in advances and quality of assets. Low-cost deposits are hard to come by in the current scenario where the banks are wooing customers with higher rates.

As with other PSU banks, the bank is leveraging on its branch network by offering various third-party products such as mutual funds and insurance.

To boost its ‘other income’, the bank has entered loan syndication, increased fee structures across various products and entered into an insurance joint venture with Dai–Ichi. The bank intends to cover operating expenses with its non-interest income this fiscal.