Waiving of service charges on low-cost deposits and ambitious branch expansion will help the bank improve its deposit base.
Mr R. M. Malla, CMD…The bank is cashing in on infrastructure financing.
M. V. S. Santosh Kumar
Fresh investments with a two-to-three year time horizon can be considered in the stock of IDBI Bank, the youngest of the public sector banks. The bank focuses mainly on infrastructure lending, a segment expected to contribute heavily to the incremental credit growth of the banking system, going forward.
The recent, much-needed capital infusion from the government will help IDBI Bank support high credit growth. Higher levels of capital would also help decrease cost of funds (by reducing dependence on deposits) for the bank, thereby aiding net interest margin (NIM) expansion. High cost of funds from the time of the IDBI-IDBI Bank merger has been a drag on the bank's NIMs. IDBI Bank's relatively lower cost-income ratio and higher contribution from fee income are key positives. It is one of the largest loan syndicators in the financing space which enables it to earn steady fee income and supports loan book growth.
At the current price of Rs 139.7, the stock trades at 10.2 times its estimated FY-11 earnings (after taking into account the equity dilution) and 1.07 times the estimated FY-11 book value. In terms of price-book value, the bank seems to be the cheapest in the large public sector bank space. Its investments in equities worth Rs 2,698 crore work out to Rs. 27 per share.
On the flipside, IDBI Bank's profitability ratio (return on net worth) is still among the lowest in the industry (12 per cent in 2009-10), though it has improved steadily from 9 per cent levels in 2006-07. Also, the net non-performing asset ratio of the bank (1.19 per cent) is higher compared to its peers. However, these two parameters (return ratio and asset quality) are set to improve, thanks to improving NIMs, the bank leveraging its expertise in fee-based activities, and improving recoveries from large sub-standard corporate accounts.
Targeting low cost funds
The merger of IDBI Bank with IDBI (the development financing institution) in 2005 led to high NPAs, low profitability and increase in the investment book (which offers lower yields ).. High-cost borrowings also increased post-merger. However, over the years, the bank has succeeded in shedding part of its high cost borrowing and securitising some of its long-term investments.
Around 70 per cent of its total deposits come from the wholesale segment (high-cost) which the bank intends to prune, going forward. Initiatives such as waiving of various service charges on current and savings bank accounts and ambitious branch network expansion plans (275 branches expected to be opened by end-2010-11) will help the bank improve its low-cost deposit base significantly and provide avenues for fee income growth. This is a significant initiative, given that the bank's low-cost deposit ratio currently is only around 13 per cent compared with over 30 per cent for its public sector peers.
Buoyant growth in advances
As of June 2010, IDBI Bank's advances grew by 38 per cent year-on-year, far higher than the industry growth of 21.7 per cent. While the credit growth levels may moderate marginally going forward, it is still expected to be above the industry average.
The recent capital infusion of Rs 3,119 crore by the government by way of preferential allotment will aid this loan book growth. The advance book is skewed towards the corporate segment (77 per cent ) while the retail loans which carry higher yields constitute only 23 per cent. Despite a low retail proportion, the bank's latest yield on total assets stood at a competitive 8.4 per cent, thanks to better yields on the long-term loans..
The capital adequacy as of June 2010 would work out to 13 per cent up from 11.3 per cent before the recent capital infusion. Besides, there is head room still available for raising an additional Rs 6,500 crore in the form of other Tier-I hybrid instruments and Tier-II instruments.
With the government stake up at 65 per cent, post capital infusion, IDBI Bank is comfortably placed to raise core-equity again next year. Improving profitability , additional head room and a possible primary market issuance next fiscal would provide the bank adequate capital to propel loan book growth over the next three to four years.
While its yield on advances has been inline with the banking sector, IDBI Bank's cost of funds continues to be above that of most of its peers. The bank's consolidated loan book grew at 30 per cent compounded annual growth rate over the period 2007-2010. The high loan book growth, however, did not translate into proportionate profit growth (net profits grew at only 20 per cent), due to higher interest and credit costs.
In the latest June quarter, the bank's net profit grew by 46 per cent on a Y-o-Y basis, thanks to improving NIM and fee income. NIM in the quarter improved to 1.67 per cent from 1.27 per cent in 2010, which itself grew from 0.99 per cent in the preceding year. Despite this, there is still catching up to do with industry averages, towards which the current initiatives will help.
Fee income contributes as much as 30 per cent of IDBI Bank's net income, sufficient to cover most of its operating costs. Also, the bank's cost-income ratio at 36 per cent for the latest quarter was higher than the industry average, thanks to high employee productivity.
The bank's asset quality continued to slip in the June quarter with the gross NPA ratio (1.94 per cent) higher than that in March 2010 (1.53 per cent). This coupled with 6.7 per cent of the assets being restructured (as of March 2010) makes IDBI Bank's portfolio riskier than most other banks'.
However, with the improving business environment, most of these accounts which belong to large corporates is expected to witness improving payouts. This should better asset quality. Also, the bank's provision coverage ratio as on June 30 stood at more than 70 per cent, higher than that mandated by RBI. Adverse impact of rising yields on the bank's significant investment book has been mitigated to some extent with the reduction in duration of the available-for-sale portfolio (which is marked-to-market periodically)
In the early ascendant part of the current interest rate cycle, IDBI Bank's NIM will improve, with yield on advances rising more than cost of funds.
As the bank prunes excess investments and high-cost borrowings, its business metrics would come in line with most of its peers over the next three-four years