Stock Review: Bank of Baroda

   STATE-OWNED Bank of Baroda (BoB) is among the few banks that have implemented the centralised banking system in almost all of its branches in India. The bank has also set up footprint overseas with its operations extending to 26 countries. As such the bank has a significant overseas portfolio too.

BUSINESS:

BoB operates primarily in Gujarat and Maharashtra with the two states having almost a third of its total branch network. However, it is increasing its presence in other parts of the country as well. The bank has a network of 3,200 branches and intends to add another 300 to its kitty by the end of the current fiscal. BoB's loan book is mainly driven by large corporate loans. The management has indicated that loans extended to retail, small and medium enterprises and mid-corporate segments would be the growth drivers in future.

   Apart from the core operation of lending and borrowing, BoB also derives its income from other sources. It provides guarantees and letters of credits and earns commissions on it. Besides, the bank also sells third-party products and gold coins. It was, therefore, able to report a 14% rise in other income even when other banks reported lower other income on account of mark-tomarket losses on government treasuries.

FINANCIALS:

BoB's net profit has grown at an average 31% y-o-y for the past four quarters. This was on the back of high net interest income growth. Net interest income, which grew by an average 32% in the same time, is the difference between interest earned and interest expended by the bank. The bank has managed to maintain its net interest margin at 3% for the past three quarters. This even after the banking regulator raised rates at which banks borrow from the RBI, or the repo rate. The bank was able to do this as almost 96% of the bank's assets are of floating rate nature. Any rise in the borrowing costs, therefore, is passed on to borrowers.

   Due to liquidity constraints, most banks raised their deposit rates to attract funds to meet their lending pace. BoB grew its loan book by an average 28% y-o-y in the past three quarters. To meet this high growth, the bank raised its deposits by 50-150 basis points. Moreover, there are expectations of another round of rate hikes by RBI in its monetary policy review scheduled towards the end of January. The combined effect of higher deposit rates and interest rates might shrink the bank's margins. The impact, however, is expected to be short term due to the floating nature of its assets. The bank has displayed exemplary asset quality. Net non-performing assets have been hovering around 0.3-0.4% for the past eight quarters. Most PSBs are expected to report higher bad loans as they convert to system-based bad loan recognition. BoB might have limited negative surprises on this front as it has already started recognising all its bad loans through the core banking system.

GROWTH PROSPECTS:

BoB is among the nine PSBs that are expected to receive fresh capital infusion from the government. This would increase the capital adequacy of the bank, which stood at 13.2% as of September 2010. A higher capital adequacy provides a cushion for potential losses and as such protects lenders of a bank. The bank looks to be in a better position to maintain its margins as all its loans are linked to the base/prime-lending rate. Further, the bank has a 36% share of current and saving account balances. This would help the bank in lowering the impact of rising interest rates.

VALUATION:

Most banking stocks have corrected due to concerns over bribery-for-loans scam, loans given towards 2G licences, loans to the micro finance sector and a pressure on bank margins due to rising interest rates. At a price-to-book value (P/BV) of 1.8, the stock is trading at its alltime low valuations. Its peers such as Punjab National Bank and State Bank of India average 2.2 P/BV. This shows that the stock is relatively cheap. The bank has shown resilience in its core operating income or net interest income over the trailing 12-month period. The bank also has a better asset quality than most other banks. This makes it a good bet for investors, who are concerned about the uncertainty in bank stocks. Investors with a long-term perspective can consider this stock.