Steady Player

Bank of Baroda (BOB) offers banking services and products to large industries, small and medium enterprises, and to retail and agricultural customers. The bank has a strong presence in states like Gujarat and Maharashtra. At the end of Q1FY12, its network of branches stood at 3,409, and the number of automated teller machines (ATMs) at 1,657. Around 34.4 per cent of its branches are situated in rural areas.

Sectoral outlook
Banks, the dominant financial intermediaries in India, have made good progress over the last five years, as is evident from several parameters such as annual credit growth, profitability, and gross non-performing assets (NPAs). While the annual rate of credit growth clocked over the past five years stands at 23 per cent, the average return on net worth over this period is a respectable 15 per cent.
However, the prospects of the banking sector have become clouded owing to the steep hike in interest rates by the central bank. This is one rate-sensitive sector that tends to underperform when interest rates are on their way up.

Positives
Improvement in tier I capital. During 2010-11, the government of India infused Rs 165 billion in public sector banks (PSBs) to raise their tier I capital to 8 per cent and to augment its stake in PSBs to at least 58 per cent. After this move, the tier I capital of PSBs has improved. Apart from State Bank of India, these banks may not require significant capital infusion in the short-term. Hence, the government of India has budgeted for a relatively lower capital infusion of only Rs 60 billion for PSBs in 2011-12.
Less capital for credit provisioning. Despite fresh slippages, credit provisioning for 2011-12 may be lower, thanks to change of norms by the Reserve Bank of India (RBI). According to a recent RBI guideline, banks will no longer be required to maintain a provision cover ratio (PCR) of 70 per cent on new NPAs (although they need to maintain a PCR of 70 per cent on NPAs arising till September 30, 2010). This is expected to reduce banks’ incremental credit provisioning requirement.
However, another guideline issued by RBI in May 2011 has enhanced the provisioning requirement for certain categories of NPAs by 5-10 per cent and asked banks to maintain 2 per cent provision on standard restructured assets. The latter guideline will absorb a part of the reduction in incremental credit provisioning resulting from the earlier relaxation.

Challenges ahead
According to a report from rating agency ICRA, currently Indian banks face several challenges arising from the following developments: increase in interest rates on savings deposits, possible deregulation of interest rates on savings deposits, tight monetary policy, large government deficit, increased stress in some sectors (such as state utilities, airlines, and microfinance), restructured loan accounts, banks’ own unamortised pension and gratuity liabilities, and implementation of Basel III.
Further, the report states that a temporary slack in credit growth (which is a regular occurrence in the first half of the year) and higher lending rates (owing to the higher rates offered on deposits) may lead to a dip in banks’ net interest margins (NIMs) in the first half of 2011-12. Subsequently, NIMs could recover if credit off-take is good. Overall, despite their higher operating expenses, banks are expected to report good core profitability, given their reasonable NIMs and lower credit provisioning requirement.

Strengths
Healthy financial performance. Between FY07 and FY11, Bank of Baroda’s advances grew at a compounded annual growth rate (CAGR) of 28.6 per cent. It thus outpaced the 19.5 per cent average annual rate of growth in advances registered by the banking sector over the same period.
BOB’s returns as well as its asset quality have been reasonably healthy relative to its peers, as reflected in a return on equity (RoE) of 23.5 per cent and net non-performing asset (NPA) of 0.4 per cent in FY11. Its RoE has almost doubled over the past five years. Its five-year average RoE is also an attractive 18.2 per cent.
The bank’s return on assets (RoA) has also been improving consistently since FY06: 0.79 per cent in FY06, 0.8 per cent in FY07, 0.89 per cent in FY08, 1.10 per cent in FY09, 1.21 per cent in FY10, and 1.33 per cent in FY11.
Focus on multiple services. The bank offers multiple service channels such as Baroda Connect (Internet Banking), phone banking, Baroda cash management services, NRI services and depository services. It has implemented an integrated global treasury solution in its major overseas territories. It has also started providing online institutional trading to its corporate customers.
Its increasing branch network has helped the bank to register a healthy current account savings account (CASA) growth rate of 20.6 per cent over FY07-11. Simultaneously its operating expenses-to-average assets ratio has declined from 2 per cent in FY07 to 1.5 per cent in FY11.
Strong bottomline growth. The bank has registered strong growth in its bottomline at a CAGR of 42.6 per cent over FY07-11. This was driven by a high CASA ratio, market share gains in credit and deposit, and paring of operating expenses.
Adequately capitalised. BoB’s overall capital adequacy ratio (CAR) is a high 14.5 per cent. Tier-I capital has improved from 9.2 per cent in FY10 to 9.99 per cent in FY11 owing to both internal accruals and infusion of Rs 24.6 billion of capital by the government of India. This latest round of capital infusion enhanced the government’s stake in the bank from 53.81 per cent to 57.03 per cent.
Tier-I capital of 9.99 per cent signifies that the bank is adequately capitalised and can grow at a fast pace in the near future. The bank proposes to maintain its CAR in the range of 13-13.5 per cent and tier-I capital between 8 and 8.5 per cent in the coming years.

Growth opportunities
Branch expansion by the bank continued at a steady pace with the opening of 41 branches in Q1FY12. According to a report from Angel Broking, the bank plans to open over 500 branches in FY12 and aims to grow its advances and deposits by 200-300 basis points (bps) higher than the banking system’s growth in advances and deposits.
Nearly 24 per cent of BoB’s business comes from its overseas operations. The bank plans to expand its overseas presence in countries such as Kenya, Uganda, Australia, New Zealand and the Gulf region. It plans to add 15 more overseas branches by March 2012.
The bank is expected to hold 40 per cent stake in its proposed Malaysian joint venture (JV) with Indian Overseas Bank and Andhra bank. The JV will be set up with an initial capital of Rs 380 crore.

Concerns
Low-cost deposits reaching maturity. About 54 per cent of Bank of Baroda’s total current deposits will mature by the end of FY12. The central bank has been raising the key policy rate (repo rate) since March 2010. Due to the steep hike in the benchmark rate (it stands at 8 per cent now), banks have also been forced into increasing both their deposit and lending rates.
As BoB’s current term deposits mature, they will be replaced by new high-cost deposits. This will increase the bank’s cost of funding, which will in turn put pressure on its margins in future.
Rising employee costs. According to Systematix Institutional Research, the bank plans to hire 4,000 employees in FY12 to staff the 500 new branches that it proposes to open.
The bank has a total corpus of Rs 51.7 billion for pension, of which Rs 14.8 billion is yet to be provided on the books of accounts. Another Rs 1.2 billion has to be realised for leave encashment, gratuity and additional retirement benefits.
The bank’s cost/income ratio (a measure that determines how costs are changing in relation to income) stands at around 40 per cent in FY11 and is expected to inch upward as it adds more branches and hires more people.

Valuation
The stock was trading at a price-to-book (P/B) ratio of 1.30 on October 5, 2011. This is slightly below its five-year median P/B of 1.36 times. However, its price-to-earnings (P/E) ratio, which stands at 6.47, is below its five-year median P/E of 7.54.
BoB has registered a five-year CAGR of 36.69 per cent in its earnings per share (EPS). Based on this its price-earnings to growth (PEG) ratio comes to 0.17.
The current rising interest rate scenario could have an adverse impact on the entire banking sector. Take this into account before you invest. And if you invest now, have an investment horizon of at least three years.