Bank of Baroda: Long road to recovery - Sell

While the Centre’s mega recap plan will help over the long run, near-term risk to earnings can weigh on the stock

The Centre’s mega recap plan of infusing ₹2.1 lakh crore into public sector banks has lent a fresh lease of life to beaten down PSU bank stocks over the past month or so. The stock of Bank of Baroda — which had delivered a lacklustre performance on the bourses until then — has rallied 20 per cent since the Centre’s announcement.

But while capital infusion by the Centre will help alleviate balance sheet stress, near- to medium-term risks to the bank’s earnings persist. Elevated bad loan provisioning, slow recovery in profitability and still modest credit offtake are likely to temper expectations in the coming quarters. The likelihood of a merger with smaller PSBs also hangs as a Damocles sword over larger banks such as Bank of Baroda. A complex merger with a weaker and under-capitalised PSU bank will be a dampener and put the bank’s recovery efforts on the backburner.

While consolidation within the sector may not happen for a while, it remains a key risk to larger lenders such as Bank of Baroda. Besides, provisioning requirement on resolution of large accounts under National Company Law Tribunal (NCLT) will continue to depress earnings over the next one year. With no significant recovery in earnings expected until the end of FY19, investors can book profit at current levels and re-enter when there is better earnings visibility.

At the current price, Bank of Baroda trades at around one time the one-year forward book, in line with its five-year historical average. But valuations based on banks’ book value can be misleading. Accounting for non-performing assets and restructured book (30 per cent), BoB trades at around 1.5 times its adjusted book, which is slightly higher than its five-year historical average of about 1.2-1.3 times.

Moderating slippages, rising provisioning



For most PSBs, after additions to bad loans peaked in the March to September 2016 quarter (after the RBI’s asset quality review exercise), growth in bad loans has moderated in the last two to three quarters. In the latest September quarter, the performance of leading PSBs displayed similar trends — lower slippages but higher provisioning. For Bank of Baroda, slippages nearly halved in the September quarter from the previous quarter. From ₹4,384 crore in the June quarter, fresh slippages stood at ₹2,586 crore in the September quarter. While this is a positive, there are some points to note.

For one, slippages for the September quarter have inched up from the levels seen in the same quarter last year (at ₹2,252 crore). Two, the significant reduction in the stock of gross non-performing assets (GNPAs) in the September quarter was mainly due to write-offs rather than recoveries or upgrades.

Write-off is a process wherein banks stop recording the bad loans in the books and take a hit on their profits by fully providing for such loans. From ₹35 crore in the June quarter, write-offs moved up sharply to ₹1,768 crore in the September quarter. Hence, the sustainability of moderation in accretion to bad loans will need watching in the coming quarters.

Also, the report on the RBI’s risk-based supervision for FY-17 is awaited; this needs to be closely watched for possible bad loan divergences (asset classification from the RBI norms) in the coming quarter.

The provisioning requirement has gone up for Bank of Baroda in the September quarter. Ageing of bad loans (a large book at that) has led to incrementally higher provisions for leading PSBs. Bank of Baroda’s bad loan provisions went up by 13 per cent YoY in the September quarter. Provision for standard loans too have nearly trebled.

On the accounts identified by the RBI for resolution under the Insolvency and Bankruptcy Code, the bank has exposure to the tune of ₹7,694 crore in the first list, where the bank has made provisions to the tune of ₹3,983 crore and an additional ₹450 crore is required. In the second list, the bank has exposure of about ₹4,274 crore, wherein provisions of ₹1,473 crore have already been made and ₹790 crore is the additional provisioning required. Higher provisioning could continue to impact earnings.

Better core performance



While asset quality concerns persist, Bank of Baroda’s core performance has been relatively better than its peers in the latest September quarter. SBI’s net interest income grew by a muted 2.5 per cent YoY in the September quarter due to flat advances. PNB’s net interest income also grew by a muted 3.5 per cent on the back of 4.5 per cent growth in overall loans (domestic growth at 8.3 per cent).

For Bank of Baroda, its net interest income grew by 8.5 per cent YoY in the September quarter, after a modest 0.98 per cent growth in the June quarter. This was backed by healthy growth of 13.8 per cent in domestic advances, driven by 25 per cent growth in retail loans. Hence, after a long period of consolidation, a pick-up in loan growth is a positive for the bank. However, the sustainability of this trend will be critical for consistent improvement in margins and core operating profit. As such, the increase in provisions can eat into the bank’s operating profit. In the latest September quarter, for instance, increase in provisions has offset the growth in operating profit (13 per cent YoY), leading to a 35 per cent YoY decline in net profit.

The bank’s return on asset and equity (annualised) stood at a weak 0.2 and 4.6 per cent, respectively, as on September 2017. Improvement in return ratios will happen only gradually over the next one to two years.

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