Bank of Baroda: Not out of the woods, yet - Sell

Uncertainty over slippages can lead to earnings volatility in the coming quarters

Despite a good pick up in credit growth, healthy growth in core net interest income and fall in slippages in the latest September quarter, the road ahead for Bank of Baroda is not without challenges. The outstanding accounts under watchlist (stressed assets pool), as of September quarter, has more or less remained similar to the levels seen in the June quarter, despite a chunk of the bank’s slippages in the September quarter, coming out of its watchlist.

This implies that there could be some more pain for the bank in the coming quarters. Also, concerns that the amalgamation of the bank with Dena Bank (weaker and low-capitalised bank) and Vijaya Bank will put BoB’s recovery efforts on the backburner, continue to persist. Uncertainty over the swap ratio (on amalgamation) also remains a key overhang for investors in the stock.

Investors can trim their exposures to the stock, given the possible volatility in earnings in the coming quarters. Also, the ongoing market volatility, ahead of general elections, warrants a more cautious approach towards public sector banks that are still riddled with growth and capital challenges.

 

 

At the current price, Bank of Baroda trades at around 0.6 times the one-year forward book, which may optically look attractive. But valuations based on the banks’ book values can be misleading. Accounting for non-performing assets and restructured book (30 per cent), BoB trades at around one time. Rise in delinquencies and provisioning are risks to valuations.

Still stressed

After reporting sharp slippages in the March quarter on account of the RBI’s framework for stressed assets, BoB has seen slippages moderate over the last two quarters.

From 12.46 per cent in the June quarter, BoB’s gross non-performing assets ratio has fallen to 11.8 per cent in the September quarter. The bank had reported sharp slippages of over ₹11,000 crore in the March quarter. This had moderated to ₹2,800 crore in the June quarter and then to ₹2,200 crore in the September quarter.

Yet, few trends in the asset quality need a watch. For one, the ₹700-odd crore fall in gross NPAs in absolute terms in the latest September quarter has been driven by a fall in NPAs in international loan book; on the domestic front, while corporate NPAs moderated, MSME and agri bad loans have inched up.

Also, while 84 per cent of the September quarter slippages have been from the June quarter watchlist (₹8,600 crore), the bank’s watchlist remains sticky at ₹8,500 crore as of September 2018. Accounts outstanding under watchlist for power, iron and steel, and textiles appear to have inched up in the September quarter.

 

 

All of this implies that the bank may still not be out of the woods and uncertainty over slippages can lead to volatility in earnings in the coming quarters.

Better core performance

While asset quality needs a watch, Bank of Baroda’s core performance has been showing signs of a pick up. The bank’s net interest income grew by 20.7 per cent Y-o-Y in the September quarter, with domestic advances growing 20 per cent on the back of strong traction in retail loans.

However, the sustainability of this trend will be critical for a consistent improvement in core performance.

As such, asset quality trend still remains the joker in the pack, as sudden rise in slippages and provisions could eat into the bank’s operating profit.

Also, uncertainty over the bank’s earnings, post amalgamation, remains a concern. Dena Bank, one of the weakest banks within the PSB space, has GNPA of 23 per cent and Tier I capital ratio of 7.6 per cent (against mandated requirement of 7 per cent) as of September 2018. Hence, for BoB investors, the amalgamation brings in a lot of uncertainty.

Importantly, the uncertainty over the swap ratio (on amalgamation) remains a key overhang for investors in the stock.

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