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Tuesday, Jul 27, 2004

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Proportion of bad loans to advances is the key

N.S. Vageesh
Suresh Krishnamurthy

Chennai , July 26

THE scheme of arrangement for the merger between Oriental Bank of Commerce and Global Trust Bank will hold value to the shareholders of the former if the degeneration in the quality of advances of Global Trust Bank were not substantial.

By end-March 2003, the net non-performing assets (advances that have turned bad because interest or principal is outstanding for more than 90 days) were about Rs 648 crore.

Between March and December 2003, GTB disclosed that it had made recoveries of about Rs 191 crore but failed to disclose the level of net NPAs. If net NPAs as on date hasnot exceeded substantially, the value of the takeover would be that much more for Oriental Bank.

A smaller increase in bad loans is critical. It is because the net NPAs, adjusted for the value of security available as collateral, wouldrepresent substantially the shortfall in the value of assets taken over. This is relative to the liabilities taken over, represented essentially by deposits of more than Rs 6,000 crore. This shortfall would represent the cost of acquisition of GTB for Oriental Bank. Cost of acquisition should be commensurate with the value of assets and the business opportunity taken over.

For this purpose, assets will include the market value of the real estate and the value attached to a retail customer base of nearly one million.

The net NPA number is also critical from another perspective. If the net NPA number is considerably higher, say closer to Rs 1,000 crore, then the deal will enhance risks for the shareholders of Oriental Bank. That will be so even if the value of the collateral security is considerably higher and covers a predominant portion of the value of this bad loan portfolio. This is because, the value of the deal and the cost of acquisition, will be entirely dependent on how Oriental Bank is able to effectively enforce security and recover bad loans. Since the rate of success in such endeavours is always difficult to estimate, the risk profile of Oriental Bank would have risen for shareholders.

If net NPAs were Rs 650 crore, the proportion of bad loans to advances will be about 3 per cent for Oriental Bank at the end of March 2005, assuming that its advances grow by about 10 per cent in 2004-05. It will be even lower if provisions were made for a bulk of such advances before it is taken into the books of Oriental Bank.

The capital adequacy ratio of Oriental Bank will also not be affected substantially. This may come down from about 14.5 per cent to just below 13 per cent, without considering the profits that will be made this year. This is much higher than the RBI requirement of 11 per cent to declare dividends without prior RBI approval.

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