The Hindu Business Line : Indian Overseas Bank: Buy

The ability to generate superior returns, the impressive business growth and the benefits likely to accrue from the acquisition of Bharat Overseas Bank make IOB a bankable stock.

Mr T. S. Narayanaswami, Chairman and MD, IOB.

The Indian Overseas Bank (IOB) stock can be added to the investment portfolio with a one/two-year perspective.

At its current price of Rs 85, the stock trades at a price-to-book multiple of 1.4 times. This appears a tad expensive compared to most of its peers in the public sector.

However, we believe that the bank's ability to deliver superior returns and manage interest rate risk better than its peers deserve a higher valuation.

IOB has been able to generate a return of over 20 per cent on shareholder funds over the last few years.

It is one of the few banks in the public sector that has weathered the storm of rising interest rates relatively better. Its return on assets at about 1.4 per cent is the highest among public sector banks. IOB's showing on its core earnings was impressive in FY-06.The bank recorded a healthy 11 per cent rise in its net interest income.

During the year, the bank sold about Rs 2,000 crore of low-yielding government securities and lent the proceeds at higher yields. This helped the bank in bringing down the SLR to 28 per cent against 37 per cent in FY-05. As a result, the bank's advances rose 36 per cent, marginally outpacing the industry average of 35 per cent.

The bank's increasing focus on mobilising low-cost deposits is a positive. Low-cost deposits now constitute about 40 per cent of the total.

With cost pressures escalating, deposit accretion for the banking industry has slowed over the past few weeks. For IOB, its focus on high-yielding small and medium enterprises, together with its ability to contain costs, is likely to help protect margins. The bank's net interest margin (NIM; the difference in the rate at which funds are borrowed and lent) at about 3.9 per cent is at the higher end compared to most banks.

Over the next few quarters, we however expect some pressure on its NIM on account of rising cost of incremental borrowings and higher provisioning.

The bank raised Rs 200 crore of debt, constituting Tier-1 capital, in FY-06 at 9.3 per cent semi-annual interest. It plans to raise another Rs 1,200 crore in FY-07.

This is likely to be priced 40-50 basis points higher than its earlier issue, resulting in a rise in the cost of working funds. Even after factoring in the impact of rising cost, the bank's NIM is likely to remain healthy in the 3.4-3.6 per cent range.

As on March 2006, the bank had 50 per cent of its investment portfolio in theHTM category.

The bank provided Rs 142 crore in the final quarter (of a total provision of Rs 228.5 crore) on account of investment depreciation and amortisation. It intends to shift more to HTM in the current quarter and take its share to 70 per cent of the portfolio.

This is expected to de-risk its investment book from interest risk. However, higher provisioning may check the earnings growth in the near term.

Acquisition benefits

The acquisition of Bharat Overseas Bank (BhOB) in February fits in well with IOB's plans to expand abroad.

BhOB has a branch in Bangkok that is making profits. BhOB also boasts of a 100-branch network at home, almost all of which are linked to a core banking solution.

BhOB is also substantially smaller than IOB and both are South-based. Integration challenges can, thus, be expected to be minimal.

A capital adequacy ratio of about 13 per cent as on March 2006 places IOB in a comfortable position to accommodate growth over the medium term.

Further, the government stake of about 61 per cent also offers the bank leeway to raise more equity.

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