Bank of India: BUY

Higher-than-expected economic growth, a narrowing current account deficit and a flurry of activity within the government to clear stalled infrastructure projects hint at early signs of recovery.

While a complete revival is still some way off, it may be time to bet on stocks that are able to benefit from the recovery. Banking as a sector has a direct correlation to the fortunes of the economy and any pick up from hereon will benefit the sector, in terms of higher loan growth and lower risks to asset quality.

In the last one year, the market has been cautious on public sector bank stocks in spite of very low valuations, owing to the mounting risk on asset quality.

But with the Reserve Bank of India now keeping a hawk-eye on incremental restructuring of loans, and putting pressure on banks to step up the recovery process, some of the incremental risk may start to recede.

Bank of India (BoI) has been among the stocks that have been beaten down by the market in the last one year due to high bad loans and low capital cushion. However, the bank’s asset quality improved in the September quarter, and the stock surged 22 per cent after the results.

Despite the pick up, the stock still trades at 0.5 times the book value and 0.8 times its adjusted book value (after factoring in 100 per cent of net non-performing assets and 30 per cent of restructured loans).

This seems an attractive entry point for investors with a two-to-three year horizon. A more cautious approach to lending in recent quarters, lower bad loans and continued efforts at recovery should bode well for the stock.

Despite the challenging environment and the bank’s high exposure to stressed sectors, BoI was able to contain further additions to its bad loan book in the September quarter.

The addition to bad loans nearly halved from last year and shrank 26 per cent on a sequential basis.

What was also heartening was that the reduction in bad loans was mainly on account of higher recoveries and upgrades rather than write-offs.

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. Write-offs came down significantly from Rs 598 crore in the June quarter to Rs 120 crore in the September quarter.

The bank also improved its provision coverage ratio (ratio of provisions to bad loans) by 300 basis points to 63.3 per cent.

As far as the restructured book is concerned, BoI has close to 5 per cent of loans under this category. During the quarter, the bank has sold close to Rs 370 crore of bad loans to Asset Reconstruction Company for recovery.

The bank has indicated a pipeline of Rs 1,000-1,200 crore of restructured loans for the December quarter.

The bank’s management has indicated that it will continue to monitor its top 100 stressed accounts which account for 47 per cent of bad loans and also aggressively pursue the recovery process.

BoI’s loan mix is skewed towards the large corporate segment, which constitutes 59 per cent of the total loans. The proportion of retail and agriculture is much lower at 11 per cent and 13 per cent. Within the corporate segment, the top three sectors are infrastructure (15 per cent), metals (per cent) and textiles (4 per cent).

The bank has been focussing on the high-yielding retail segment. In the September quarter, the growth in domestic advances of 27 per cent was led by agriculture, MSME (medium and small enterprise), and retail segments, which grew 33 per cent, 26 per cent and 24 per cent respectively.

Within retail, the secured mortgage and home loans grew 44 per cent and 24 per cent. The management has indicated that retail and SME will continue to be the growth focus for the bank. Within the corporate segment, while the high level of exposure to stressed sectors is a concern, the bank has now placed certain group lending limits to restrict risks from any particular entity/group.

BoI also has a strong overseas presence across 20 countries. The overseas loan book has grown at 30 per cent annually in the past five years, and now constitutes one third of the bank’s lending. This has helped the bank to tap into the growing opportunities abroad.

BoI has also been able to pare its bulk deposits. These deposits now constitute just 5 per cent of total deposits as against 19 per cent a year back.

The bank has also swapped $1.13 billion of foreign currency non-resident (FCNR) deposits under the special window provided by the RBI at lower cost.

This is expected to help reduce the cost of funds in the coming quarters. BoI’s net interest margin (NIM) at 2.4 per cent in the September quarter was around the same level it was last year.

The decline in cost of funds due to reduction in bulk deposits has helped offset the decrease in yields on advances.

The management has indicated that the domestic NIM (currently at 2.9 per cent) would improve to 3.1 per cent by the end of 2013-14.

The bank’s core Tier I capital adequacy ratio at 8 per cent as of the September quarter just meets the minimum requirement (8 per cent) as per Basel III norm.

The government has now infused capital of Rs 1,000 crore into the bank, which will improve its capital adequacy ratio by about 40 basis points.

The infusion has happened at nearly half the book value of the stock. This has been the case with most other public sector banks too which trade below their book value.

Any further infusion at below book value may hurt minority shareholders. However, as the recovery sets in and asset quality further improves, an increase in earnings should help the BoI stock recoup and trade at its earlier price to book levels of 1.1-1.2 times. This should cap further dilution.

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