Oriental Bank of Commerce (OBC), India’s tenth largest PSU bank, has an asset size of $23.2 billion (as on March 31). The bank has underperformed the BSE Bankex and Sensex in the past five years due to deterioration in operating parameters and apprehensions over its ability to maintain credit quality post merger with Global Trust Bank (GTB) in FY05.
In our view, legacy issues related to the merger have been resolved and the risk-reward ratio for OBC has turned highly favourable, given its undemanding valuations and likely improvement in operating parameters.
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However, as the management sharpens its focus on improving the CASA base to 25% in FY10 and 30% in FY11, margins are expected to increase. Over FY09-FY11, we are factoring in a 21% CAGR in advances. Expansion in interest margins is likely to translate into a 25% CAGR in NII during this period.
OBC’s loan slippages have remained in the 0.9-1.2% range over FY06-FY09; with higher recovery rates, gross NPA has declined to 1.5% in FY09 from 6% in FY06.
At the end of FY09, the bank had restructured loans amounting to 7.7% of its outstanding loan book (based on borrower-wise classification); this is relatively higher than its peers.
About 80% of OBC’s restructured assets merely involve the deferral of principal payment, lowering the probability of defaults.
OBC forayed into the life insurance business through Canara HSBC OBC Life Insurance, a joint venture with Canara Bank and HSBC; OBC holds a 23% stake in this venture.
The company started underwriting policies from June ’08 and has gained a 2.3% market share among private players in the first four months of FY10.
We are not assigning any value to this business at present, but believe that if the company maintains its current performance over the next two years, it will generate significant value for OBC’s shareholders.
The bank is adequately capitalised with a CAR of 12.9% and tier I ratio of 9.1% at the end of Q1FY10. Therefore, capital requirement would not be a constraining factor for growth.
We initiate coverage on OBC with a BUY rating and a target of Rs310 (1x FY11E ABV). At our valuation, the stock will trade at 25-30% discount to larger PSU banks.