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Suresh Krishnamurthy

Above-average business growth is working to the bank's advantage.

AN INVESTMENT in the stock of Indian Overseas Bank can be considered. Among public sector banks, IOB has weathered the storm of rising interest rates relatively better. Above average business growth is also in the bank's favour.

Despite the bank's considerable strengths, the stock trades at a discount to the valuation of a number of its high-profile peers.

Lower sensitivity

Since April 2004, public sector banks have to deal with a number of significant issues that would ordinarily reduce profit growth. Prices of government securities declined, leading to losses.

A wage agreement with the trade unions entailed a larger outgo than anticipated. Deposit rates inched higher even as the system was flush with liquidity, putting pressure on the spread (difference in the rate at which funds are lend and borrowed). The spectre of a further rise in interest rates also loomed.

There one one silver lining was the unprecedented growth in advances. The situation called for a transformation of the balance-sheet principally to reduce the proportion of government securities.

In most cases, this would have normally led to a decline in profits. But IOB weathered the storm well and reported a moderate profit growth of about 13 per cent.

That was possible because IOB managed to grow its advances at a rate higher than the industry-average and improve the spread earned on its working funds.

The spread improved partly because IOB sold low-yielding government securities and lent the proceeds to borrowers at higher yields; and the bank garnered more low-cost savings and current account deposits and brought down the cost of deposits below 5 per cent.

IOB lends at an average of 9 per cent-plus. These improvements would have led to higher profit growth but for the provisions made for wage arrears and to cover losses on government securities.

The bank also improved its management of bad loans. Despite lower provisions for non-performing assets, the proportion of such bad loans is now down to about 1.57 per cent and may close the fiscal below 1 per cent.

The absolute amount of gross and net non-performing assets has also declined. This clearly indicates that balance-sheet expansion alone did not contribute to the decline.

The profit growth in the next quarter is expected to be better than that in the first nine months. This is because the demand for credit is continuing to maintain momentum while interest rates have stabilised for the time being.

A lower base would also boost reported profit growth for the quarter-ended March 2005 as IOB made large provisions against its bad loans in the quarter ended March 2004.

Attractively valued

The stock trades at a price-to-earnings multiple of about six times its likely earnings for the year ended March 2005. The stock also offers a dividend yield of about 3.5 per cent.

IOB's capital adequacy, which is likely to be 14 per cent at the end of the fiscal in March 2005, is enough to accommodate strong advances growth over the next year or two, even without further equity expansion.

The Government stake of about 61 per cent also allows the bank leeway to raise more equity. IOB also has a number of other strengths. It has a treasury department that is active in the equity, foreign exchange and debt markets.

This is reflected in the strong growth in `other income' excluding profits from sale of government securities. IOB has also developed its core banking solution in-house.

This will help speedy rollout of total banking automation across all its branches at a substantially lower cost vis-à-vis other banks.

The IOB stock, however, trades at a discount to several of its peers such as Corporation Bank, Union Bank of India and Oriental Bank of Commerce. Investment in the stock , thus, looks attractive.

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