Worst not yet over for IOB

Since January 2015, the management has enhanced efforts towards improving the bank's financial health, but the recovery is likely to be gradual

Last week, the Reserve Bank of India (RBI) initiated prompt corrective action (PCA) on Indian Overseas Bank (IOB) and asked its management to improve profitability, return ratios and asset quality. RBI also restricted the bank from opening new branches and, instead, directed it to improve the efficiency of existing ones.

The news had little impact on market sentiments, given the IOB stock has gained since then. A reason for this could be the fact that the stock had fallen to an 11-year low in early September; baring a surge in mid-2014, it has been on the decline since May 2011, under-performing the broader markets. Continued stress on credit quality, weak return ratios and weak capitalisation are a few reasons behind the under-performance.

While implementation of the measures suggested by RBI should lead to a turnaround, any improvement is likely to be gradual. This is because the bank’s financials are weighed down by rising non-performing assets and second, the slow pick-up in economy will likely make the management’s job a little difficult.

To achieve a turnaround, the bank management says it is working on a few areas. These include improving recoveries, ramping up the current account and savings account (Casa) ratio, reducing costs by shedding high-cost deposits and lending only to the retail and medium, small and micro enterprises segments. This is being done since January this year, when the current managing director took charge.

The results are partly visible: After posting net losses of Rs 246 crore and Rs 516 crore for the September 2014 and December 2014 quarters, respectively, the bank reported a net profit for each of the past two quarters. But performance hasn’t stabilised yet. This is because in the June 2015 quarter, profits fell sequentially and non-performing assets (NPAs) continue to rise. The bank’s gross NPA ratio has increased from 5.8 per cent in the June 2014 quarter to 9.4 per cent in the June 2015 quarter. IOB’s return on assets stood at a measly 0.02 per cent for the June 2015 quarter. Its quarterly slippages, too, remain elevated at a run-rate of about Rs 2,500 crore in the past two quarters.

The bank has stepped up efforts to improve recoveries and is aiming to record break-even for the branches opened in the past three-four years. It has set up a special recovery force, which has been deployed across regions. However, these measures will take time to show results.

The management agrees. “We are taking steps to improve the bank’s financial health, but these will take time. We estimate we will see improved profitability by March 2016 or June 2016,” says a senior IOB executive.

Additionally, rising stress in the metals, real estate and infrastructure sectors pose further downside risk on the asset quality front.

For FY16, IOB aims to reduce its gross NPA ratio to 7.4 and expects loan growth to be around 12 per cent (including overseas lending).

In the quarter ended June this year, the bank’s Casa ratio stood at 25 and it will not be easy to ramp this up, given the restrictions on opening new branches and rising competition from new and existing banks, say analysts. This could limit margin gains in the interim. Technology initiatives, however, could provide some assistance on this front.

In this backdrop, investors would be better off waiting for sustained improvement in IOB’s financials before considering any investment, even as valuations might be close to trough levels.