Suresh Krishnamurthy

INVESTMENT in the book-built public offer of Oriental Bank of Commerce need not be considered. The merger with it of the beleaguered Global Trust Bank has cost Oriental Bank in terms of growth in FY-05. It could take longer for the bank to assimilate GTB. During this period, the bank may have to put on hold aggressive business expansion.

Given that there are several banks trading at attractive valuation, and are also poised to take advantage of growth opportunities, investment in the Oriental Bank's offer can be avoided. Investors could, however, keep a tab on the bank's performance and accumulate the stock at more attractive price levels.

A costly merger

Oriental Bank was the first Indian outfit to report zero net non-performing assets. What was impressive about Oriental Bank of Commerce was that the progress to zero NPAs was achieved with a large contribution from recoveries of loans previously classified as NPA. This gave the bank confidence to consider the merger of GTB with itself.

The deal did look attractive in August 2004 when the merger was announced with talks of tax benefit alone reported to be running into hundreds of crores of rupees. In the process, Oriental Bank would also get about 100 branches and one million customers. The numbers, however, reveal the substantial level of costs that Oriental Bank has had to incur.

For starters, the `shortfall', representing excess of liabilities (mainly deposits) over assets (mainly advances and investments) taken over from GTB — is about Rs 1,225 crore. This represents the investment made by Oriental Bank in taking GTB. Then, there is another Rs 464 crore representing advances not readily realisable. Even if we put a number of Rs 300 crore against possible tax benefits, the costs associated with the merger appear significant.

For this sizeable investment to pay off, Oriental Bank has to recover a substantial proportion of advances classified bad. GTB's bad loans were about Rs 1,300 crore at the time of merger.

Oriental Bank has recovered Rs 100 crore, while restructuring of dues, settlements and upgradation would account for Rs 700 crore. That is, the bank has made progress in dealing with GTB's bad loans. This, however, will still not offset the costs associated with the merger.

Capital adequacy

The primary concern, however, relates to opportunities lost because of the merger, because of which the capital adequacy ratio of Oriental Bank has fallen from 16 per cent at end-March 2004 to 9.4 per cent at end-December 2004. The RBI guidelines require a capital adequacy ratio of 9 per cent.

The fall in ratio has affected Oriental Bank in two ways — one, the bank is constrained from taking advantage of the blistering growth in demand for credit as done by its peers. Oriental Bank's advances growth may have been only about 5 per cent between March and December 2004 when its peers registered average growth of about 15 per cent.

Two, the bank could not take advantage of the RBI's relaxation of rules relating to transfer of government securities to ``held to maturity'' category.

Such a transfer would have insulated Oriental Bank from an increase in interest rates. Now, the bank remains vulnerable and may also have to make considerable provisions in the quarter ended March 2005.

There is also the matter of Rs 300 crore lent to IFCI classified as standard advances till now. In addition, if the bank also provides for the `shortfall' in the quarter ended March 2005, then, even after this equity offer, the capital adequacy would not be high. While other banks would sport capital adequacy ratio far in excess of 12 per cent Oriental Bank would have to make do with a lower figure.

Regulatory changes on capital adequacy could mean additional burden especially given the quality of GTB's advances. A low ratio would mean that the bank would have to settle for lower business growth in the next few years too. A capital adequacy ratio of less than 11 per cent could also constrain dividend declaration, given the applicable RBI regulations.

Value from bad loans

These factors ensure that growth in value for shareholders has to come primarily from bad loan management. Impressive bad loan management would have a significant positive effect on Oriental Bank's finances. It would boost profitability as well as release capital that can be used to fuel growth. However, this exercise is fraught with risks.

The offer price does not appear to have factored in such risks. Post-offer, the price-to-book ratio would work out to 1.8 times for the price of Rs 260. This is similar to the ratio at which most banks trade and is higher than the ratio for SBI. Considering the risks involved and the concerns of capital adequacy, the valuation appears demanding.

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