UCO Bank

Investors targeting higher returns can consider exiting the UCO Bank stock after its 81 per cent gain from its March lows.

The stock is not among our preferred exposures in the banking space given its relatively thin margins, which may compress further as yields harden.

The bank may under-perform peers over the next few quarters as treasury gains taper off, even as a lower credit-deposit ratio and scarce low-cost deposits hurt margins. At the current market price of Rs 39.80, the stock trades at 3.8 times the FY-09 earnings and 0.8 times its March 2009 book value.

The price-to-book value (P/BV) is at a discount to larger public sector banks and at a premium to smaller banks such as Allahabad Bank, Vijaya Bank and Syndicate Bank. Despite having market Beta close to 1, underperformance of the bank vis-À-vis its peers may continue.

UCO Bank operates on lower spreads (net interest margin of 1.75 per cent for 2008-09) and has a relatively low proportion of low-cost deposits (24.1 per cent) in its deposit base.

The cost-income ratio (54.9 per cent) is relatively high, while the profitability ratio (ROA of 0.59 per cent) is modest. Limited Tier-1 capital despite a Rs 450 crore capital infusion by the government and low provision coverage (45.75 per cent) have constrained UCO Bank’s financial performance.
Financials

UCO Bank, a mid-sized Kolkata-based bank has performed well in terms of earnings in the last few years despite relatively higher levels of non-performing asset (NPA).

The bank’s net profits grew by 44 per cent compounded annually in the period 2006-08 while the advances grew 21 per cent during the same period. For the year ended March 2009, the net profit grew by 35.4 per cent.

Net interest income grew by 10 per cent in a year even as advances grew by 25.2 per cent, as net interest margins compressed to 1.75 per cent in 2008-09 (1.86 per cent in 2007-08).

Higher growth in other income (32 per cent) owing to treasury gains (49 per cent growth), strong fee income growth (21 per cent) and lower operating expenses led to higher profit growth.

The asset quality has improved significantly as the bank’s GNPA ratio fell from 2.97 per cent to 2.21 per cent due to prudent lending by the bank; but the provision coverage is still among the lowest at 47.5 per cent. The net NPA ratio is at 1.18 per cent, still higher than many peers.

The bank’s restructured assets also grew by 180 per cent in a year and form 3.5 per cent of total advances in 2008-09. The bank took a hit of Rs 97 crore on the fair value of the restructured portfolio. The bank’s low capital adequacy ratio resulted in it being one of the recipients of the re-capitalisation package from the government.

The bank has already received Rs 450 crore out of Rs 1,200 crore to meet its Tier-1 needs. But despite this and the reduction in risk weights by the RBI on certain sectors, the CRAR stood at 9.75 per cent according to Basel 1 norms and 11.9 per cent (Basel 2) with Tier-1 capital (6.48 per cent), just above the RBI-mandated 6 per cent.

The residual portion of the re-capitalisation package (Rs 750 crore due) may give it higher headroom on fund-raising, but may remain a constraint on advances growth. The recent capital restructuring also led to government stake falling from 74.98 per cent to 63.59 per cent.

Outlook

Sustainability of the bank’s strong pace of net profit growth will depend on advances growth and its ability to source low-cost deposits and contain the overall costs.

While credit transmission, according to the latest RBI data, does not look encouraging, getting low-cost deposits has become a challenge for most banks with competitive hotting up and private peers also eyeing the same clients. The slow pace of technology adoption at UCO Bank may also make it challenging to improve its low-cost deposit base in such a scenario.

In 2008-09, the bank had a incremental credit-deposit ratio of 67 per cent, which is on the low side, leading to investments of residual deposits in low-yielding assets, putting pressure on margins. Asset quality concerns may creep in as the deadline for the restructuring nears. The bank may be more vulnerable than its peers due to its lower provision coverage.

While the bank has a network of 2,069 branches, it is still not completely CBS-enabled (almost 49 per cent of the branches as of March 09 were yet to be CBS-enabled). While the fee income looks sustainable, going forward, other income components may take a hit.

If the yields rise, there is probability of losses on the treasury portfolio. Fee income may see growth once the bank becomes 100 per cent CBS-enabled. The bank is also looking to venture into insurance business in the coming months.

via BL