Andhra Bank

Shareholders with a two-year time horizon can stay invested in Andhra Bank stock as the bank, which posted a robust business and advances growth in the last few years is expected to maintain its momentum, going forward. At the current market price of Rs 78.6, the stock is trading marginally above the bank’s March 31 book value of Rs 75 and 5.8 times its trailing one-year earnings. The dividend yield on the stock is 5.7 per cent.

Even at these valuations, the bank is trading at a premium to its peers such as Vijaya Bank, Allahabad Bank, Dena Bank, Syndicate Bank and UCO Bank but given the high credit-deposit ratio (75 per cent) and superior asset quality, the valuations seem justified.

Stable return ratios (Return on Assets of 1.03 per cent and ROE of 17.9 per cent) and net interest margin of 3.03 per cent, high NPA provision coverage (81 per cent) and high levels of capital adequacy are the key arguments in favour of investing in the bank.
Business

The bank managed a 24 per cent CAGR in advances during the period 2006-08. In 2008-09, advances grew by 29 per cent, thanks to high credit growth in lending to medium and small scale enterprises (34 per cent) and large corporates (75 per cent).

The advances growth (29 per cent) outpaced the deposit growth (20 per cent) and the credit-deposit ratio improved to 75 per cent during the year. The bank’s incremental credit-deposit ratio for the year was almost 100 per cent, showing improved asset-liability management. The proportion of low cost deposits fell from 33.5 per cent in 2007-08 to 31.5 per cent in 2008-09; one of the lowest ratios in the public sector bank space. However, the increase in cost of funds was contained as the bank retired bulk deposits which carry higher interest rates.
Financials

Despite strong advances growth, the bank’s net profits grew by a modest 8.8 per cent during the period 2006-08 owing to high interest cost and inconsistency in the other income component during the period. For the year ended 2008-09, this growth improved to 13 per cent driven by net interest income (20 per cent growth) and stable net interest margins for the year. Other income also contributed to the net profit growth primarily due to profits on sale of investment.

The bank generated fee-based income making up about 6 per cent of the operating profit, which can be expected to increase as the bank rools out CBS across all its branches.

Higher employee expenses (up by 24 per cent) and an increase in NPA provisions, plus a provision for depreciation in the value of investment, tempered profit growth. However, higher provisioning for NPAs helped the bank maintain the quality of its loan book.

The bank’s gross NPA ratio has fallen from 1.07 in 2007-08 to 0.83 in 2008-09, while Net NPA ratio also improved to 0.18 per cent with a good provision coverage of 81 per cent.

Further to the RBI allowing restructuring of loans, the bank restructured 3.6 per cent of the total credit which is in line with most of its public sector peers. The amount sacrificed on restructuring (1.4 per cent of total restructured amount) is very low compared to most of the peers.

Though the bank is adequately capitalised at 13.2 per cent to take care of its capital needs for the next few quarters, capital raising may be constrained as the government stake is close to 51 per cent. The recapitalisation package, which is due for many banks including Andhra Bank, may help in this regard.
Outlook

The first quarter may see a moderation of the credit-deposit ratio, in line with the entire banking sector. This will mean pressure on margins as interest costs remain high due to the expanding deposit base.

The re-pricing of the lending portfolio (through a lending rate cut) may have a stronger impact om margins in the near term than the falling deposit rates.

While the bank may benefit from a fall in yields in the first quarter of 2009-10, the treasury gains may not be as significant as earlier. The investment depreciation in non-SLR securities may fall as the spread between non-SLR and SLR securities narrows.

Going forward, high operating expenses arising out of new recruitments, branch roll-outs and AS-15 provisions may lead to a spike in costs for the bank. Expenses arising out of CBS, which the bank proposes to amortise over the next five years may also understate the profits.

However, these issues may be compensated by the bank improving its operating efficiency (by reducing cost-income ratio which is at 46 per cent) and the additional fee income generated by the roll-out of CBS.

The bank expects to reach Rs 1,30,000 crore business (advances+deposits) by the end of this fiscal which looks tough in the given environment of moderating credit offtake and falling deposit rates.

The bank is planning to add 121 branches this fiscal, mostly outside of AP which may help it increase the proportion of low-cost deposits.

Plans to enter the insurance business in a joint venture with Bank of Baroda and an overseas branch in Malaysia by forming a joint venture with BOB and IOB are also on the anvil.