United Bank of India IPO Analysis

Investors can refrain from subscribing to the United Bank of India's public offer. Though the offer is modestly priced, the bank doesn't appear to be a preferred exposure in the banking space, where there are a large number of other listed options. At the upper end of the price band of (Rs 66), the stock is trading at 4.37 times its trailing one year earnings.

This includes a huge proportion of income as well as write-backs from the treasury portfolio, as the debt market had a good run for the year ended September 30, 2009.

The price-to-adjusted book value post dilution (excluding the preference shares) works out to 0.9 as of September 30, 2009.

While this valuation is at a discount to peers, it may be justified as the bank may continue to lag its peers in terms of earnings performance. Banks with similar valuations such as Allahabad Bank and Andhra Bank have better operational parameters and may deliver better returns, going forward.

Choppy earnings

The bank suffers from low credit-deposit ratio (63.7 per cent), high cost-income ratio (57 per cent) and low net interest margins (NIMs of 2.4 per cent ). A low provision coverage (48 per cent) is also a concern and this may need to be bolstered, given RBI norms.

These also depressed the return on net worth of the bank which stood at 14 per cent as of March 2009. The profits of the bank were volatile during the period 2004-09 despite the bank witnessing a 32 per cent compounded annual growth in advances. Choppy earnings may continue until the bank reduces the investment-deposit ratio (36 per cent ).

United Bank of India, a Kolkata-headquartered bank, has 1,505 branches with predominant East and North-East presence.

The total business (deposits and advances) of the bank stood at 1.05 lakh crore as of September 2009. Advances grew by 32.8 per cent compounded annually for the period 2004-09 albeit on a low base.

This helped the bank to improve its credit-deposit ratio to 65.5 per cent; however this is still low compared with peers.

The current offer proceeds are to be used to bolster the capital adequacy which is necessary to fund future loan book growth. The capital adequacy of the bank stood at 12.93 per cent as of September 30 2009. The current fund raising plans (including an additional Rs 550 crore infusion from the government through preference share allotment) would bolster the capital adequacy base to more than 15 per cent.

Post-offer, the government's stake would fall to 84 per cent. Government stake is well above the mandatory 51 per cent stake, which may allow the bank to raise capital from time-to-time, which many other peers cannot do.

Historically volatile treasury income has impacted the bank's earnings and this will continue to be a factor in the quarters ahead.

Over a third of this investment portfolio is exposed to interest rate risk, which is a significant proportion compared with its peers. With a modified duration of 2.9 years, it may have to provide as much as Rs 2.47 crore for every one basis point increase in bond yields.

CASA advantage

High concentration in the Eastern region, where the demand for credit is low but the deposit inflows are high, has helped United Bank build a strong low-cost deposit base. Low-cost deposit base stood at 34 per cent as of September 2009, high compared with the nationalised banks' average.

Even though the cost of funds is low, the bank has a relatively low net interest margin (2.4 per cent for the half year ended September 2009) compared with most peers. While the December quarter may see slight improvement in NIMs, the recent hike in CRR would pressure margins. While the bank has done well to bring down the gross NPA ratio from 4.66 per cent in March 2006 to 2.5 per cent in September 2009, the proportion is high.

With a provision coverage of 48 per cent, the net NPA ratio stood at 1.3 per cent. The net NPA ratio of the bank is higher than the nationalised bank average. We expect asset quality slippages in line with the banking industry in the December quarter.

Total restructured assets of the bank is around 5.3 per cent of the total advances. Further asset quality slippages can be expected from the restructured loans.

While its current operational parameters are not impressive, United Bank has immense scope to improve its operational parameters over the medium to long term.

Investors should watch for such improvement before considering investment.