Indian Bank a good wager on loan growth, stable asset quality

Banking-sector stocks have been underperforming in the last few months over concerns on margin pressures due to macro headwinds like rising interest rates and tight liquidity conditions.

However, with interest rate cycle nearing peak and liquidity conditions expected to ease, the banks with high yielding assets and low cost deposits are better placed to withstand margin pressure. Indian Bank, a medium sized public sector bank with excellent operational parameters is expected to show steady growth in coming years.

Business: Indian Bank has a pan India presence with a strong hold in South India. It has a network of 1,822 branches (including 3 overseas), 37 extension counters and 1,085 ATMs across India.

The bank mainly caters to commercial and corporate segments which form 53% of the overall advances while lending to retail segment for home loans, vehicle, education and personal loans constitutes 15% of the overall loan book (as on  December 2010).

It has maintained a special focus on priority sector lending for agriculture and micro small medium enterprise (MSME) segments, which forms more than 42% of the loan book. It has diversified and extensive presence in semi-urban, urban and metro locations as well with 27%, 25% and 20% of the branches located in these regions, respectively. All the branches are computerised and connected to core banking solutions (CBS) net. The  bank is aiming to take its branch count to 2,500 in the next three years.

The bank in its bancassurance business has tied up with HDFC Standard Life Insurance for distribution of latter’s insurance products and with United India Insurance company for its non-life products. The bank also offers mutual fund products from UTI and Reliance AMC. It also offers depositary participants services and wealth management services on selective basis to high net worth individuals.

Investment rationale: The bank has over the years shown steady growth in lending and deposits with its high interest rate differential leading to strong operating profitability. Advances have grown at a compounded annual growth rate (CAGR) of over 28% over the last four years while deposits grew over 21%. The bank enjoys higher yield on assets or interest earned as it lends mostly to MSME and mid-sized corporates, while the cost of deposits remain reasonable as it has moderate levels of low-cost CASA (current and savings account) deposits with fairly large presence in rural and semi-urban areas. The CASA has been growing steadily and stood at 32.87% of overall deposits as on December 2010 end.  

This interest rate differential between bank’s lending and borrowing known as net interest margin (NIM) has remained at over 3.4% consistently over the last five years, which is one of the best in the industry.

The bank during December 2010 quarter reported NIMs of 3.84% and is likely to maintain it over 3.4% in the coming year.
Indian Bank further benefits from its low cost-to-income ratio which stands at 37.72% over last three quarters and is among the lowest in the industry.

Though the bank has witnessed deterioration in asset quality after adopting CBS-based NPA recognition but the same has been improving over last two quarters led by lower slippages. The bank’s gross NPAs at the end of December quarter stood at 1.02% while net NPAs were at 0.57%. The bank further has a comfortable provision coverage ratio (PCR, or the extent of funds a lender has kept aside to cover its loan losses or non performing assets) at 83% as at December end, which ensures profitability would not be impacted to meet the RBI’s desired norms. Going forward, lower slippages due to early detection through CBS and immediate remedial steps to recover the same would help to keep its NPAs low.

The bank’s strong financial profitability ratios like return on assets (RoA) and return on equity (RoE) further provide comfort to investors. Indian bank’s ROA at 1.73% (as on December end) is one of the best in the industry while its ROE stands at over 24%.   
Indian Bank’s capital adequacy ratio (CAR), which is a measure of banks strength stood at 12.35% at the end of December quarter while its tier 1 capital stood at 9.69%. Tier 1 capital is the core measure of a bank’s financial strength and consists primarily of equity capital and disclosed reserves.

The higher CAR ensures bank has enough capital to fund its business growth by raising its tier II capital. The bank has headroom to raise `5,072 crore of tier II capital apart from raising capital through issue of fresh equity.

Concerns: Due to higher exposure to vulnerable segments like agriculture and MSME, the bank may witness deterioration in asset quality if the macro environment gets worse or if the bank is unable to recover the loans impacting profitability. 

Valuations: At current market price of Rs229.95, the stock trades at 1.21 times its expected FY11E book value and 5.73 times its FY11E earnings per share. The bank’s loan growth is expected to continue at over 20% in the coming few years.

Considering its loan growth, stable asset quality and superior profitability ratios like RoA and NIMs compared to its peers, investors can consider buying the stock on declines.

Disclaimer: The writer does not hold any shares in the company.