Karur Vysya Bank — Rights offer: Invest

Superior profitability ratios, robust net interest margins and strong provision coverage, pegging the non-performing ratio at low levels, make the stock attractive.



Shareholders of Karur Vysya Bank (KVB) can subscribe to its rights offer. The rights are at a steep 62 per cent discount to the current market price. KVB is a small sized private sector bank with more than half its branches located in Tamil Nadu.

At the current price of Rs 394, the stock trades at 1.6 times its estimated FY-12 book value, after adjusting for the rights issue. The price-to-earnings (FY12 earnings) multiple of the KVB stock works out to eight times.

On book value basis, the stock trades at a premium to most of the old private sector banks. However, the premium is justified, given that KVB has superior profitability ratios, robust net interest margins (NIM) and strong provision coverage, pegging the non-performing ratio at low levels.

The return on assets for the nine month ended December 2010 stood at 1.6 per cent (annualised). The provision coverage was in excess of 87 per cent as of December 2010.

Additionally, improving operating efficiency parameters of KVB are comparable to that of new-age private banks. The net interest margin of KVB was at 3.43 per cent for the nine months ended December 2010. The cost-to-income ratio during the same period was at 40 per cent as compared to 43 per cent for the nine months ended FY10.

The profit per employee of the bank improved from Rs 4.8 crore per employee in 2006-07 to Rs 5.95 crore in 2008-09 and further trended up to Rs 8 crore in 2009-10.

Strong capitalisation

The current capital raising of Rs 455 crore by way of rights issue would improve the bank's Tier-1 capital ratio to more than 13.5 per cent as against the RBI's comfort level of 8 per cent. Even before the rights issue, the Tier-1 ratio was at 10.17 per cent (December 2010). KVB's move to enhance capital through Tier-1 capital instead of Tier-II capital (debt) will help it contain interest costs.

This will shield it from the the current interest rate scenario. Going forward, we expect the bank's deposit rising to improve leverage which would enhance shareholder returns.

The current capital infusion will also support margins. During the 2008-09 fiscal, when banks saw major hardening in the interest rates due to monetary tightening and liquidity crunch, KVB saw net interest margins shrink to 2.95 per cent.

This time around, the liquidity situation is slightly better and the short-term rates are near peak.

Market experts feel that these elevated short-term rates will come off over the next couple of quarters. Karur Vysya Bank raises majority of its deposits in the shorter end of maturity therefore it may get some relief as the rates moderate.

With KVB concentrating on high-yielding small and medium enterprises segment and retail segments, margins will get further support.

One concern with old private banks, in general, and KVB, in particular, is that the cost of deposits tend to be high. However, given the maturity patterns on the assets and the liabilities are evenly matched, the risk of the rising interest rate may be mitigated to some extent.

The low-cost deposit ratio of the bank stood at 25 per cent. An expansion in branch network (360 as of December 2010) would improve the retail deposit base.

Advance book growth

The rights issue is to support future credit growth at a higher rate. During the period between FY2007 and FY2010, the loan book grew at a compounded rate of 24 per cent. KVB clocked a 30 per cent loan book growth during the first nine months thanks to revived demand from retail and SME segments.

Without any further capital raising, post-rights capital adequacy ratio would be maintained at more than 12 per cent even as the loan book grows at 30 per cent annually over the next two years.

The credit-deposit ratio of the bank at 73 per cent, as of December 2010, is slightly lower than the aggregate scheduled commercial banks' ratio 75 per cent ratio.

As the RBI wants the deposit growth to match the credit growth, this ratio may come down for the banking system as a whole. However, KVB can maintain the ratio at the current levels given the capital infusion.

While high exposure to the booming infrastructure sector is less of a concern, exposure to the textile sector, which is not yet out of woods, continues to be a worry, especially in the current rising rate scenario. High proportion of restructured assets is another risk. However, the bank has done well in provisioning adequately. The net non-performing asset of the bank, as of December 2010, was 0.19 per cent.

The bank has an ambitious growth targets for its loan and deposit books. Focus on retail deposits, especially the low-cost deposits will help the bank reduce the volatility in the margins. KVB given its high cost of funds and low savings account and current account proportion will benefit from the possible savings rate de-regulation.

Issue details

For every five shares held, shareholders are entitled to two through this rights issue. The issue closes on March 17, 2010.

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