Investors with stomach for risk can consider fresh exposure to the stock of South Indian Bank (SIB). This old private sector bank has over the last few years managed to improve its return ratios and asset quality.

The return on equity improved from 14 per cent in FY07 to 17.6 per cent for the half year ended September 2011. Gross NPA ratio is down from 3.94 per cent in FY07 to 0.99 per cent in September 2011. There is further scope for improvement in its other operating metrics once the full benefits of the management's initiatives are realised over the long-term. This may warrant a valuation premium to SIB over its old private sector bank peers.

At the current price of Rs 24, the SIB stock trades at 1.1 times its estimated FY13-end adjusted book value and 6.7 times its estimated FY13 earnings. Despite out-performing most banks on a year-to-date basis, SIB's valuations continue to be attractive. Its valuations are inline with other old private banks despite its metrics being better than those of its peers.

The second largest branch network among old private banks (which is largely under-utilised), rising proportion of high-yielding gold and SME portfolios supporting margins, superior asset quality, thanks to majority of the asset book being secured, are key positives for the bank. The bank's net interest margin (NIM) improved from 2 per cent in FY08 to 3 per cent in September 2011. While Kerala accounts for 56 per cent of the bank's branches, it is slowly diversifying into other areas with more than 50 per cent of incremental branches being set up outside the state.

Business

SIB has a well-diversified loan book. However, gold loan portfolio has taken the centre stage in recent times with the management planning to increase its focus on high-yielding loans (including SMEs).

Gold loans currently account for 26 per cent of the loan book. The rates on SIB's gold loans are lower, which may prompt borrowers to shift from gold-financing companies. The portfolio is also relatively protected with loan to value in the 73-76 per cent range.

The bank's overall business, thanks to a low base, has grown at 27 per cent compounded annually during FY07-FY11. Net profit during the same period grew at 30 per cent. The September-end business (deposits plus advances) of the bank stood at Rs 56,386 crore. Given its high historical rate of growth, even after considering some moderation in loan book growth, SIB may still achieve its internal target of Rs 75,000 crore of business by FY13 end.

To fund its future business growth, SIB plans to raise Rs 1000 crore of capital once the market scenario improves. Raising close to 50 per cent of the existing net worth is indicative of bank's aggressive business plans. SIB plans to increase its branch network from the present 644 branches to 750 branches by FY13.

Scope for improvement

Old private banks, in general, and SIB, in particular, suffer from low business per branch. For the year ended March 2011, the business per branch was low at Rs 77 crore as against the all-bank average of Rs 129 crore.

The profit per employee of the bank is also low at Rs 5 lakh per employee as against the all-India average of Rs 7 lakh due to low fee income contribution. SIB plans to use its branch network for distribution of third-party products, which will enhance its fee income.

Low business per branch, while improving, is partly due to relatively low credit-deposit ratio of 70 per cent. SIB has always been conservative in terms of credit-deposit ratio despite having high levels of capital.

This move has also limited margin expansion in spite of the bank moving to high-yielding businesses. As credit-deposit ratio improves, in addition to balance-sheet growth, the business per branch would improve automatically.

Improvement in credit-deposit ratio would also neutralise strain from rising costs due to savings rate de-regulation, thereby allowing the bank to maintain margins at 3 per cent. The net interest margin for the second quarter of FY12 was 3 per cent, an improvement of 10 basis points from the June quarter.

Even as SIB's low-cost deposits (including NRI deposits) account for close to 30 per cent of its total deposits, the bank has one of the highest cost of funds (7.66 per cent) in the system. Given that the states of Kerala and Tamil Nadu are crowded in terms of banks, high interest rates need to be offered to attract depositors. As the bank moves into more under-penetrated areas, it would have the flexibility to price its products more economically.

Good asset quality

The bank is positioned among the best in the system in terms of asset quality, with net NPA ratio of 0.25 per cent as of September 2011.

With close to 85 per cent of its portfolio being secured, asset quality pressures may be limited for the bank. The restructured asset proportion is also low at less than 2 per cent of the loan book.

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