The Hindu Business Line : South Indian Bank: Invest at cut-off

INVESTMENTS in the seasoned offer of South Indian Bank can be considered. The stock is being offered to the public, and also trades in the secondary market, at a considerable discount to its book value.

Among the about 50 reasonably sized banking and non-banking companies that are listed on the stock market, only a handful trade below their book value.

This discount, coupled with the improvement in the financial health of South Indian Bank, offers investors an opportunity to generate returns that are commensurate with the risks involved.

Overwhelming challenges

Raising capital to ease growth constraints.

Through the 1990s, the banking system was subject to formidable challenges. Rising default on loan repayment spelt crisis for the banks. Since 2001, however, windfall gains on the government securities portfolio bailed out Indian banks.

With advances growth also rising sharply during this period, banks were able to tackle the bad loan menace successfully. The financial health of banks has now improved considerably. South Indian Bank was among the few to not make use of this period to bring the bad loan problem under control.

As at September 2005, bad loans accounted for more than 6 per cent of the advances of South Indian Bank — this ratio being among the highest in the banking industry. In addition, since end-March 2004, there has been an increase in bad loans. Even after setting aside profits to account for the rise in bad loans, the net non-performing assets are still above 3 per cent of advances.

The bank has also found it difficult to generate reasonable returns on its deployments. The net interest margin has been below 3 per cent for most of the past five years.

With interest rates also rising since May 2004, profitability has come under stress in the backdrop of poor margins and the pressure on the bad loans front. South Indian Bank has been overwhelmed by these challenges. For the first time in many years, it did not declare dividends for the year-ended March 2005.

Signs of change

There are, however, signs that South Indian Bank is coming to terms with these challenges.

The net interest margin in the first nine months of FY-06 has risen despite muted business growth. The advances growth was constrained because of low capital adequacy.

With the proceeds from this offer, capital constraints to growth can be removed. South Indian Bank, incidentally, has not had too much problems in boosting business growth.

Problems have come in the form of poor margins and a higher default rate. In this backdrop, improved margins, coupled with brisk business growth, can boost profitability significantly.

In addition, nearly 80 per cent of government securities is now in the held-to-maturity category. This reduces the risk posed by rising interest rates to profitability and capital adequacy.

Rising interest rates reduce the value of government securities requiring charges against profits. Such charges need not be made if the Gilts are classified as held-to-maturity.

Attractively valued

Post-offer, South Indian Bank's net worth would be about Rs 650 crore. The price-to-book ratio works out to less than one, making the valuation attractive. The bank also holds a 10 per cent stake in Bharat Overseas Bank.

The current market value of this private sector bank could add another 5 per cent to the intrinsic value of the stock.

In addition, with low return on assets of about 0.9 per cent and a return on net worth of 12 per cent, South Indian Bank would be able to report an earnings per share of Rs 10 even on the expanded capital.

That would place price-to-earnings multiple at less than seven, on an offer price of Rs 66 — the higher end of the price band.

Even less-efficient banks aspire for return on assets in the region of 1.1-1.3 per cent. If South Indian Bank manages to extract more from its assets, the upside potential would be relatively high.

Offer details: About 2.5 crore shares are on offer in this issue, which opened on February 10.

The offer, lead-managed by ICICI Securities, closes on February 15. The price band for the offer is Rs 60-66.

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