Within the banking space, old private sector banks appear to be an attractive investment option today. Public sector banks are beset by bad loan problems. New private banks trade at rich valuations. But the South Indian Bank stock is a good ‘buy’ for investors who can wait for two-three years.

A low valuation compared to peers, a low proportion of bad loans at a time when asset quality problems are rampant and proposed capital raising which should power growth, make this a good business to own. Here are five reasons to buy the stock.

Low valuations

 South Indian Bank trades at 0.83 times its estimated FY14 book value and just four times its estimated earnings for the same year. In contrast, the stocks of Karur Vysya Bank, Federal Bank and City Union Bank trade at about 34 per cent premium to this bank.

The discount is not justified given that South Indian Bank has sharply improved its return on assets. It was 1.18 per cent (annualised) in the latest June quarter compared with 0.9 per cent two years ago. The improving trend in margins may sustain.

The bank’s loan book is high yielding, given the rising focus on gold loans. Less reliance on bulk deposits curbs costs. And an expanded branch network which is yet to pay off fully is expected to not only aid business growth but also lift fee income.

Business growth

South Indian Bank’s loan book has grown at a 27 per cent annual rate between June 2008 and June 2012. This has helped it peg up its market share in bank lending from 0.44 per cent in June 2008 to 0.57 per cent.

The bank’s aggressive branch expansion will help it ramp up business outside the home State of Kerala.

The expansion may particularly benefit the gold loan portfolio, which yields high margins. The gold loan business holds promise for banks with the RBI curbing lending to NBFCs in this business.

Improving margins

 The loan growth has been accompanied by better margins too, with net interest margins improving from 2.8 per cent to 3.15 per cent over the past year.  Higher yields from loans and a lower proportion of bad loans have both aided margins. The bank’s conscious effort to reduce reliance on high-cost bulk deposits has also helped. Low-cost deposits and savings account deposits from non-resident Indians account for as much as 27 per cent of their overall deposit base, suggesting that the bank has access to low-cost funds. Bulk deposits from companies are one-fourth of this base.

 The improving trend in margins looks likely to continue. The RBI’s recent cut in SLR ratio will free up funds for lending too.

The bank’s credit-deposit ratio at 73.6 per cent is lower than the industry’s, allowing scope for more lending.

Given that yields on advances tend to be 5 percentage points more than that on government bonds, this will immediately benefit profits.

Low on bad loans

 The net NPA ratio of South Indian Bank is 0.35 per cent compared with 1.46 per cent for the banking sector as a whole and 0.5 per cent for the private banks. A majority of the bank’s loans (89 per cent) are secured. This reduces the risk of losses due to write-offs.

The restructured loan proportion of South Indian Bank, though, at 4.3 per cent of the loan book is slightly on the high side.

However, the stock price seems to have factored an adverse scenario of restructured loans completely being written off.

Comfortable on capital

 South Indian Bank proposes to raise Rs 500 crore through a Qualified Institutional Placement offer this year.

This may bring in multiple benefits for the bank. One, it will bolster the capital in line with Basel III norms.

The regulatory requirement is 9.5 per cent and the bank’s present tier-1 capital ratio is at 10.9 per cent. This will go up to 14.5 per cent after fund-raising.

This added to the bank’s accrued profits may power strong loan growth over the next five years.

This is important at a time when most banks face a constraint on capital. The fund-raising will not dilute earnings much, though it will expand the equity base by 20 per cent.


The bank’s focus on high-yielding loans and lesser dependence on bulk deposits should help maintain profitability. It is also comfortable on capital.

Why Buy Attractive valuations Improving return ratios High proportion of secured loans Superior asset quality

(This article was published in the Business Line print edition dated September 2, 2012)
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