Challenges in the banking sector such as slowing credit demand, rising bad loans and pressure on margins have only become more pronounced in recent weeks.

The Reserve Bank of India’s liquidity tightening measures and increase in short-term borrowing costs have resulted in banking stocks slipping sharply. In this scenario, banks with a healthy low-cost deposit ratio and sufficient capital cushion to weather asset quality deterioration are good bets.

ING Vysya Bank is one such bank with healthy low-cost deposit ratio, strong fee income growth and stable asset quality. Moreover, in a worsening macro environment where the risk of delinquencies remains high, ING Vysya has less exposure to stressed sectors such as power, infrastructure and textiles.

The bank also maintains sufficient capital cushion and a high provision coverage ratio to withstand higher risk of defaults in the near term. The bank has been consistently improving its profitability over the past four years, with the return on assets improving from 0.7 per cent in 2008-09 to 1.3 per cent in the recent June quarter.

Healthy net interest margin (NIM), sound asset quality and improving productivity of branches should continue to drive profitability of the bank.

The stock has corrected 21 per cent in the last two months, and now trades at 1.2 times its one-year forward book value.

This is an almost 18 per cent discount to its historical average. The recent fall offers investors an opportunity to buy the stock with a two-to-three year time horizon.

High-yield focus

ING Vysya has been building its high-yielding small and medium enterprises (SME) loan portfolio. This segment has grown 33 per cent annually over the last four years.

From a share of 22 per cent in 2008-09, the SME loans now contribute 33 per cent of the entire loan book. While SME as a segment entails risk in the current environment, the bank has been able to maintain its quality of loan portfolio within this segment.

Close to 75-80 per cent of its SME loan book is for working-capital financing, with almost three-fourths being lent to non-manufacturers.

Since the loan book is largely consumption-driven, it has been able to buck the slowdown and has grown 23 per cent in the June quarter. Also, the entire portfolio is backed by collateral.

Shifting focus to this segment has led to significant improvement in the bank’s NIMs. From 2.8 per cent in 2008-09, the NIMs have increased to 3.5 per cent, which has been the key driver for improvement in the bank’s overall profitability.

The total loan book for the bank has grown 18 per cent annually over the last four years, with net interest income growing at a faster pace of 24 per cent during the same period. The return on equity increased from 11.6 per cent in 2008-09 to 14.8 per cent in the June quarter.

On the other hand, the bank has also been able to increase its share of low-cost deposits over the years. The current account savings account (CASA) ratio improved from 27 per cent in 2008-09 to 33 per cent in 2012-13. Also, within this, more than half is from current account deposits.

This account carries zero interest, translating into lower cost of funds. The current account relationships have also allowed the bank garner higher fee income by cross selling services.

This is reflected in the banks’ strong fee income growth of 29 per cent in the June quarter (excluding one-time income).

Capital cushion

The bank has its entire SME portfolio backed by security against assets. This along with minimal exposure to stressed sectors such as power, infrastructure and textiles (3-5 per cent of corporate loans) has helped the bank stay ahead of most of its mid-sized peers in terms of asset quality. ING Vysya’s net NPA stood at 0.19 per cent in the June quarter. The restructured assets are also low at 1 per cent of loans.

The bank’s high provision coverage (provision for bad loans/gross NPA) of 89 per cent, as of June quarter, offers comfort in difficult market conditions. Also, the bank has a healthy capital adequacy of 12.6 per cent.

This does not take into account the capital of Rs 1,836 crores raised by the bank in July. This will provide additional capital for growth and improve ability to bear asset quality risk.

The capital raising will also aid margins, mitigating any increase in cost of funds for the bank in the near term.

ING Vysya has a larger portion of its deposits in the less than one year bucket, and following RBI’s recent measures to increase cost of short-term borrowings, there may be some pressure on the bank’s cost of funds.

However, the additional capital infusion, along with other levers such as low-cost deposits will offset some of the pressure.

Also, improving productivity of branches that have seen a significant decline in cost-to-income ratio in recent years should continue to drive profitability for the bank.

The cost-to-income ratio declined from 64.5 per cent in 2008-09 to 56 per cent in 2012-13. Improving branch productivity has seen assets per branch increase from Rs 66 crore to Rs 101 crore during the same period.

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