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Andhra Bank public issue: Our view - Views on News from Equitymaster
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Andhra Bank public issue: Our view
Jan 16, 2006

Andhra Bank’s second public issue (100% book building) for 85 m equity shares will be open for bidding between the 16th and 20th of January 2006. The bank has reserved 8.5 m shares for eligible employees and minimum 26.8 m shares for retail investors. Going by the price band of Rs 82 to Rs 90 per share, the bank is expected to mop up Rs 7.6 bn (at the higher end of the band) through the offer. The issue is slated to bring down government's holding in the bank from 62.5% to 51%.

‘Andhra’ centric bank
Andhra Bank was founded in 1923 and following nationalisation in April 1980, became a wholly owned government bank. In 1964, the bank merged with Bharat Lakshmi Bank to further consolidate its position in Andhra Pradesh. The bank made its initial public offer (IPO) in February 2001 wherein the government shareholding in the bank reduced to 62.5%, which will further reduce to 51.5% at the end of this follow on public issue. At the end of September 2005, the bank had 1,177 branches, of which 854 (73% of the branches) were located in the state of Andhra Pradesh. Through the said franchise, Andhra Bank serves 13.9 m customers. The bank has also registered a CAGR of 11% in deposits and 24% in advances during the past four years. The bank has to its credit the repute of being one of the first ones to introduce credit cards in India and amongst the first PSU banks to undertake mortgage backed securitisation of housing loans.

Objects of the issue
  • To increase the Tier I capital adequacy ratio (at present 8.3%) and overall CAR (at present 11.9%) for meeting the Basel norms going forward. Also, the bank needs to hike its capital base to meet the growth in the corporate and retail credit segment.

  • The bank also needs capital to make its branches technologically well equipped.

Reasons to apply
Steady asset growth: Andhra Bank has witnessed a steady growth in its advance book over the past couple of years (4 year CAGR of 24%). A majority of its exposure is in the corporate segment (44%) and going forward, demand growth in this segment will augur well for the bank’s credit portfolio. Also, it may be noted that despite the growth in its credit portfolio, the bank continues to retain the same proportion of corporate exposure. This has helped it enjoy one of the highest net interest margins amongst PSU banks (4 year average NIM is 3.7%).

Improving efficiency: The bank has witnessed a steady growth in terms of its efficiency parameters and is in line with the industry benchmarks. This is very unlike most PSU banks and is therefore a positive for Andhra Bank. The bank has established specialized branches for corporate customers to improve productivity further.

Low cost funding: Over the years, Andhra Bank has consistently replaced its borrowings with low cost deposits, which comprised 37% of the bank’s incremental funding during 1HFY06. Interest free demand deposits and low interest savings deposits respectively constituted 8.7% and 28.8% of the total deposit base at the end of 1HFY06. This has enabled the bank to reduce its cost of deposits from 7.1% in FY03 to 4.7% in 1HFY06.

Prudent on quality: Andhra Bank enjoys one of the best asset qualities amongst PSU banks. At the end of 1HFY06, the bank had gross NPA of 2.2% and net NPAs of 0.3%. Also, at the end of 1HFY06, the percentage of its priority sector gross NPAs to total priority sector advances was 2.9%, the percentage of agricultural gross NPAs to total agricultural advances was 1.2% and the ratio of SSI NPAs to advances was 5.7%, which is appreciable and in line with the best in the industry. The fact that the bank has a coverage ratio of 80% (1HFY06) is also a matter of comfort.

Lower treasury risk: Closely in tune with the government mandate of 25% (of net demand and time liabilities - NDTL) SLR investment, Andhra Bank has SLR investments at 28% of NDTL. This exposes the bank to lower interest rate risk in a rising interest rate regime. Given that the bank derived 35% of its income from treasury operations in 1HFY06, the fact that 65% of the investments are in HTM category is a matter of comfort.

Attractive returns: Andhra Bank enjoys the repute of having one of the highest return ratios (return on net worth or RONW) amongst Asian banks. The bank has consistently maintained above 30% RONW over the past 3 years and the same was at 31% in FY05. Besides strong asset growth and relatively high net interest margins (NIMs), the same can be attributed to the fact that the bank has made consistent efforts to economise its cost to income ratio (42% in FY05).

Reasons not to apply
‘Andhra’ concentration: The Bank has a regional concentration in the state of Andhra Pradesh. At the end of 1HFY06, 854 branches, or approximately 73% of the total branches of the bank were located in the state of Andhra Pradesh and approximately 58% of the its loans and advances were from branches located in the state of Andhra Pradesh. The concentration of assets in this state exposes the bank more acutely to any adverse economic, political or environmental circumstances in this region of the country. The bank’s performance thus remains vulnerable to a sustained downturn in the economy of the state of Andhra Pradesh.

Lower fee based income: The bank’s ‘other income’ is heavily relied on treasury income as against fee-based income. Fee based income formed barely 13% of the total other income at the end of FY05. In 1HFY06 however, the bank’s initiatives with respect to entering into contracts with companies for cash management services and vending third party products, has helped improve the fee income contribution to 40% of total other income.

Margin pressures: Despite a reasonable growth in loan book and access to low cost deposits, the bank has witnessed a downslide in its net interest margins (NIMs) over the last couple of quarters. Given the pricing pressures on the asset side, we do not expect the bank to sustain its margins in the medium term. Also, as we go forward, with the interest rates keeping an upward bias, we expect some pressure at the NIM levels for the banking sector as a whole.

(Rs m) FY03 FY04 FY05 1HFY06
Interest earned 21,950 22,272 22,735 12,525
Interest expended 14,421 13,167 12,044 6,896
Net Interest Income 7,529 9,105 10,691 5,629
Other income 6,036 6,780 7,534 1,951
Total income 13,565 15,885 18,225 7,580
Other Expenses 6,098 6,942 7,674 4,121
Operating profit 1,431 2,163 3,017 1,508
OPM (%) 6.5% 9.7% 13.3% 12.0%
Provisions 1,827 2,426 2,501 596
Profit before tax 5,640 6,517 8,050 2,863
Tax 1,692 2,241 2,228 830
Net profit 3,948 4,276 5,822 2,033
NPM (%) 18.0% 19.2% 25.6% 16.2%
No. of shares (m) 400.0 400.0 400.0 400.0
EPS (Rs) 9.9 10.7 14.6 10.2
1HFY06 EPS is annualised

Our view
At the current market price of Rs 97, the stock is trading at 1.9 times its adjusted 1HFY06 book value. Post the issue, the bank is expected to trade at 1.6 times its FY06 post issue adjusted book value (assuming the shares get subscribed at the higher end of the band).

Comparitive valuations
NPA (%)
Andhra Bank 30.0% 3.6% 16.2% 11.9% 0.3% 1.9
OBC 8.2% 3.0% 11.6% 12.0% 0.8% 1.3
SBI 18.4% 3.2% 14.6% 12.4% 2.3% 2.2
ICICI Bank 12.9% 2.4% 17.9% 12.0% 1.0% 2.4
HDFC Bank 14.7% 3.9% 21.0% 12.2% 0.3% 4.7
* P/ABV has been calculated by considering prices as on 12th January 2006

Although Andhra Bank traditionally holds a repute of being a fundamentally strong bank, its margin sustainability and regional concentration remain a concern for the longer term. The bank has no concrete plans in place for regional / portfolio diversification and the same may position it very unfavorably in the wake of increasing competition in the sector. However, it is undeniable that with the increment in the CAR, the bank certainly holds potential for future growth. As most of the potential upside seems to already factor in the key positives, apart from listing gains, we do not see a substantial upside to the stock in the medium term. We will, therefore, advise investors to look for better valuations for their investment in the banking sector itself.

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