Buy SOUTH INDIAN BANK- Steady performance:: Edelweiss

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SOUTH INDIAN BANK
Steady performance


􀂄 Steady core operating performance
South Indian Bank’s (SIB) core operating performance was strong in Q3FY11.
Net interest income (NII) grew 19% Y-o-Y and 4% Q-o-Q to INR 2.04 bn (in
line); this was led by 8% Q-o-Q advances growth and less-than-expected NIM
(cal) contraction (7bps) as the bank managed to maintain lending spreads
despite rising cost of deposits. CD ratio remained stable at 71%. Core fees
income, at INR 400 mn (up 20% Y-o-Y, 4% Q-o-Q), came in line with our
estimate. PAT stood at INR 753 mn (21% Y-o-Y), in line with our estimate.
SIB reported estimate of liability towards wage settlement in respect of pension
and gratuity and second pension option of INR 1.47 bn (at FY11 end). The bank
has been providing for the liability throughout the financial year at the rate of
INR 122 mn/quarter (including the current quarter). Staff expenses declined
sequentially (11% Q-o-Q) as the bank had made higher provisions in the
previous quarter towards pension/gratuity to make up for the deficit during
Q1FY11, which was normalised during the current quarter. Slippage during
Q3FY11 came in high at INR 486 mn (1.2% annualized), higher than the 0.5%
average over the past two quarters, but below the industry average.

􀂄 Above average business growth
SIB’s business growth continued its strong traction, with advances growth at
~32% Y-o-Y and 8% Q-o-Q to INR 191 bn. Gold loans grew 15% Q-o-Q (61% Yo-
Y) to INR 38 bn (equivalent to 20% of loan book), followed by agricultural
advances growing at 39% Y-o-Y. SSI grew below the overall loan book growth at
3.1% Q-o-Q while corporate book remained flat. Deposits grew 30.8% Y-o-Y and
7.7% Q-o-Q to INR 270 bn. However, SIB’s CASA ratio declined 416bps Q-o-Q to
22.4%. Further, the bank saw increase in contribution of bulk deposits, which
catapulted 280bps Q-o-Q to 22.5%. However, contribution of NRE deposits
remained stable (14.4%) sequentially.
􀂄 Outlook and valuations: Constant performer; maintain ‘BUY’
The bank reported strong core operating performance in Q3FY11. Business
growth remained healthy and above industry, while margin contraction was
below expectation. Provision coverage was stable. The stock is currently trading
at 1.3x FY12E book, reasonably attractive for a bank, delivering RoE of 19%. We
maintain ‘BUY’ recommendation on the stock and rate it ‘Sector Performer’ on
relative return basis.


􀂄 Asset quality deteriorated marginally
Slippage during the quarter came in high at INR 486 mn (1.2% annualized), higher than
0.5% average over the past two quarters, but below the industry average. Of this, ~INR
160 mn came in from single retail account. LLP (annualized) after declining to 0.15% in
Q2FY11 increased to 0.53% in Q3FY11. Gross NPAs jumped 11% Q-o-Q to INR 2.53 bn
(1.33%), while net NPAs increased 10.8% Q-o-Q to INR 743 mn (0.39%). Provision
coverage remained stable at 71%.
􀂄 Other highlights
• Treasury income stood at INR 97 mn.
• Cost-income ratio stood at 44%.
• AFS book formed 14% of investment book (duration 0.44 years).


􀂃 Company Description
SIB, a private sector bank, was incorporated at Thrissur in Kerala, south India. The bank
has a pan- India presence with a network of over 550 branches and over 300 ATMs
across 23 states, and 2 Union Territories. ~56% of the branches are in Kerala.
SIB came out with an IPO in 1998, followed it up with a rights issue of 1:3 at a premium
of INR 30 in 2004, and came out with a follow on public issue at INR 66 in 2006. SIB
raised equity capital of INR 3.26bn (20m shares at Rs163/share) through a Qualified
Institutional Placement in September 2007.
The new management’s efforts at improving the bank’s operating performance are
visible with improvement in return on assets (RoA) to 1% in FY09 from 0.1% in FY05.
Over the past four years, the bank has achieved considerable progress in terms of
bringing profitability focus among branches, re-energizing employees, improving asset
quality, and creating greater brand awareness and technology coverage. The employee
compensation has been linked to performance and union clout has diminished. The rebranding
exercise of bank has created greater brand re-call and awareness among
customers. The bank has implemented core banking solution (CBS) platform covering
the entire business. We believe the present management is innovative and dynamic, and
so far superior to other regional banks’ management.
􀂃 Investment Theme
South Indian Bank is one of the best regional-based private banks in the country. We
like the bank for its strong regional presence, good technology network, and possible
M&A play. SIB generates decent margins on the back of its structurally strong deposit
franchise. Around 30% of its deposits comprise low-cost current account and savings
account (CASA) deposits, and non-residential external (NRE) deposits. Of this, 24% is
CASA deposits and 6% NRE deposits, (where the bank pays lower interest), which
collectively enable the bank to contain its deposit costs. It offers an attractive play on
robust loan growth, improving asset quality, and consolidation in the Indian banking
space.
􀂃 Key Risks
• System wide economic slowdown will lead to a sharp deterioration in asset quality
and lower than anticipated recoveries.
• Slowdown in business growth is a key systematic risk for the bank as 80% of total
revenues are derived from net interest income. Being a mid-sized bank, it does not
have huge diversification option.
• Disruption by employee union and the management’s inability to sustain pace of
reforms could cause concern.
• Redemption in NRE deposit base will lead to rise in cost of funds thereby impacting
margin.