As a small cap stock, with a market capitalisation of ₹51.7b, operating in the financial services industry in IN, ANDHRABANK is a complex investment. A bank’s cash flow is directly impacted by economic growth as it is the main driver of deposit levels and demand for loans which banks profits from. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. These reforms target banking regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. A bank’s financial position may rapidly deteriorate in an adverse macro event such as political instability which is why it is crucial to understand how well it manages its risks. Insufficient liquidity coupled with high levels of leverage may place Andhra Bankin a risky position in the face of adverse headwinds. Today we will be measuring Andhra Bank’s risk-taking behaviour by looking at three leverage and liquidity metrics.
Is ANDHRABANK’s Leverage Level Appropriate?High leverage may expose the bank to higher risks around its ability to repay its debtors. Its leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. While financial institutions are required to have a certain level of buffer to meet capital adequacy levels, Andhra Bank leverage level of less than the suitable maximum level of 20x, at 22.5x, is considered to be very cautious and prudent. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so. The bank may ratchet up interest costs and deteriorate its financial position even more if it decides to further increase its debt level.
What Is ANDHRABANK’s Level of Liquidity?Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, consistent with Andhra Bank’s case with a ratio of 61%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.
Does ANDHRABANK Have Liquidity Mismatch?ANDHRABANK profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans may be fixed term and often cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. The disparity between the immediacy of deposits compared to the illiquid nature of loans puts pressure on the bank’s financial position if an adverse event requires the bank to repay its depositors. Since Andhra Bank’s loan to deposit ratio of 72% is within the sensible margin, below than the appropriate maximum of 90%, this level places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.
While the bank has retained appropriate liquidity, its high debt level may impede its capacity to repay the large pool of debtors in times of adverse circumstances. Weak leverage risk management increases the risk of Andhra Bank as an investment for shareholders. Today, we’ve only explored one aspect of Andhra Bank. However, as a potential stock investment, there are many more fundamentals you need to consider. Below, I’ve compiled three pertinent factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for ANDHRABANK’s future growth? Take a look at our free research report of analyst consensus for ANDHRABANK’s outlook.
- Historical Performance: What has ANDHRABANK’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
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