The risk in investing in a small-cap business, accentuated by financial industry regulations, makes small-cap financial stocks like Andhra Bank (NSE:ANDHRABANK) a complicated investment. ANDHRABANK operates in the financial services industry in IN with a market capitalisation of ₹39.20b. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting these banks level of cash flows. Post-GFC recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like Andhra Bank 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. Check out our latest analysis for Andhra Bank
Is ANDHRABANK’s Leverage Level Appropriate?Banks with high leverage are exposed to higher risks around its ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. While financial institutions are required to have a certain level of buffer to meet capital adequacy levels, Andhra Bank leverage level of 22.5x is significantly below the appropriate ceiling of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. If the bank needs to increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position. The bank has very little headroom to increase its debt level as it may ratchet up interest cost and further deteriorate its financial position.
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. Generally, they should make up less than 70% of total assets, which is consistent with Andhra Bank’s state given its ratio of 60.58%. 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. Relative to the prudent industry loan to deposit level of 90%, Andhra Bank’s ratio of over 71.64%is appropriately lower, which 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.
Even though the bank has upheld a high level of liquidity, its elevated level of debt compared to its equity may impact its ability to pay back its large group of debtors in times of adverse conditions. Weak leverage risk management increases the risk of Andhra Bank as an investment for shareholders. Keep in mind that a stock investment requires research on more than just its operational side. There are three essential aspects 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.