As a small-cap finance stock with a market capitalisation of IN₨40.45B, the risk and profitability of Andhra Bank (NSEI:ANDHRABANK) are largely tied to the underlying economic growth of the region it operates in IN. 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 it profits from. 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. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Andhra Bank to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. Low levels of leverage coupled with sufficient liquidity may place Andhra Bank in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today. See our latest analysis for Andhra Bank
Why Does ANDHRABANK’s Leverage Matter?Banks with low leverage are better positioned to weather adverse headwinds as they have less debt to pay off. A bank’s leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. While financial companies will always have some leverage for a sufficient capital buffer, Andhra Bank’s leverage ratio of less than the suitable maximum level of 20x, at 20x, 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.
How Should We Measure ANDHRABANK’s Liquidity?As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up the bank’s total asset. Generally, they should make up less than 70% of total assets, which is consistent with Andhra Bank’s state given its ratio of 60.71%. 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.
What is ANDHRABANK’s Liquidity Discrepancy?ANDHRABANK profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans tend to be fixed term which means they cannot be readily realized, however, customer deposits are liabilities which must be repaid on-demand and in short notice. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Compared to the appropriate industry loan to deposit level of 90%, Andhra Bank’s ratio of over 70.02% is sensibly lower and within the safe margin, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.
Andhra Bank ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. Its high liquidity and low leverage levels mean the bank is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for ANDHRABANK in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should further examine:
- 1. 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.
- 2. Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Andhra Bank’s board and the CEO’s back ground.
- 3. 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.