As a small cap stock, with a market capitalisation of ₹43.58B, operating in the financial services industry in IN, ANDHRABANK is a complex investment. Since banks make money by reinvesting its customers’ deposits in the form of loans, poor economic growth will reduce the level of savings deposits and demand for loans, directly impacting the cash flows of these banks. 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 regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. Unpredictable macro events such as political instability can rapidly deteriorate the health of a bank which is why it is important to understand how prudent it is at managing its risk levels. High levels of liquidity coupled with insufficient liquidity may place Andhra Bank in a risky 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. Check out our latest analysis for Andhra Bank
Is ANDHRABANK’s Leverage Level Appropriate?A high level of leverage may subject the bank to higher risk and lowers its ability to pay back its debtors. Leverage can be thought of as the amount of assets the bank owns relative to its shareholders’ funds. 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 23x, is considered to be very cautious and prudent. With assets 23 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. 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. If the bank increases its debt level, it can ratchet up interest cost and further deteriorate its financial position.
What Is ANDHRABANK’s Level of Liquidity?As abovementioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Usually, they should not be higher than 70% of total assets, which is the case for Andhra Bank’s ratio at 60.58%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.
What is ANDHRABANK’s Liquidity Discrepancy?Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans tend to be fixed term which means they cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. 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. Relative to the prudent industry loan to deposit level of 90%, Andhra Bank’s ratio of over 71.64%is appropriately lower, 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.
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. Below, I’ve compiled three pertinent aspects you should look at:
- 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.
- 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.
- 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.