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Sunday, Oct 27, 2002

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Allahabad Bank: Unattractive

Suresh Krishnamurthy

INVESTMENTS in Allahabad Bank's initial public offer can be avoided. The bank's capital adequacy is sensitive to fluctuating profit growth. One year of decline in profits can set back the bank significantly.

Allahabad Bank is raising Rs 100 crore from the market through this offer. The shares are priced at Rs 10. The bank recorded a total income of Rs 2,658 crore and profits of Rs 80 crore in the year ended March 2002. It declared a dividend of 65 paise per share in the year ended March 2002.

The sensitivity assumes significance because the growth in profits in year ended March 2002 came on the back of rise in `other income'. Beyond March 2003, the contribution of profits from investments may decline. Its impact on profit growth could be significant.

Swamped by NPAs

Similar to most Indian banks, Allahabad Bank has had to face the NPA scourge. Unlike the leading banks, Allahabad Bank has, however, been swamped by NPAs. Non-performing assets adjusted for provisions and write-offs worked out to 10.57 per cent of net advances. However, it has come down sharply from more than 15 per cent at end-March 1998 to the present levels. However, they are still quite high. Consider this. The net worth of the bank (adjusted for investment in loss-making subsidiary) was Rs 682 crore at end-March 2002. Net NPAs though were higher than this amount at Rs 1,160 crore.

In other words, net NPAs are about 1.7 times the net worth of the bank. Yes, the capital infusion of Rs 100 crore from the initial public offer will help. However, net worth will still be lower than the net NPAs. As such, if times get tough, profits will decline because provisions will eat into it.

The sensitivity can be reduced only through large provisions in the next couple of years. Allahabad Bank has been making large provisions — between 42 and 63 per cent of profits before provision — for bad and doubtful debts. This needs to be continued and that will need the banks' profits to grow.

But, if treasury profits decline then profits will come under pressure. This is because Allahabad Bank's operating expenses has been rising. Operating expenses, as a proportion of total income less profit on sale of investments, has risen to 90 per cent at end-March 2002 from 86 per cent at the end of March 1998. In fact, profits may decline from present levels.

This was what was happening between March 1998 and March 2001. In year ended March 2002, the decline in interest rates and the consequent increase in profit on sale of investments boosted profits. In the absence of such a boost, profits may be under pressure.

These factors suggest that the threat to sustainability of large provisions without affecting profits is real. If provisions eat into profits, it can ensure that no or lower dividends are paid on the stock.

Relatively unattractive

The sensitivity to profit decline and the possibility that it will remain so in the next few years makes Allahabad Bank's IPO unattractive.

There are other banks, which are financially healthier. Such banks may offer better scope for share price appreciation.

The stock's valuation is also relatively unattractive. The bank has priced the offer at Rs 10 when its book value is around Rs 29.

However, when adjusted for net non-performing assets, the book value turns negative. In the case of Union Bank of India, the book value adjusted for non-performing assets was around Rs 8 and the offer was priced at Rs 16.

In the case of Punjab National Bank, the valuations were even better — book value adjusted for non-performing assets was almost equal to the offer price.

Share prices of banking stocks have traditionally exhibited lower volatility compared to the indices. However, relatively smaller and less financially healthy banks such as Allahabad Bank may exhibit higher volatility compared to its well-established peers.

The dividend yield of 6.5 per cent (rate of dividend declared for March 2002 divided by offer price) is also lower than that on quite a few public sector bank stocks.

In addition, the dividends are as sensitive to profit decline as Allahabad Bank's capital adequacy.

This suggests reduced ability to maintain dividends during tough times. Given this backdrop, investors can avoid the offer.

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