City Union Bank: BUY. This CUB can roar

With the economy likely on the rebound path, a few sectors are well placed to play out the recovery theme. Banking, for one, is directly linked to the fortunes of the economy. In the last year, the divergence in the performance of private and public sector banks has widened substantially. Private banks, due to less trouble on the bad assets front, continue to command a steep premium over public sector banks. Even so, there are a few small regional private sector banking stocks such as City Union Bank (CUB) that still look attractive.

CUB with its strong regional presence in South India has been able to deliver healthy growth in loans and maintain stable asset quality. The bank’s return on assets of 1.5 per cent is higher than most of its smaller peers, and its capital ratios are sound (Tier I capital ratio at 15 per cent). It also has strong presence in the small and medium enterprises (SME) segment. Investors with a two- to three-year time frame can buy the CUB stock.

It trades at an attractive 1.6 times its one-year forward book value — which is in line with peers such as Federal Bank.

With an expected earnings growth of over 20 per cent over the next two years, CUB’s valuation offers good scope for upside in the stock.

City Union Bank’s well-entrenched presence in South India, especially Tamil Nadu, has helped it build a strong SME client base. The bank’s loan portfolio has grown at a healthy 20 per cent annually over the last three years till 2013-14. It added close to 200 new branches in the last three years; this will aid growth when the economy turns around. The bank’s total branch network of 445 as of December 2014 is expected to go up to 500 over the next few months.

CUB’s loan growth was subdued in the recent December quarter at 7 per cent. This was mainly due to a decline in gold loans and advances to large corporates. But the bank’s high-yielding micro, small and medium enterprises (MSME) portfolio, which accounts for about a third of its loans, continued to show healthy growth. This segment grew by 26 per cent year-on-year in the recent December quarter.

Within this segment, most of the bank’s exposure is secured and is lent towards working capital loans; this mitigates risk. The MSME segment, along with wholesale and retail traders, which are also high-yielding businesses, constitutes 50 per cent of the bank’s loan portfolio.

As the economy revives, the bank’s loan growth is expected to scale back up to 20 per cent levels over the next year or so.

The bank has also been able to sustain its net interest margin (NIM) in the range of 3.3-3.5 per cent. CUB has a relatively lower share of low-cost deposits (CASA ratio) of about 16 per cent, given its regional presence. However, its focus on high-yielding segments has helped it maintain a steady margin profile. While the bank may face some pressure on margins as rates head south in the next year or so, it is not likely to deviate much from the current levels.

Despite the stress in the banking system, CUB has been able to maintain a steady asset quality over the last year. The slippages of about ₹65 crore in the recent December quarter, were the lowest since the June 2013 quarter. The bank’s gross non-performing assets (GNPAs) stood at 2.1 per cent of loans in the December quarter, while the net NPAs stood at 1.3 per cent. At 1.5 per cent of loans, the restructured assets of the bank are also among the lowest compared with peers.

During the December quarter, the bank restructured loans worth ₹6.8 crore, the only restructuring in the current fiscal. CUB has extended ₹100-crore loan to SpiceJet against deposits and another ₹100 crore working capital loan against collateral. The management has stated that SpiceJet has cleared its arrears for the quarter.

CUB is well capitalised for growth over the next two years. As the economy revives, its competence in the SME segment, healthy returns and steady asset quality should translate into robust earnings growth.