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FEDERAL BANK 2QFY11: In-line; NIM improves further; Higher slippages remains a concern; Buy
Federal Bank (FB IN, Mkt Cap US$1.8b, CMP Rs471, Buy) PAT grew 39% YoY to Rs1.4b (in-line) on back of 33% YoY growth in NII (in-line), supported by higher margins (up 74bp YoY) despite muted loan growth.
Key highlights
- In 2QFY11, loans grew 7% YoY and 2% QoQ to Rs276b whereas deposits grew 8% YoY and 3% QoQ to Rs361b. CD ratio declined to 77% v/s 78% in 1QFY11.
- CASA deposits grew 23% YoY and 5% QoQ, higher than overall deposit growth, leading to improvement in CASA ratio to 29.4% (from 25.8% in 2QFY10 and 29% in 1QFY11).
- NII grew 33% YoY and 6% QoQ led by expansion in margin to 4.4% in 2QFY11 (up 27bp QoQ and 74bp YoY). Improvement in yield on loans was the key margin driver. Re-pricing benefits kept cost of deposits under control with sequential increase of just 6bp whereas YoL increased 40bp QoQ.
- Fee income growth of 10% QoQ is encouraging.
- GNPAs in absolute terms increased 5% QoQ to Rs12b; however, NNPA declined 7% QoQ to Rs1.9b as bank made higher NPA provisions leading to improved PCR to 83% vs 81% a quarter ago. While low rise in GNPA is positive, continued higher slippages of Rs2.6b in 2QFY11 (although moderated from Rs3.3b in 1QFY11), and annualized slippage ratio of 3.8% for 2QFY11 and 4.3% for 1HFY11 remain concerns.
Business growth remains muted
- Loans grew 7% YoY and 2% QoQ to Rs276b led by strong pick-up in SME loans (up 8% QoQ). Under the leadership of Mr Srinivasan, the key focus of the bank will be to improve back-end processes to improve asset quality. In the near term, management expects to grow in line with or marginally lower than industry with primary divers for loan growth being retail and SME. We have reduced our loan growth assumptions to 16% in FY11 vs 21% earlier and to 18% vs 21% earlier for FY12.
- Deposits grew 8% YoY and 3% QoQ to Rs361b in 2QFY11. CASA deposits grew 23% YoY and 5% QoQ, higher than overall deposit growth, leading to improvement in CASA ratio to 29.4% from 25.8% in 2QFY10 and 29% in 1QFY11.
Margin expansion continues
- NII grew 33% YoY and 6% QoQ led by strong expansion in margin. NIM expanded further to 4.4% in 2QFY11 (up 27bp QoQ and 74bp YoY) led by increase in yield on loans. Yield on loans improved by 40bp QoQ to 11.2% as against marginal rise (6bp QoQ) in cost of deposits (re-pricing benefits) driving the margins.
Fee income growth remains muted
- While fee income growth remained muted YoY at 6%, QoQ growth of 10% is encouraging. Trading income declined to Rs141m v/s Rs166m in 1QFY11 and Rs299m in 2QFY10; however, recoveries from written-off accounts were strong at Rs468m vs Rs180m in 1QFY11 and Rs280m in 2QFY10.
- On the back of higher core operating income and operating efficiency, core cost to income ratio improved to 34% v/s 36% in 1QFY11 and 35% in 2QFY10.
- Bank is planning to scale up its branch network to 1,000 branches in next 2 years from 719 branches as on 2QFY11, which may result in some cost pressure.
Valuation and view
- Under the leadership of Mr Srinivasan, bank will continue to focus on Retail and SME as the prime growth drivers. However, in the medium term, balance sheet growth will remain moderate till back-end processes improve. With large balance sheet, capabilities and distribution strength already in place, key focus will be on improving risk management systems and processes (to tackle NPA issues and have quality growth ahead).
- Once branch expansion and investment in technology/manpower picks up, C/I ratio will increase to 40%+ vs 35% reported in FY10.
- While RoA of the bank will remain strong at 1.3-1.4%, RoE is likely to remain in mid-teens till FY12 as growth moderates. We estimate EPS of Rs36 in FY11 and Rs44 in FY12 i.e. FY10-12 EPS CAGR of 27%. The stock trades at FY12E P/E of 11x and P/BV of 1.4x. Maintain Buy with a revised target price of Rs540 (1.6x FY12E BV of Rs337).
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