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Federal Bank recorded net profit growth of 6.5% qoq and 38.9% yoy to `140cr,
above our estimates of `127cr mainly on account of better-than-estimated
non-interest income. Substantial spike in gross and net NPAs was the key
highlight of the results. We maintain an Accumulate rating on the stock.
Core operating income above expectations; slippages continue to be high:
During the quarter, advances and deposits growth was muted qoq as well as yoy.
Advances grew by 1.8% qoq and 7.2% yoy to `27,636cr and deposits registered
growth of 3.2% qoq and 8.0% yoy to `36,116cr. On a yoy basis, retail loans
recorded 14.6% growth and SME loans grew 5.6%. On the deposits side, CASA
deposits grew by healthy 23.2% yoy, driven by a 25.9% yoy increase in current
account deposits and 22.6% yoy growth in savings account deposits. CASA ratio
improved to 29.4% from 29.0% in 1QFY2011 and 25.8% in 2QFY2010. Driven
by a 40bp qoq and 26bp qoq rise in yield on advances and yield on investments,
respectively, reported NIM improved by 27bp qoq to 4.44%. Consequently, NII
increased by healthy 6.1% qoq and 32.9% yoy to `438cr. Gross NPAs increased
in absolute terms by 4.9% qoq to `1,095cr, while net NPAs declined by 7.2% qoq
to `186cr. The bank’s provision coverage ratio including technical write-offs stood
at ~92% as against ~90% in 1QFY2011.
Outlook and valuation: At the CMP, the stock is trading at 1.4x FY2012E ABV.
While lower leverage is leading to low RoE at present, the bank’s core RoAs are
relatively high and should improve further as asset quality pressures start
moderating. We maintain Accumulate on the stock, assigning a multiple of 1.5x
FY2012E ABV to arrive at a Target Price of `505, implying an upside of 7.2%
from current levels.
Advances and deposits growth below industry
For 2QFY2011, advances and deposits growth was muted on a qoq as well as yoy
basis. Advances grew by 1.8% qoq and 7.2% yoy to `27,636cr and deposits
registered growth of 3.2% qoq and 8.0% yoy to `36,116cr. On a yoy basis, retail
loans recorded 14.6% growth, SME loans grew 5.6% and corporate loans grew
marginally by 0.9%. While on a sequential basis, corporate loans registered a
3.0% decline, while SME and retail loans grew by 7.6% and 3.0%, respectively.
On the deposits side, CASA deposits grew by healthy 23.2% yoy, driven by a
25.9% yoy increase in current account deposits and 22.6% yoy growth in savings
account deposits. On a sequential basis, CASA deposits grew by 4.7% qoq on the
back of a 7.0% increase in current account deposits and 4.1% growth in savings
account deposits. CASA ratio improved to 29.4% from 29.0% in 1QFY2011 and
25.8% in 2QFY2010.
Driven by a 40bp qoq and 26bp qoq rise in yield on advances and yield on
investments, respectively, the reported NIM improved by 27bp qoq to 4.44%.
Consequently, NII increased by healthy 6.1% qoq and 32.9% yoy to `438cr. For
FY2011, management expects NIM to moderate to 3.7–3.8% from current levels.
Strong recoveries drive non-interest income
Non-interest income registered growth of 31.1% qoq and 5.6% yoy to `144cr, in
spite of a 14.7% qoq and 51.8% yoy decline in treasury income. Growth in
non-interest income excluding treasury was healthy at 39.2% qoq and 21.3% yoy.
Growth in other income was driven by strong recoveries, which increased by
160.1% qoq and 66.8% yoy to `47cr compared to `18cr in 1QFY2011 and `28cr
in 2QFY2010. Commission, exchange and brokerage (CEB) income growth was
muted, in line with advances growth.
Operating costs under control
During the quarter, the bank’s operating expenses increased by 21.0% yoy, driven
by a 34.6% increase in employee costs and 4.4% increase in other operating
expenses. Cost-to-income ratio improved on the back of healthy operating
performance to 33.9% (from 35.9% in 1QFY2011 and 35.0% in 2QFY2010).
Slippages still high
Gross NPAs increased in absolute terms by 4.9% qoq to `1,095cr, while net NPAs
declined by 7.2% qoq to `186cr. Gross NPA ratio deteriorated to 3.84% as against
3.73% in 1QFY2011, while net NPA ratio improved from 0.74% in 1QFY2011 to
0.68% in 2QFY2011. Gross slippages stood at `257cr (as against `327cr in
1QFY2011), indicating an annualised slippage ratio of 3.8% (4.8% in 1QFY2011).
Majority of the slippages were from the SME segment (`121cr), while the retail
loans segment witnessed slippages of `75cr, of which slippages of ~`60cr were
from the housing segment. Out of the outstanding gross NPAs, the SME loans
segment accounts for 45.2% and the retail and corporate loans segments account
for 33.1% and 21.7%, respectively. Management has indicated that it will take
about 4–6 quarters for the slippage rate to come down by 150–200bp.
Accordingly, we have conservatively increased our estimates for provision expenses
for FY2011 by 25.1% and for FY2012 by 9.9%. There could be an upside to our
earnings estimates from stronger-than-expected recoveries and upgrades (already
`126cr or 1.9% of advances in 2QFY2011) along with strong recoveries from fully
written-off accounts (already `47cr in 2QFY2011).
On the positive side, the bank’s provision coverage ratio including technical
write-offs remained strong at ~92% as against ~90% in 1QFY2011. The bank
restructured `103cr of its loans during the quarter, taking its cumulative
restructured loans to `1,243cr (4.5% of loans, 25.1% of net worth).
The bank made provisions of `143cr towards NPAs in 2QFY2011, up 5.3% from
`136cr made in 1QFY2011. The bank had to provide for depreciation of `8cr on
investments compared to a write-back of `4cr in 1QFY2011 and `27cr in
2QFY2010. The bank also made provisions of ~`16cr on account of the second
pension option, of which total liability is estimated to be ~`145cr.
Comfortable capital adequacy (CAR)
The bank’s CAR was strong at 17.3% as compared to 17.9% in 1QFY2011.
Tier-I capital component was at 16.0%, constituting 92.6% of the total CAR.
Investment arguments
Healthy deposit mix
Federal Bank’s CASA deposits grew at a 20.4% CAGR during FY2005–10, leading
to a stable 25%+ CASA ratio. Further, a key differentiator for the bank is the
low-cost NRI deposits base, which constitutes 15.6% of total deposits. Thus,
effectively, low-cost deposits as a proportion of total deposits stand at around
45.0%, which are expected to underpin calculated NIM of about 3.6% in FY2012E,
even as the bank grows its advances faster than the industry to leverage its large
net worth.
Impact of Dubai crisis within manageable limits
The stock has been an underperformer due to concerns over the impact of the
Dubai crisis on the bank’s business model, which benefits meaningfully from
Middle East NRI clients. However, as indicated by the management, the bank has
a very low direct loan exposure of about `350cr (1.3% of loan book) to these
clients. Hence, the impact of the crisis on asset quality is expected to be within
manageable limits.
Reasonable valuations
At the CMP, the stock is trading at 1.4x FY2012E ABV. While lower leverage is
leading to low RoE at present, the bank’s core RoAs are relatively high and should
improve further as asset quality pressures start moderating. We maintain
Accumulate on the stock, assigning a multiple of 1.5x FY2012E ABV to arrive at a
Target Price of `505, implying an upside of 7.2% from current levels.
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