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Federal Bank (FB)
Banks/Financial Institutions
Valuations attractive. Upgrade to BUY. We believe that structural changes, viz.
focus on improving fee business, process re-engineering to strengthening delivery
platform and stronger provisioning policy, will cushion strong earnings momentum in
the medium term while a well-capitalized tier-1 ratio is positive. After 21% correction in
the last one month, the stock is trading at attractive levels - 1.1X book and 8X FY2012E
EPS delivering 28% EPS growth in FY2011-13E and RoEs in the range of 15-17%. We
upgrade our rating to BUY; maintain estimates and TP of `500.
Valuations look good; attractive entry point for long-term investors
We believe that recent correction provides an attractive entry point for long-term investors.
Weaker-than-expected performance during 1QFY12 and general selloff in equities have likely
driven a sharp correction in the stock price. We would, however, like to reiterate strong financial
metrics: (1) NIMs to remain healthy at over 3.5% levels while loan growth to remain above
industry average, (2) coverage ratios (excluding write-off) to remain strong at 80% levels giving
comfort on higher slippages (currently being addressed), (3) well-capitalized balance sheet with
tier-1 ratio at 15.6%, (4) cost-income ratios at about 40% levels and (5) recent changes on
business delivery that will enable better risk-adjusted returns (lower provisions) and healthy fee
income growth.
Strong provisioning policy gives comfort despite overhang of high slippages in last quarter
We note that 1QFY12 saw higher slippages at 4% levels, reversing the trend shown over previous
few quarters. In this backdrop, we derive comfort from a few factors: (1) Coverage ratios have
been maintained at over 80% levels, (2) recoveries and upgradation have been consistently
improving over the past three years, (3) selective outsourcing (third party independent call centers)
and renewed focus by senior managers to monitor loan performance will deliver results, albeit
slower than our previous expectations. We expect loan-loss provisions to decline to 1.1% levels in
FY2012E from current 1.7% levels.
Expect roadblocks in the path of change; focus on the ability to deliver results in the medium term
The HR issue in the previous quarter does show that transition for an old private sector bank is
likely to have roadblocks resulting in disappointments in a few quarters. Some of the steps which
are positive to build a scalable business include: (1) Credit delivery changes: Hub and spoke model
is fully functional as against a decentralized model earlier. Branches will act as originating agents
for nearly all products. (2) Training has been completed on credit appraisal in these centers. (3)
Branch managers are being trained on fee income products. Hiring has been completed at the
senior level. (3) Medium-term projects have been given to consultants to improve scoring models
on loan appraisal and streamline process delivery.
NIMs to remain at 3.5% levels; loan growth to remain above average
We expect Federal Bank to report margins at over 3.5% levels (1QFY12 was at 3.9% levels
compared to 4% levels in 4QFY11). NIMs (KS calc.) would decline by 30 bps yoy in FY2012E
as the focus shifts towards better risk-adjusted returns. It is important to note that Federal
Bank has a strong NRI franchise which gives access to low-cost deposits apart from the
CASA ratio of 27% (as of 1QFY12). We expect loans to grow marginally higher than
industry average but focus would shift towards more secure form of lending.
Fee income contribution to rise
We expect overall contribution of fee income to grow faster (35% CAGR on a low base, 1%
of assets) than balance sheet growth as the new initiatives taken should steadily reflect in
earnings. The bank has (1) made a lateral hire to strengthen its corporate banking business,
especially on forex and other loan-related fee business, (2) ability to improve share of
business from NRI flows to other fee income like wealth management products. Significant
training is being imparted to managers/staff to move from their current roles to more
fee/service oriented ones.
Cost structures to remain at closer to 40% levels
Despite pressure on margins, we expect overall cost-income ratio to remain below 40%
levels in FY2012-13E as the current management is unlikely to make significant changes to its
current employee base. We believe that a few product specialists, similar to the recent hire at
corporate level, could happen to strengthen delivery, manage risk and complete the basket of
products that can be offered to clients. FY2012E would also see higher operating leverage as
there would be no one-off provisions for retired employees.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Federal Bank (FB)
Banks/Financial Institutions
Valuations attractive. Upgrade to BUY. We believe that structural changes, viz.
focus on improving fee business, process re-engineering to strengthening delivery
platform and stronger provisioning policy, will cushion strong earnings momentum in
the medium term while a well-capitalized tier-1 ratio is positive. After 21% correction in
the last one month, the stock is trading at attractive levels - 1.1X book and 8X FY2012E
EPS delivering 28% EPS growth in FY2011-13E and RoEs in the range of 15-17%. We
upgrade our rating to BUY; maintain estimates and TP of `500.
Valuations look good; attractive entry point for long-term investors
We believe that recent correction provides an attractive entry point for long-term investors.
Weaker-than-expected performance during 1QFY12 and general selloff in equities have likely
driven a sharp correction in the stock price. We would, however, like to reiterate strong financial
metrics: (1) NIMs to remain healthy at over 3.5% levels while loan growth to remain above
industry average, (2) coverage ratios (excluding write-off) to remain strong at 80% levels giving
comfort on higher slippages (currently being addressed), (3) well-capitalized balance sheet with
tier-1 ratio at 15.6%, (4) cost-income ratios at about 40% levels and (5) recent changes on
business delivery that will enable better risk-adjusted returns (lower provisions) and healthy fee
income growth.
Strong provisioning policy gives comfort despite overhang of high slippages in last quarter
We note that 1QFY12 saw higher slippages at 4% levels, reversing the trend shown over previous
few quarters. In this backdrop, we derive comfort from a few factors: (1) Coverage ratios have
been maintained at over 80% levels, (2) recoveries and upgradation have been consistently
improving over the past three years, (3) selective outsourcing (third party independent call centers)
and renewed focus by senior managers to monitor loan performance will deliver results, albeit
slower than our previous expectations. We expect loan-loss provisions to decline to 1.1% levels in
FY2012E from current 1.7% levels.
Expect roadblocks in the path of change; focus on the ability to deliver results in the medium term
The HR issue in the previous quarter does show that transition for an old private sector bank is
likely to have roadblocks resulting in disappointments in a few quarters. Some of the steps which
are positive to build a scalable business include: (1) Credit delivery changes: Hub and spoke model
is fully functional as against a decentralized model earlier. Branches will act as originating agents
for nearly all products. (2) Training has been completed on credit appraisal in these centers. (3)
Branch managers are being trained on fee income products. Hiring has been completed at the
senior level. (3) Medium-term projects have been given to consultants to improve scoring models
on loan appraisal and streamline process delivery.
NIMs to remain at 3.5% levels; loan growth to remain above average
We expect Federal Bank to report margins at over 3.5% levels (1QFY12 was at 3.9% levels
compared to 4% levels in 4QFY11). NIMs (KS calc.) would decline by 30 bps yoy in FY2012E
as the focus shifts towards better risk-adjusted returns. It is important to note that Federal
Bank has a strong NRI franchise which gives access to low-cost deposits apart from the
CASA ratio of 27% (as of 1QFY12). We expect loans to grow marginally higher than
industry average but focus would shift towards more secure form of lending.
Fee income contribution to rise
We expect overall contribution of fee income to grow faster (35% CAGR on a low base, 1%
of assets) than balance sheet growth as the new initiatives taken should steadily reflect in
earnings. The bank has (1) made a lateral hire to strengthen its corporate banking business,
especially on forex and other loan-related fee business, (2) ability to improve share of
business from NRI flows to other fee income like wealth management products. Significant
training is being imparted to managers/staff to move from their current roles to more
fee/service oriented ones.
Cost structures to remain at closer to 40% levels
Despite pressure on margins, we expect overall cost-income ratio to remain below 40%
levels in FY2012-13E as the current management is unlikely to make significant changes to its
current employee base. We believe that a few product specialists, similar to the recent hire at
corporate level, could happen to strengthen delivery, manage risk and complete the basket of
products that can be offered to clients. FY2012E would also see higher operating leverage as
there would be no one-off provisions for retired employees.
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