02 January 2012

Federal Bank: Impact at the margin ::Kotak Securities

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Federal Bank (FB)
Banks/Financial Institutions
Impact at the margin. RBI’s move to de-regulate interest rates on foreign currency
deposits is likely to impact Federal (and South Indian) Bank given higher dependence on
these deposits. We believe that the impact of likely higher rates will be visible from
FY2013E as this regulation applies on incremental deposits. We reduce our estimates by
7-8% for FY2013E and FY2014E. Nevertheless, we still expect Federal Bank to deliver
21% EPS CAGR between FY2011 and FY2014E and medium-term RoEs of 15% levels
by FY2013E. Maintain BUY with price target of Rs500.
De-regulation of interest rates on foreign deposits
RBI has recently de-regulated interest rates on foreign currency deposits (with immediate effect) in
order to increase deposit mobilization from non-residents. Foreign currency deposits have been
growing at 8% CAGR (in USD terms) between 2002 and 2011- well below the overall growth in
domestic deposits. This is likely due to depositor’s preference to convert foreign currency deposits
into domestic rupees and thereby capture the benefit of higher interest rates on the latter.
Key aspects of the regulation
�� Interest rates de-regulated on both savings and term deposits (maturity of one year and above)
under NRE Deposit accounts and savings deposits under NRO accounts.
�� Interest rates offered these deposits cannot be higher than that offered on comparable
domestic rupee deposits. Till recently, banks were offering Libor+275 bps for these deposits as
against 9% for comparable rupee term deposits. The revised rates would be applicable on fresh
deposits.
Downside for Federal Bank
We believe that Federal Bank (20% NRI deposits) and to some extent, South Indian Bank (13% of
deposits) will be negatively impacted due to the higher share of foreign deposits. However, note
that not all deposits would be re-priced as (1) certain foreign deposits can be taken at domestic
rates and (2) the regulation applies to incremental deposits.
Federal Bank has 7% share in the remittance business despite having a market share of about 1%
in balance sheet. A large share of this business comes from the NRIs from the middle-east Asian
countries which has been a primary source of these low cost deposits.

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