With the RBI looking at issuing new bank licenses, competition in the banking industry
is expected to heat up. In such a situation the future of old private banks which are
smaller in size and geographically concentrated appears uncertain. In our opinion one
of two scenarios are likely to play out 1) old private banks especially those with poor
profitability and asset quality concerns could become takeover targets for new private
sector banks and 2) larger old private banks could scale up operations and re-engineer
business processes to bridge the gap between themselves and new private banks. This
in turn could lead to a re-rating in the stock price of these banks. Given its large size
and proactive management, we believe that Federal bank is amongst the best placed
old private sector banks to make the transformation into a new generation bank.
NIM likely to improve to 3.4% in FY15
Federal Bank reported a NIM of 3.1% for Q1FY14, which improved sequentially by 6 bps.
The NIM improvement came on the back of a reduction in bulk deposits and an
improvement in the CASA ratio. Going ahead we expect Federal Bank’s NIM to improve
further as the bank continues to focus on reducing bulk deposits and improving CASA.
Non-interest income to pick up going ahead
Federal bank’s initiatives such as tying up with foreign banks for raising LC’s, installing
CRM solutions to identify cross selling opportunities, leveraging on NRI clientele to
increase other income etc would lead to a pick up in fee based income going ahead. We
expect fee based income to grow by a CAGR of 18% from FY13-15.
Asset quality impacted by volatile slippages in the corporate segment, SME, Agri and
Retail slippages in check
Federal Bank revamped its processes to improve asset quality. Some of the measures
undertaken by the bank included – separation between loan sourcing and sanctions,
improving loan appraisal systems and focus on credit monitoring and collection. Post
the revamp, the bank has managed to keep in check slippages in the SME, Agri and retail
segments. However volatile corporate slippages have impacted asset quality. Once the
economy stabilizes, corporate slippages are likely to stabilize. Additionally the bank has
a strong provision coverage ratio of 81% including technical write offs. This will act as a
buffer in case of asset quality deterioration.
Adequately capitalized
The bank is adequately capitalized with a capital adequacy ratio of 15% almost entirely
comprised of Tier 1 capital. As the bank leverages on its capital, return on equity is likely
to improve going ahead.
Buy with a price target of `547
At the current market price of `318, the bank trades at 0.8x it FY14E ABV and 0.7x its
FY15E ABV. We believe the worst in terms of NIMs compression, asset quality and
return ratios is behind us and focus on strong and profitable growth, prudent lending
and likely improvement in asset quality will drive earnings growth going forward. Thus
we have a Buy rating on the stock with a price target of `547 (1.5x FY14E ABV adjusted
for slippages from restructuring).
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is expected to heat up. In such a situation the future of old private banks which are
smaller in size and geographically concentrated appears uncertain. In our opinion one
of two scenarios are likely to play out 1) old private banks especially those with poor
profitability and asset quality concerns could become takeover targets for new private
sector banks and 2) larger old private banks could scale up operations and re-engineer
business processes to bridge the gap between themselves and new private banks. This
in turn could lead to a re-rating in the stock price of these banks. Given its large size
and proactive management, we believe that Federal bank is amongst the best placed
old private sector banks to make the transformation into a new generation bank.
NIM likely to improve to 3.4% in FY15
Federal Bank reported a NIM of 3.1% for Q1FY14, which improved sequentially by 6 bps.
The NIM improvement came on the back of a reduction in bulk deposits and an
improvement in the CASA ratio. Going ahead we expect Federal Bank’s NIM to improve
further as the bank continues to focus on reducing bulk deposits and improving CASA.
Non-interest income to pick up going ahead
Federal bank’s initiatives such as tying up with foreign banks for raising LC’s, installing
CRM solutions to identify cross selling opportunities, leveraging on NRI clientele to
increase other income etc would lead to a pick up in fee based income going ahead. We
expect fee based income to grow by a CAGR of 18% from FY13-15.
Asset quality impacted by volatile slippages in the corporate segment, SME, Agri and
Retail slippages in check
Federal Bank revamped its processes to improve asset quality. Some of the measures
undertaken by the bank included – separation between loan sourcing and sanctions,
improving loan appraisal systems and focus on credit monitoring and collection. Post
the revamp, the bank has managed to keep in check slippages in the SME, Agri and retail
segments. However volatile corporate slippages have impacted asset quality. Once the
economy stabilizes, corporate slippages are likely to stabilize. Additionally the bank has
a strong provision coverage ratio of 81% including technical write offs. This will act as a
buffer in case of asset quality deterioration.
Adequately capitalized
The bank is adequately capitalized with a capital adequacy ratio of 15% almost entirely
comprised of Tier 1 capital. As the bank leverages on its capital, return on equity is likely
to improve going ahead.
Buy with a price target of `547
At the current market price of `318, the bank trades at 0.8x it FY14E ABV and 0.7x its
FY15E ABV. We believe the worst in terms of NIMs compression, asset quality and
return ratios is behind us and focus on strong and profitable growth, prudent lending
and likely improvement in asset quality will drive earnings growth going forward. Thus
we have a Buy rating on the stock with a price target of `547 (1.5x FY14E ABV adjusted
for slippages from restructuring).
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