Federal Bank:On the fast track: ICICI Sec

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Federal Bank



On the fast track…
The Federal Bank (FDB), a Kerala-based private sector bank, is perfectly
poised to enter into a high growth phase given the ongoing operational
restructuring, strong focus on the high-margin retail and SME segment
and expanding geographical presence. We forecast FDB will grow its
business mix at 23% CAGR in FY10-13E. With the pick-up in the
domestic credit market and stable macroeconomic outlook for Middle
East countries, we expect the bank to improve its leverage. This will
help FDB to increase its RoE to 18% in FY13E from a trough of 10% in
FY10. We forecast NIMs will remain high at 4% in FY13E.


Process restructuring, change in management to improve return ratios
FDB is rapidly changing into a new-age bank given the focus on
diversified business portfolio, technology-driven operational processes
and improvement in geographical presence. In our view, the stage is set
for incumbent CEO Shyam Srinivasan to lead the bank into the next level
of high growth phase. We expect FDB to show a strong operational
performance with NII growth of 22% CAGR over FY10-13E, supported by
high share of low cost deposits (~45% of total deposits). During FY10-
13E, we forecast loan growth of 23% CAGR to | 49,786 crore and deposits
posting 22% CAGR to | 66,256 crore.

Slippages likely to come down in FY12E-13E
The management expects slippages to remain high in FY11E due to high
system generated NPAs, leading us to forecast GNPA of 3.2% in FY11E
vs. 3.1% in FY10. However, we expect asset quality concerns to recede in
FY12E-13E due to the revamping of the bank’s credit disbursal policy and
improving loan monitoring system. As a result, we forecast GNPA of 2.7%
in FY13E. Also, the high provision cover of 82% in H1FY11 provides
strong support to balance sheet growth, going forward.

Valuations
At the CMP of | 455, the stock is trading at 1.5x FY13E P/ABV. The bank
with higher return ratios (RoA of 1.3%) and branch profitability compared
to peers (Exhibit 33) commands a premium multiple. We expect FDB to
improve its RoE and RoA to 18% and 1.4%, respectively, in FY13E by
leveraging its equity base and forecast NIM at 4%. We have valued the
bank at 1.8x FY13E ABV and initiated coverage with a STRONG BUY
rating and a target price of | 563.