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STRONG ON CONSUMPTION<br />
Company Description<br />
Federal Bank Ltd. is a private commercial bank<br />
headquartered at Aluva, Kerala having more than<br />
thousand branches and ATMs spread across 25 States and<br />
5 Union Territories in India. The Bank was incorporated in<br />
1931 and became a scheduled commercial bank in 1970.<br />
Federal Bank has a balance sheet size of Rs 938 billion.<br />
FED mainly caters to four segments -Corporate, retail<br />
(including NRI), SME and agriculture. Barring agriculture,<br />
which is present only on the application side, the<br />
remaining three segments contribute to the funding and<br />
application side.<br />
Investment Rationale<br />
Strong earnings revival in the offing<br />
Federal Bank’s earnings are set for a strong revival after<br />
53% yoy de-growth in FY16 due to higher provisions. The<br />
bank has opted for elevated provisioning primarily due to<br />
some event-led provision required for food credit to<br />
Government of Punjab, Discom UDAY related and some<br />
backdated AQR related provisioning. The provisions for bad<br />
loans nearly jumped by 6 times to 948 crore in FY16. The<br />
management indicated that worst of asset quality fears are<br />
behind. As of Q1FY17, fresh slippages have declined to Rs<br />
280 crore from Rs 536 crore in Q4FY16 and Rs 317 crore<br />
in Q1FY16. For Q1FY17, there have been no sale to ARCs,<br />
no 5:25 Structuring, no SDR and no S4A. Besides, the<br />
management has stated that NPA addition to the tune of Rs<br />
100-200 crore could arise in the coming quarters. Thus,<br />
slippages are expected to moderate from here on and<br />
would provide fillip to profitability on low provisions going<br />
ahead.<br />
Established retail franchise<br />
Federal bank has built a strong retail franchise over the<br />
years which has been the key driving force of the bank’s<br />
deposits and advances growth over the years. The bank<br />
has grown its credit at a modest pace of 13.9% CAGR in<br />
FY10-16 while deposit growth has always been<br />
maintained better than industry growth rate. The retail<br />
loan book constitutes 29%, wholesale (35%), SME (26%)<br />
and Agri (11%) accounts for the rest. The retail loan book<br />
is primarily constituted by Housing (46%). The retail<br />
deposit ratio is as strong as 98% as of Q1FY17 while the<br />
CASA ratio also remains strong at 32.83%. Federal bank<br />
enjoys a strong presence in the state of Kerala with nearly<br />
50% of branches accounting from Kerala. The bank holds<br />
market share of 13.9% in Kerala and there has been<br />
constant effort on the part of the management to improve<br />
pan India presence and also build strong markets in certain<br />
non-south states. However, Federal Bank also has a strong<br />
NRI client base due to its locational advantage in NRI<br />
stronghold south India which is supporting the deposit and<br />
advance momentum. NRE deposits account for 38% of<br />
Federal Bank’s deposit mix. Over the period from FY12-16,<br />
share of total NRI remittances made through Federal bank<br />
increased by 506 bps from 7.49% to 12.55%.<br />
Stable net interest margins<br />
Net Interest income grew at a CAGR of 8% between FY11<br />
& FY16 while the net interest margins have been above<br />
3% mark during this time frame. Strong margins have<br />
been driven by continuously improving CASA ratio from<br />
28.5% in FY13 to 32.5% by FY16, thus resulting in<br />
declining cost of funds. Going ahead, further reduction in<br />
interest rates will help federal bank owe its dependence<br />
on deposits as source of funds (more than 95%).<br />
Asset quality concerns contained<br />
Asset quality over the years has remained stable until the<br />
past three to four quarters incidental with its exposure to<br />
SME and corporate loans. On the asset quality front, post<br />
higher slippages in the last three or four quarters, GNPA<br />
slippages eased at Rs 280 crore in Q1FY17. On a<br />
sequential basis, decline in slippages has seen across<br />
segment with slippages in corporate book at Rs 45 crore<br />
vs. Rs 254 crore in Q4FY16, Slippage in SME book has also<br />
lowered at Rs 134 crore in Q1FY17 vs. Rs 154 crore in<br />
Q4FY16. Besides, Federal bank continues to be<br />
conservative on building its corporate portfolio over the<br />
last three years and continues to stay away from risky<br />
large ticket infrastructure loans.<br />
Healthy Capital Adequacy ratio<br />
Federal Bank has a comfortable capital adequacy ratio of<br />
13.6%, considerably higher than the RBI stipulated 9%.<br />
This reduces risks of dilution in equity in the near future.<br />
Decent return ratios<br />
Over the years, Federal Bank’s return on assets (ROA) have<br />
hovered ~1.3% mark while return on equity (ROE) ~13%<br />
mark until from FY09-15. However, higher provisions have<br />
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