Federal Bank - Initiating Coverage 13-08-14

Institutional
Equity
Research
Banking | India
Federal Bank
Initiating Coverage
Rs
Rs
%
Market data
Mkt capitalisation
Average daily vol
52-week H/L
Shares O/S
Free float
Promotor holding
Foreign holding
Face value
SME and Retail to drive the growth; Improved asset quality

ahead
BUY
Current price (12 Aug)

Target price
Upside/(downside)
115
141
23
Rs bn
'000
Rs
mn
mn
%
%
Rs
Federal Bank (FB) is a Kerala based Old-Generation Private sector Bank (OGPB) that
distinguishes itself from its peers through a strong liability profile (CASA - 30.8% and
Bulk 2.75%), well distributed credit book, improving asset quality and healthy NIMs.
Focus on the SME and NR businesses will help sustain margins. We expect the
earnings quality to improve on the back of 1) pick-up in loan growth; 2) lower interest
reversals; and 3) lower NPA provisioning. We initiate coverage on FB with a BUY
rating and a TP of Rs141, valuing at 1.4x P/ABV F16e ABV of Rs100.4.
98.2
3903.6
136 / 44.25
855.1
855.1
0.0
38.7
2.0
Business growth to re-emerge on SME and Retail lending: Post a period of

consolidation in which FBs credit book grew at a meagre CAGR of 13.9% from F1114, de-growing in F14, FB is resuming its growth trajectory on the back of strong SME
and Retail lending. The bank has realigned its book from a Corporate-heavy to a welldistributed mix with the 3 core segments. Change in political scenario bodes well for
the overall economy, leading to pick-up in credit.
Price performance (%)

Nifty (abs)
Stock (abs)
Relative to Index
1m
3.6
1.3
(2.3)
3m
10.2
17.0
6.9
6m
27.0
47.9
20.9
1yr
37.7
73.6
35.9
Performance
150
August 13, 2014
FB IN; FED.BO
Core profitability to improve substantially in F16e: With advances growth picking

up and lower interest reversals courtesy of declining gross slippages in F15e/F16e,
we expect NII to grow at a CAGR of 20% from F14-F16e. Federal has maintained
higher-than-peer NIMs as a result of strong SME relationships. An improved liability
profile higher CASA and reduced Bulk proportion should support the margins. In
conjunction with lower NPA provisioning, we expect RoA of 1.3% in F16e, up from
1.2% in F14, and sustain there onwards.
(%)
(Rs)
60
40
120
20
90
0
60
(20)
30
Aug-13
(40)
Nov-13 Feb-14 May-14 Aug-14
Federal Bank (LHS)
Rel. to Bankex (RHS)
Source: Bloomberg, SSLe
Asset quality in a relatively better shape: A balanced trade-off between growth

and quality helped contain credit cost. Reduced underwriting in the big-ticket
corporate exposure, improvement in back-end processes and risk management
systems has resulted in a downward slippage trend. Federal has successfully brought
down its GNPAs from 3.5% in F12 to 2.5% in F14. The Banks PCR stands at 84%.
Though we remain conservative in our slippage estimates, we are building in
incremental restructuring of 1%, which brings the OSRB to below 5% from F15e.
BUY at current levels; initiate with TP of Rs141: We expect FB to deliver sustained
RoE of ~15% and RoA of 1.3% from F16e, one of the best among OGPBs. The
Banks median 6-month forward P/ABV has been at 1.3x. With strong return ratios
and an excellent tier-I of 13.2%, FB is a BUY at current levels. We initiate coverage
with BUY rating and TP of Rs141, valuing at 1.4x P/ABV F16e ABV Rs100.4.
Financial summary
Divyanshi Dayanand
+91 22 4227 3385
divyanshi.dayanand@sbicapsec.com
Ravikant Bhat
+91 22 4227 3349
ravikant.bhat@sbicapsec.com
Ankit Ladhani
+91 22 4227 3380
ankit.ladhani@sbicapsec.com
Aayush Dureha
+91 22 4227 3456
aayush.dureha@sbicapsec.com
Y/E Mar (Rs mn)

Net interest income
F12
19,534
F13
19,747
F14
22,286
F15e
24,691
F16e
30,166
Operating profit
15,065
14,596
14,804
16,847
20,874
12,142
7,768
8,382
8,389
9,669
EPS (Rs)
9.1
9.8
9.8
11.3
14.2
ABV (Rs)
64.3
69.3
77.4
88.7
100.4
P/ABV (x)
1.8
1.7
1.5
1.3
1.1
Dividend yield (%)

RoE (%)
1.6
1.6
1.7
1.7
1.7
14.4
13.9
12.6
13.2
14.8
1.4
1.3
1.2
1.2
1.3
PAT
RoAA (%)
Source: Company, SSLe
SBICAP
Research on Bloomberg SBICAP <GO>, www.securities.com
Please refer to our disclaimer given at the last page.
Federal Bank
SBICAP Securities Ltd
Strong presence in Kerala augurs well for FB

One of the most socially developed states in India, Kerala has grown at a pace
much faster than Indias. In F13, the state economy grew at 8.2% vs Indias
growth at 4.5%. The States per capita income was Rs63,493 in F13 as compared
to a national average of Rs45,238.
Unlike its neighbouring states where manufacturing is strong, Kerala has
traditionally relied on agriculture and tourism to run its economy. Additionally, the
state is heavily dependent on inflow remittances from abroad, leading to Kerala
being occasionally termed as the Remittance economy or Money Order
economy. Recent statistics indicate that one out of six Keralites is working
abroad, mainly in Persian Gulf. High presence of NRIs has made the regional
banks offer a range of assets and liabilities products for NRIs. Owing to strong instate presence (586 branches), Federal has a market share of 8.6% of Indias
remittances, up from 7% in F11.
Federal Bank (FB) is a Kerala based OGPB with ~80% of the business coming
from Kerala and 5 focus states Tamil Nadu, Karnataka, Maharashtra, Gujarat
and Punjab. The bank has predominantly concentrated on the SME and NR
businesses. Future growth will depend on its competitiveness in these segments,
along with Retail.
Exhibit 1: Keralas growth rate and per-capita income exceeds national average
7.5
60,000
(Rs)
70,000
(%)
10.0
5.0
2.5
50,000
40,000
0.0
F09
F10
F11
F12
GSDP Growth rate at constant prices
30,000
F13
F09
F10
F11
India
F12
F13
Kerala
Source: Government of Kerala, SSLe
divyanshi.dayanand@sbicapsec.com I ravikant.bhat@sbicapsec.com I ankit.ladhani@sbicapsec.com I aayush.dureha@sbicapsec.com
13 August 2014 | 2
Federal Bank
Consolidation phase over, credit growth to re-emerge

In an environment where general economic downturn has meant poor credit offtake and slower repayments for the broader banking industry, Federal
deliberately took its foot off the gas. The Bank realigned its credit profile in F14 to
mitigate risks emanating from the large corporate book and improve the share of
SME and Retail. FBs underlying portfolio has improved significantly courtesy of
sustained focus for the past few quarters. The mix is currently well distributed
between Retail - 32%, SME & Agri - 37% and Corporate - 31%.
Exhibit 2: De-bulked the credit book with a shift away from Corporate segment
F13
F14
Retail
30%
Corporate
42%
Agri
10%
Retail
32%
Corporate
31%
Agri
12%
SME & agri

18%
SME & agri

25%
600,000
23
450,000
15
300,000
150,000
(%)
(Rs mn)
Exhibit 3: Expect a revival in loan growth post consolidation phase
(8)
F09
F10
F11
Advances (LHS)
F12
F13
F14
F15e
F16e
Advances growth (RHS)
Challenging economic environment and resultant stress in the corporate book led FB
to consciously taper this segment by in F14. Consequently, the credit book marginally
declined by 1.5% during F14. The management shall await sustained economic
environment to re-grow its corporate book and expects the new stable government to
put in place a set of progressive policy steps during 2HF15. The bank has already
sanctioned Rs30-40bn worth of corporate loans. Although the bank has guided for a
credit growth of ~20%, we remain slightly cautious towards our estimates due to a lack
of improvement in economic activity at the ground level. We expect the bank to grow
its loan book in F15 by 15.3% and by 18.1% in F16, with the proportion of Retail and
SMEs inching up further.
13 August 2014 | 3
Federal Bank
Exhibit 4: Break-up of SME book

Hotels &
restaurant
s
3%
Others
39%
Exhibit 5: Break-up of Corporate book
5% Basic
Metals
5%
Food &
beverages
9%
Constructi
on others
8%
Wholesale
trade
16%
NBFC
13%
Education
4% Textiles
Others
37%
Wholesale
trade
12%
Food &
beverages
3%
Power
10%
Electricity
gas
3%
Retail trade
4%
Retail
Trade
11%
Real estate
- HFC
3%
Basic
metals
Road 8%
bridges
railways
7%
SME business to drive earnings

Federals core strength remains conventional SME lending. SME offers high growth
potential and is showing steadiness in asset quality. Banks strategy has been to open
branches in regions, within and outside Kerala, that are active in SME and Retail
lending. The bank has its own skill-sets and products in SME and over the years has
reduced its exposure to risky SMEs. Since F13, the bank has scaled up its SME
proportion by ~700bps to 25.4%. The current stress witnessed in the SME loan
portfolio relates to legacy accounts and not pertains to recent advances.
Exhibit 6: Credit quality of the SME book healthy
FB4
9%
Others
2%
FB1
9%
FB2
30%
FB3
50%
Thrust towards gold-loan and mortgage to continue

Federal believes that the Retail business is more sustainable and predictable. An
aggressive attitude towards home loans and gold loans has led to a healthy growth
path for the Retail book. The current growth rate of 25% (F14) is higher than the
industry average. Despite a decline in the gold loan book, the retail proportion has
moved up from 27.4% in F13 to 32% in F14. Focus will continue to remain on housing
and mortgages, which have grown ~780bps since F12 to 53.6% of the Retail portfolio.
13 August 2014 | 4
Federal Bank

Exhibit 7: Housing and mortgage have gained traction since F13
100%
75%
50%
22
22
22
23
21
10
12
32
30
29
27
25
38
40
40
40
42
4QF13
1QF14
2QF14
3QF14
4QF14
25%
0%
Housing
Gold
Mortgage
Others
The bank plans to regain its impetus towards the gold business in F15. Volatility in
gold prices led to a sharp reduction in gold loans during 9MF14 as the portfolio shrank
Rs6.7bn during the period. However, 4Q did see an addition of Rs3.6bn to that
portfolio and the management expects the steady state run-rate of Rs1-1.5bn per
month incremental in F15. Further expansion in Karnataka, Tamil Nadu and home
market should help towards this cause.
Strong foothold in NR business
With 50% of its branches in Kerala, a state that has the highest proportion of NRIs, FB
has a significant amount of low cost NR deposits and they account for 34.55% of the
total deposits. High NR deposits also enhance CASA as NR SA deposits comprises
43.8% total SA. Post RBIs swap rules that allowed banks to raise funds from foreign
markets, FB raised Rs4bn of FCNR deposits during 3QF14. FCNR deposits, with postaverage cost of ~8.75%, are mobilized by the bank towards export credit and foreign
currency requirements of clients. The bank will continue to have sustained NR
business over the years and this should continue to provide cushions to the margins.
Higher CASA, lower Bulk the story of Federals liability profile
Federal bank has consistently managed healthy margins on the back of a strong
deposit profile. Higher than peer-average CASA, high proportion of NR deposits and a
declining bulk deposit book help keep the cost of funds under control and make
Federals liability franchise stand apart from its competitors. Branch addition in SME
and NRI regions, in Kerala and other Southern geographies, has improved the liability
profile as well. The bank is currently 93% retail funded as opposed to 70% in F10.
Exhibit 8: Improving CASA and declining Bulk strengthen
liability franchise
100%
Exhibit 9: Retail Deposit proportion at 93%

100
2.8
22.6
25.3
14.6
14.7
95
43.1
75%
44.7
41.4
17.0
90
37.5
50%
23.4
(%)
40.0
85
11.5
10.7
13.3
25.9
26.5
27.4
26.9
30.8
80
F10
F11
F12
F13
F14
75
25%
0%
CASA
NRI TD
Resident retail TD
Bulk
4QF13
1QF14
2QF14
3QF14
4QF14

13 August 2014 | 5
Federal Bank

FB has been growing its deposits at a CAGR of 13.2% from F09 to F14, which is tad
lower than the industry average. The banks strategy has been to reduce its
dependence on bulk deposits. The proportion of bulk deposits is now down from
25.3% in F11 to 2.75% in F14, which has helped contain the cost of funds.
Exhibit 10: Deposits have grown much slower than the industry
1,100,000
30
23
660,000
15
(%)
(Rs mn)
880,000
440,000
8
220,000
0
F09
F10
F11
F12
Deposits (LHS)
F13
F14
F15e
F16e
Deposits growth (RHS)
Concerted efforts on SME and Retail has led to the bank growing handsomely on the
Savings side. Banks sustainable focus on SA has ensured that CASA remains
370bps higher than the peer-average. While the peer CASA has remained flat YoY at
23.6%, FB has seen it improve from 23.5% in F13 to 30.8% in F14. The
managements plan to open ~200 new branches in F15 and F16 will further aid in
CASA growth. The bank had been guiding for 30%+ CASA for 1HF14 and has
achieved that target. We expect CASA to be 31.1% in F15 and 32.2% in F16 and
CASA/ branch to improve to Rs192mn/ branch, by F16e, from the current Rs159mn/
branch.
Exhibit 12: Low-cost deposit proportion much higher than peer-average
200
40
225,000
180
30
150,000
160
75,000
140
10
120
0
F10
F11
F12
CASA (LHS)
F13
F14
(%)
300,000
(Rs mn)
(Rs mn)
Exhibit 11: CASA momentum to sustain
20
F15e F16e
City Union DCB Bank

Bank
CASA/ Branch (RHS)
ING
Vysya
Karnataka
Bank
Karur
Vysya
Bank
Federal
Bank
South
Indian
Bank
Exhibit 13: CASA Trend

F14
Proportion
Growth (%)
14
Kerala (CA)
12,500
6.8
Non-Kerala (CA)
18,660
10.1
11
117,270
63.7
21
35,580
19.3
18
Kerala (SA)
Non-Kerala (SA)
13 August 2014 | 6
Federal Bank
Declining slippages; caution still maintained

A disciplined attitude towards portfolio growth and proactive management of new
accounts has borne well for the Banks asset quality. A balanced trade-off between
growth and quality helped contain credit cost. Gross NPAs have also boosted courtesy
of sale of assets to ARCs.
F14 witnessed a marked reduction in NPAs as also better recoveries. Federal ended
F14 on an encouraging note largely on the back of some disciplined credit lending that
it has been doing for 8-10 quarters. The reduction in NPAs is all the more laudable as
the bank did not grow its credit book in F14. Sequentially for almost 10 quarters
barring one in which a large quasi government account created a one-off impact
slippages have consistently come down.
18,000
13,500
9,000
4,500
0
F09
F10
GNPA (LHS)
(%)
(mn)
Exhibit 14: Lower slippages and sales to ARCs help credit quality
F11
F12
NNPA (LHS)
F13
F14
GNPA (RHS)
F15e
F16e
NNPA (RHS)
To contain slippages, Federal has consciously reduced underwriting in the big-ticket

corporate exposure and has trimmed its large corporate portfolio. This has borne quite
well for the bank as it is now witnessing lower stress in the segment.
Exhibit 15: Segment-wise NPAs
6%
5%
3%
2%
0%
Agriculture & allied Industry (Micro,
activities
small, medium and
large)
Services
Personal Loans
As per the management, the underwriting standards have dramatically improved

courtesy of concerted efforts towards creating a stable portfolio. Furthermore,
improvement in back-end processes and risk management systems has resulted in a
downward slippage trend in SME and Retail. The SME + Agri slippages reduced by
Rs610mn YoY to Rs3.26bn in F14. The Gross NPA of 2.46% is now the best the bank
has had post-2008. Provision Coverage Ratio (PCR), including technical write-offs
(TWO), increased from 80.9% to 84.2% YoY in F14.
13 August 2014 | 7
Federal Bank
Retail
SME & Agri
SME
Corporate
4QF14
3QF14
2QF14
1QF14
4QF13
3QF13
2QF13
4QF14
3QF14
2QF14
1QF14
4QF13
0.0
3QF13
2QF13
0.5
1QF13
1000
1QF13
1.0
4QF12
2000
3QF12
1.5
2QF12
3000
(%)
2.0
1QF12
Exhibit 17: Significant improvement in Retail and SME slippages
4000
4QF12
(Rs mn)
Exhibit 16: Declining slippage trend encouraging
Retail
We remain slightly conservative in our assessment of Federals credit quality as we

feel that stress has not entirely abated. With the economy not completely recovered,
there exists risk of slippages from the large corporate segment. Accordingly, we
expect gross slippages to be 1.2% during F15-F16. However, a strong PCR of 84%
limits the downside risk to our estimates.
1.2
90
0.9
85
0.6
80
0.3
75
0.0
(%)
(%)
Exhibit 18: Asset quality showing signs of revival; PCR strong
70
F09
F10
F11
F12
Credit cost (LHS)
F13
F14
F15e
PCR (RHS)
F16e
Higher sale of assets to ARCs has led to an accretion of Rs6.05bn of SRs on banks
books. Failure to recover these assets impacts banks future profitability. The fact that
the bank will start creating provisions on these SRs from 3QF15 onwards eases some
of our concerns.
The restructured book currently stands at 5.8%, which is on the higher side amongst
OGPBs. However, the combined exposure to Air India and SEBs is 2%. As the current
pipeline for restructuring is insignificant in nature, we expect incremental restructuring
at 1% of gross advances and outstanding restructured assets below 5% of the book.
13 August 2014 | 8
Federal Bank
Earnings quality to sustain

With focus on Retail, SME and Gold, Federal has enjoyed best profitability amongst
all Kerala based banks and remains better placed than peers in terms of quality of
earnings. Last 3 years have been challenging for the bank from the earnings
perspective. RoA was impacted in F14 because of decline in NII, higher operating
costs and elevated credit cost. Lower balance sheet growth and higher interest
reversals led to subdued core earnings. FBs NII has grown at a CAGR of 8.5%
from F11-F14. De-bulking of the corporate book, balance sheet growth and lower
interest income reversals from NPAs should bode well in future. We anticipate NII to
grow at a CAGR of 16.3% from F14-F16.
Structural improvement in liability profile (reduced proportion of bulk to 2.75% and
93% book retail funded), stable CASA (30.8%) and improved share of SME credit
(36%YoY growth in F14) will provide cushion to the margins. Cost of funds has
remained largely stable for Federal mainly owing to a portfolio shift on the liabilities
front from a bulk heavy to a CASA heavy book. The banks strength in retail
deposits portfolio gives it the ability to keep the cost of borrowings in check.
Exhibit 19: Funding costs remain in check
16
(%)
12
0
F09
F10
F11
Yield on advances
F12
F13
F14
F15e
Cost of Deposits
F16e
Strong growth of SME credit (18.4% in F13 to 25.4% in F14) bodes well for NIMs.
SME products typically earn ~100bps higher yields than corporate loans and ~50bps
higher than Retail. Federals strategy was to bring down the NIMs to balance the risk
generating from its vintage SME portfolio. With improved risk management systems
and better underwriting standards, the quality of SME portfolio has amended. The
Bank can achieve its NIM target of 3.3-3.35% on the back of increased volumes,
better CASA and lower credit cost.
13 August 2014 | 9
Federal Bank
2,000
1.4
1,500
1.3
1,000
1.2
500
1.1
(%)
(Nos.)
Exhibit 20: Substantial network expansion in the past 3 years
1.0
F09
F10
Branches (LHS)
F11
F12
F13
ATMs (LHS)
F14e
F15e
F16e
ATM/Branch ratio (RHS)
Substantial network investment during F12-F14 - 224 branches added should help in
profitable growth in coming years. With no capital infusion plans in place, Federal aims
to expand its RoE by ~400bps by F16 with the help of lower cost of deposits, lower
interest reversals, lower NPA provisions and higher yields generated through SME
and Retail products. We expect RoA to improve to 1.3% in F16.
Fee income could provide positive surprise to earnings
Fee income has historically been an area of weakness for Federal as it has
consistently lagged advances growth. Fee income as a percentage of assets has
declined from 0.87% in F11 to 0.57% in F14. The bank did not show any material
improvement in the other income during F14 and it remains an area of concern. With a
th
solid branch network of 1174 branches (4 best amongst private banks), the bank
intends to leverage its distribution capabilities and garner third party distribution fees.
The bank has set-up a new Sales vertical which has taken a series of new initiatives
on the product front. An improvement in fee income can offer a positive earnings
surprise. We envisage other income to grow by 20.9 % in F15 and 15.5% in F16.
Exhibit 21: Loan growth and third-party sales to drive non-interest income growth
1.6
(%)
1.2
0.8
0.4
0.0
F09
F10
F11
F12
Non-interest income/ average assets
F13
F14
F15e
F16e
Fee income/ average assets
13 August 2014 | 10
Federal Bank
Cost-income may remain a dampener

Federals escalating cost-income has been a cause for concern since F13. High C/I
has been a resultant effect of lower income growth. Heavy branch expansion, pension
cost, wage revision and employee addition have led to C/I ratio rise 9.9% since F12.
With the addition of 224 branches from F12-F14, Federal already has strong
distribution capabilities. It has the largest branch network among its peers and 4th
largest among private banks, bettered only by ICICI Bank, HDFC Bank and Axis Bank.
The bank should start soon reaping benefits from the heavy investments in the
distribution channels. We expect to see an improvement in the fee-cost gap from F16
onwards. We expect the opex growth to continue in F15 and our estimates lead us to
a C/I of 49.1% in F15 and 47.6% in F16.
Exhibit 22: Higher cost remains a concern
39
56
1.50
(%)
2.00
(%)
58
(%)
52
1.00
26
54
13
52
0.50
50
0.00
0
F09
F10
F11
C/I Ratio (LHS)
F12
F13
F09
F14 F15e F16e
F10
F11
F12
F13
F14e
F15e
F16e
Opex/ assets
Staff cost/Expenses (RHS)
Expansion in focus states should improve productivity

With a large balance sheet and distribution strength in place, Federal has the ability to
improve its productivity in F15 and F16. The bank has previously faced several issues
from employee unions which have impacted its productivity. Business per branch has
traditionally been Rs200mn worse off in Kerala as compared to out-of-state. As
incremental branch expansion is expected to be focused more towards the focus
markets (Tamil Nadu, Karnataka, Maharashtra, Gujarat and Punjab), we expect
business per branch to improve.
Exhibit 23: Out-of-state expansion should aid productivity
25.0
1,050
(Nos.)
15.0
910
(%)
20.0
980
10.0
840
5.0
0.0
770
F11
F12
F13
Business per branch
F14
F15e
F16e
NII Growth
13 August 2014 | 11
Federal Bank

Strong capital position should support the near-term growth ambitions
Federal Bank has sufficient capital to withstand any asset quality shocks and pursue a
credit growth of 25-30% till F17. Capital adequacy of 14.2% is second best amongst
peers (after ING Vysya Bank) and should comfortably suffice growth requirements for
another 3 years. In 4QF14, Federal received government clearance to hike the foreign
equity participation in the bank from 56.16% to 74% - sub-limits of 49% for FIIs and
24% for NRIs.
Exhibit 24: CAR (%)
F10
F11
F12
F13
F14
F15e
F16e
Tier I
16.77
15.45
15.86
14.09
13.19
12.81
13.15
Tier II
1.56
1.22
0.78
0.64
0.97
0.80
0.77
CAR
18.33
16.67
16.64
14.73
14.16
13.61
13.92
9.32
10.08
10.63
11.17
10.74
10.80
10.60
Leverage (Asset/NW) (x)

13 August 2014 | 12
Federal Bank
Valuations and recommendations

With advances growth picking up and lower interest reversals courtesy of declining
gross slippages in F15e/F16e, we expect NII to grow at a CAGR of 16.3% from F14F16e. Federal has maintained higher-than-peer NIMs as a result of strong SME
relationships. An improved liability profile higher CASA (30.8%) and reduced Bulk
proportion (2.75%) should support the margins. In conjunction with lower NPA
provisioning, we expect RoA of 1.3% in F16e, up from 1.2% in F14, and sustain there
onwards.
As the Bank will not raise capital at least for the next 7-8 quarters, we expect an
increase in RoE to 14.8% by F16e. With 224 new branches in the past 8 quarters, we
expect operating leverage to kick in during F15e.
1.6
16.0
1.2
12.0
0.8
8.0
0.4
4.0
(%)
(%)
Exhibit 25: Much improved RoE from F16e
0.0
0.0
F10
F11
F12
F13
RoA (LHS)
F14
F15e
RoE (RHS)
F16e
At CMP of Rs 115, the stock is currently trading at 1.15x F16e ABV of Rs100.4, which
is at a discount to the median valuations. We value the Bank at 1.4x F16e P/ABV on
the bank of an improving RoE trend. We arrive at a price target of Rs141, a potential
upside of 23%. Initiate coverage on Federal Bank with a BUY rating.
Exhibit 26: Better performance metrics amongst peers
4QF14
City Union Bank
Advances
160,968
Deposits CASA
220,169
16.7
CAR (Tier I)
14.5
NIM RoA
RoE
3.3
17.1
1.8
1.2
62.0
1.3
GNPA NNPA PCR
% Restructured
C/I ratio
1.7
47.7
DCB Bank
81,402
103,252
25.0
12.9
3.6
1.3
13.8
1.7
0.9
80.5
62.4
ING Vysya
358,289
412,168
33.4
14.6
3.7
1.0
10.3
1.8
0.3
84.2
1.6
55.2
J&K Bank
463,846
693,359
39.1
11.2
4.1
1.4
18.9
1.7
0.2
90.3
3.4
40.7
Karnataka Bank
283,455
405,828
25.4
10.7
2.4
0.7
10.5
2.9
1.9
75.5
Karur Vysya Bank
342,260
437,580
20.6
11.6
3.1
1.4
20.6
0.8
0.4
75.0
4.1
57.6
Federal Bank
434,361
597,313
30.8
14.6
3.6
1.5
16.3
2.5
0.7
84.1
5.8
47.7
South Indian Bank
362,299
474,911
20.7
10.9
3.0
1.0
14.8
1.2
0.8
62.7
4.8
55.6
13 August 2014 | 13
Federal Bank
Exhibit 27: Median P/ABV for the last 6 months at 1.31x

2.0
(x)
1.5
1.0
Feb-14
Aug-14
Apr-13
Sep-13
Jun-12
Nov-12
Jan-12
Aug-11
Oct-10
Mar-11
May-10
Jun-09
Dec-09
Jan-09
Aug-08
Oct-07
Mar-08
May-07
Jul-06
Dec-06
Feb-06
Apr-05
0.0
Sep-05
0.5
Source: Bloomberg, SSLe
Exhibit 28: Key Assumptions

Y/E Mar (Rs mn)
F15e
F16e
Credit Growth (%)
15.3
18.0
Deposits Growth (%)
16.0
21.8
Investments (%)
22.5
21.2
CD Ratio (%)
72.2
70.0
Balance Sheet Assumptions
Asset Quality Assumptions

Slippage Ratio (%)
1.2
1.2
Net Recovery Ratio (Reductions as % of slippages)
40.0
40.0
Provisioning Cover (%)
82.8
85.3
Source: SSLe
13 August 2014 | 14
Federal Bank
Key concerns
Delayed economic revival may result in higher credit costs Federals asset
quality has shown a marked improvement towards 2HF14. While slippage rate of SME
and Retail has dropped from 1.5% and 0.5% respectively in F11 to 0.6% and 0.2% in
F14, we remain cautious towards the corporate book. In case economic revival takes
longer than expected, we may revisit our credit cost estimates for the Bank.
Stronger currency can dampen remittances Keralas economy, which is hugely
reliant on inward remittances, has historically benefited from a weaker currency.
During 1HF14, Federal Bank had seen a surge of inflows in fixed deposits and savings
accounts from NRIs because of weakness of the rupee. A further strengthening of INR
may have an adverse impact on NR deposits.
13 August 2014 | 15
Federal Bank
Company description
Federal Bank is one of the leading private sector banks headquartered at Aluva,
Kerala. The Bank has an exceptionally strong grip in its home state and has been
targeting Tamil Nadu, Karnataka, Maharashtra, Gujarat and Punjab for the past few
years. The bank primarily focuses on SME, Retail and NRI customers.
th
As of F14, the bank had a balance sheet size of ~Rs746bn. It has the 4 largest
branch network among private banks with 1174 branches. 50% of its branches are in
Kerala and 33% in five focus states. The bank has a wide network of ATMs 1,359
in onsite and offsite locations.
Exhibit 29: Branch distribution

Rural
10%
Metro
15%
Urban
18%
Semi-urban
57%
Key Management
Mr. Shyam Srinivasan, MD & CEO
As the CEO of the Bank since September 2010, Mr. Srinivasan has been instrumental
in increasing the presence of the Bank to a national level, creating capabilities within
the Bank to reinvent customer-centric processes and focusing on the under-writing
quality at every stage. In a career that spans over 20 years, he has gained significant
expertise in SME banking, retail lending and wealth management. Mr. Srinivasan is an
alumnus of IIM, Kolkata and REC, Tiruchirapally.
Mr. Abraham Chacko, ED
Mr. Abraham Chacko joined Federal in 2011 as ED in charge of Wholesale Banking.
Mr, Chacko has over thirty years of banking experience across MNCs such as HSBC
and ABN AMRO, and in regions such as Dubai, Sri Lanka and Singapore, apart from
India. Mr. Chacko has done his post-graduate studies in business management from
XLRI.
13 August 2014 | 16
Federal Bank
Financials
Income statement
Y/E Mar (Rs mn)
Ratios
F12
F13
F14
F15e
F16e
Y/E Mar (Rs mn)
F12
F13
F14
F15e
F16e
9.1
9.8
9.8
11.3
14.2
Interest earned
55,584
61,676
69,461
73,571
87,715
Per share data (Rs)
Interest expended
36,050
41,929
47,175
48,880
57,549
EPS
Net interest income
19,534
19,747
22,286
24,691
30,166
Book value per share
66.7
74.4
81.2
90.2
102.0
11.8
1.1
12.9
10.8
22.2
Adjusted book value
64.3
69.3
77.4
88.7
100.4
1.8
1.8
2.0
2.0
2.0
Growth (%)
Other income
5,323
6,644
6,938
8,389
9,692
Dividend per share
Fee-based income
2,516
3,047
3,338
4,006
4,807
Asset quality (%)
Forex income
842
794
1,251
1,564
1,955
Gross NPAs
3.4
3.4
2.5
1.9
1.6
Treasury income
821
2,058
1,562
1,640
1,722
Net NPAs
0.5
1.0
0.7
0.3
0.2
746
26,391
6.2
11,795
6,265
4,744
787
14,596
(3.1)
2,658
11,938
3,556
29.8
8,382
7.9
787
29,225
10.7
14,421
7,715
5,766
939
14,804
1.4
2,684
12,120
3,731
30.8
8,389
0.1
1,178
33,079
13.2
16,233
9,244
5,997
991
16,847
13.8
2,834
14,013
4,344
31.0
9,669
15.3
1,208
39,859
20.5
18,985
10,668
7,128
1,189
20,874
23.9
3,162
17,713
5,571
31.5
12,142
25.6
84.7
3.5
72.2
6.8
70.4
4.6
82.8
1.7
85.3
1.6
14.4
1.4
4.1
24.7
12.8
39.4
40.7
13.9
1.3
3.5
21.4
12.3
44.7
48.5
12.6
1.2
3.6
19.4
11.0
49.3
52.1
13.2
1.2
3.7
20.6
11.8
49.1
51.6
14.8
1.3
3.8
21.4
12.5
47.6
49.8
Earning ratios
Y/E Mar
Yield on advances
Yield on investments
Yield on IEA
Cost of deposits
Cost of IBL
Spread
F12
12.0
11.4
11.7
7.2
7.4
4.4
F13
11.3
10.5
11.0
7.2
7.2
3.8
F14
11.4
11.0
11.4
7.2
7.4
4.0
F15e
10.8
11.3
11.0
7.3
6.8
4.2
F16e
11.1
10.6
11.0
7.3
6.7
4.3
Valuations
Y/E Mar
P/E
P/BV
P/ABV
Dividend yield (%)
F12
12.7
1.7
1.8
1.6
F13
11.7
1.5
1.7
1.6
F14
11.7
1.4
1.5
1.7
F15e
10.2
1.3
1.3
1.7
F16e
8.1
1.1
1.1
1.7
Capital adequacy ratio

Y/E Mar
Tier-I (%)
Tier-II (%)
Total (%)
Leverage (Asset/NW)
F12
15.9
0.8
16.6
10.6
F13
14.1
0.6
14.7
11.2
F14
13.2
1.0
14.2
10.7
F15e
12.1
0.8
12.9
11.4
F16e
11.8
0.8
12.6
12.0
Other miscellaneous income

Operating income
Growth (%)
Operating expenses
Staff cost
Other operating expense
Depreciation
Pre-provision profits (PPP)
Growth (%)
Provisions
Profit before taxes
Taxes
Tax rate (%)
Profit after taxes
Growth (%)
1,145
24,858
9.8
9,793
5,439
3,788
567
15,065
5.6
3,370
11,695
3,927
33.6
7,768
32.3
Balance sheet
Y/E Mar (Rs mn)
LIABILITIES
Capital
Reserves & surplus
Deposits
Borrowings
Other liabilities & provisions
Total liabilities
F12
F13
F14
F15e
F16e
1,710
55,299
489,371
42,410
17,423
606,268
1,711
61,884
576,149
51,870
18,831
710,496
1,711
67,745
597,313
56,880
22,243
745,941
1,711
1,711
75,419
85,567
692,883
843,585
88,344
93,764
21,921
22,774
880,328 1,047,450
ASSETS
Cash on hand & with RBI
24,241
Money at call and short notic 11,084
Advances
377,560
Investments
174,025
Fixed assets
3,261
Other assets
16,096
Total assets
606,268
27,425
9,775
440,967
211,546
3,975
16,808
710,496
31,043
14,251
434,361
241,179
4,250
20,859
745,941
51,793
68,349
14,251
14,251
500,735
590,922
295,547
358,243
4,867
5,880
13,135
9,805
880,328 1,047,450
NPA coverage
NNPA/networth (%)
Profitability ratios (%)
RoE
` RoA
NIM
Operating profit margin
Net profit margin
C/I ratio
C/I (excl. treasury gains
13 August 2014 | 17
Federal Bank
RoAA decomposition
Y/E March (%)
F12
F13
F14
F16e
Interest earned
9.92
9.37
9.54
9.05
9.10
Interest expended
6.43
6.37
6.48
6.01
5.97
Net interest income
3.49
3.00
3.06
3.04
3.13
Other income
0.95
1.01
0.95
1.03
1.01
Fee-based income
0.65
0.58
0.57
0.64
0.62
Forex income
0.15
0.12
0.17
0.19
0.20
Treasury income
0.15
0.31
0.21
0.20
0.18
Other miscellaneous income

Operating income
Operating expenses
Staff cost
Other operating expense
Depreciation
Pre-provision profits (PPP)
Provisions
Profit before taxes
Taxes
Profit after taxes
0.00
4.44
1.75
0.97
0.68
0.10
2.69
0.60
2.09
0.70
1.39
0.00
4.01
1.79
0.95
0.72
0.12
2.22
0.40
1.81
0.54
1.27
0.00
4.01
1.98
1.06
0.79
0.13
2.03
0.37
1.66
0.51
1.15
0.00
4.07
2.00
1.14
0.74
0.12
2.07
0.35
1.72
0.53
1.19
0.00
4.14
1.97
1.11
0.74
0.12
2.17
0.33
1.84
0.58
1.26
F15e
13 August 2014 | 18
Federal Bank
SBICAP Securities Limited

Corporate Office: Mafatlal Chambers, A-Wing, 2nd Floor, N. M. Joshi Marg, Lower Parel, Mumbai -400013.
Tel.: 91-22-42273300/01 | Fax: 91-22-42273335 | Email: sbicapresearch@sbicapsec.com | www.sbicapsec.com
KEY TO INVESTMENT RATINGS (w.e.f. February 2013)

Guide to the expected return over the next 12 months. 1=BUY (expected to give absolute returns of 15 or more percentage points);
2=HOLD (expected to give absolute returns between -10 to 15 percentage points); 3=SELL (expected to give absolute returns less then 10 percentage points)
DISCLAIMER
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Federal Bank
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Federal Bank - Initiating Coverage 13-08-14

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Institutional

SME and Retail to drive the growth; Improved asset quality

Current price (12 Aug)

Business growth to re-emerge on SME and Retail lending: Post a period of

Price performance (%)

August 13, 2014

Core profitability to improve substantially in F16e: With advances growth picking

Federal Bank (LHS)

Rel. to Bankex (RHS)

Source: Bloomberg, SSLe

Asset quality in a relatively better shape: A balanced trade-off between growth

Y/E Mar (Rs mn)

Dividend yield (%)

Please refer to our disclaimer given at the last page.

SBICAP Securities Ltd

Strong presence in Kerala augurs well for FB

Source: Government of Kerala, SSLe

divyanshi.dayanand@sbicapsec.com I ravikant.bhat@sbicapsec.com I ankit.ladhani@sbicapsec.com I aayush.dureha@sbicapsec.com

SBICAP Securities Ltd

Consolidation phase over, credit growth to re-emerge

SME & agri

SME & agri

Source: Company, SSLe

Exhibit 3: Expect a revival in loan growth post consolidation phase

Advances growth (RHS)

Source: Company, SSLe

divyanshi.dayanand@sbicapsec.com I ravikant.bhat@sbicapsec.com I ankit.ladhani@sbicapsec.com I aayush.dureha@sbicapsec.com

SBICAP Securities Ltd

Exhibit 4: Break-up of SME book

Exhibit 5: Break-up of Corporate book

SME business to drive earnings

Source: Company, SSLe

Thrust towards gold-loan and mortgage to continue

divyanshi.dayanand@sbicapsec.com I ravikant.bhat@sbicapsec.com I ankit.ladhani@sbicapsec.com I aayush.dureha@sbicapsec.com

SBICAP Securities Ltd

Source: Company, SSLe

Exhibit 9: Retail Deposit proportion at 93%

Source: Company, SSLe

SBICAP Securities Ltd

Deposits growth (RHS)

Source: Company, SSLe

Exhibit 11: CASA momentum to sustain

City Union DCB Bank

CASA/ Branch (RHS)

Source: Company, SSLe

Exhibit 13: CASA Trend

divyanshi.dayanand@sbicapsec.com I ravikant.bhat@sbicapsec.com I ankit.ladhani@sbicapsec.com I aayush.dureha@sbicapsec.com

SBICAP Securities Ltd

Declining slippages; caution still maintained

Source: Company, SSLe

To contain slippages, Federal has consciously reduced underwriting in the big-ticket

As per the management, the underwriting standards have dramatically improved

SBICAP Securities Ltd

SME & Agri

Exhibit 17: Significant improvement in Retail and SME slippages

Exhibit 16: Declining slippage trend encouraging

Source: Company, SSLe

We remain slightly conservative in our assessment of Federals credit quality as we

Exhibit 18: Asset quality showing signs of revival; PCR strong

Credit cost (LHS)

Source: Company, SSLe

divyanshi.dayanand@sbicapsec.com I ravikant.bhat@sbicapsec.com I ankit.ladhani@sbicapsec.com I aayush.dureha@sbicapsec.com

SBICAP Securities Ltd

Earnings quality to sustain