msfl - federal bank - initiating coverage - june 17 2010

8/6/2019 MSFL - Federal Bank - Initiating Coverage - June 17 2010

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[Type text]

MSFL Researc h

Institutional Business Group, MSFL

@p-sec, 306, Gresham Assurance House, 132, Mint Road, Fort, Mumbai 400 001 IndiaTel + 91 22 22690474 / 75 www.marwadionline.com

Optimal leverage to aid growth

Summary FinancialsRs.mln FY09 FY10 FY11P FY12PNet Interest Income 13155 14108 16648 19676

Other Income 5158 5309 5962 6758

Pre-Provisioning Profit 12598 12649 14696 17183

Net Profit 5005 4646 6107 7887

EPS 29.3 27.2 35.7 46.1

Networth 43259 46905 51940 58443

Deposits 321982 360580 443513 541086

Advances 223919 269501 331486 401099

BUYCMP 324Target Price 400

Upside Potential 23%

Price Performance52 wk Hi/Lo 355/213

All time Hi/Lo 498/28

6 mnth Average Vol 552444

Stock Beta 0.79

ValuationFY10 FY11P FY12P

P/E (x) 11.9 9.1 7.0

P/BV (x) 1.2 1.1 0.9

RONW (%) 10.3 12.4 14.3

ROA (%) 1.1 1.3 1.3

Peer ValuationINVYB SIB Avg.

P/ABV 1.4 1.1 1.4

ROA 0.8 1.0 1.1

Equity DataMarket Cap. (Rs bn) 56

Face value (Rs) 10

No of shares o/s (mn) 171

Mar09 Mar10 %chPromoters 0 0 -

DFI's 20.87 25.60 0.23

FII's 38.89 35.05 - 0.10

Public 40.24 39.35 - 0.02

RoE Expansion underwayFederal Banks return on equity (RoE) had contracted by 770 bps in 2008 from about 20% on

account of rights issue done However; the bank has delivered an average return on assets

(RoA) of 1.3% in the past five years. The deviation in the RoE and RoA is primarily due to the

lower leverage ratio of the bank vs its peers. With its business growth likely to gain traction

on the back of the economic recovery, the bank should be able to optimally leverage its

equity base and hence improve its RoE.

Strong southern playFederal Bank, the fourth largest private sector bank in India in terms of asset size, has

traditionally been a strong player in the southern region especially Kerala. However, it has

taken initiatives to expand its geographic footprint by increasingly opening new branches

outside Kerala to achieve a pan-India presence. It is well placed to capitalise on the revival in

credit growth with a comfortable level of capital adequacy (17.26%) and a low-cost deposit

base (CASA + NRI deposits form 46.5% of its total deposit base).

CSB acquisition - Chances recedingStrong reservations from various stakeholders of CSB (especially Archdiocese of Thrissur) has

receded the prospect of merger with Federal Bank which we believe is positive for the bank

as any possible merger would have strained the profitability of Federal Bank.

High provision coverage provides asset quality comfortFederal bank has witnessed stress on its asset quality due to high exposure to SME and Retail

segment and banks current GNPA of 2.97% stands higher than peer average of 2.25%.

However the same appears to be manageable due to banks high provision coverage ratio of91% (including technical write offs), revival seen in Retail segment and revamped credi

assessment and monitoring mechanisms of the bank.

Upbeat on long term prospects of the bankAt the CMP of Rs324, Federal Bank trades at 1.1x and 1x of its FY2011E and FY2012E ABV per

share. We value the bank at 1.23x FY2012E ABV per share, considering the bank's potential to

grow above the industry average in future as well as for the superior quality of its earnings

We initiate coverage on Federal Bank with a Buy recommendation and a price target of

Rs400.

Federal Banknitiating Coverage

Laxmi [email protected]

(+ 91 22 2269 0474 / 75)

June 17, 2010


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MSFL Research

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Investment RationaleRoE Expansion underway..Federal Bank has been grappling with low RoE deliverance since 2008 from about 20% to around10.3% currently on account of the rights offering done. The resultant rights issue led to compression o

RoE by 770 bps in 2008. Subsequently the global financial slowdown led to the adoption of a

conservative growth startegy by the bank which never really allowed the bank to take the advanatge othe available liquidity in the balance sheet. However; the bank has delivered an average return on

assets (RoA) of 1.3% in the past five years. The RoA for the bank in FY10 stood at 1.1%, which could

have been better had it not incurred higher than expected tax provisions (46%) in FY10 due to an

impending I-T case. Hence we believe that the deviation in RoA and RoE is on account of low leverage

ratio, which currently is comparatively lower than peers.

Exhibit 1: Trend in return ratios

Source: Company, MSFL Research

Exhibit 2: *Comparative Leverage Ratio

Source: Company, MSFL Research*As of 31 March 2009

However with Indian economy getting back on high growth trajectory, Federal Bank is likely to give

away its cautious approach as credit growth has seen revival since December 2009 and the same is

likely to continue going forward on the back of strong growth projections for the country. This implies

better deployment opportunities for the bank which should translate into optimal leverage and hence

better RoE for the bank. However we believe that RoE expansion will happen gradually over a period

and expect Federal Bank to deliver an average RoE of 13.3% over FY11-12P.

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

FY2006 FY2007 FY2008 FY2009 FY2010

ROE ROA

16.5

14.213.2

12.4 11.911.2

7.7

IVYB SIB K'ka Bk CUB DhanBk KVB Fed Bank

Leverage (x)

Rights issue in 2008 led tocompression of RoE by 770bps

Average RoE of 13.3% overFY11-12P expected due tobetter deployableopportunities


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MSFL Research

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.As business growth gains tractionThough the business mix for Federal Bank has grown at 19% CAGR for FY2008- 10, the growth is lower

than some of its peers that have grown at an average CAGR of 24% in the similar period. The primaryreason for the relatively slower balance sheet expansion is the cautious stance adopted by the bank in

the wake of the worldwide financial crisis in FY2009 and the more recent crisis in the Middle Eastern

countries. However, with the domestic economy getting back on track and the gradual recovery incredit demand, we believe that the balance sheet expansion rate is likely to inch up in the coming

years.

The advance book of the bank primalrily comprises of Retail and SME segment, forming 62% of the

loan book and are typically high risk-high margin businesses while the balance portfolio is made up of

Corporate segment. The bank has a 10% exposure to gold loans out of its total retail loans; these are

high-yielding and secured loans. The unsecured assets such as Personal Loans (around 1% of Retai

book) and credit cards form a very negligible part of Federal Banks overall Retail book which are

typically more riskier assets.

Exhibit 3: Loan Book break-up Exhibit 4:Retail Loan Book break-up


We expect the business of the bank to grow at CAGR of 22% over FY10-12P with Deposits and

Advances growing at CAGR 22.5% and 22% respectively for the similar period.

Exhibit 5: Business Growth


SME

31%

Retail

31%

Corporate

38%

Hsg

56%

Gold

10%

Home

O/D

4%

Mortgage

4%

AAS/AAD

8%

Car

5%

Edu

3%

PL

1% Others

9%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

0

100,000

200,000

300,000

400,000

500,000

600,000

FY2008 FY2009 FY2010 FY2011P FY2012P

Advances Deposits Dep Growth Adv Growth

Advance growth of CAGR 22%expected in FY11-12P

High risk-high margin sectorsdominate loan book


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MSFL Research

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Margins Amongst the best in the industryFederal Bank has been maintaining healthy margins of above 3% (calcualted basis) in past few years an

is comparable to the top three private banks in the industry. The key reason for maintaining stabl

margins over the period is access to low cost funds by the bank in the form of CASA as well as NR

deposits. The Savings deposits for the bank have grown at CAGR 22% in FY2006-10 while Curren

deposits have grown by 17% for the similar period. The CASA ratio for FY10 stood at 26% for the banWith bank expanding its geopgraphic footprints over the country, we expect banks CASA deposits t

grow at CAGR 27% in FY11-12P.

Exhibit 6: Yield Trend


NRI Deposits Providing strength to the marginsFederal Bank has around 58% of its branches in Kerala with around 46% of its business coming from t

state. Traditionally bank has had strong foothold in the state which has helped it to leverage its positi

in garnering low cost NRI deposits. These deposits over the past few years have formed one-fifth of

total deposits. These deposits typically carry lower interest rates compared to domestic deposits. Finstance, the FCNR deposits (fixed deposits in foreign currency) are paid interest at the rate of 2.02-3.6

by Federal Bank currently compared with the 7.75% paid to the INR fixed depositsthats a difference

about 400 basis points. Currently, the NRI deposits account for approximately 20% of the overall depo

base which provides a sticky source of inexpensive funds and helps the bank to contain the cost

deposits and improve its margins. While the near-term growth outlook for the NRI deposits has com

under clouds (due to the crisis in the Middle East), we believe that the long-term outlook remains stable

Exhibit 7: Low Cost deposit composition


0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2005 2006 2007 2008 2009 2010

Cost of Deposits Yield on Advances NIM

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2005 2006 2007 2008 2009 2010

CASA NRI


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MSFL Research

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Adequately capitalized for GrowthFederal Bank had raised around Rs 21250 mln in 2008 through rights issue which was equivalent to

networth. On account of this huge capital raising and conservative growth strategy adopted, Fede

Bank has been having highest capital adequacy ratio amongst its peers withthe Tier-I capital at 15.27This high proportion of Tier-I capital provides enough headroom for the bank to raise money by way

Tier-II capital for funding its growth without straining its balance sheet. This high capital adequacy w

enable the bank to pursue its organic and inorganic growth initiatives in the next two to three yea

thereby improving its RoE by leveraging its capital position, which is low at present.

Exhibit 8: Highest CAR amongst peers


Stable Non Interest Income growthThe non-interest income (excluding treasury) of Federal bank has grown at a healthy pace of CAGR 24

over the past five years on the back of various fee generating revenue streams and a strong remittanc

business. The overall non-interest income for the bank in past three years has grown at CAGR 20.6

while the Non-Treasury portion has grown by 18.6%. The bank has various fee revenue streams such

foreign exchange (forex), distribution of third party products and cash management services. The ba

also has a tie-up with BNP Geojit Paribas Financial Services to offer online trading facilities known as Fe

e-Trade. It provides insurance services through its life insurance joint venture with IDBI Bank and For

Insurance International N.V. wherein it holds a 26% stake. In its first year of operations itself, as on Mar

31, 2009, the joint venture company collected more than Rs3280 mln in premiums through over 87,0

policies and over Rs28250 mln in sum assured. In view of the strong branch expansion ahead, the for

into wealth management and the optimal leveraging of technology, we believe that the core fee incom

could gain further traction from hereon.

Exhibit 9: Strong non-treasury income contribution


17.26

12.9914.91 15.39

12.3714.49

Fed Bnk Dhan Bnk INVYB SIB K'tka Bnk KVB

0%

50%

100%

150%

2004 2005 2006 2007 2008 2009 2010

Treasury Non Treasury

Well capitalized for futuregrowth

New initiatives could result totraction in core fee income


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MSFL Research

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Coupled with healthy non-interest income growth and lower operating expenses, the Burden ratio (N

Interest Income covering opex) for the bank stands at 78% as compared to peer average of 72%. Wh

opex of the bank will inch up as it is adding new branches to expand its geographical footprints, CA

growth of 13% in Non Interest Income in FY11-12E would maintain burden ratio at above 70% level.

Exhibit 10: Burden ratio A peer comparison


Dominant Southern player Strength to reckon forFederal bank is the fourth largest private sector bank in India in terms of asset size though it is less th

one-fifth of the size of the average assets of that of top three private banks in India. However Fede

bank has traditionally been a strong player in the southern region especially Kerala. Federal Banks ass

is nearly 2.4x of the average size of its peers and the branch network is nearly 1.5x of that of pee

average. Thus the sheer size and scale of the bank makes it a dominant south based private player. Bei

the oldest private sector bank in this region, Federal Bank has an enviable NRI customer base of 0.4 m

of the total customer base of 5 mln. Federal Bank has around 58% of its branches in Kerala with arou

46% of its business coming from the state. It is because of this geographic distribution that the bank

traditionally viewed as a Kerala-based bank. However, in line with its expansion strategy, the bank

planning to increasingly open its new branches outside Kerala. Federal bank currently has 672 branch

Further, it expects to add another 75-100 branches in FY2011 with focus on regions such as the Nation

Capital Region, Maharashtra and Bangalore. Federal bank is planning to open 70-80% of the n

branches outside Kerala to achieve a pan-India presence and shed the identity of being a regional ban

The stated goal for retail franchisee is 1,000 branches by the end of FY2012.

11: Asset base comparison (peer banks) Exhibit 12: Asset base comparison (South based banks)

ource: Company, MSFL Research Source: Company, MSFL Research

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0%

20%

40%

60%

80%

100%

FedBank KVB IVYB CUB DhanBk K'ka Bk

Burden Average

0

1000

2000

3000

4000

ICICI

HDFC

Bk

Axis

FedBk

J&

K

Bk

INVYB

Kotak

IndusIn

d Yes

K'tka

Total Assets (in bln)

0

100

200

300

400

500

FedBk

INVYB

K'tka

SIB

KVB

LVB

CSB

Dhan.

Bk

Total Assets (in bln)

Largest south based privatebank with 1.5x more branchpresence than that of peers


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MSFL Research

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Enviable franchise network.Due to its geographical presence, Federal Bank has been able to build an enviable franchise netwo

with low cost deposits forming 46.4% of the total deposits on account of strong NRI customer ba

combined with CASA deposits. With a strong branch network of 672 branches, the low cost deposit p

branch matrix stands most valuable compared to peers.

Exhibit 13: Low cost deposits per branch A peer comparison


..though not reflective in franchise valuationInspite of having the most valuable franchise network amongst the peers, Federal Banks franch

valuation doesnt reflect similar strength. The most important reason we believe is the overhang of t

Catholic Syrian Bank (CSB) merger while the other reason was asset quality concerns which weigh

heavily on banks performance in past one year. We believe that the inherent strength of the franch

network cannot be ignored and shouldcommand adequate valuation over a period of time.Exhibit 14: Market Cap per branch A peer comparison


0.00

50.00

100.00

150.00

200.00

250.00

300.00

Fed Bank IVYB SIB KVB K'ka Bk DhanBk

Low Cost Deposits/Branch

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

KVB IVYB Fed Bank K'ka Bk DhanBk SIB

Highest low cost deposits perbranch ratio amongst itspeers

Certain concerns keepvaluation depressed


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MSFL Research

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Operational Efficiency Best amongst the peersFederal bank is one of the oldest private sector banks in India and in spite of which it has be

technologically at par with many new-aged private sector banks. The bank has made substant

investments in technology over the last three to four years. It was the first traditional private sect

bank to computerise all its branches (as early as in January 2004) and amongst the earliest banks in Ind

to implement real-time gross settlement (RTGS) in all branches. This has given Federal bank an ed

over the other banks in terms of fee income stream, service quality and efficiency. The bank al

completed the roll-out of the Core Banking Solution (CBS) in less than a year, which is commendab

especially for an old generation private sector bank. This largely reflects in the cost to income ra

which over the past five years stands at an average of around 38%. Also given the size of the bank, t

opex/branch ratio is below average to that of peers thus making it the most efficient bank down sou

in terms of operational effeciency. Having said that, we believe that the cost-income ratio of the bank

likely to inch up in FY2011 and FY2012 on account of the aggressive branch expansion.

Exhibit 15: Operating Expenses A peer comparison


Exhibit 16: Business Efficiency - A peer comparison


0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

0.00

5.00

10.00

15.00

20.00

Fed

Bank

SIB KVB IVYB DhanBk K'ka Bk

Opex/Branch Cost to Inc

- 200 400 600 800 1,000 1,200

Fed Bank

SIB

KVB

IVYB

DhanBk

K'ka Bk

Bus/Employee Bus/Branch

Early adoption of technolgy isbearing fruits now for thebank


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MSFL Research

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Asset Quality Tad Apprehension.Federal Banks asset quality deteriorated in line with the industry trend in the last fiscal due to its hi

exposure to sectors such as Retail and SME. For Q4FY10, the GNPA on relative basis was stable at 2.97

though on absolute basis it showed deterioration with 3.8% addition. Of the Rs 3.2 bln slippages duri

the quarter, Rs 1.6 bln was contributed by four large corporates however retail formation (especia

Housing) is coming off (Rs. 0.6 bln). The Net NPA for the bank has improved by 8 bps sequentially

0.48% on account of increase in provisions. Mangement has guided that stress on assets could lik

persist for couple of quarters; however with economy showing signs of revival, the pressure cou

relatively ease out in couple of years. Also the provision coverage ratio (PCR) which currently stands

~91% (including technical write-offs) augurs well for the bank and provides comfort in terms of impa

on the bottomline. Though the current GNPA stands higher than the average of the peers( Average

2.25%), the PCR stands out for the bank.

On restructured assets front, Federal Bank has restructured assets worth Rs 650 mln during Q4FY10 th

taking the cumulative restructuring to Rs 10930 mln, forming 4.1% of the advances. Of the ass

restructured, accounts worth Rs 610 mln slipped into NPA during Q4FY10 while for FY10 the slippag

amounted to Rs 1200 mln forming 11% of the total restructured assets.

Exhibit 17: Restructured Assets Details


Exhibit 18: NPA Movement Exhibit 19: NPA Peer comparison

Source: Company, MSFL Research Source: Company, MSFL Research

0

1000

2000

3000

4000

Q1FY10 Q2FY10 Q3FY10 Q4FY10

Standard Total

76.0%

78.0%

80.0%

82.0%

84.0%86.0%

88.0%

90.0%

92.0%

0.0%

0.5%

1.0%

1.5%2.0%

2.5%

3.0%

3.5%

4QFY08

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

GNPA NNPA PCR

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

0

1

2

3

4

K'tka

Bnk

Fed Bnk INVYB Dhan

Bnk

KVB SIB

GNPA % NNPA % PCR

Slippages of 3.3% on accountof Corporate and Retailsegment

Restructured assets 4.1% ofAdvances; in line withIndustry trend


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MSFL Research

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.but could be managedOne of the key reasons for the higher slippages is the crisis in the Middle Eastern countries, which had

strong impact on the income levels of the NRIs residing there and hence led to stress on the ban

housing loan portfolio. While the housing loan portfolio of the bank is likely to remain under stress

the near term as the bank holds a huge restructured loan portfolio (4.1% of total loans), the pressure

likely to taper off as the concerns related to Dubai and the other Middle Eastern countries are abatin

thus resulting in coming off of slippages in Retail segment.

Also the concerns seems to be manageable considering the following.

1. The credit assessment and monitoring mechanism has been revamped. Under the prior set-up, t

credit appraisal was done at branch level, which is now done at specialised offices. Moreov

Federal Bank has put in place a clear hierarchy of escalation of loan proposals depending on t

size (amount).

2. The recovery mechanism is in the process of getting restructured and is now a key focus ar

Boston Consulting Group is helping with this.

3. The slippages are primarily from the retail segment, which is witnessing a revival as indicators su

as income levels, employment and consumption are reviving.

4. The high provisioning coverage of +91% (including technical write-offs) is well above t

mandatory 70% level and best among the peers. This provides significant comfort in terms of tbanks ability to bear the credit losses without undue stress on the bottom line.

CSB Merger A Closed Chapter?One of the major reason for Federal bank stocks underperformance in the past two years is t

apprehension which was loominng large over its proposed merger with Catholic Syrian Bank (CSB). T

talks of CSB acquisition were initiated by Federal bank way back in 2008 and since then the acquisiti

has been in a limbo. The basic idea of acquiring CSB was to consolidate Federal Banks dominati

position in Kerala to withstand any future competition in the state. However while initially CSB h

agreed on the acquistion plans, the plan could not be consummated due to various resistances fac

such as valuation differences, strong reservations from the Archbishop of the Diocese of Thrissur

major stakeholder) over the loss of identity, employee dissent and so on.

High PCR and necessary stepstaken by bank could keepasset quality under control

Comparative weakfundamentals of CSB Amajor concen over themerger


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MSFL Research

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Exhibit 20: Comparative Study of Financials*Comparative Analysis(in mln) Federal Bank CSBNetworth 43258.7 3883

Deposits 321981.9 63328.3

Advances 223918.7 36838.4Net Profit 5004.9 371.9

EPS 29.3 19.7

Book Value 252.9 184.1

GNPA (%) 2.6 4.6

NNPA (%) 0.3 2.4

PCR (%) 88.4 48.8

RoE (%) 12.1 12.2

RoA (%) 1.4 0.6

NIM (%) 3.7 2.5

Cost to Inc (%) 31.2 70.3

Branches 612.0 363.0

Business/Branch 892.0 275.9

Profit/Branch 8.2 1.0

Business/Employee 72.1 37.4

Profit/Employee 0.7 0.1


* As of 31 March 2009

The comparative analysis as above (Exhibit) validates the concerns of the Federal Bank-CSB merger

account of the following grounds

Branch Network OverlapFederal Bank and CSB dominantly operate in Kerala region with often the branches of both the ban

being in the same cities, towns and villages. Had the merger consummated there could have be

serious overlap of branch networks in nearly 100 locations which is a deterrent since geographi

synergies are generally the biggest motivation behind bank mergers. This merger would furth

concentrate Federal Banks branches as post-merger ~61% of the branch network would be in Kera

Federal Bank already has the strongest presence in Kerala and by acquiring CSB it will be undoing all

effort to diversify by expanding its footprints outside Kerala.

CSBs weak fundamentalsCSB is comparatively a weak bank with its profitability being less than one-tenth of that of Federal Ban

Apart from the profitability aspect, CSB is weak on most of the operational parameters as shown in t

comparative study. CSB is yet to complete its core banking implementation which Federal Bank h

done long back and is reaping the benefits in terms of operational effeciences. (See Exhibit 15)

Resistance from various stakeholdersThe proposed merger, since the time of announcement, has been facing various hurdles from vario

stakeholders of the bank. Archbishop of the Diocese of Thrissur, a major stakeholder of CSB, has be

strongly opposing the merger as it sees any takeover attempt as a loss of CSBs identity. Another hurd

is in the form of strong employee union who are largely dissatisfied with the merger proposal.

Overall, the merger possibility with CSB has diminished substantially due to strong reservations fro

various stakeholders and this we believe is positive for Federal Bank as it is far more superior bank a

the possible merger would only have strained the profitablity of Federal Bank.


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MSFL Research

1

Inherent Fundamentals remain StrongWhile Federal Banks RoE has been strained by excess liquidity on the balance sheet post rights iss

bank has delivered an average RoA of 1.3% in the past five years thus exhibiting the superior quality

sustainable earnings on account inherently strong fundamentals of the bank. Low cost deposits, stro

margins, focus on high yielding sectors and valuable franchise network are some of the positives whi

outweigh the burden of high provisions (due to exposure to riskier segments).

Exhibit 21: Breakdown of RoA Federal BankParticulars 2006 2007 2008 2009 201nterest Income 7.7% 7.9% 8.7% 9.3% 8.9%

nterest expenses 4.5% 4.7% 5.7% 5.6% 5.5%

II/avg assets 3.2% 3.1% 3.0% 3.7% 3.4%

ther Inc/avg. assets 1.2% 1.3% 1.4% 1.4% 1.3%

otal Net Income 4.4% 4.5% 4.4% 5.1% 4.7%

perating exp/avg. assets 1.9% 1.8% 1.6% 1.6% 1.6%

perating profit/avg assets 2.4% 2.7% 2.8% 3.5% 3.1%

rovisions/avg. assets 0.9% 1.0% 1.0% 1.3% 1.0%

BT/avg. assets 1.5% 1.7% 1.7% 2.2% 2.1%

ax/avg. assets 0.3% 0.4% 0.5% 0.8% 1.0%

AT/avg. assets 1.2% 1.3% 1.3% 1.4% 1.1%


Further, the comparative study of RoA decomposition suggests that Federal Bank has been abo

average on all key operating performances with its RoA for FY10 being 1.13% (calculated) compared

peer average RoA of 0.9%. The performance on RoA could have been better had not the bank had

make higher tax provisions (46%) for an exceptional item. This exceptional item is on account of

impending tax case with Income Tax department for which the bank has made full provisions a

expects a normalised tax rate of 33-34% going ahead. Nevertheless, the sustainable RoA deliverance

the bank points out towards the strong fundamentals of the bank and going forward we expect Fede

Bank to deliver an average RoA of 1.3% for FY11-12E.

22: RoA Breakdown Federal Bank Exhibit 23: RoA Breakdown Peer comparison

ource: Company, MSFL Research Source: Company, MSFL Research

8.9%

3.4%

1.1%

5.5%1.3%

1.6%

1.0%1.0%

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%

7.5%

2.1%0.9%

5.4%1.3%

1.9% 0.4% 0.3%

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%

Return on Assets (RoA) standsout amongst peers


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MSFL Research

1

Peer ComparisonThe divergence in RoA and RoE as well as concerns on possible CSB merger has played heavily

Federal Banks stock and as a result of which the stock has been trading at shallow band of 0.5-1x of

one year forward P/ABV in the past 2 years. However, the strengths of the bank such as super

technological network, valuable franchise network, high yielding loan book exposure and contained c

of funds outweigh the concerns on provisioning burden for the bank. Inspite of higher tax expen

(46% for FY10) due to exceptional item, Federal Bank reported RoA of 1.13%, higher than peer avera

of 0.9%, thus reflecting the soundenss of the earnings quality of the bank. Considering all these facto

we believe that the bank is trading at a significant discount to its peers across important parameters.

Exhibit 24: Comparative ValuationFedBank KVB IVYB CUB DhanBk K'ka Bk SI

P/ABV 1.12 1.63 1.46 1.47 1.71 1.18 1.1

ROA 1.3% 1.5% 0.8% 1.6% 0.5% 0.8% 1.0%

ROE 12.4% 21.8% 11.4% 23.1% 9.3% 12.1% 18.4%

Source: Bloomberg, MSFL Research

Exhibit 25: RoA-P/ABV Peer Comparison

Source: Company, MSFL ResearchValuation and viewThe core profitability of the bank and growth outlook has been above average compared to pee

While till recently Federal Bank was grappling with depressed RoE due to low leverage on account

economic crisis, the same same we believe is set to change. Federal Bank could be a a key beneficiary

the economic upcycle in light of sustained economic recovery and the conducive environment for t

banking sector ahead as bank can now leverage its capital position for growth. In addition to t

conducive macro environment, we believe that the bank would maintain the lead over its peers acro

operating parameters. Against this backdrop, we strongly believe that below the peer average valuati

of the bank are unjustified considering the scale and superior quality of earnings of the bank.

At the current market price of Rs324, Federal Bank trades at 1.1x and 1.0x of its FY2011E and FY201

ABV per share. Historically, the stock has traded in the range of 0.5-1.4x its one-year forward price/ A

multiple. We value the bank at 1.24x FY2012E ABV per share, considering the bank's potential to gr

above the industry average in future. We initiate coverage on Federal Bank with a Buy recommendat

and a price target of Rs400.

FedBank

KVB

IVYB CUB

DhanBk

K'ka Bk

SIB

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0%

PAB

ROA

Avg: 1.1%

Avg:1.38


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Source: Company, MSFL ResearchRisks and concernsAsset qualityIn line with the industry trend, the bank's asset quality improved substantially from FY2002 onwar

Going forward, we believe that the bank may continue to face asset-quality pressures for the next f

quarters, in view of its higher exposure to the retail and SME segments. Though we have factored in tstabilising/improving trend in its asset quality from 2011 onwards, unforeseen eve

(globally/domestically) could materially change the near-term outlook on its asset quality.

Increased competition from larger playersIncreasing focus of larger banks increasingly focus on Tier- II and Tier-III cities down South

incremental operational expansion, could result in tough competition for Federal Bank which already h

presence in such cities. Also banks inability to execute the aggressive branch expansion for achievi

pan-India presence could materially change the key underlying assumptions of our earnings estimates

CSB acquisitionWhile the acquisition of CSB is not expected to fructify in near future, a sudden turn of events on t

front leading to an eventual acquisition would have a significant impact on some of our key assumptio

(due to reasons discussed already) and could materially alter our near-term outlook on the bank.High dependence on NRI depositsBeing based in the state whos economy largely thrives on expatriates in the Middle East; deposits com

cheap to this bank. However it also exposes the bank to the downturn risk in these countries and as

result of which low CASA ratio (26% currently) could be detrimental to its earnings.

Company BackgroundIncorporated in 1931, Federal Bank is an old private-sector bank with a dominant presence in t

southern state of Kerala. It currenlty operates with 672 branches and 732 ATMs across the country wit

customer base of over 5 mln including NRI clientele base of over 0.4 mln. Federal Banks business h

grown at CAGR 21.3% over FY2006-10 while the current asset base of the bank is Rs. 436757 mln. Banadvances are primarily dominated by SME and Retail segment which form 30.7% and 31.2% of the lo

book respectively. The bank completed the acquisition of Ganesh Bank in 2006 and added 32 branch

to its existing network, thereby increasing its foothold in Western India. The bank holds a 4.99% sta

each in CSB, South Indian Bank and Lakshmi Vilas Bankall south-based banks with a strong presence

Kerala.

0.50

0.75

1.00

1.25

1.50

1.75

0

50

100

150

200

250

300

350

400

450

500

Apr-05

Jun-05

Aug-05

Oct-05

Dec-05

Feb-06

Apr-06

Jun-06

Aug-06

Oct-06

Dec-06

Feb-07

Apr-07

Jun-07

Aug-07

Oct-07

Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Aug-09

Oct-09

Dec-09

Feb-10


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Subsidiaries, Joint Ventures and Other InitiativesIDBI Fortis Life Insurance Company LtdIDBI Fortis Life Insurance Company is the Bank's Joint Venture Life Insurance Company in associati

with IDBI Bank Ltd and Fortis Insurance International N.V, in which Federal Bank has 26% stake. Fede

bank has infused Rs 1.17 bln as share of capital in this JV. The JV company started selling life insuran

products from March 2008.

FedBank Financial Services LtdIs a 100% subsidiary of the bank established for marketing retail products of the banks. It also propos

to sell Insurance/Mutual Fund products through Retail Hubs established at major centers. Federal ba

has established separate mechanism for speedy and dedicated processing of loans sourced through t

channel. In future this subsidiary is expected to help fuel growth of retail advances and fee income fro

retail loan processing and cross selling of third party products.

Fed-e-TradeFederal Bank also has launched its retail broking business known as - FED-e-TRADE - in association w

BNP Geojit Paribas Financial Services.UAE Representative OfficeThe bank has a representative office at Abu Dhabi, Capital of U.A.E. This representative office is

gateway of the bank to the whole of Middle East and has helped in increasing the reach of the ba

among Non-Resident Indians in the Gulf Countries and has established an interface between existi

customers of GCC countries and Branches/Offices in India. This has enabled the bank to garner a go

chunk of low cost NRI deposits which currently constitute around 25.4% (excluding ordinary no

resident term deposits which have interest rates in line with domestic term deposits) of the ret

liabilities of the bank.


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Profit & LossParticulars (Rs in mn) 2008 2009 2010 2011P 201Interest Income 25,154 33,154 36,732 44,493 54,8

Interest Expense 16,474 19,999 22,624 27,846 35,1

Net Interest Income (NII) 8,680 13,155 14,108 16,648 19,6

Other Income 3,950 5,158 5,309 5,962 6,7

Net Total Income 12,630 18,312 19,417 22,610 26,4Operating Expenses 4,689 5,715 6,769 7,913 9,2

Pre-Provisioning Profit (PPP) 7,941 12,598 12,649 14,696 17,1

Provisions & Contingencies 2,940 4,668 4,053 5,582 5,4

PBT 5,002 7,930 8,596 9,115 11,7

Tax 1,321 2,925 3,950 3,092 3,0

PAT 3681 5005 4646 6107 78Net Interest Margin (NIM) 3.0% 3.7% 3.4% 3.4% 3.3

EPS 21.5 29.3 27.2 35.7 46

NII Growth (%) 21.1% 51.5% 7.2% 18.0% 18.2

PAT Growth (%) 25.7% 36.0% -7.2% 31.5% 29.2

Balance SheetParticulars (Rs in mn) 2008 2009 2010 2011P 201Liabilities

Equity 1,710 1,710 1,710 1,710 1,7

Reserves & Surplus 37,547 41,548 45,194 50,229 56,7

Networth 39,257 43,259 46,905 51,940 58,4

Deposits 259,134 321,982 360,580 443,513 541,0

Borrowings 7,920 7,489 15,468 13,981 22,

Other Liabilities & Provisions 18,755 15,779 13,804 22,019 22,6

Total Liabilities 325,065 388,509 436,757 531,453 644,8AssetsCash & balances with RBI 23,557 22,144 23,189 25,200 33,2

Balances with banks & money

at call3,898 12,227 4,045 12,037 7,

Investments 100,266 121,190 130,546 150,886 188,8

Advances 189,047 223,919 269,501 331,486 401,0

Fixed assets 2,328 2,808 2,898 4,372 5,6

Other assets 5,969 6,221 6,577 7,471 8,4

Total Assets 325,065 388,509 436,756 531,453 644,8


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RatiosValuation Ratios 2008 2009 2010 2011P 201P/E 15.1 11.1 11.9 9.1

P/BV 1.4 1.3 1.2 1.1

P/ABV 1.4 1.3 1.2 1.1

P/PPP 7.5 4.7 4.7 4.0

EPS 21.5 29.3 27.2 35.7 4DPS 4.0 5.0 5.0 5.4

Book Value (BV) 229.5 252.9 274.2 303.7 34

Adjusted Book Value (ABV) 226.6 248.6 266.4 290.2 32

Profitability RatiosROE 13.6% 12.1% 10.3% 12.4% 14.

ROA 1.3% 1.4% 1.1% 1.3% 1.

Leverage (x) 6.9 7.7 8.1 8.9

Spread AnalysisYield on Advances 10.8% 12.4% 11.6% 11.7% 11.Yield on Investments 7.3% 6.3% 6.2% 6.3% 6.4

Cost of Deposits 6.4% 6.4% 6.3% 6.5% 6.

Cost of Funds 6.7% 6.7% 6.5% 6.7% 6.

Net Interest Margin (NIM) 3.0% 3.7% 3.4% 3.4% 3.

Asset QualityGross NPA (%) 2.4% 2.6% 3.0% 3.0% 2.

Net NPA (%) 0.2% 0.3% 0.5% 0.7% 0.

Provision Coverage Ratio 90.8% 88.4% 84.3% 77.9% 79.

Slippage Ratio 1.8% 3.0% 3.3% 3.0% 2.

Effeciency RatiosCost/Income Ratio 37% 31% 33% 35% 3

Burden 84% 90% 78% 75% 7

Business per Branch (in mln) 836 905 938 1044 11

Business per Employee (in mln) 64 72 81 98 1


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MSFL Disclaimer:All information/opinion contained/expressed herein above by MSFL has been based upon information available to the public and

the sources, we believe, to be reliable, but we do not make any representation or warranty as to its accuracy, completeness or

correctness. Neither MSFL nor any of its employees shall be in any way responsible for the contents. Opinions expressed are

subject to change without notice. This document does not have regard to the specific investment objectives, financial situation

and the particular needs of any specific person who may receive this document. This document is for the information of the

addressees only and is not to be taken in substitution for the exercise of judgement by the addressees. All information contained

herein above must be construed solely as statements of opinion of MSFL at a particular point of time based on the information as

mentioned above and MSFL shall not be liable for any losses incurred by users from any use of this publication or its contents.

Analyst declarationI, Laxmi Ahuja, hereby certify that the views expressed in this report are purely my views taken in an unbiased manner out ofinformation available to the public and believing it to be reliable. No part of my compensation is or was or in future will be linked

to specific view/s or recommendation(s) expressed by me in this research report. All the views expressed herewith are my personal

views on all the aspects covered in this report.

MSFL Investment RatingThe ratings below have been prescribed on a potential returns basis with a timeline of up to 12 months. At times, the same may

fall out of the price range due to market price movements and/or volatility in the short term. The same shall be reviewed fromtime to time by MSFL. The addressee(s) decision to buy or sell a security should be based upon his/her personal investment

objectives and should be made only after evaluating the stocks expected performance and associated risks.

Key ratings:Rating Expected ReturnBuy > 15%

Accumulate 5 to 15%

Hold -5 to 5%

Sell < -5%

Not Rated -

Marwadi Shares & Finance LimitedInstitutional Business Group@p-sec, 306, Gresham Assurance House

Registered OfficeMarwadi Financial Plaza, Nava Mava Main Road,

132, Mint Road, Fort, Mumbai 400 001 Off 150 FT. Ring Road, Rajkot,- 360 005

Tel : + 91 22 2269 0474 / 75 Fax : +91 22 2269 0478 Tel : + 91 281 2481313 / 3011000

msfl - federal bank - initiating coverage - june 17 2010

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