Federal Bank

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Financial summaryY/E Mar (Rs mn) F12 F13 F14 F15e F16eNet interest income 19,534 19,747 22,286 24,691 30,166

Operating profit 15,065 14,596 14,804 16,847 20,874

PAT 7,768 8,382 8,389 9,669 12,142

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 (%) 1.6 1.6 1.7 1.7 1.7RoE (%) 14.4 13.9 12.6 13.2 14.8

RoAA (%) 1.4 1.3 1.2 1.2 1.3Source: Company, SSLe

SME and Retail to drive the growth; Improved asset quality ahead

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.

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 F11-14, 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 well-distributed mix with the 3 core segments. Change in political scenario bodes well for the overall economy, leading to pick-up in credit.

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.

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.

Initiating Coverage BUY

Current price (12 Aug) RsTarget price RsUpside/(downside) % 23

Market dataMkt capitalisation Rs bn 98.2Average daily vol '000 3903.652-week H/L Rs 136 / 44.25Shares O/S mn 855.1Free float mn 855.1Promotor holding % 0.0Foreign holding % 38.7Face value Rs 2.0

Price performance (%)1m 3m 6m 1yr

Nifty (abs) 3.6 10.2 27.0 37.7Stock (abs) 1.3 17.0 47.9 73.6Relative to Index (2.3) 6.9 20.9 35.9

Performance

115 141

(40)

(20)

0

20

40

60

30

60

90

120

150

Aug-13 Nov-13 Feb-14 May-14 Aug-14

Federal Bank (LHS) Rel. to Bankex (RHS)

(%)(Rs)

Source: Bloomberg, SSLe

August 13, 2014Banking | India Federal Bank FB IN; FED.BO

Divyanshi Dayanand +91 22 4227 3385 [email protected] Ravikant Bhat +91 22 4227 3349 [email protected] Ankit Ladhani +91 22 4227 3380 [email protected] Aayush Dureha +91 22 4227 3456 [email protected]

Federal Bank SBICAP Securities Ltd

[email protected] I [email protected] I [email protected] I [email protected] 13 August 2014 | 2

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 in-state 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

0.0

2.5

5.0

7.5

10.0

F09 F10 F11 F12 F13

(%)

GSDP Growth rate at constant prices

30,000

40,000

50,000

60,000

70,000

F09 F10 F11 F12 F13

(Rs)

India Kerala Source: Government of Kerala, SSLe



Consolidation phase over, credit growth to re-emerge

In an environment where general economic downturn has meant poor credit off-take 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

Retail30%

SME & agri18%Agri

10%

Corporate42%

F13

Retail32%

SME & agri25%

Agri12%

Corporate31%

F14

Source: Company, SSLe

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

(8)

0

8

15

23

0

150,000

300,000

450,000

600,000

F09 F10 F11 F12 F13 F14 F15e F16e(%

)

(Rs

mn)

Advances (LHS) Advances growth (RHS) Source: Company, SSLe

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.



Exhibit 4: Break-up of SME book Exhibit 5: Break-up of Corporate book

Hotels & restaurant

s3%

Education4% Textiles

5% Basic Metals

5%Food &

beverages9%

Construction others

8%Retail Trade11%

Wholesale trade16%

Others39%

NBFC13%

Wholesale trade12%

Power10%

Basic metals

8%Road bridges railways

7%

Real estate - HFC

3%Retail trade

4%

Electricity gas 3%

Food & beverages

3%

Others37%


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

FB19%

FB230%

FB350%

FB49%

Others2%


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.



Exhibit 7: Housing and mortgage have gained traction since F13

38 40 40 40 42

32 30 29 27 25

22 22 22 23 21

8 8 9 10 12

0%

25%

50%

75%

100%

4QF13 1QF14 2QF14 3QF14 4QF14

Housing Gold Mortgage Others Source: Company, SSLe

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 post-average 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 Exhibit 9: Retail Deposit proportion at 93%

22.6 25.314.6 14.7

2.8

40.0 37.544.7 41.4

43.1

11.5 10.7 13.3 17.023.4

25.9 26.5 27.4 26.9 30.8

0%

25%

50%

75%

100%

F10 F11 F12 F13 F14

CASA NRI TD Resident retail TD Bulk

75

80

85

90

95

100

4QF13 1QF14 2QF14 3QF14 4QF14

(%)




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

0

8

15

23

30

0

220,000

440,000

660,000

880,000

1,100,000

F09 F10 F11 F12 F13 F14 F15e F16e

(%)

(Rs

mn)

Deposits (LHS) Deposits growth (RHS) Source: Company, SSLe

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 11: CASA momentum to sustain Exhibit 12: Low-cost deposit proportion much higher than peer-average

120

140

160

180

200

0

75,000

150,000

225,000

300,000

F10 F11 F12 F13 F14 F15e F16e

(Rs

mn)

(Rs

mn)

CASA (LHS) CASA/ Branch (RHS)

0

10

20

30

40

City Union Bank

DCB Bank ING Vysya

Karnataka Bank

Karur Vysya Bank

Federal Bank

South Indian Bank

(%)


Exhibit 13: CASA Trend

F14 Proportion Growth (%)Kerala (CA) 12,500 6.8 14

Non-Kerala (CA) 18,660 10.1 11

Kerala (SA) 117,270 63.7 21

Non-Kerala (SA) 35,580 19.3 18




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.

Exhibit 14: Lower slippages and sales to ARCs help credit quality

0

1

2

3

4

0

4,500

9,000

13,500

18,000

F09 F10 F11 F12 F13 F14 F15e F16e

(%)

(mn)

GNPA (LHS) NNPA (LHS) GNPA (RHS) NNPA (RHS) Source: Company, SSLe

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

0%

2%

3%

5%

6%

Agriculture & allied activities

Industry (Micro, 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.



Exhibit 16: Declining slippage trend encouraging Exhibit 17: Significant improvement in Retail and SME slippages

0

1000

2000

3000

40004Q

F12

1QF1

3

2QF1

3

3QF1

3

4QF1

3

1QF1

4

2QF1

4

3QF1

4

4QF1

4

(Rs

mn)

Retail SME & Agri Corporate

0.0

0.5

1.0

1.5

2.0

1QF1

2

2QF1

2

3QF1

2

4QF1

2

1QF1

3

2QF1

3

3QF1

3

4QF1

3

1QF1

4

2QF1

4

3QF1

4

4QF1

4

(%)

SME Retail Source: Company, SSLe

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.

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

70

75

80

85

90

0.0

0.3

0.6

0.9

1.2

F09 F10 F11 F12 F13 F14 F15e F16e

(%)

(%)

Credit cost (LHS) PCR (RHS) Source: Company, SSLe

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.



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

0

4

8

12

16

F09 F10 F11 F12 F13 F14 F15e F16e

(%)

Yield on advances Cost of Deposits Source: Company, SSLe

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.



Exhibit 20: Substantial network expansion in the past 3 years

1.0

1.1

1.2

1.3

1.4

0

500

1,000

1,500

2,000

F09 F10 F11 F12 F13 F14e F15e F16e

(%)

(Nos

.)Branches (LHS) ATMs (LHS) ATM/Branch ratio (RHS)

Source: Company, SSLe 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 solid branch network of 1174 branches (4th 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

0.0

0.4

0.8

1.2

1.6

F09 F10 F11 F12 F13 F14 F15e F16e

(%)

Non-interest income/ average assets Fee income/ average assets Source: Company, SSLe



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

50

52

54

56

58

0

13

26

39

52

F09 F10 F11 F12 F13 F14 F15e F16e

(%)(%

)

C/I Ratio (LHS) Staff cost/Expenses (RHS)

0.00

0.50

1.00

1.50

2.00

F09 F10 F11 F12 F13 F14e F15e F16e

(%)

Opex/ assets Source: Company, SSLe

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

0.0

5.0

10.0

15.0

20.0

25.0

770

840

910

980

1,050

F11 F12 F13 F14 F15e F16e

(%)

(Nos

.)

Business per branch NII Growth Source: Company, SSLe



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

Leverage (Asset/NW) (x) 9.32 10.08 10.63 11.17 10.74 10.80 10.60




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 F14-F16e. 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.

Exhibit 25: Much improved RoE from F16e

0.0

4.0

8.0

12.0

16.0

0.0

0.4

0.8

1.2

1.6

F10 F11 F12 F13 F14 F15e F16e

(%)

(%)

RoA (LHS) RoE (RHS) Source: Company, SSLe

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 peers4QF14 Advances Deposits CASA CAR (Tier I) NIM RoA RoE GNPA NNPA PCR % Restructured C/I ratioCity Union Bank 160,968 220,169 16.7 14.5 3.3 1.3 17.1 1.8 1.2 62.0 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 47.7South 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




Exhibit 27: Median P/ABV for the last 6 months at 1.31x

0.0

0.5

1.0

1.5

2.0

Apr-

05Se

p-05

Feb-

06Ju

l-06

Dec

-06

May

-07

Oct

-07

Mar

-08

Aug-

08Ja

n-09

Jun-

09D

ec-0

9M

ay-1

0O

ct-1

0M

ar-1

1Au

g-11

Jan-

12Ju

n-12

Nov

-12

Apr-

13Se

p-13

Feb-

14Au

g-14

(x)

Source: Bloomberg, SSLe Exhibit 28: Key Assumptions Y/E Mar (Rs mn) F15e F16eBalance Sheet AssumptionsCredit Growth (%) 15.3 18.0

Deposits Growth (%) 16.0 21.8

Investments (%) 22.5 21.2

CD Ratio (%) 72.2 70.0

Asset Quality AssumptionsSlippage Ratio (%) 1.2 1.2

Net Recovery Ratio (Reductions as % of slippages) 40.0 40.0

Provisioning Cover (%) 82.8 85.3

Source: SSLe



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.



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.

As of F14, the bank had a balance sheet size of ~Rs746bn. It has the 4th 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

Metro15%

Urban18%

Semi-urban57%

Rural10%


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.



Financials

Income statement Ratios Y/E Mar (Rs mn) F12 F13 F14 F15e F16e Y/E Mar (Rs mn) F12 F13 F14 F15e F16eInterest 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 9.1 9.8 9.8 11.3 14.2 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 Growth (%) 11.8 1.1 12.9 10.8 22.2 Adjusted book value 64.3 69.3 77.4 88.7 100.4 Other income 5,323 6,644 6,938 8,389 9,692 Dividend per share 1.8 1.8 2.0 2.0 2.0 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 Other miscellaneous income 1,145 746 787 1,178 1,208 NPA coverage 84.7 72.2 70.4 82.8 85.3 Operating income 24,858 26,391 29,225 33,079 39,859 NNPA/networth (%) 3.5 6.8 4.6 1.7 1.6 Growth (%) 9.8 6.2 10.7 13.2 20.5 Profitability ratios (%)Operating expenses 9,793 11,795 14,421 16,233 18,985 RoE 14.4 13.9 12.6 13.2 14.8 Staff cost 5,439 6,265 7,715 9,244 10,668 ` RoA 1.4 1.3 1.2 1.2 1.3 Other operating expense 3,788 4,744 5,766 5,997 7,128 NIM 4.1 3.5 3.6 3.7 3.8 Depreciation 567 787 939 991 1,189 Operating profit margin 24.7 21.4 19.4 20.6 21.4 Pre-provision profits (PPP) 15,065 14,596 14,804 16,847 20,874 Net profit margin 12.8 12.3 11.0 11.8 12.5 Growth (%) 5.6 (3.1) 1.4 13.8 23.9 C/I ratio 39.4 44.7 49.3 49.1 47.6 Provisions 3,370 2,658 2,684 2,834 3,162 C/I (excl. treasury gains 40.7 48.5 52.1 51.6 49.8 Profit before taxes 11,695 11,938 12,120 14,013 17,713Taxes 3,927 3,556 3,731 4,344 5,571 Earning ratiosTax rate (%) 33.6 29.8 30.8 31.0 31.5 Y/E Mar F12 F13 F14 F15e F16eProfit after taxes 7,768 8,382 8,389 9,669 12,142 Yield on advances 12.0 11.3 11.4 10.8 11.1 Growth (%) 32.3 7.9 0.1 15.3 25.6 Yield on investments 11.4 10.5 11.0 11.3 10.6

Yield on IEA 11.7 11.0 11.4 11.0 11.0 Balance sheet Cost of deposits 7.2 7.2 7.2 7.3 7.3 Y/E Mar (Rs mn) F12 F13 F14 F15e F16e Cost of IBL 7.4 7.2 7.4 6.8 6.7 LIABILITIES Spread 4.4 3.8 4.0 4.2 4.3 Capital 1,710 1,711 1,711 1,711 1,711Reserves & surplus 55,299 61,884 67,745 75,419 85,567 ValuationsDeposits 489,371 576,149 597,313 692,883 843,585 Y/E Mar F12 F13 F14 F15e F16eBorrowings 42,410 51,870 56,880 88,344 93,764 P/E 12.7 11.7 11.7 10.2 8.1 Other liabilities & provisions 17,423 18,831 22,243 21,921 22,774 P/BV 1.7 1.5 1.4 1.3 1.1 Total liabilities 606,268 710,496 745,941 880,328 1,047,450 P/ABV 1.8 1.7 1.5 1.3 1.1

Dividend yield (%) 1.6 1.6 1.7 1.7 1.7 ASSETSCash on hand & with RBI 24,241 27,425 31,043 51,793 68,349Money at call and short notic 11,084 9,775 14,251 14,251 14,251 Capital adequacy ratioAdvances 377,560 440,967 434,361 500,735 590,922 Y/E Mar F12 F13 F14 F15e F16eInvestments 174,025 211,546 241,179 295,547 358,243 Tier-I (%) 15.9 14.1 13.2 12.1 11.8 Fixed assets 3,261 3,975 4,250 4,867 5,880 Tier-II (%) 0.8 0.6 1.0 0.8 0.8 Other assets 16,096 16,808 20,859 13,135 9,805 Total (%) 16.6 14.7 14.2 12.9 12.6 Total assets 606,268 710,496 745,941 880,328 1,047,450 Leverage (Asset/NW) 10.6 11.2 10.7 11.4 12.0




RoAA decompositionY/E March (%) F12 F13 F14 F15e F16e

Interest earned 9.92 9.37 9.54 9.05 9.10Interest expended 6.43 6.37 6.48 6.01 5.97Net interest income 3.49 3.00 3.06 3.04 3.13Other income 0.95 1.01 0.95 1.03 1.01Fee-based income 0.65 0.58 0.57 0.64 0.62Forex income 0.15 0.12 0.17 0.19 0.20Treasury income 0.15 0.31 0.21 0.20 0.18Other miscellaneous income 0.00 0.00 0.00 0.00 0.00Operating income 4.44 4.01 4.01 4.07 4.14Operating expenses 1.75 1.79 1.98 2.00 1.97Staff cost 0.97 0.95 1.06 1.14 1.11Other operating expense 0.68 0.72 0.79 0.74 0.74Depreciation 0.10 0.12 0.13 0.12 0.12Pre-provision profits (PPP) 2.69 2.22 2.03 2.07 2.17Provisions 0.60 0.40 0.37 0.35 0.33Profit before taxes 2.09 1.81 1.66 1.72 1.84Taxes 0.70 0.54 0.51 0.53 0.58Profit after taxes 1.39 1.27 1.15 1.19 1.26Source: Company, SSLe



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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)

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ContentsStrong presence in Kerala augurs well for FBConsolidation phase over, credit growth to re-emergeDeclining slippages; caution still maintainedEarnings quality to sustainCost-income may remain a dampenerValuations and recommendationsKey concernsCompany descriptionKey ManagementFinancialsDisclaimer

Federal Bank

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