Federal Bank Share research report by ICICI Bank.

8/8/2019 Federal Bank Share research report by ICICI Bank.

1/23

November 19, 2010

ICICIdirect.com|Equity Research

nitiating Coverage

ting Matrix

ting : Strong Buy

get : | 563

get Period : 12-15 months

ential Upside : 24%

rformance highlights

Crore) FY10 FY11E FY12E FY13E

1411 1707 2065 2564

P 311 377 443 526

T 465 584 724 957

ock Data

oomberg Code FB:IN

uters Code FED.BO

ce Value (Rs) 10

arket Cap (Rs cr) 7,780 week H/L 501 / 223

nsex 19,865

erage volumes (BSE) 1,058,391

mparative return matrix (%)

mpany 1m 3m 6m 12m

B 6.8 36 86.5 91.9

uth Indian Bank 1.3 30.8 86.5 91.9

analakshmi Bank -5.3 -2 21.3 22.5

rnataka Bank 6.4 9.7 27.9 51.4

ce movement

1000

2000

3000

4000

5000

6000

7000

Oct-0

9

Dec-0

9

Feb-1

0

Apr-1

0

Jun-1

0

Aug-1

0

100

200

300

400

500

Nifty FDB

alysts name

ajal Gandhi

[email protected]

iraj Gandhi

[email protected]

Mani Arora

[email protected]

On the fast trackThe Federal Bank (FDB), a Kerala-based private sector bank, is perfectlypoised to enter into a high growth phase given the ongoing operationalrestructuring, strong focus on the high-margin retail and SME segmentand expanding geographical presence. We forecast FDB will grow itsbusiness mix at 23% CAGR in FY10-13E. With the pick-up in thedomestic credit market and stable macroeconomic outlook for MiddleEast countries, we expect the bank to improve its leverage. This willhelp FDB to increase its RoE to 18% in FY13E from a trough of 10% inFY10. We forecast NIMs will remain high at 4% in FY13E.

Process restructuring, change in management to improve return ratios

FDB is rapidly changing into a new-age bank given the focus on

diversified business portfolio, technology-driven operational processes

and improvement in geographical presence. In our view, the stage is set

for incumbent CEO Shyam Srinivasan to lead the bank into the next level

of high growth phase. We expect FDB to show a strong operational

performance with NII growth of 22% CAGR over FY10-13E, supported by

high share of low cost deposits (~45% of total deposits). During FY10-

13E, we forecast loan growth of 23% CAGR to | 49,786 crore and deposits

posting 22% CAGR to | 66,256 crore.

Slippages likely to come down in FY12E-13E

The management expects slippages to remain high in FY11E due to high

system generated NPAs, leading us to forecast GNPA of 3.2% in FY11E

vs. 3.1% in FY10. However, we expect asset quality concerns to recede inFY12E-13E due to the revamping of the banks credit disbursal policy and

improving loan monitoring system. As a result, we forecast GNPA of 2.7%

in FY13E. Also, the high provision cover of 82% in H1FY11 provides

strong support to balance sheet growth, going forward.

ValuationsAt the CMP of | 455, the stock is trading at 1.5x FY13E P/ABV. The bank

with higher return ratios (RoA of 1.3%) and branch profitability compared

to peers (Exhibit 33) commands a premium multiple. We expect FDB to

improve its RoE and RoA to 18% and 1.4%, respectively, in FY13E by

leveraging its equity base and forecast NIM at 4%. We have valued the

bank at 1.8x FY13E ABV and initiated coverage with a STRONG BUY

rating and a target price of | 563.Exhibit 1:Key Financials

FY09 FY10 FY11E FY12E FY13E

Net Profit (| cr) 500 465 584 724 957

EPS (| ) 29.3 27.2 34.1 42.3 56.0

Growth (%) 36.0 -7.2 25.6 24.1 32.2

P/E (x) 15.5 16.8 13.3 10.7 8.1

ABV (| ) 248.6 266.4 274.0 291.1 313.1

Price / Book (x) 1.8 1.7 1.6 1.5 1.4

Price / Adj Book (x) 1.9 1.7 1.7 1.6 1.5

GNPA (%) 2.6 3.0 3.2 3.0 2.7

NNPA (%) 0.3 0.5 0.6 0.4 0.4

RoNA (%) 1.4 1.1 1.2 1.3 1.4

RoE (%) 12.1 10.3 12.2 14.4 17.9

Source: Company annual reports, ICICIdirect.com Research, *Standalone financials

Federal Bank (FEDBAN)

455

CICI Securities Limited


2/23ICICIdirect.com|Equity Research

Page 2

Company Background

Incorporated in 1931 in Kerala, The Federal Bank (FDB) is a one of theoldest private sector banks in India with a network of 719 branches and761 ATMs. The bank has a total business mix of | 63750 crore (H1FY11)and derives a majority of its business from Kerala (~47% of business

mix). FDB has employee strength of 7,896 (March 2010).

In September 2006, FDB acquired Maharashtra-based Ganesh Bank ofKurundwad (with a branch network of 20) in order to diversify itsgeographical base. Although the bank has improved its presence acrossIndia, the majority of the branches are still concentrated in the southernstates (~77%).

FDB entered into the insurance business in November 2006 by acquiring a26% stake in a joint venture (JV) with India-based IDBI Bank (48% stake)and Belgium-based Ageas Insurance (erstwhile Fortis InsuranceInternational NV). The total amount invested by the three companies was| 450 crore and the entity had issued over two lakh policies withcombined sum assured of ~| 9,160 crore (Q1FY11). Further, FDBcollaborated with Geojit BNP Paribas Financial Services (an India-basedbrokerage house) to introduce an online trading facility, Fed-e-Trade, forits customers in September 2008.

Key management change

FDB received approval from The Reserve Bank of India (RBI) for theappointment of Shyam Srinivasan as the new MD and CEO of the bankafter the retirement of M Venugopalan in July 31, 2010. Mr Srinivasan

joined FDB in September 2010. Prior to joining FDB, he was the countrymanager at Standard Chartered Bank where he was responsible for itsconsumer business division. Mr Srinivasan has considerable experiencein the consumer banking business such as retail lending, SME banking(FDBs forte) and wealth management in the domestic as well asinternational market.

Exhibit 2:Region-wise branch network (H1FY11)Rural

17%

Semi-

urban

46%

Urban

22%

Metro

15%

Source: Company quarterly presentation,,ICICIdirect.com

Research

Exhibit 3:Region-wise ATMs network (H1FY11)

Metro

14%

Urban

29% Semi-urban

46%

Rural

11%

Source: Company quarterly presentation,,ICICIdirect.com

Research

Share holding pattern (Q30)

Shareholder Holding (%)

Promoters -

Institutional investors 51.3

General public 48.7

FII & DII holding trend (%)

3740

37 36

14 14 13 12

10

20

30

40

50

Q3FY10 Q2FY10 Q1FY10 Q4FY09

(%)

FII DII

Shareholding pattern (H1FY11)

Shareholders Holding (%)

Institutional Investors 60.7

Others 39.3

Institutional holding trend (%)

3436 37 37

2326

18

24

0

10

20

30

40

Q3FY10 Q4FY10 Q1FY11 Q2FY11

(%)

FII DII

CICI Securities LimitedCICI Securities Limited



Page 3

Exhibit 4:Business segment FDBTie

Source: Company quarterly presentation, ICICIdirect.com Research

Exhibit 5:Evolution of FDB


1931 1959 1970 1989 1994 2002 2002 2006 2006 2008 2008

Commenced

operation

Became a

Scheduled

Commercial

Bank

Came with an IPO

which was

oversubscribed 60

times, Started

leasing business Bonus share of 2:1

Acquired Ganesh

Bank of Kurundwad in

Sept 2006 and

entered into Life

Insurance JV with

IDBI & FORTIS in Nov

2006

Association with

M/s Geojit Financial

Services to provide

online stock trading

facility in Sept

2008

Completed 1:1

rights issue inJanuary 2008 and

opened first

representative

Office at Abu

Dhabi, UAE

Licensed under

Section 22 of theBanking Companies

Act, 1949

Commenced

merchant bankingoperations

All the 412

branches were fullycomputerised

FDB issued 18 million

GDR (for US$ 71.5million) and 2 millionGDR with green shoeoption (for ~US$ 8.5million) in Jan 2006.

Each GDR were pricedat US$ 3.97 (| 175)

2010

Appointment of Mr.

Shyam Srinivasan(ex- Standard

Chartered) as CEO

and MD

FDB

Core Business

2% stake each in

South Indian, Catholic

Syrian and Laxmi

Vilas bank

Capital Markets

26% stake in a JV

with IDBI and Ageas

Insurance

5% stake in United

Stock Exchange

Tie-up with Geojit

BNP Paribas for retail

broking

Life Insurance




Page 4

Investment Rationale

We believe FDBs return ratios are set to improve during FY11E-13Edriven by the induction of a new CEO, improving credit standards andthe ongoing operational restructuring, which is expected to improveproduct focus and enhance productivity. As a result, we forecast RoE

and RoA at 18% and 1.4% in FY13E, respectively. FDB witnessed ahealthy RoE of 23% during FY05-07, which successively deterioratedduring the next three years and bottomed at 10% in FY10. The declinewas triggered after the rights issue (worth | 2,142 crore in the ratio of1:1) offered by the bank in January 2008.

With ~45% of total deposits as low cost deposits, high margins of 4%and decline in GNPA to 2.7% in FY13E despite high dependence on retailand SME sectors, FDB presents a significantly attractive franchise ascompared to its peers. We expect the business mix to grow higher thanindustry at 23% CAGR to | 116,043 crore and PAT to grow at 27% CAGRto | 957 crore in FY10-13E.

Improving return ratios backed by better business fundamentalsFDB enjoys superior business fundamentals vis--vis its peers in terms ofbetter RoA (1.3% in Q2FY11), healthy NIM (4.4%), low-cost depositsfranchise (~45% of the total deposits) and strong CAR (17.2%). Further,the bank is currently undergoing operational restructuring. This is aimedat streamlining business processes, improving the product focus andstrengthening credit quality, which is expected to fuel robust growthstarting FY12E.

Also, with the rising opportunities in the domestic market, a stablemacroeconomic environment in the Middle East and high C/D ratio (76%in H1FY11), we believe the bank will be able to leverage its equity base(asset to equity ratio to rise to 13% in FY13E vs. 9% in FY10). As a result,

we expect FDBs RoE and RoA to improve to 18% and 1.4% in FY13E,respectively.

FDBs topline was negatively impacted by the global economic slowdown(during 2009-10) and the subsequent Middle East crisis, which led thebank to adopt a conservative growth strategy. With significant pressureon the topline and rising taxes, FDBs PAT declined by 7% to | 465 crorein FY10. Now, with the induction of a new CEO and the banks aggressive

plans ahead, we see better capital utilisation in a growing economy. As aresult, we expect FDBs PAT to grow at 27% CAGR to | 957 crore in FY10-13E. This would push up the RoE to 14% in FY12E and 18% by FY13E.

Return ratios to gain significant traction in FY13E

after witnessing a slow down during FY08-10

Exhibit 6:Higher return ratio expected in FY13E due to improving leverage and

5.0

10.0

15.0

20.0

25.0

FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

(%)

0.4

0.8

1.1

1.5

(%)

ROE (LHS) ROA (RHS)

Source: Company annual reports, ICICIdirect.com Research

PAT to grow at 27% CAGR during FY10-13E driven

by the strong business fundamentals, improvement

in leverage and new leadership on board




Page 5

The bank always managed to maintain RoA of over 1% but the leveragewas high during FY05-07, which warranted dilution in FY08. The dilutioncoupled with a slowdown in business growth during FY08-10 led to lowerRoE of 10%. We anticipate a turnaround in the business growth cycle andexpect RoA of 1.4% and RoE of 18% for FY13E.

Exhibit 7:strong growth of 27% CAGR in PAT during FY10-13E

90

225293

368

500 465

584

724

957

0

200

400

600

800

1000

1200


(|

Crore)


Exhibit 8:RoE decompositionFY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Net interest income/ avg total assets 6.0 3.2 3.1 3.0 3.7 3.4 3.6 3.6 3.7

Non-interest income/ avg total assets 2.5 1.2 1.3 1.4 1.4 1.3 1.2 1.1 1.1

Net total income/ avg total assets 8.5 4.4 4.5 4.4 5.1 4.7 4.8 4.7 4.7

Operating expenses/ avg total assets 3.7 1.9 1.8 1.6 1.6 1.6 1.7 1.7 1.7

Operating profit/ avg total assets 4.8 2.4 2.7 2.8 3.5 3.1 3.1 3.0 3.1

Provisions/ avg total assets 3.4 0.9 0.9 1.0 1.3 1.0 1.3 1.1 1.0

Return on avg assets 1.1 1.2 1.3 1.3 1.4 1.1 1.2 1.3 1.4

Leverage (avg assets/ avg equity) (x) 23.2 19.0 16.6 10.6 8.6 9.2 10.0 11.5 13.0

Return on equity 24.9 22.8 21.3 13.6 12.1 10.3 12.2 14.4 17.9 Source: Company annual reports, ICICIdirect.com Research




Page 6

supported by pick-up in business momentum

FDB is aiming to grow its business mix at a higher growth rate than theindustry in the next two or three years. We expect the banks businessmix to grow at 23% CAGR to | 116,043 crore in FY10-13E (vs. 19% CAGRfor the industry). This will be backed by 23% CAGR growth in advances

(vs. 20% CAGR for industry) to | 49786 crore and 22% CAGR growth indeposits (vs. 18% CAGR for industry) to | 66256 crore.

SME and retail segment to drive growth in advances

During FY05-10, FDBs net advances grew at 25% CAGR to | 26950 crore,which was higher than the industry credit growth of 24% CAGR. Thegrowth in advances was driven by the banks well-diversified loan

portfolio, primarily divided into large corporates (38% of gross advancesin FY10), SME (31%) and retail (31%) segments. According to themanagement, the SME and retail segments are expected to drive the loanbook, going forward, given the banks strong focus on these high-marginsegments.

Exhibit 10:Loan book growth path

8823

11736

148

99

18905

22392

26950

32810

40331 4

9786

0

10000

20000

30000

40000

50000

60000

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

(|

Crore)


Exhibit 11:Break up of loan book

42130

49580 6

7630

84740 1

05230

49710

60990

69550

73820

84970

29960

42200

56090

70510

86140

0

2000040000

60000

80000

100000

120000

FY06 FY07 FY08 FY09 FY10

(

Rscrore)

Corporate SME Retail


Further, we believe the significant effort by the bank to streamline itscredit disbursal mechanism through central processing centres willimprove its credit quality and facilitate better loan disbursement. Also,

FDB is planning to introduce specialised corporate credit branches inmetros primarily to improve its opportunity as lead banker (vs. traditionalrole in consortiums) and increase its market share in the non-fund

Business mix to grow higher than the industry

during FY10-13E

Exhibit 9:FDBs business mix to grow higher than industry at 23% CAGR in FY10-13E

24015

29615

3

6484

44818

54590

63008

7684 0 9

4161 1

16043

0

30000

60000

90000

120000


(|C

rore)

0.5

0.6

0.7

0.8

0.9

1.0

(%)

Business Mix (LHS) Market Share (RHS)


SME and retail segments are the primary growth

drivers of FDBs loan portfolio




Page 7

business. The bank has already opened two corporate branches each atDelhi and Mumbai and is planning to open more branches in othermetros. With the strong pick-up in the domestic credit environment andcomfortable CAR ratio, we forecast FDBs loan book will grow at 23%CAGR to | 49,786 crore in FY10-13E.

FDBs retail loan portfolio is tilted towards the housing segment, whichconstituted ~57% of the total retail portfolio in H1FY11. The high share ofhousing loans provides stability to the banks retail portfolio as they areconsidered to be secured loans. Unsecured retail loans such as personaland credit card loans form a very small proportion (~1%) of the totalloans. Also, gold loans constitute 10.5% of the total retail portfolio, whichare secure loans and yield high-margin (~11-12% vs. ~9% on traditionalretail loans).

Robust deposit franchise, dominated by low cost depositAbout 50% of the FDBs total deposit accounted for low cost deposit,(~28% CASA and ~22% NRI deposits). Traditionally, the bank has beenable to maintain low cost deposits in the range of ~45-50%. This helpsthem to consistently maintain NIM of ~4% in the last few quarters.

In our view, FDBs deposit mobilisation will gather pace driven by risinginterest rates and the banks focus on retail customers through branchexpansion plans. The bank has added 60 new branches in FY10 and is

expected to add ~200 branches in FY11E-13E. According to themanagement, the bank is concentrating on Tier II and Tier III cities in orderto diversify its deposit base. As a result, we expect FDBs total deposit togrow at 22% CAGR to | 66,256 crore in FY10-13E.

High share of housing loans provides stability to thebanks retail loan portfolio

Exhibit 12:FDBs loan book break up (H1FY11)

Large

Corporate38%

SME

31%

Retail

31%

Source: Company quarterly presentation, ICICIdirect.com

Research

Exhibit 13:Break-up of retail portfolio (H1FY11)

115 4 8 6 3 1

7

57

0

20

40

60

80

Hous

ing

Go

ld

Overdra

ft

Mortgage

AAS/AAD

Car

Educationa

l

Persona

l

Others

(%)

Source: Company quarterly presentation, ICICIdirect.com

Research

Low cost deposit constitutes ~50% of the banks

total deposit franchise

Exhibit 14:Deposit base to expand by 22% CAGR in FY10-12E

17879

2158425913

53830

66256

44031

3605832198

0

15,000

30,000

45,000

60,000

75,000

FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

(|C

rore)

0

8

15

23

30

(%)

Total deposits (LHS) Growth YoY (RHS)





Page 8

Strong branch expansion to expand CASA base

FDB expanded its branch network from 456 in FY05 to 672 in FY10 and further to 719 by H1FY11. As the bank accounts for ~10% of the totalindustry branches in Kerala, we believe further branch expansion in thehome state is limited. Also, FDB is highly susceptible to concentration risk

as ~60% of the banks branches are located in Kerala. According to themanagement, the bank is planning to add ~200 branches in FY11E-13E.Out of this, ~75-80% of the branches will be outside Kerala. This willboost CASA accumulation as the state account for the lowest CASA perbranch. Consequently, we expect FDBs CASA ratio to improve to 30% inFY13E vs. 26% in FY10.

The CASA ratio will improve by ~382 bps to 30% in

FY10-13E driven by a rising branch network outside

Kerala

Exhibit 15:FDBs CASA ratio to improve to 30% in FY12E

456 472536

603 612672

772822

872

0

250

500

750

1000


(Noofb

ranches)

20.0

25.0

30.0

35.0

40.0

(%

)

Branches CASA ratio (RHS)


Exhibit 16:Kerala accounts for lowest CASA per branch

10

13 13 12 12

20

29

0

7

14

21

28

35

Kerala North-East East Central South North West

(|C

rore)

Source: RBI trend and progress, ICICIdirect.com Research

Area of operation




Page 9

The share of Kerala in FDBs business mix is expected to decline steadily

as it moves out of the regional tag. We expect the share to decline in thenext two or three years as FDB is trying to improve its pan-India presence.

NRE deposits as hidden CASA

FDB has significantly benefited from its presence in Kerala due to thestates large NRI population (~40% of Indias total NRI population) that isprimarily responsible for the huge remittances received by the state. As a

result, NRI deposits constitute ~22% of the total deposits of the bank onwhich the interest costs are in the range of 1.8-3.1%. On the other hand,FDBs retail deposit costs ~7.5-8% at present. The cost savings from NRIdeposits coupled with high CASA deposits translates into a significantsource of inexpensive funds for FDB.

Exhibit 17:FDB has higher CASA ratio as compared to its peers

28.5

25.6

24.2

21.4

20.4

20.0

22.5

25.0

27.5

30.0

FDB SIB* Karnataka DLB# City Union

(%)

Source: Company quarterly presentation, ICICIdirect.com Research, *SIB-South Indian, #DLB-Dhanalakshmi

Declining share of Kerala in the banks total business

mix reduces concentration risk

Exhibit 18:Contribution of Kerala in FDBs business mix to reduce, going forward

47 46 46 47 4753 54 54 53 53

0

20

40

60

80

Q2FY10 Q3FY10 FY10 Q1FY11 Q2FY11

(%)

Kerala Outside Kerala


NRE deposit provides an inexpensive funding source

to the bank




Page 10

With the slowdown witnessed in the Middle East countries (whichconstitutes majority of the remittances in Kerala) and resultant job losses,we are expect the growth of FDBs NRE deposits to moderate in the next

few years. As a result, we expect the share of NRE deposits in FDBs totaldeposits to moderate to 15% in FY13E vs. 20% in FY10.

Exhibit 19:Low deposit rates on NRE and FCNR deposits provides support to NIMsFCNR (B) Deposit Rate (%)

Period USD GBP EURO

1 year to less than 2 years 1.8 2.5 2.4

2 years to less than 3 years 1.6 2.3 2.5



5 Years only 2.5 3.1 3.0

RFC Deposits (%)

Period USD GBP EURO

6 months to Less than 1 Year 1.8 2.5 2.4

1 Year to Less than 2 Years 1.8 2.5 2.4

2 Years to Less than 3 Years 1.6 2.3 2.5

3 Years only 1.9 2.5 2.6

NRE Term Deposit Rate (%)

Period

1 Year to less than 2 years 2.5

2 years to less than 3 years 2.4

3 years and above 2.6

Retail Deposit Rate (%)

PeriodLess than Rs.15

LakhsBetween 15-100

lakhs

1 Year to Less than 2 Years 7.5 7.5

2 Years to Less than 3 Years 7.5 7.5

3 years to less than 5 years 7.8 7.8

5 years and above 8.0 8.0 Source: Company quarterly presentation, ICICIdirect.com Research

The slowdown in the Middle East markets will

negatively impact the FDBs NRE deposit base




Page 11

driven by operational restructuring and quality of new management

In our view, FDB is in the process of successfully implementing thebusiness transformation roadmap suggested by the Boston ConsultancyGroup (BCG), which is expected to help the bank in cementing its positionas a new generation private sector bank. The result of the key policy

changes are as follows: FDB has established six key business verticals in order to bring a

strong focus to business processes and products and also toimprove decision making standards. SME, retail and recoveryverticals are headed by PR Kalyanaraman and other verticals suchas NRI, large corporate and treasury are headed by PC John

The bank has established a centralised loan sanctioning processwhere each regional office is responsible for the creditassessment and appraisal of loans between | 10and | 25 lakh. Fora loan amount greater than | 25 lakh, approval is taken from thehead office. This is in sharp contrast to the earlier system whereindividual branches were disbursing every kind of loans without

any central monitoring system. This process was adoptedprimarily to improve the appraisal and monitoring system in orderto reduce slippages. At the same time, product delivery(disbursement and servicing) is managed at the branch level toimprove the turnaround time

Specialised corporate banking branches have been established inDelhi and Mumbai to focus on corporate clients and improve fee-based income. According to the management, the bank isexpected to open ~11 new centres in different metros in FY11E

FDB is planning to provide differentiated services to the large NRIpopulation in Kerala in order to tap the low-cost of deposits

Plans to launch Esops and variable pay packages to inculcate aperformance-based culture. Also, the bank has started recruitinglocally for branches that are opened outside Kerala

Further, the appointment of Shyam Srinivasan as the CEO of the bank isexpected to complement FDBs traditional strength in the SME and retailsegments as Mr Srinivasan has significant experience in retail, SME andwealth management markets in India, Middle-East and South East Asia. Inour view, FDB is expected to leverage its strength under the newleadership by aggressively focusing on the SME and retail sector. This willdrive the business mix growth of the bank in the next two or three years.

Strong initiative to streamline operating processes in

order to boost business parameters.




Page 12

NIM to expand to 4% in FY12E

With higher focus on the SME and retail segment, we expect FDBs yieldson advances to expand by 30 bps to 11.9% in FY13E (vs. 11.6% in FY10).Although deposit rates are also expected to remain firm, the high share oflow cost deposit is expected to strengthen FDBs margins, going forward.

As a result, we expect the banks NIMs to improve by 25 bps to 4% inFY13E vs. 3.7% in FY10.

Higher yields on advances due to rising interest

rates and large source of inexpensive funds will help

FDB to maintain healthy NIMs

Exhibit 20:NIM expansion in FY11E-13E

3.4 3.3 3.3

4.13.7 3.8

3.9 4.0

0.0

1.2

2.4

3.6

4.8

FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

(%)

Source: Company annual report, ICICIdirect.com Research

Exhibit 21:FDB has better NIM as compared to its peers (Q1FY11)

4.2

3.7 3.63.4

2.6

1.7

0.0

1.3

2.5

3.8

5.0

FDB LVB City Union KVB DLB Karnataka

(%)

Source: Company quarterly presentation, ICICIdirect.com Research, Lakshmi Vilas, ~Karur Vysya,

#Dhanalakshmi,




Page 13

Improvement in asset quality expected in FY12-13E

FDBs loan book is dominated by SME and retail loans that collectivelyaccounted for ~61% for the total gross advances in H1FY11. During thelast few quarters, the bank has increasingly witnessed stress on itsadvances. FDBs GNPA deteriorated to 3.8% in H1FY11 vs. 3.0% in

H1FY10 and NNPA to 0.7% in H1FY11 vs. 0.5% in H1FY10. FDB reportedtotal gross slippages of | 327crore in Q1FY11, out of which ~40% (|132crore) was contributed by the retail segment and ~37% by the SMEsegment. In the retail loan segment, higher slippages were reported in theNRI housing segment primarily due to the negative fallout of theslowdown witnessed in Middle East countries, resulting in job losses andlower wages for NRI. Also, the slowdown witnessed in the domesticmarket led to higher slippages in the SME segment.

The stress on the loan portfolio was aggravated by the loose creditdisbursal policy of the bank where individual branches were responsiblefor sanctioning loans without adequate appraisal skills. This coupled withthe aggressive system-generated NPA, which resulted in early recognition

of bad loans, added further to the woes of the credit quality of the bank.However, FDB has strengthened its credit disbursement system withcentralised processing centres (for better credit assessment) and is in theprocess of revamping its recovery mechanism. According to themanagement, the slippages will continue to remain high in FY11E system-generated NPAs. However, the situation is expected to improve fromFY12E onwards. As a result, we forecast FDBs GNPA will increase to3.2% in FY11E (vs. 3.1% in FY10) and then improve to 3% in FY12E and2.7% in FY113E (in line with the expectation of the management).

As on H1FY11, FDB reported total restructured assets of | 1,140 crore,representing ~4% of the total loan book. This is in line with the otherplayers in the industry. Additionally, the bank has maintained asignificantly high provision cover in order to adequately handle any shockon the asset quality. We believe FDB will continue to maintain a highprovision coverage ratio (PCR) in FY11E-12E given high slippagesexpected by the management in FY11E.

Asset quality concerns to remain high in FY11E.

However, the situation is expected to normalise

from FY12E onwards

Exhibit 22:FDBs GNPA ratio to improve to 2.7% in FY13E

0.0

1.0

2.0

3.0

4.0

5.0

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

Q3FY10

Q4FY10

FY10

H1FY11

FY11E

FY12E

FY13E

(%)

0

25

50

75

100

(%)

GNPA (LHS) NNPA (LHS) PCR* (RHS)

Source: Company quarterly presentation, ICICIdirect.com Research, *Provision coverage ratio

High provision cover allays fear of asset quality for

the bank




Page 14

Core fee-based income to drive non-interest incomeDuring FY05-10, FDBs non-interest income grew by 20% YoY to | 531crore aided by high remittances inflow, healthy fee-based income andstrong trading gains. However, we expect the growth in non-interestincome to moderate to 12% CAGR to | 741 crore in FY10-13E due to

lower trading gains.

Nevertheless, we believe the core non-interest income (excluding tradinggains) will grow at a healthy rate of 15% CAGR to | 640 crore in FY10-13Edriven by improving fee-based income due to strong product focus oncorporate, SME and retail segment at the branch level. Also, FDBs tie-upwith IDBI-Ageas Insurance and Geojit BNP Paribas Financial Services isexpected to augment the fee-based income for the bank in FY11E-13E.

Further, FDB is focusing its marketing efforts on the NRI segmentprimarily to capture the huge remittances inflow in India and presentssignificant wealth management and forex opportunities. According to theWorld Bank, remittances inflows in the country increased to US$ 52 billionin FY08 from US$22 billion in FY05. It declined in FY09 due to the globaleconomic slowdown. As reported by the World Bank, Indian expatriatesare expected to remit about $55 billion into the country in FY11 as thenumber of emigrants rises to 11.4 million. The report expects India to bethe top receiver of remittances followed by China. We believe FDB will bethe primary beneficiary of remittances inflows into India due to its strong

presence in the southern states of the country, which traditionally receivehigher remittances inflow.

FDB has initiated tie-ups with non-life insurance and

financial services companies to boost its fee-based

income

Strong remittances inflow in India provides

opportunity in wealth management and forex

opportunity for FDBExhibit 23:Core fee-based income to grow at healthy 15% CAGR in FY10-13E

212 217

303

395

516 531

598643

741

0

200

400

600

800


(|C

rore)





Page 15

FinancialsCAGR growth of 22% expected in NII in FY10-13EDuring FY05-09, FDBs net interest income (NII) witnessed a robustgrowth of 27% CAGR to | 1,315 crore driven by healthy NIMs at 3.6%during the period. However, NII grew by merely 7% YoY in FY10 due to

the global economic slowdown and the subsequent Middle East problem.As a result, FDB adopted a cautious business approach resulting inmoderate balance sheet growth of 12% YoY in FY10 vs. growth of 23%CAGR during FY05-09.

We believe the ongoing restructuring, high C/D ratio (76% in H1FY11) andstrong capital base will put FDB into a higher growth trajectory startingFY13E. We expect FDBs business mix to grow higher than the industryresulting in NII growth of 22% CAGR to | 2,564 crore in FY10-13E.

Investment in technology and people bearing fruit - controlling cost

FDB has immensely benefited from the continuous investment intechnology in the last five or six years leading to lowest cost-to-incomeratio among its peers. FDB has been one of the earliest adopters of new-age banking services such as core banking solutions (CBS), real timegross settlement (RTGS) services and channels for online remittancessuch as Fed India Remit Service and SWIFT. Also, the bank hascollaborated with Tata Communications Banking Infra Solutions fordeploying point-of-sale (POS) terminals at merchant locations in order toimprove its presence in the SME segment in a cost-efficient manner.

Ongoing operational restructuring and strong

business fundamentals to build the base for higher

growth after one or two years

Exhibit 24:CAGR growth of 22% in NII in FY10-13E

502 600

716868

1315 1411

17072065

0

1100

2200

3300

4400

5500

FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E

(|C

rore)

Interest Income Interest Expenses NII


Emphasis on technology has helped the bank to

control its costs

Exhibit 25:FDB leads in terms of cost efficiency among its peers (Q1FY11)88.4

59.851.7 50.1

41.736.8 35.9

0

25

50

75

100

DLB# Karnataka LVB^ SIB* KarurVysya City Union FDB

(%)

Source: Company, ICICIdirect.com Research,, #Dhanalakshmi, Lakshmi Vilas,*South Indian, ~Karur Vysya




Page 16

Exhibit 26:Business per employee

562

670778 832

9151030

1203

461

0

375

750

1125

1500

FY06

FY07

FY08

FY09

FY10

FY11

E

FY12

E

FY13

E

(|La

khs)

Source: Company presentation, ICICIdirect.com Research

Exhibit 27:Profit per employee

3.54.4

5.4

6.95.9

6.67.7

9.7

0

2

4

6

8

10

12

FY06

FY07

FY08

FY09

FY10

FY11

E

FY12

E

FY13

E

(|

Lak

hs)

Source: Company presentation, ICICIdirect.com Research

In order to shed its regional tag and improve its pan-India presence, FDBis increasingly expanding its branch network outside Kerala (~75-80% of

200 branches in FY11E-13E to come outside Kerala) and is planning torecruit ~1000 new employees in FY11E. Further, the bank has introduceda new appraisal system for its employees that requires rigorous trainingand skill development. In our view, the rising investment in people andbranch expansion plans will lead to a deteriorating cost structure inFY11E. As are result, we forecast FDBs cost-to-income ratio will inch upto 36% in FY11E vs. 31% in FY09.

Operating expenses expected to inch up in FY11EWe expect FDBs operating expenses to increase at 20% CAGR to | 1,159crore in FY10-13E (vs. 17% CAGR to | 677 crore in FY05-10) primarily dueto the strong branch expansion plans (~200 new branches in FY11E-13E)and business-related expenses such as establishment of centralisedprocessing centres in metros (~11 centres expected in FY11E) and pointof sale terminals (targeted at current account customers). Further, weexpect the employee costs to shoot up as the bank is planning to recruit~1000 new employees in FY11E. As a result, we expect the banks cost toincome ratio to deteriorate to 36% in FY11E vs. 35% in FY10.

Introduction of performance based pay structure to

enhance employee productivity going ahead

The cost-to-income ratio will increase in FY11E due

to strong branch expansion plans and rising

recruitment expenses

Exhibit 28:Cost to income ratio inches up in FY10 on lower income43.9 44.6

39.837.1

31.234.9 36.0 36.2 35.1

0

13

25

38

50


(%)


Operating expenses on the rise in FY11E as a result of

strong expansion plans and investment in new

technologies




Page 17

Nevertheless, we believe the investment in technology and people isyielding benefits to the bank as FDB has the lowest cost to income ratio ascompared to its peers. Also, the bank has witnessed a continuousimprovement in its business on a per branch and employee basis. Weexpect this to continue in our forecast period.

MTM hit limited due to high share of HTM securities

FDB is well-placed in the current rising interest rate environment due tothe high share of HTM securities (73%) in its investment book of |12,816crore in H1FY11. The duration of HTM securities was reported at 2.5years. The rest of the investment book is divided into AFS (23%) and HFT(4%) categories where each has duration of ~1.6 years.

Exhibit 29:Cost to income ratio to deteriorate to 36% in FY11E vs. 35% in FY10

0

300

600

900

1200

1500


(|C

rore)

0

13

25

38

50

(%)

Employee costs (LHS) Total operating costs (LHS) Cost to income (RHS)


Exhibit 30:Business per employee to improve ~1.4x in FY10-12E

0

30

60

90

120


(|C

rore)

0

3

6

9

12

15

(|C

rore)

Business/Branch Business/Employee


Limited impact of rising interest rates in FDBsinvestment portfolio in FY10-12E




Page 18

During January-July 2010, the WPI index rose at an average of 10% YoYprimarily driven by higher food prices. As a result, yields of governmentsecurities (G-sec) have also spiked up during this period. However, wehave observed that the rise in the yields of 10-year government bondshas been more prominent than the five-year bonds. In our view, themovement in five-year bond yields will be stable as compared to the 10-year government yields, leading to limited impact on FDBs investmentbook (~77% SLR securities).

Exhibit 31:HFT securities dominates FDBs investment book in H1FY11

(Rs Crore)HFT, 554 , 4%

AFS, 2,890 , 23%

HTM, 9,372 , 73%

Source: Company, ICICIdirect.com Research, HTM-Held till Maturity, AFS-Available for Sale, HFT-Held for Trading



19/23

ICICIdirect.com|Equity ResearchPage 19

Risks and concerns

High concentration riskWith ~60% branches in Kerala, FDB faces high concentration risk.

Although the bank is planning to reduce its dependence on the home

state by planning to open new branches in other states, aggressiveexpansion in other parts of India remains a challenge. Inability to develop

a branch network outside Kerala can make the bank vulnerable to region-

specific risks.

Asset quality concern remains

FDBs management expects slippages to continue in FY11E and believes

it will reduce once the centralised loan appraisal system is fully

operational. Any delay in the implementation of the system is expected to

pose a significant challenge to the growth of the loan portfolio in our

forecast period.

Continuance of economic slowdownA slower than expected improvement in the domestic as well as

international credit market can negatively impact our growth estimates for

FDB. Further, the bank is heavily dependent on the NRI population

primarily in Middle East countries. A delay in recovery in these markets

will impact the banks business growth and profitability.

Delay in implementing BCG growth plan

We have assumed that FDB will be able to successfully implement therecommendation put forward by BCG in order to propel itself to a high

growth trajectory starting FY13E. Any delay in implementing the plan can

derail our assumptions resulting in lower growth prospects for the bank.

Regulatory measures may impact Insurance ventureFDB has 26% ownership in IDBI Fortis Life JV with its investment of | 117

crore. Currently the JV has done well on NBP (new business premium),

however with increasing pressure on products, cap on charges and

commission etc, the business may grow slower than anticipated. This

may hurt future returns from the venture.




Page 20

ValuationsAt the CMP of | 455, the stock is trading at 1.5x P/ABV for FY13E. Webelieve that the current operational restructuring will strengthen FDBsbusiness fundamentals and propel it into the next level of growth phase.We forecast RoE and RoA of 18% and 1.4%, respectively, for the bank inFY13E. This is expected to improve further to ~20% in FY14E. Also, wehave assumed that asset quality concerns will decline, going forward,driven by the implementation of a centralised loan sanctioning processand a new credit appraisal system. This is expected to facilitate bettermonitoring of loans and boost the asset quality. We expect GNPA of 2.7%in FY13E (vs. 3.2% expected in FY11E). We have valued the bank at 1.8xFY13E P/ABV and arrived at a target price of | 563. We initiate coverageon the stock with a STRONG BUY rating.

FDB is the fourth largest private bank in terms of asset size with adominant market position in Kerala. The bank is currently undergoing anorganisational restructuring, which is expected to put it into the next levelof growth trajectory from FY13E. With the huge low-cost depositsfranchise (~50% of the total deposits), strong capital base and ability togenerate high NIMs as compared to its peers, FDB is an attractive play inthe domestic banking space. In our view, the improvement in thedomestic credit environment and high C/D ratio (78% in Q1FY11) will helpthe bank to optimise its leverage (asset to equity of 13% in FY13E vs. 9%in FY10) in the next two or three years. As a result, we believe the bankwill be able to improve its RoE to 18% in FY13E and ~20% in FY14E.

Exhibit 33:Comparative matrixBank FY10 FY11E FY12E FY10 FY11E FY12E FY10 FY11E FY12E FY10 FY11E FY12E

South indian Bank 0.4 0.4 0.5 1.1 1.0 1.1 17.9 17.8 19.5 2.1 1.8 1.5

Federal bank 0.7 0.8 0.9 1.1 1.2 1.3 10.3 12.2 14.4 1.7 1.7 1.6

Dhanlaxmi Bank 0.1 0.2 0.3 0.3 0.4 0.6 5.4 6.5 11.5 2.9 2.0 1.9

IOB 0.3 0.5 0.6 0.6 0.7 0.8 11.5 14.6 16.4 2.0 1.5 1.2

Syndicate bank 0.4 0.5 0.6 0.6 0.7 0.8 15.3 18.2 20.5 1.9 1.6 1.5

Profit/branch (Rs crore) RoA (%) RoE (%) P/ABV (%)

Source: Company specific presentation, ICICIdirect.com Research

However, FDB faces significant asset quality concerns with GNPAstanding at 3.7% of total gross advances in Q1FY11 vs. 2.7% in Q1FY10.Further, the bank also faces high concentration risk as ~60% of the banksbranches are located in Kerala.

We have valued FDB at 1.8x FY13E P/ABV and arrived at a

target price of | 563/share

In our view, FDB commands premium valuation than its

peers given the banks strong business fundamentals.

Further, with the change in management and ongoing

operational restructuring, we expect the banks return

ratios to improve significantly from FY13E

Exhibit 32:P/ABV band chart

0

100

200

300

400

500

Mar-05

Jun-0

5

Sep-0

5

Dec-0

5

Mar-06

Jun-0

6

Sep-0

6

Dec-0

6

Mar-07

Jun-0

7

Sep-0

7

Dec-0

7

Mar-08

Jun-0

8

Sep-0

8

Dec-0

8

Mar-09

Jun-0

9

Sep-0

9

Dec-0

9

Mar-10

Jun-1

0

Sep-1

0

(Rs

)

Price Average 1.8x 1.4x 0.8x

Source: Company, NSE, ICICIdirect.com Research




Page 21

Exhibit 34:Ratios*FY09 FY10 FY11E FY12E FY13E

Valuation

No. of Equity Shares 17.1 17.1 17.1 17.1 17.1

EPS (Rs.) 29.3 27.2 34.1 42.3 56.0

BV (Rs.) 252.6 273.9 284.9 301.2 324.2

BV-ADJ (Rs.) 245.7 263.7 271.4 286.6 307.8

P/E 15.5 16.8 13.3 10.7 8.1

P/BV 1.8 1.7 1.6 1.5 1.4

P/ABV 1.9 1.7 1.7 1.6 1.5

Div. Yield (%) 1.3 1.3 1.5 1.9 2.5

DPS (Rs.) 5.9 5.8 6.7 8.5 11.4

Yields & Margins (%)

Yield on avg int earning assets 10.2 9.6 9.8 10.1 10.1

Avg. cost on funds 6.5 6.3 6.7 6.8 6.7

Net Interest Margins 4.1 3.7 3.8 3.9 4.0

Avg. Cost of Deposits 6.4 6.4 6.3 6.4 6.3

Yield on average advances 12.4 11.6 11.7 11.9 11.9

Profitabilty (%)

Interest expense / total avg. assets 5.6 5.5 5.6 5.8 5.7

Interest income/ total avg. assets 9.3 8.9 9.1 9.3 9.4

Non-interest income/ avg. assets 1.4 1.3 1.2 1.1 1.1

Non-interest income/ Net income 28.2 27.3 26.0 23.8 22.4

Net-interest income/ Net income 71.8 72.7 74.0 76.2 77.6

Cost / Total net income 31.2 34.9 36.0 36.2 35.1

Quality and Efficiency (%)

Credit/Deposit ratio 69.5 74.7 74.5 74.9 75.1

GNPA 2.6 3.0 3.2 3.0 2.7NNPA 0.3 0.5 0.6 0.4 0.4

RoNW 12.1 10.3 12.2 14.4 17.9

RoA 1.4 1.1 1.2 1.3 1.4

Source: Company annual report, ICICIdirect.com Research *Standalone financials

Exhibit 35:ROE decomposition*(%) FY09 FY10 FY11E FY12E FY13E

Net interest income/ Avg. assets 3.7 3.4 3.6 3.6 3.7

Non-interest income/ Avg. assets 1.4 1.3 1.2 1.1 1.1

Net total income/ Avg. assets 5.1 4.7 4.8 4.7 4.7

Operating expenses/ Avg. assets 1.6 1.6 1.7 1.7 1.7

Operating profit/ Avg. assets 3.5 3.1 3.1 3.0 3.1

Provisions/ Avg. assets 1.3 1.0 1.3 1.1 1.0

Return on Avg. assets 1.4 1.1 1.2 1.3 1.4

Leverage (Avg assets/ Avg equity) (x) 8.6 9.2 10.0 11.5 13.0

Return on equity 12.1 10.3 12.2 14.4 17.9





Page 22

Exhibit 36:Profit and loss account*Rs Crore FY09 FY10 FY11E FY12E FY13E

Interest Earned 3315 3673 4374 5387 6560

Interest Expended 2000 2262 2668 3322 3996

Net Interest Income 1315 1411 1707 2065 2564

growth (%) 51.5 7.3 21.0 21.0 24.2

Non Interest Income 516 531 598 643 741

Fees and advisory 101 105 126 149 179

Trading Gains 83 108 92 96 101

Other income 332 318 381 398 461

Net Income 1831 1942 2305 2708 3305

Employee cost 317 366 454 537 633

Other operating Exp. 254 311 377 443 526

Gross Profit 1260 1265 1475 1729 2147

Provisions 467 405 604 648 718

PBT 793 860 871 1081 1429

Taxes 293 395 287 357 472

Net Profit 500 465 584 724 957

growth (%) 36.0 -7.2 25.6 24.1 32.2


Exhibit 37:Balance sheet*Rs Crore FY09 FY10 FY11E FY12E FY13E

Liabilities

Capital 171 171 171 171 171

Reserves and Surplus 4155 4519 4707 4986 5379

Networth 4326 4690 4878 5158 5550

Deposits 32198 36058 44031 53830 66256

Borrowings 1219 1547 1892 2287 2740Subordinated Debt 0 0 0 0 0

Other Liabilities & Provisions 1108 1380 1559 1647 1761

Total 38851 43676 52360 62921 76307

Assets

Fixed Assets 281 290 348 384 432

Investments 12119 13055 15192 17721 20793

Advances 22392 26950 32810 40331 49786

Other Assets 622 658 709 471 437

Cash with RBI & call money 3437 2723 3301 4014 4859

Total 38851 43676 52360 62921 76307




23/23

RATING RATIONALE

CICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assignsratings to its stocks according to their notional target price vs. current market price and then categorises themas Strong Buy, Buy, Add, Reduce and Sell. The performance horizon is two years unless specified and the

notional target price is defined as the analysts' valuation for a stock.

Strong Buy: 20% or more;Buy: Between 10% and 20%;Add: Up to 10%;Reduce: Up to -10%Sell: -10% or more;

Pankaj Pandey Head Research [email protected]

ICICIdirect.com Research Desk,

ICICI Securities Limited,7th Floor, Akruti Centre Point,MIDC Main Road, Marol Naka,Andheri (East)Mumbai 400 093

[email protected]

ANALYST CERTIFICATIONWe /I,Kajal Gandhi CA Viraj Gandhi MBA-CM Mani Arora MBA research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research reportccurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specificecommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

Disclosures:CICI Securities Limited (ICICI Securities) and its affiliates are a full-service, integrated investment banking, investment management and brokerage and financing group. We along with affiliates are leadingnderwriter of securities and participate in virtually all securities trading markets in India. We and our affiliates have investment banking and other business relationship with a significant percentage ofompanies covered by our Investment Research Department. Our research professionals provide important input into our investment banking and other business selection processes. ICICI Securitiesenerally prohibits its analysts, persons reporting to analysts and their dependent family members from maintaining a financial interest in the securities or derivatives of any companies that the analystsover.

he information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. The report and information contained herein is strictly confidential andmeant solely for the selected recipient and may not be al tered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without

rior written consent of ICICI Securities. While we would endeavour to update the information herein on reasonable basis, ICICI Securities, its subsidiaries and associated companies, their directors andmployees (ICICI Securities and affiliates) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent ICICI Securitiesrom doing so. Non-rated securities indicate that rating on a particular security has been suspended temporarily and such suspension is in compliance with applicable regulations and/or ICICI Securitiesolicies, in circumstances where ICICI Securities is acting in an advisory capacity to this company, or in certain other circumstances.

his report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. Thiseport and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financialnstruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. ICICI Securities will not treat recipients as customers by virtue of theireceiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specificircumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investmentbjectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate

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o observe such restriction.


Federal Bank Share research report by ICICI Bank.

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