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Asset quality turning better; RoA expansion to continue
Asset mix improving; liability franchise remains top-class
We attended Federal Bank (FB) Analyst Day, wherein the bank discussed the recent trends and opportunities, along with the key levers for RoA expansion.
* FB has identified new revenue streams such as micro finance, credit card, CV/CE and business banking for margin expansion. It has set a target of achieving a retail:wholesale loan mix of 55:45 over the medium-to-long term.
* The bank reiterated that there is no residual stress in corporate accounts above INR1b. It thus expects the slippage trend to moderate significantly, which in turn will drive controlled credit cost.
* Work is happening to improve productivity by adding branches in a calibrated manner and a high focus is placed on leveraging the distribution channel through the RM model. This will drive a further improvement in the C/I ratio.
* FB has guided for an exit RoA of 1.25% by FY21. Overall, the bank is aiming to increase RoA by 25-30bp over the next 2-3 years.
We believe that the stock trades at inexpensive valuations (1.1x Sep’21E ABV) and thus offers ample scope of re-rating as the earnings cycle recovers. We thus project earnings CAGR of 25% over FY20-22 with RoA/RoE of 1.2%/15.5% by FY22. Maintain Buy with a target price of INR115 (1.4x for Sep’21E ABV).
Focus on sustainable growth; retail loan mix to improve gradually FB has been looking for sustainable loan growth with a strong focus on growing the retail book at 25% YoY while consciously slowing down in the wholesale segment due to the current challenging environment. The bank has been gaining market share in chosen segments like Housing (~5% of pvt. sector), Auto (~2%) and Personal loans (0.6%) and has also identified new revenue streams such as micro finance, credit card, CV/CE and business banking. The core focus is to shift the asset mix toward high-yielding segments. It has set a target of achieving a retail:wholesale loan mix of 55:45 over the medium-to-long term.
Wholesale lending: Watch-list dissolution nearly complete; ~96% of portfolio of investment grade
The bank has improved its rating profile in the wholesale book over the last few years (~96% of wholesale book is of investment grade v/s 74% in FY15). It reiterated that there is no residual stress in corporate accounts above INR1b, mainly led by the higher focus on working capital loans and cash flow-based lending, which resulted in lower stress on the incremental portfolio. Further, the bank expects the mid-corporate segment to grow at a higher pace compared to large corporate lending.
Asset quality to improve gradually; maintains healthy coverage ratio at 66.2% (incl. TWO) FB has reported a sharp decline in net stressed loans to ~1.6% of average assets from 3.4% in FY15. Also, there is no stress in corporate accounts above INR1b. It thus expects corporate slippages to moderate significantly and cash recovery trends to remain strong. Also, retail/agri/business banking trends are improving for last few quarters, and thus NPAs in retail assets have improved to 1.8% from 2.1% in 3QFY18. FB maintains a healthy coverage ratio of 66.2% (incl. TWO), which will facilitate controlled credit costs (our estimate: ~62bp over FY20-22).
Strong liability franchise; CASA + retail TD constitute ~91% of total deposits Liability franchise has been holding up well, with term deposits growing at 20% YoY. Also, CASA + retail term deposits constitute ~91% of total deposits. It has lower cost of funds (5.8% as on 3QFY20) advantage compared to other mid-size banks. FB is a strong player in NRI remittances – it has a market share of 6.1% in the pan-India NR business and 15.7% in personal inward remittances. FB is focused on cross-selling liability products to corporate clients to garner salary accounts.
Levers for RoA expansion; guides for exit RoA of 1.25% by FY21 Margins were impacted in the past due to lower yields and higher interest reversal (~5bp impact in 3QFY20). However, moderating slippage trends and asset mix change toward high-yield segments (such as business banking, disbursing higher gold loans in semi-urban areas, expanding micro loans through BC model, CV/CE and credit cards) will help in improving the margin trajectory by 10-15bp. Further, FB has been working to improve productivity by adding branches in a calibrated manner and placing a higher focus on leveraging the distribution channel through the RM model. This will further drive an improvement in the C/I ratio. Also, high focus on retail assets will help improve fee income, further supporting incremental RoAs. Overall, the bank has guided for an exit RoA of 1.25% by FY21. It is looking for an RoA increase of 25-30bp over the next 2-3 years.
In our view, FB is well placed to deliver RoA expansion led by moderating slippage trends, which will facilitate controlled credit costs. Margin prospects appear promising with the asset mix change toward high-yield segments. Also, the strong liability franchise will enable lower cost of funds. The bank will add branches in a calibrated manner and thus the C/I ratio is expected to improve to ~48% by FY22 from 50% in FY19. We slightly tweak our estimates and project earnings CAGR of 25% over FY20-22 with RoA/RoE of 1.2%/15.5% by FY22. We believe that the stock is trading at inexpensive valuations (1.1x Sep’21E ABV) and thus offers ample scope of re-rating. Maintain Buy with a TP of INR115 (1.4x for Sep’21E ABV).
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