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Strong delivery on growth; margins and asset quality to drive-up RoAs

* Federal Bank reported a strong beat on PAT yet again, at Rs7bn (vs est: Rs 6.3bn), mainly backed by better delivery on growth/margins, fees and treasury, and partly offset by higher provisions to shore-up PCR. The bank has clocked 1.2% RoA in Q2 and is gaining confidence on growth/margins, given that it has upped its RoA guidance for FY22 to 1.2% (Q4 exit RoA to 1.25%).

* Bank delivered a strong 20% YoY/6% QoQ credit growth, mainly led by acceleration in the corporate book and continued traction in Retail/SME. This, coupled with continued asset re-pricing and lower NPA drag, led to healthy improvement in margins, by 8bps QoQ to 3.3%. Bank expects margins to remain elevated, supported by the enduring strong growth and some additional benefit expected to flow from asset re-pricing.

* Overall asset quality continues to trend well, with GNPA ratio down by 23bps QoQ to 2.5%, which the bank expects to retain despite some macro-dislocation. Tier I capital remains reasonable at 13.6% (Calc), while Management maintains that it is in no hurry to raise capital.

* We revise our earnings estimate by 7% for FY23 and by 4% for FY24-25, factoring-in better delivery on margin/fees, and expect RoA/RoE to steadily improve to 1.2%/16% by FY25E (without accounting for capital raise). We retain BUY on the stock, with revised TP of Rs150/share, valuing the bank at 1.2x Sep-24E ABV and subs value at Rs8/share.

* Accelerating credit growth, coupled with asset re-pricing, driving-up margins: The bank has posted higher credit growth at 20% YoY/6% QoQ (highest in the past 13 quarters), which now looks to be broad-based, with even the corporate book seeing acceleration. Within Retail, mortgage growth remains healthy; CV and gold loan book are also gaining traction. Card partnership, too, is delivering good results, thereby supporting fee growth, which is otherwise fueled by acceleration in credit growth. Deposit/CASA growth has slightly lagged, leading to some drop in CASA ratio to 36%, which we believe is becoming an industry-wide phenomenon. However, the bank has logged strong margins – up 8bps QoQ to 3.3% – and guides to margins remaining elevated led by strong growth/asset repricing.

* NPA trend down, but the bank shores-up PCR: Slippages moderated to Rs3.9bn/1.2% in Q2 due to lower slippages in Retail and relapse from the restructured book. This, along with better recoveries/w-offs, led to 23bps reduction in GNPA ratio to 2.5%. The restructured pool stood surprisingly flat QoQ at Rs39bn (2.4% of the loans); the bank expects the pool to decline, as it has started to come out of the moratorium. Further, the bank has made sufficient provision on the RSA book and has not utilized any provisions yet, which grants comfort. The bank has shored-up its PCR to 69% (66% in Q1), which puts it in a better position to absorb any asset-quality shocks

* Outlook and valuations We revise our earnings estimate by 7% for FY23 and by 4% for FY24-25, factoring-in better delivery on margin/fees and expect RoA/RoE to steadily improve to 1.2%/16% by FY25E (ex capital raise). Potential value unwinding in the NBFC subsidiary (FedFina) via an IPO could be an additional catalyst for the stock and may help shore up the receding capital levels. Key risks: Higher relapse from the restructured pool and top management attrition.

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