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Despite QoQ decline in NIMs and rise in provisioning, Federal Bank (Federal) reported reasonable Q1FY24 PAT of Rs8.54bn (up 42% YoY, down 5% QoQ), driven by strong ‘other income’. Annualised RoA came in at 1.28% vs 1.44% QoQ. Loan growth continues to outpace the system and stood at 21% YoY (up 5% QoQ) and, more importantly, it was broad-based. NIMs declined further ~15bps QoQ as rise in cost of deposits outpaced rise in loan yields. Compared to peers, Federal’s performance on the NIM front has been muted, which seems partly due to the bank’s pursuit of growth and pressure on the share of CASA + granular deposits. Unlike management expectations of stable NIMs and RoA uptick YoY, we model ~10bps YoY decline in calculated NIMs and stable RoA for FY24. We expect the bank to report steady ~1.2% RoAs for FY24-25E with strong fee income broadly offsetting pressure on NIMs. Stock trades inexpensive at ~0.9x FY25E ABV, adjusted for Rs12 per share of subs. Maintain BUY with an unchanged target price of Rs155, valuing the stock at ~1.2x FY25E ABV (in line with potential RoA). Key near-term trigger lies in the impending capital raise as tier 1 now stands at 12.54%. Key risks: Inability to manage growth / NIMs due to competition.

* Loan growth strong and broad-based: Loan growth, as already indicated in provisional numbers, was healthy at 21% YoY and 5% QoQ. Importantly, growth was broad-based wherein retail grew 20% YoY and 6% QoQ. Retail growth was driven by the recently launched high-yielding book such as personal loans, MFI, CV/CE (up 60-245% YoY though on small base). The bank reiterated its loan and deposit growth guidance of 18-20% YoY for FY24.

* NIMs decline QoQ; management expects recovery in H2FY24: Cost of deposits inched up by 20bps QoQ outpacing the rise in loan yields (up 8bps QoQ). Thus, despite a rise in LDR, Federal saw NIMs compression of 15bps QoQ (on top of an 18bps compression in Q4FY23) to 3.15%. NIMs on YoY basis were also lower by 7bps. CASA ratio declined sharply to ~31.8% vs 32.7% QoQ and 36.8% YoY. Management expects rise in NIMs Q2FY24 onwards as bulk of the repricing of deposits is already over while loan mix should aid yields. Bank maintains its guidance of YoY stable NIMs (at 3.30%) for FY24, suggesting healthy uptick from current levels. The guidance does not factor-in any benefits from the imminent capital raise. However, we model ~10bps YoY compression in NIMs YoY due to firm cost of deposits trajectory, pressure on CASA and limited rise in yields due to a sizeable share of the EBLR book.

* Slippages inch-up; headline NPA ratio stable: Gross slippages inched up QoQ to Rs5.0bn (vs Rs4.5bn QoQ). Retail slippages increased from 1.4-1.67% in the last two quarters to 1.92% in Q1FY24, mainly coming from restructured book. Recovery was soft, hence net slippages increased to Rs2.55bn (~56bps) vs Rs0.55bn (13bps) QoQ. This, along with miniscule write-offs, led to ~6% rise in gross NPA QoQ. Gross / Net NPA ratios were broadly stable QoQ while reported credit costs stood at 41bps. We are building-in credit costs at 50-55bps for FY24E-FY25E with broadly stable PCR.

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