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Strong growth momentum; RoA trajectory to remain at >1%

Business Update – Q2FY23

* Federal Bank (FB) posted higher-than-expected growth, at 19% YoY/6% QoQ (the highest in the past 13 quarters) in Q2FY23 vs 16% YoY/5% QoQ in Q1. The growth is now broadbased across loan products, with YoY retail book growth at 19% and wholesale credit growth at 20%. We believe that retail credit acceleration is mainly driven by mortgages, followed by gold and auto loans. Factoring-in the strong growth momentum for the industry and the bank, we revise our credit growth for Federal Bank to 18% in FY23E from 16%.

* Deposit growth remained moderate at 10% YoY, with retail deposits growth at 9% YoY; hence, the LDR improved to 87% in Q2 vs 83% in Q1. CASA ratio remained stable at 36%. We believe better LDR coupled with higher retail growth and healthy CASA should help the bank on the margin front.

* Amid industry concerns about rising stress in the SME pool, Bank has reiterated that the asset quality remains well under control and that it should see further decline in NPAs. The bank has conservatively built-in PCR of >65% on existing NPLs and, thus, incremental credit cost will remain low, leading to healthy profitability. Bank’s Q1 performance on the treasury front too was outstanding, and should endure, with G-Sec yields largely remaining flat in Q2.

* Retain BUY: Equipped with a healthy liability profile and strong retail product basket, the bank is continuously paddling for better credit growth. Thus, factoring-in better growth, we revise our earnings estimate for FY22-25E by 3-6%. The bank previously struggled to cross the 1% RoA mark, but now seems to be well positioned to deliver +1% RoA on the back of improving growth/margin trajectory, moderating opex and credit cost. We retain BUY on FB, with revised TP of Rs147 (vs Rs142), given the improving RoA trajectory, management stability and strong digital adoption among small-/mid-cap banks. Potential value unwinding in its NBFC subsidiary (FedFina) via an IPO could be an additional catalyst for the stock and also shore up receding capital levels.

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