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Mixed bag

Core softer, delivery on stated parameters, the key

Federal Bank’s (FB IN) Q3FY24 PAT at INR 10bn surpassed estimates on higher other income (stake sale of Fedfina), even as NIMs (lower-than-expected) and higher opex (impact of wage hike) curtailed the benefit. The key highlight was the NIM pressure (yet again, missed management guidance) in the backdrop of sustained funding cost pressures and higher slippages (a corporate account, which management expects to get rectified in Q4). Stepping forward, sectoral headwinds (on NIMs) and various variables at play (essentially on deposits) may lead to some disappointments, essentially amidst regulator’s focus on CD ratios. Investors have had concerns over core operating performance and thus, FB's delivery on stated parameters (essentially on RoA) is imperative to build confidence and aid sustained rerating.         

NIM fell short of expectations; trajectory hereon, the key 

Q3 was characterized by further NIM disappointment (down 3bps, despite capital benefits), even as business momentum (loan growth of ~3.3% QoQ, deposit growth of 2.9% QoQ) was as expected. Given current liquidity and amidst regulatory focus on CD ratios, we believe scurry for deposits may persist and deposit cost may rise further. This with limited yield levers may entail further pressure on NIMs. Also, opex rose 6% QoQ/27% YoY, as FB provided for wage hike. Given that the impact of pension is still pending, we believe opex may run elevated, offering limited levers for RoA improvement.  

Asset quality saw slight blip; consistency, key for RoA delivery

Slippages rose to INR 4.96bn (96bps versus 77bps in Q2FY24), largely given higher corporate slippages (one account of INR 780mn). FB provided 100% towards this (and expects this to recover in Q4FY24). That said, provision write-back of INR 1.12bn (release from restructured book) helped cushion credit cost. FB, over time, has shored up coverage (from 50% in FY20 to >70% currently), leading to NNPL at 64bps (flat QoQ). We see asset quality trends currently in comfort zone, with no major red flags, and performance the key for guided RoA delivery.

Valuations: Recommend Buy; TP raised to INR 189 

Q3FY24 was a mixed bag for FB, but its strengthened underlying in the past few years may help deliver RoA/RoE of 1.2%/12-13% (post capital raising), despite headwinds (on NIMs). Factoring in Fedfina stake sale, we raise FY24E EPS by 10%, while FY25E remains broadly unchanged. We introduce FY26E estimates and roll to September 2025E, leading to raised TP of INR189 (valuing FB at 1.3x P/BV and INR11 for Fedfina).

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