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Strategy sounds sensible, balanced and scalable

We participated in the Analyst Meet held by Federal Bank (FED) and gleaned the following key takeaways (1) The new CEO’s vision of building a truly pan-Indian universal bank with a move to top-tier private sector peer set metrics is encouraging (2) Margin improvement will be a key RoA driver, sensibly underpinned by liability franchise enhancement, driven by CA share augmentation and backed by loan mix enhancement, driven first by medium-yield assets (3) Management is intent on filling up white spaces when it comes to lending segments and also scaling up a hitherto subpar fee income franchise (4) Other key initiatives would be to improve brand recall, build a wealth management overlay on the liability franchise with capital markets linkage, leverage branch strategy, alter sourcing strategy and optimize cost.

The new CEO’s vision of building a truly pan-Indian universal bank with a move to top-tier private sector peer set metrics is encouraging

The new CEO has introduced genuine incremental ambition into the DNA of the bank. KVS Manian is acutely aware that for any “challenger” bank to scale profitably in a sustainable manner, (1) it has to adopt a pan-Indian approach and not be dependent on a catchment area approach (2) it has to be a universal bank in the true sense of the word and not have any white spaces when it comes to offerings and services (3) it has to optimize sales orientation with risk management. 

Margin improvement will be a key RoA driver, sensibly underpinned by liability franchise enhancement, driven by CA share augmentation

The intention is to improve the CASA ratio from about 30% currently in FY25 to about 36% in FY28. This will be mainly derived from the CA ratio which is currently low for the bank at around 6% and the intention is to take it to 10%. Non-resident deposits (NR) is a moat that the bank has created but the bank wishes to expand beyond its stronghold of GCC-Kerala. Engagement with capital markets will be increased since this is transaction intensive and positive for CASA ratio. Loan mix improvement will also be a lever, with an aim to scale of up medium-yield segments. As the environment improves, the bank will pursue high yield assets as well. The intention is to decrease the share of low-yield loans from 64% in FY25 to 58% in FY28. The share of medium-yield assets would rise from 31% to 34%.

Management is intent on filling up white spaces when it comes to lending segments and also scaling up a hitherto sub-par fee income franchise

Expanding product portfolio would entail scaling up businesses like used vehicle finance, micro-LAP, agri and MFI, gold loan and tractor finance. Unsecured business loans, affordable housing finance, real estate loans and sustainable finance would also be carried out. Fee income enhancement, which would be the second most important RoA lever after margin, would entail ramping up trade and forex, wealth management, bancassurance, credit cards and cash management. The bank would like NII to grow faster than its advances growth and aim for a fee income growth faster than NII growth.

Other key initiatives are to improve brand recall, wealth management, targeted branch expansion, altering sourcing strategy and optimizing cost

For branch expansion, the bank will first focus on the top 10 states, which will see 80- 90% of the incremental branch addition. In total, 400-450 branches would be added by FY28. The share of partner sourcing is planned to be reduced from 70% in FY25 for credit cards to 55% in FY28. This may increase upfront cost but it will also mean the bank will not have to share profit down the line. For personal loans, the share of partner sourcing would increase from 40% to 50%. Cost would be optimized using enhanced productivity, low-cost sales, leveraging Fedserv, centralizing and regionalizing, AI and automation. Opex to assets would decline to levels in between the top 3 banks and next 3 banks.             

We maintain ‘BUY’ rating on FED with a revised price target of Rs 230      

We value the standalone bank at 1.4x FY24 P/BV, valuing the subsidiaries at Rs 11.

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