IGI Logo

Laying groundwork for steady improvement in RoA

Estimate 20% earnings CAGR over FY25-28 and FY28-exit RoA of 1.5%

* Federal Bank (FB) has demonstrated strong business growth and is rebalancing its portfolio toward medium- and high-yielding segments like LAP, used CVs, gold loans, and credit cards to drive profitability. Thus, the bank aims for ~17% loan CAGR over FY25-28 while maintaining strong asset quality.

* Deposit growth is expected to accelerate to a 15.1% CAGR over FY25-28, supported by a CA-led CASA push, a stronger NR franchise, and the realignment of its branch network. We estimate CASA share to improve to 34-35% by FY28E.

* NIMs may face near-term pressure due to high funding costs, muted CASA growth, and T+1 repricing of a 51% repo-linked book; however, FB targets medium-term NIMs of 3.5% by FY28.

* C/I ratio is estimated to stay high at 53-55% in the near term due to investments in Neo, Project Udaan, and tech upgrades, though it is expected to improve with scale and productivity gains.

* Asset quality remains robust, with GNPA/NNPA at 1.84%/0.44% in FY25 and a healthy PCR of >75%. Credit costs are likely to remain contained at ~35-45bp.

* Under new CEO Mr. KVS Manian, FB is addressing its legacy inefficiencies and pivoting toward sustainable, return-driven growth across businesses and geographies. We estimate RoA/RoE at 1.4%/15.6% by FY28E, driven by better margins, asset mix shift, and improved cost efficiency. The C/I ratio is likely to fall to ~48.8%.

* FB remains one of our preferred BUY-rated ideas among mid-size private banks with a TP of INR250 (1.5x FY27E ABV).

Targeting balanced growth with improving asset mix

FB is strategically shifting toward profitable growth by reshaping its asset mix to favor medium- and high-yield segments while preserving asset quality. In FY25, it reported modest credit growth of 12% as the bank deliberately slowed non-friendly corporate loan growth, while other segments like LAP, CV/CE, and gold loans continued to grow at a healthy pace. Although gold loan growth slowed in 4Q due to regulatory factors, recent LTV relaxations by the RBI should support recovery. FB remains cautious on unsecured credit but expects a gradual re-entry as conditions improve. We estimate FB to deliver ~17% loan CAGR over FY25-28E.

Focusing on CA to boost deposit growth and ease funding costs

FB is strengthening its deposit franchise by accelerating CA deposit growth. Overall deposit growth was moderate at 12% YoY in FY25, led by 15.6% CASA growth, though the CASA ratio remained modest at ~30.2%. While the bank has underperformed peers in CA deposits, it is garnering deposits through innovative offerings and increased focus on SME/mid-corporate customers. We note that FB’s CA mix at 7% is relatively smaller than the 12-16% range for other top 5 private banks despite FB having ~31% mix of non-retail loans. FB is also reorienting its branch strategy toward liability-led growth, transforming its outlets into active deposit hubs. With a strong NR franchise (~29% of deposits), the bank plans to expand beyond Kerala and the GCC, leveraging wealth and investment offerings. These initiatives will help to improve the CASA ratio in the medium term. Additionally, the bank has consciously pruned nonLCR-friendly wholesale deposits, resulting in a healthy LCR of 142% as of FY25 (128% in FY24). With this improved liquidity profile, deposits are expected to grow steadily at a 15% CAGR over FY25-28, with CASA growth being faster at 20% over the same period.

NIMs to be under pressure in near term; aspires to reach 3.5% by FY28E

FB’s NIMs are likely to remain under pressure for the near term due to rising funding costs, muted CASA growth, and yield compression from the transmission of repo rate cuts. Its high repo-linked book (51%) and faster T+1 repricing model (vs. peers) add to the pressure. However, FB is repositioning for medium-term margin expansion, targeting NIM of 3.5% by FY28. It is focusing on high-yield segments, such as used CVs, affordable housing, LAP, tractor financing, SME & mid-corporate lending and credit cards, while reducing exposure to low-margin mortgages, corporates & NBFCs. The bank has exited select non-remunerative corporate loans, replacing them with better-yielding assets. With aligned repricing, a shift in asset mix, and improving liabilities mix, FB aims to structurally enhance margins and improve its margin profile. We estimate margin to improve to 3.45% by FY28E.

Expect gradual reduction in cost ratios; fee intensity to improve further

The bank is strategically investing in long-term franchise growth while focusing on cost efficiency and fee income expansion. In FY25, opex rose due to branch additions, marketing spends, and tech-led initiatives, pushing the 4QFY25 C/I ratio to ~56.7% vs. a full-year average of ~54%. Investments in platforms like Neo (sales and marketing) and Project Udaan (branch productivity) are expected to drive future growth but will keep costs high in the near term, with the C/I ratio likely to stay in the 53-55% range. However, scale benefits, process centralization, and operating leverage are expected to aid gradual improvement in C/I ratio, with most of the benefits to be visible from FY28E when C/I ratio is estimated to improve to 48.8%. Simultaneously, FB is scaling up its fee income on the back of strong traction in cards, wealth, and fintech cross-sell. It is aiming to improve the fee-to-assets ratio, thus enhancing RoA while balancing growth and operating efficiency.

RoA recovery to begin in FY27E; estimate sharp uptick to 1.5% by exit FY28E

FB, as a franchisee, has operated with a conservative risk profile and that partly is the reason why the bank has operated in a lower return ratio profile. Over the past five years, the bank’s RoA has been in the range of 0.9-1.2%, which is lower than that of its industry peers. FB has set an aspiration to grow and realign its product portfolio toward mid- and high-yielding assets while being conscious of its asset quality metrics, which should help to keep the credit cost contained. As operating leverage kicks in and the C/I ratio sees a calibrated decline, fee income will remain strong amid cross-selling and better growth in high-yielding assets. These measures collectively set the stage for a gradual RoA improvement for FB, pointing to a credible pathway toward ~1.4% RoA by FY28E (exit RoA of 1.5%).

Asset quality stable; factoring in slight rise in credit cost as mix of highyielding assets increase

FB has consistently maintained strong asset quality, with GNPA/NNPA improving to 1.84%/0.44% in FY25, driven by controlled slippages, strong recoveries, and prudent provisioning. Robust underwriting, especially in mid-corporate and SME segments, underpins this performance. Even in higher-yielding areas like microfinance and credit cards, the bank has remained cautious and has made accelerated provisions, prioritizing quality over growth. The restructured book has declined to 0.6%, and PCR has improved to >75%, strengthening the balance sheet. With a disciplined credit culture, selective unsecured exposure and proactive risk framework, FB is well positioned to manage asset quality across cycles. We estimate credit cost to stay contained or increase slightly to ~50bp by FY28E as the bank consciously increases the mix of high-yielding loans. We thus estimate GNPA/NNPA to improve further to 1.7%/0.4% by FY28E.

Valuation and view

* FB recorded slower growth in FY25 due to its ongoing portfolio rejig and conscious shift toward higher-yielding products. Its strategic focus—driven by asset mix improvement, liability optimization, and digital initiatives—positions it well to improve upon its profitability profile.

* Under new CEO Mr. Manian, the bank is addressing key gaps and is on track to deliver stable growth with improved margins and stronger return ratios.

* Though the stock trades at a discount to peers, improving fundamentals and a better RoA/RoE profile should support valuation re-rating over time, particularly as the steps that management is taking begin to yield results.

* We estimate RoA to expand to 1.4% and RoE to 15.6% by FY28E, with potential upside from rising margins and continued asset mix shift. As operating leverage improves, the C/I ratio is likely to decline to ~48.8% by FY28. FB remains one of our preferred BUY-rated ideas among mid-size private banks with a TP of INR250 (1.5x FY27E ABV).

For More Research Reports : Click Here 

For More Motilal Oswal Securities Ltd Disclaimer
http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html
SEBI Registration number is INH000000412