Why You Should Buy Fed Stock Now

Federal Bank is one of the older “younger” private sector banks that have been around for 76 years. However, Managing Director and CEO, Shyam Srinivasan, has never liked the badge of an old private bank. To break the restrictions, in fiscal 2018, he decided to change three important aspects regarding the bank – increasing the use of digitization to grow the balance sheet, building a likable retail deposit base and breaking the perception of being a Kerala-based bank.

With nearly 88 percent of digital transactions, on par with the three largest private sector banks, and a retail deposit share of 94 percent, the best in the industry, new branches have opened outside its home state (though Kerala continues to do so). (representing 50 percent of the bank’s business), Federal Bank is among the few banks in the South that have gained their presence and image as an All India Bank by ticking the right boxes.

At a rate of 1.2 times the FY23 estimate, the lender is going through an interesting turn in terms of achieving growth in the banking sector. While there are some asset quality issues that can arise, these will largely be contained in the restructured ledger. So, with a lot of the pandemic-related issues addressed and the bank back on the one percent return on assets (ROA) path, the downside risks seem to be priced in. We recommend investors with a long-term horizon to buy stocks.

Changes in approach

About five years ago, the Fed’s retail business was littered with gold loans, home loans, loans against property, and unsecured loans. Today, it has made inroads into credit cards, despite partnering with One Card, auto loans including commercial vehicles and used cars and has a much more structured personal loan business. Similarly, the share of corporate advances to less investment grade entities fell from 17 percent in FY2017 to 11 percent in FY22, and the share of loans classified above rose from 70 percent to 78 percent during this period. The underwriting criteria for SME loans have also seen a similar improvement for the bank.

Overall, although there was no dramatic change in the composition of the Fed’s loan book, its level of detail has improved, with the share of retail loans (including agriculture) increasing from 40 percent in FY17 to 46 percent in FY22. The share of corporate loans is approaching around 36 percent and the share of SME loans has shrunk from 24 percent in FY17 to 18 percent in FY22.

Continuous investment in digital partnerships has helped the bank build an integrated product offering like any large private sector bank and this is what makes the Fed growth ready.

While the bank’s compound annual growth rate (CAGR) loan growth in the 2019-22 fiscal period was 6 percent and was lagging compared to the five largest private sector banks, in the first quarter of fiscal year 23, with a lot of pandemic-related pain behind the bank, it grew Advances of 16 percent, largely driven by retail loans. The bank has guided growth from the mid-to-high teens, in line with what large banks expect in fiscal year 23. Its leadership in inward remittances with more than 22 percent market share makes the bank attractive to acquire this business as well.

This should translate into better quality of earnings. In the first quarter of FY23, the Fed’s return on assets (return on assets) improved to 1.1 percent (from 0.9 percent in FY22) and this trend, driven by lower provisioning cost, could continue, down 51 percent in the quarter. The first is in FY 23 and 26 percent in FY 22. But the hard part may be with regard to increasing profitability or net interest margin (NIM). At 3.2 percent in the first quarter, the Fed’s NIMs were flat, both sequentially and on an annual basis, because the 90 basis point repurchase rate hike through the first quarter did not fully transfer to customers. With 140 basis points absorbed now and the rallies likely to reverse in the coming months, the NIM could improve quite a bit.

However, unlike the large private sector banks at 4 percent NIM, the Fed may not see such high margins soon, as about 40 percent of its retail book is still in the early stages of construction. With the yield on loans falling significantly in the past two years and cost pressures slowly accumulating, the space for NIM’s expansion is narrow. However, with a cost-to-income ratio of over 50 percent and a NIM of over three percent if a bank can cross the 1 percent threshold of return on assets, that’s a testament to the quality of its loan book.

Asset quality

The slips in the first quarter were raised at Rs 444 crore and came largely from retail loans. However, the bulk of the slip comes from the book restructured at ₹3,366 crore (2.2 per cent of the total advances). However, since this portfolio covers provisions at 66 percent, the impact of the stress may not be very significant. As with most banks, the Fed is also seeing an easing of asset quality issues as the Gross NPA and Net NPA declined to 2.7 percent and 0.9 percent respectively (see table). The contraction of the stressed loan pool and the easing of NPA ratios should help the bank in fiscal year 23.

Management

Shyam Srinivasan has been the bank’s front since 2010 and has largely managed its fortunes. He is expected to remain in the position of managing director and CEO until September 2024, when the bank will have to search for a new president. The Bank has a strong leadership team at present and is well equipped to find a replacement for Srinivasan internally. This should provide convenience in terms of leadership, business and operational continuity for investors.

Why

Strong digital footprint, on par with major lenders

The downside risk of asset quality issues appears to be priced

High quality loan book and large deposit base for individuals

Posted in

August 27 2022

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