We do not expect a quick recovery in the stock. Investors should gradually build up position in this weak phase
– Tax benefit supports bottom line
– NIM contracts due to interest reversal, excess liquidity and fall in external benchmark
– Cost-to-income ratio rises due to ad-hoc provision
– Advances growth falls, retail still going strong
– Slippage high driven by a large corporate
– Stressed book might impact numbers in coming quarters
– Strong growth in fees and deposits
– Valuation turning attractive, near-term clouded, gradually accumulate
Federal Bank’s reported profits for the September quarter looked strong aided by lower taxes, but there were several areas of disappointment. While the tax bounty has been used to beef up provisions, and hence welcome, higher slippages from the corporate book, sharp decline in interest margin, rise in one-off costs and softer credit growth were the areas that took the sheen off the reported numbers.
The stock has underperformed both the benchmark Nifty and Bank Nifty in recent times and is a whisker away from its 52-week low price. It is trading at an attractive valuation of 1X FY21e book. Our stress case scenario for the bank suggests limited downside. While the sentiment will continue to remain adverse in light of the challenging macro, the weakness may be an opportunity to gradually build up a position for the long run as the bank’s strategic intent inspires confidence.
The headline growth in profitability masks weak core performance – net interest income grew 10 percent YoY and declined sequentially, owing to a fall in margin by 14 basis points to 3.10 percent. About 4 basis points could be attributed to excess liquidity i.e. much faster deposits growth than advances; another 4 basis points on account of interest reversal due to higher slippage and the remaining to a decline in the yield on external benchmark-linked loans where there was a steep decline in T-Bill rates.
There was a sequential decline in yield on advances as well.
The bank has now moved to a repo-linked external benchmark for close to 14 percent of the book. Since a part of the liability is also floating, the bank is targeting to recoup margin by the end of the fiscal year.
The cost-to-income ratio shot up to 53 percent as the bank incurred ad-hoc expenses of Rs 43 crore. A part of it – around Rs 27 crore – was for creating provisions for a wage hike and the rest for higher pension liability on account of a decline in interest rates.
Slippages were higher as a large troubled corporate account (ADAG group) of Rs 180 crore was classified as non-performing.
In terms of troubled exposure that are still standard in its books, the bank has Rs 190 crore exposure to IL&FS (operating asset), Rs 300 crore to Indiabulls Housing and Rs 175 crore to DHFL. In the quarter, it has created standard assets provision of Rs 72 crore against these exposures. The management, however, clarified that it is not witnessing new stress from any other pocket.
While Federal Bank has gained market share in deposits as well as advances, in the quarter gone by there was a sharp deceleration in the growth in advances which in fact has fallen below the bank’s guided range. Growth was driven by retail with wholesale taking a calculated back seat.
The bank has over 8 percent of advances as exposure to NBFC, over 6.5 percent to housing finance companies and over 3.5 percent to real estate. However, barring the accounts highlighted, the other exposures enjoy good credit ratings.
The Reserve Bank of India has approved the re-appointment of Shyam Srinivasan as the Managing Director and CEO of Federal Bank for another year subject to the bank’s performance. Hence the continuity of the senior management is contingent on the bank’s performance in the ensuing quarters.
Non-interest income growth is clearly turning out to be a key differentiator with the bank having taken a number of initiatives to beef up this source of revenue. In the quarter gone by, the 30 percent jump in non-interest earnings was aided by fees, trading gains as well as recovery in written-off accounts.While advances moderated, the management reiterated that it isn’t chasing growth and would not on-board undue risks. The proportion of wholesale to retail is 51:49 and is inching closer to the bank’s targeted 50:50 mark.
Deposits grew at a healthy 18 percent YoY with good growth in term deposits. CASA (low cost current and savings accounts) grew well sequentially with CASA share stable at 31.5 percent
The bank used the tax bonanza to step up provision and resorted to Rs 131 crore of write-offs. Consequently, provision coverage with technical write-offs stood at 66 percent.
Despite the miss in the quarter, the bank is still guiding to reach RoA (return on assets) of 1.25 percent by FY21.
Are all the risks priced in?
Given the myriad misses and the potential stress in light of the fast deteriorating macro and the bank’s substantial exposure to SME, sentiment towards the stock will remain negative. However, as our calculation suggests, even if 50 percent of the known troubled exposure were to turn into loss assets it would amount to 2.5 percent of FY20e net worth, therefore not meaningfully denting performance. While we do not expect a quick recovery in the stock, the bank’s strategic intent of building a less risky book, focus on fees and market share gains from weak PSU banks should stand it in good stead in the long-run. Investors should therefore gradually build up position in this weak phase.