Monday, June 29, 2009


Investment Rationale

Federal Bank has one of the highest capital adequacy ratio's (CAR 20.2%, Tier I CAR 17.5%) which can be deployed to ramp up business as the economic scenario improves. The management has guided a loan growth of ~20% in the current scenario, but may increase it to ~25% if the macro-environment improves. We expect loans and deposits to grow at a CAGR of 22% and 19% respectively over FY09-FY11.

Fed bank's NIM (4.1% in FY09*) is highest amongst peers whereas cost to income ratio (31%) is lowest the sector. We believe that the bank will maintain NIM in the range of ~3.9% and cost to income ratios at 32% over FY09-11E.

Suppressed RoEs (due to 1:1 rights issue in FY08) and increase in slippages have led to underperformance of stock. However, we expect bank's RoE to improve to 14.1% in FY11 (12% in FY09) led by 20% CAGR growth in profits. We also expect bank to maintain provision coverage of 80% for the next two years (88% in FY09) which will shield earnings against rise in NPAs.

Fee income of the bank is expected to grow at ~20% CAGR over FY10-11E due to strong growth in remittances, forex, processing fees etc. We believe that lower recoveries from written off accounts coupled with decline in treasury income will lead to muted growth in non interest income.

Fed Bank is in talks with Catholic Syrian Bank (based at Kerala) for merger which has 362
branches and a business size of INR 100bn. As the merger goes through, Federal Bank's
branch tally will increase to ~1000 and will be among the top three private banks (after
ICICI & HDFC Bank) in terms of branch network.

Valuations and Outlook
We expect Fed bank's advances to grow at CAGR of ~22% over FY09-F11E whereas profits to
grow at 20% CAGR over the same period. This would translate into ROE's of 14.1% in FY11E
(currently 12%). Despite sharp run up the stock is trading a 0.9x and 0.8x FY10 & FY11 adj
book values. We initiate coverage on the Federal bank with a target price of INR 300 (1x
FY11 ABV) and Buy recommendation.

To see full report: FEDERAL BANK