federal bank - jm - ic - feb 2012

8/2/2019 Federal Bank - JM - IC - Feb 2012

1/21

JM Financial Institutional Securities Private Limited

A promising franchise with improving ROE

Robust and stable ROAs at 1.3%; normalising credit costs to catalyse re-

rating: Federal Bank has a formidable franchise with asset base of`579bn

delivering healthy ROA of c.1.3%. Asset quality and scaling up of franchise arethe key challenges for the bank. With its task cut out, the reconstructed

management has taken definite steps in last eighteen months - It has overhauled

banks risk management system and put forward a focused growth strategy,

which leverages banks competitive skills in SME/mid-corporate segment,

dominant position in Kerala and traction with NRI population. While near-term

challenges emanates from a) NIM compression (arising out of de-risking of

balance sheet and deregulation of NRE deposits interest rate), and b) ambitious

branch expansion putting pressure on costs, ROA is likely to remain stable as

credit costs normalise in coming years. Increase in leverage, from a very strong

capital position (with Tier 1 ratio of c.15%), should nudge ROEs higher.

Measured loans growth in select areas; margins moderate but remain

strong at 3.5% (FY13, calc.): While new operational practices streamline, the

bank looks to focus on areas of its competitive strength (of SME/NRI pedigree),and hence plans to expand outside Kerala, only where it can leverage its niche.

We forecast loan book CAGR of 18% (FY11-14E) driven by SME, higher rated

corporate and home loans and gold loans in retail segment. Margins are

moderating from high levels (FY11: 4.0%) given a) de-risking of balance sheet to

less riskier assets, b) leverage increasing to 12x by FY14E (FY11: 10.1x), and c)

rising cost of deposits due to deregulation of NRE TDs. We forecast NIM to come

down to 3.51% (calc.) in FY13 (FY11: 3.76%). Core non-interest income CAGR at

16% (FY12-14) is expected to slightly lag B/S growth.

Asset quality under dual challenges; risk adj. margins and credit costs to

improve:Asset quality faces challenges from a) continued high gross slippages

(9M12: 4.48%), and b) exposure to critical sectors (e.g. aviation (`4.1bn) and

power (`19.5bn)) in a slowing environment. However, we derive comfort from a)

overhauled risk management system and ageing of legacy NPAs bringing creditcosts under control, and b) high coverage (82%) and strong capital base

providing buffer to withstand shocks. We estimate adjusted credit costs of

c.1.2% in FY13 and FY14 (FY11: 1.87%, FY12E: 1.33%). Risk adj. NIM will thus

remain stable at 2.72% over FY13 and FY14 (FY11: 2.57%, FY12E: 2.81%).

Attractive valuation provides an entry point into a promising turnaround

story; initiate with BUY and Dec12 TP of `525: The bank should maintain itsROA at healthy level of c.1.3%, as reduction in credit costs offset margin

compression. ROE would improve to 15% by FY14 (FY11: 12%). We value the

bank at 9.0x Dec13 EPS (1.3x fwd BV), arriving at Dec12 target price of

`525. Initiate with BUY.

JM Financial Research is also available o

Bloomberg - JMFR , Thomson Publisher & Reute

Please see important disclosure at the end of the rep

Ravi SingRavi.singh@jmfinancial

Tel: (91 22) 6630 305

Puneet [email protected]

Tel: (91 22) 6630 307

Karan Uberoi, CFA, FR

[email protected]

Tel: (91 22) 6630 308

Amey Sathe, [email protected]

Tel: (91 22) 6630 302

Sanketh [email protected]

Tel: (91 22) 6630 306

Key Data

Market cap (bn) `72.2 / US$ 1

Shares in issue (mn) 171

Diluted share (mn) 171

3-mon avg daily val (mn) `209.2/US$ 4

52-week range `480.0/322

Sensex/Nifty 18,073/5,4

`/US$ 49

Daily Performance

Federal Bank

250

300

350

400

450

500

550

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

-10%

0%

10%

20%

30%

40%

50%

F ederal B ank R elat iv e t o Sens ex (R HS)

% 1M 3M 12

Absolute 10.1 24.1 21

Relative* 2.1 8.9 21

* To the BSE Sensex

Shareholding Pattern (%

3QFY 11 3QFY 1

Promoters 0.0 0

FII 38.3 41

DII 23.3 20

Public / others 38.4 38

Federal Bank | FB IN

24 February 2012

India | Banking & Financial Services | Initiating CoveragePrice:`422

BUY

Target:`525 (Dec12)

Exhibit 1. Financial Summary (` mn)Y/E March FY10 FY11 FY12E FY13E FY14E

Net Profit 4,645 5,871 7,534 8,847 10,372

Net Profit (YoY) (%) -7.2% 26.4% 28.3% 17.4% 17.2%

Assets (YoY) (%) 12.4% 17.8% 19.6% 17.5% 17.5%

ROA (%) 1.13% 1.23% 1.33% 1.32% 1.32%

ROE (%) 10.3% 12.0% 14.0% 14.7% 15.3%

EPS (`) 27.2 34.3 44.0 51.7 60.6

EPS (YoY) (%) -7.2% 26.4% 28.3% 17.4% 17.2%

PE (x) 15.5 12.3 9.6 8.2 7.0

BV (`) 274 298 332 372 420

BV (YoY) (%) 8.4% 8.9% 11.4% 12.0% 12.7%

P/BV (x) 1.54 1.41 1.27 1.13 1.01

Source: Company data, JM Financial. Note: Valuations as of 23/02/2012


2/21

Federal Bank 24 February 2


Strong ROAs and stabilising asset quality provide are-rating candidate

Changing face of the bank: Following the appointment ofMr. Shyam Srinivasan as MD

and CEO of the bank in September 2010 and some subsequent key senior management

changes, Federal Bank, has, in last eighteen months, focused on transforming its

operations. Key features of these changes are:

Risk management systems: The management team has overhauled its risk

management system by separating credit origination and appraisal system and

centralising the sanction to tackle legacy asset quality issues. Increased focus is

being given to recovery of NPLs.

Loans growth strategy: The bank is following a focused growth strategy, which

revolves around its traditionally strong areas of mid-corporate/SME segments,

dominant position in Kerala and healthy share of NRI customers. Overall, the loan

book mix is likely to remain unchanged and diversified across corporate, SME and

retail. Current focus on SME and mid-corporates will continue. For corporate loans,

focus is on good quality credit; gold and housing loan are key products in retail

segment.

Branch strategy: The bank has an ambitious plan to take branch network from 835

currently to 1,000 in 2012. While Kerala still accounts for large share in existing and

new branches, the bank has identified states, such as Tamil Nadu, Maharashtra,

Karnataka, Gujarat and Punjab, for opening new branches. In these states, the bank

can take advantage of its experience with SME/NRI customers.

Fee income franchise: Fee income franchise has been weak. The bank has

addressed the issue by hiring some experienced personnel at senior management

level for wholesale banking and treasury. It has also opened specialised branches in

Mumbai and New Delhi for this purpose.

Culture at the bank: Being an old private sector bank, management needs to orient

the culture to modern banking. This will be a gradual process and management has

taken initial steps such as introducing employee stock options.

Historically, the bank has delivered strong margins (helped by focus on high yielding

mid-corporate/SME segments and low leverage) and kept a competitive cost base (FY11

CI ratio of 37%). Higher slippages in recent years (gross slippages FY11: 3.27%, FY10:

3.35%), however have kept credit costs relatively higher. Fee income growth (FY06-11

CAGR: 10%) has also lagged balance sheet growth. As a net result though, the bank has

managed to generate healthy ROAs of c.1.3% (FY06-11 average).

Stable ROA and increasing leverage to drive ROE improvement: We forecast NIM to

moderate from 3.76% (calc.) in FY11 to 3.44% by FY14. Though the bank is trying to

address weakness of its fee income franchise, we build core non-interest income CAGR

of 16% (FY12-14), slightly lower than B/S growth. CI ratio is expected to rise to 39.2% by

FY14 (FY11: 36.9%), as a result of branch expansion plan and associated recruitment.We expect gross slippages (FY12E: 3.75%, FY13E: 3.00%, FY14E: 2.70%) and net

slippages (FY12E: 1.45%, FY13E: 1.38%, FY14E: 1.27%) to decline given banks initiatives

in risk management and recovery efforts. Reduction in coverage ratio (FY14E: 70%,

FY12E: 80%) should bring down LLP to c.1.0% (9M12: 1.14%, FY11: 1.71%). A strong core

tier I ratio of 14.97% (Dec11) places bank in a strong position to withstand asset quality

issues in an adverse external environment and to scale up operations. The bank is

expected to thus deliver stable ROA of 1.33% over FY12-14 (FY11: 1.23%). As the bank

deploys surplus capital to business, we expect leverage to increase and ROE to improve

to 15.3% by FY14 (FY11: 12.0%).


3/21



a) Expanding footprints; leveraging competitive strengths

Federal Bank commands a strong position in its home state Kerala, where it has c.11%

market share in advances and c.12% in deposits, supported by c.10% market share in

number of branches (exhibit 2). Behind the SBI Group, it is the largest bank in state of

Kerala.

Exhibit 1.

Exhibit 2. Federal Bank: Market share in Kerala

FY09 FY10 FY11

Braches 8.9% 8.8% 9.5%

Deposits 13.3% 11.6% 12.1%

Advances 15.2% 11.8% 10.7%

Source: RBI, Company, JM Financial

Exhibit 3. Top five banks, by market share of branches, in Kerala

FY10 FY11

Branches Market share Branches Market share

State Bank of Travancore 616 14% 642 14%

Federal Bank 400 9% 457 10%

State Bank of India 391 9% 409 9%

South Indian Bank 324 7% 366 8%

Canara Bank 290 6% 314 7%

Source: RBI, JM Financial

Keralas share in total system deposits and advances has slightly declined over the

long term. While Keralas share in system deposits was relatively higher in earlier

years, it has gradually declined over the years. CD ratio has improved to 72% (FY03:

43%) and is now in-line with overall CD ratio of 75% for the system. CASA ratio of

Kerala deposits (FY10: 38%) is in-line with system CASA ratio (FY10: 39%). However,

it is skewed towards SA ratio (FY10: 32%) vs the system SA ratio (FY10: 27%)

Exhibit 4. Banking system of KeralaKerala FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY1

Share in national GDP 4.0% 4.0% 3.9% 3.8% 3.8% 3.8% N

Share in total branches 5.0% 5.0% 5.0% 5.1% 5.1% 5.2% 5.2% 5.2% 5.1% 5.0% 5.1

Share in total deposits 4.8% 4.8% 4.7% 4.4% 4.0% 3.8% 3.7% 3.4% 3.4% 3.3% 3.1

Share in total advances 3.5% 3.3% 3.4% 3.5% 3.4% 3.2% 3.1% 3.0% 2.9% 2.9% 3.0

Kerala deposits growth 16% 14% 12% 6% 13% 20% 15% 24% 11% 13

Kerala advances growth 15% 15% 22% 25% 25% 23% 18% 15% 17% 28

CD ratio (Kerala) 43% 43% 43% 47% 56% 62% 64% 65% 60% 64% 72

CD ratio (System) 59% 62% 59% 59% 66% 73% 75% 74% 73% 73% 75

Source: RBI, JM Financial.


4/21



At c.40%, personal loans form relatively large proportion of advances in Kerala and

indicate need for higher penetration of branch network in the state.

Exhibit 5. Sectoral break-up of credit outstanding in Kerala

FY07 FY08 FY09 FY10

Agriculture 14.0% 16.5% 14.7% 17.3%

Industry 16.4% 15.9% 14.6% 13.9%

Transport Operators 1.3% 1.2% 1.2% 1.4%

Professional & other services 6.0% 5.6% 6.2% 6.1%

Personal loans 38.9% 38.6% 41.4% 40.0%

-Housing 22.6% 21.5% 22.4% 21.9%

-Others 16.3% 17.1% 19.0% 18.1%

Trade 14.2% 14.0% 13.3% 12.9%

Finance 1.9% 2.2% 4.2% 5.4%

Others 7.4% 6.1% 4.3% 2.9%

Total Bank Credit 100% 100% 100% 100%

Source: RBI, JM Financial.

In-line with other regional banks, FB has higher branch concentration in one

particular state (Kerala in the case of Federal Bank).

Exhibit 6. Branch concentration for south India-based banks

Branches Federal Bank South Indian Bank Dhanlaxmi ING Vysya Karnataka Bank Karur Vysya

States Dec11 % Dec11 % Mar11 % Dec11 % Dec11 % Mar11

Kerala 491 59% 373 55% 161 59% 23 4% 11 2% 9 2

Tamilnadu 62 7% 117 17% 38 14% 39 7% 32 7% 219 59

Karnataka 60 7% 38 6% 14 5% 125 24% 296 61% 27 7

Andhra Pradesh 26 3% 44 7% 18 7% 170 32% 36 7% 80 22

Maharashtra 77 9% 24 4% 25 9% 48 9% 35 7% 23 6

Rest of India 119 14% 78 12% 17 6% 122 23% 79 16% 11 3

Total 835 100% 674 100% 273 100% 527 100% 489 100% 369 100

Source: Company, JM Financial.

Exhibit 7. Keralas market share in Federal Banks business

FY09 FY10 FY11

Braches 61% 58% 60%

Deposits 50% 49% 48%

Advances 46% 42% 41%

Source: RBI, Company, JM Financial

This regional focus has imparted two key characteristics to the banks customer profile:

SME and mid-corporate: Regional south Indian presence has lent business focus

to SME and mid-corporate loans. FB reports 32% of its loans as SME and 37% as

corporate advances; significant part of corporate advances is mid-corporate in

nature. The total share of mid-corporate/SME loans is thus estimated at c.41% of

loans (32% SME and 9% mid corporate). As at Dec11 end, retail loans comprised

31% of overall advances.

NRI customers: Given extensive diaspora (estimated at c.2.5mn, against state

population of c.31mn) from Kerala to middle-east, FB has had good share of NRI

customers. High remittance of this client base has been a steady source of

deposits for FB. As at Dec11, NRI deposits formed 16% of FBs total deposits.


5/21



Ambitious branch expansion; but focus on strategically important areas:The bankhas opened 92 branches in 9M12 and opened 71 branches in FY11. Going ahead, it

plans to continue its ambitious expansion plan, taking branch network from 835 (3Q12

end) to 1,000 by July 2012. Keralas share in total branches currently stands at 59%.

This is down from 73% share in FY05, but in the last three years, the share has been

stable around 60%

Most of the new branches (c.45%) would still come up in Kerala as a) the NRI deposit

base is fairly diverse across the state, b) many new branches are small, manned by 2-3staff, c) incremental cost of opening new branch and brand building is low in Kerala,

and importantly, d) it allows FB to open more tier III-VI centre branches in Kerala (to

meet RBI guidelines) and branches in more attractive locations outside Kerala.

Outside Kerala, the expansion is focused on states such as, Tamil Nadu, Karnataka,

Maharashtra, Gujarat and Punjab, where bank relies on its traditional operational

strength in mid-market SME and NRI population.

Exhibit 8. Federal Bank: Branches opened since FY10 end

State Branches opened Mix

Kerala 100 61%

Tamil Nadu 15 9%

Maharashtra 14 9%

Karnataka 12 7%

Gujarat 12 7%

Other 10 6%

Total 163 100%

Source: Company, JM Financial


6/21



b) Measured loan book growth of c.18% over FY11-14E

Loan book to register measured CAGR of 18% for FY11-14E: FB has delivered healthy

5-years loan book CAGR of 22% (FY06-11) (exhibit 9). The loan book of`343bn, as at

Dec11 end, is fairly well diversified across three segments of corporates (42%), SME

(29%) and retail (29%). In recent years, the loans mix has changed slightly in favour of

corporates (exhibit 10), a trend expected to continue in coming years. SME/mid-

corporate segment remains the mainstay for bank and is expected to see healthy

growth. Growth in gold loans, up 110% YoY in 3Q12, has driven retail loans in recentquarters (exhibit 11). However, with gold loans still comprising 5.5% of total loans,

there is significant room to grow this portfolio. Gold and housing loans are FBs key

focus areas in retail the segment.

Exhibit 9. Federal Bank: Growth trend for loans (`bn)

62 7788

117

153

193

230

270

320

374

442

521

0

100

200

300

400

500

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

0%

8%

16%

24%

32%

40%Loans (LHS) yoy growth(%)


Exhibit 10. Federal Bank: Break-up of the loan book by segment

FY10

Large & mid

corporate

38%

SME

31%

Retail

31%

3Q12

Large & mid

corporate

42%

SME

29%

Retail29%



7/21



Exhibit 11. Federal Bank: Retail loans mix (` bn)Gross Advances 3Q11 2Q12 3Q12 YoY (%) QoQ (%)

Housing loans 58.8 57.1 55.3 -6% -3%

Gold loans 8.9 14.5 18.8 110% 29%

Adv. Against deposits 8.9 10.6 10.9 21% 2%

Vehicle loans 5.1 5.8 4.9 -3% -15%

Education loans 2.9 2.9 3.9 38% 36%

Others 4.7 5.8 4.9 4% -15%

Total gross retail advances 89.3 96.7 98.7 10% 2%

Mix(%)

Housing loans 66% 59% 56% -10% -3%

Gold loans 10% 15% 19% 9% 4%

Adv. Against deposits 10% 11% 11% 1% 0%

Vehicle loans 6% 6% 5% -1% -1%

Education loans 3% 3% 4% 1% 1%

Others 5% 6% 5% 0% -1%

Total gross retail advances 100% 100% 100%


Management has guided for credit growth of 18-20% in FY13. We expect the bank toregister 18% CAGR in loan book for FY11-14E, at marginal premium to system growth.

The bank will benefit from geographical expansion, improving utilisation of branches

and sufficient headroom provided by the surplus capital.

Exhibit 12. Federal Bank: Business growth and CD ratio (`

117153

193230 270

320

374

442

522

179216

259

322361

430

508

604

713

50

150

250

350

450

550

650

750

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

0%

4%

8%

12%

16%

20%

24%

28%

Advances Deposits Business growth (% yoy)

65.6%

69.0%

73.0%

69.5%

74.7%74.3%

73.6%73.2% 73.

60%

62%

64%

66%

68%

70%

72%

74%

76%

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY

C-DRatio


Exhibit 13. Loan book growth: Federal Bank vs peers

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14

Federal Bank 15% 33% 27% 27% 18% 20% 19% 17% 18% 18

South Indian Bank* 28% 19% 24% 32% 13% 34% 29% 27% 22% 22

ING Vysya Bank 31% 13% 17% 22% 14% 10% 28% 22% 22% 21

HDBC Bank 44% 37% 34% 35% 56% 27% 27% 25% 23% 22

ICICI Bank 46% 60% 34% 15% -3% -17% 19% 18% 18% 18

Axis Bank 67% 43% 65% 62% 37% 28% 36% 20% 19% 19

IndusInd Bank 23% 3% 19% 15% 23% 30% 27% 29% 25% 25

Yes Bank 216% 161% 50% 32% 79% 55% 16% 27% 23

Source: Company, JM Financial. *Based on Bloomberg consensus estimate.


8/21



c) Deregulation has affected attractiveness of NRI deposits; CASAgrowth is key monitorable now

NRI deposits form a significant share: There is a large number of migrants from

Kerala in the Middle East (estimated at c.2.5mn, against state population of c.31mn)

and they send healthy remittances to their home state every year (on an average,

remittance income is estimated to contribute c.22% to state income). FB has

successfully exploited this opportunity over the years to support its deposit base

(exhibit 14). At 3Q12 end, NRI deposits (NRE/NRO/FCNR) accounted for 16% of totaldeposits. This compares with share of NRI deposits in total system deposits at c.4.3%.

Low cost NRI deposits formed 36% of these deposits (6% of total deposits). Along with

CASA deposits of 28%, total low-cost deposits thus stood at 34% of total deposits at

3Q12 end.

Deregulation of NRE deposits poses a challenge: On 16 December, RBI deregulated

interest rates for NRE deposits (savings and term) and NRO savings deposits (term

deposits were deregulated already). Before the deregulation, Federal Banks interest rate

on one year NRE deposits was 3.82%. However, the deregulation led to rate-war, with

almost all banks raising NRE term deposit rate to close to 10%. The Federal Bank has

also now increased one year interest rate on NRE deposits to 9.5%. The revised rates

apply to fresh deposits and on renewal of maturing deposits. While the impact on 3Q12

cost of deposits was negligible for Federal Bank, the attractiveness of NRE deposits,from low cost of deposits point of view, is now permanently reduced. Given that

majority of NRE term deposits mature in a year, the bank will see rising cost of

deposits, both from higher interest rates and migration of NRE savings to term

deposits. Though low cost FCAB deposits (2% of total deposits) are still out of purview

of interest rate deregulation, the direction of regulations indicates these could also be

deregulated eventually. Management has guided cost of funds to rise by 10-15bps in

FY13. NRI deposits however remain important for FB as differentiated set of

relationships and source of forex transactions fee income.

Exhibit 14. Federal Bank: Low cost deposits

28% 29% 29% 26% 27% 26% 28%

3% 3% 3%

3% 3% 3%3%

5% 4% 4%

3% 3% 2%2%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12

CASA FCAB NRE TD


CASA traction thus gains prominence to check cost of deposits: Given that

attractiveness of NRI deposits has diminished, progress on CASA growth is critical for

the bank now. Though the bank has an aggressive branch expansion plan and there is

significant scope to improve current CASA per branch; we remain cautious and will wait

to see the actual performance in current high interest rate environment. We expect

CASA ratio of 26-27% over FY12-14E.


9/21



Exhibit 15. CASA ratio: Federal Bank vs peers


Federal Bank 24.5% 25.0% 25.2% 25.1% 24.5% 26.2% 26.9% 27.3% 26.6% 26.4

South Indian Bank 24.8% 26.4% 23.9% 24.1% 23.8% 23.1% 21.5% 21.5%*

ING Vysya Bank 24.2% 27.0% 28.9% 31.5% 27.0% 32.6% 34.6% 32.0% 31.5% 31.5

HDBC Bank 60.6% 55.4% 57.7% 54.5% 44.4% 52.1% 52.8% 48.3% 48.0% 48.2

ICICI Bank 25.1% 24.0% 22.6% 26.9% 30.2% 43.8% 47.5% 44.6% 43.5% 43.1

Axis Bank 38.0% 40.0% 40.0% 46.3% 44.1% 48.1% 42.6% 42.0% 41.6% 41.6

IndusInd Bank 10.7% 12.9% 14.9% 15.7% 19.2% 23.7% 27.2% 28.0% 30.5% 33.0

Yes Bank n.a. n.a. 5.8% 8.5% 8.7% 10.5% 10.3% 13.5% 15.8% 17.0

Source: Company, JM Financial. *As at 3Q12 end.

Exhibit 16. CASA per branch: Federal Bank vs peers (` mFY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14

Federal Bank 78 95 99 106 127 141 156 163 169 18

South Indian Bank 46 51 58 69 79 91 99 113*

ING Vysya Bank 72 83 101 145 136 170 200 209 232 26

HDBC Bank 472 578 576 722 449 505 553 523 574 64

ICICI Bank 431 611 665 505 442 493 402 398 420 45

Axis Bank 355 364 431 622 639 672 559 571 597 64

IndusInd Bank 113 133 155 166 236 301 311 303 317 34

Yes Bank n.a. n.a. 118 168 121 188 222 204 269 32

Source: Company, JM Financial. *As at 3Q12 end.


10/21



d) Margins to moderate but stay robust at 3.5% (FY13E, calc.);steps taken to enhance fee income franchise

De-risking of assets and higher cost of deposits to drive NIM compression of

32bps over FY12E-14E: FB has historically enjoyed strong margins thanks to a) high

yield on assets on account of its SME focus, b) low leverage ratio, and c) controlled cost

of deposits. Given the asset quality focus, FB is now looking to lend mainly to

corporates with better credit ratings, albeit with lower yields. Cost of funds would come

under some pressure due to deregulation of interest rate on NRI deposits and migrationfrom savings to term deposits in a high interest rate environment. Leverage is estimated

to increase to 11.8x (FY11: 10.1x) as surplus capital is deployed in the business. We

forecast NIM (calc.) to reduce from 3.76% in FY11 to 3.51% in FY13 and 3.44% in FY14.

The margins however remain strong compared to its peers (exhibit 18).

Exhibit 17. FB: Margins and spread (%) and NII growth (`b

3.21% 3.24% 3.25%3.10%

3.78% 3.76%3.65%

3.44%

3.05% 3.01%2.95%

2.41%

2.92%

2.74%

3.13%

2.89%2.79% 2.75%

3.51%3.50%

2.0%

2.2%

2.4%

2.6%

2.8%

3.0%

3.2%

3.4%

3.6%

3.8%

4.0%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

NIM (%) Spread (%)

0

5

10

15

20

25

30


2

2

4

NII (Rs bn) NIM (%) (RHS)


Exhibit 18. NIM (calc.): Federal Bank vs peers


Federal Bank 3.21% 3.24% 3.25% 3.10% 3.78% 3.50% 3.76% 3.65% 3.51% 3.44

South Indian Bank* 2.76% 2.97% 2.94% 2.51% 2.85% 2.53% 2.78% 2.88% 2.96% 2.97

ING Vysya Bank 2.69% 2.86% 2.63% 2.36% 2.42% 2.70% 2.91% 2.99% 3.05% 3.05

HDBC Bank 3.53% 3.84% 4.42% 4.88% 4.90% 4.31% 4.44% 4.24% 4.26% 4.23

ICICI Bank 2.18% 1.98% 1.98% 2.06% 2.21% 2.34% 2.48% 2.48% 2.56% 2.64

Axis Bank 2.36% 2.40% 2.49% 2.93% 2.96% 3.14% 3.19% 3.14% 3.16% 3.13

IndusInd Bank 2.95% 1.83% 1.29% 1.46% 1.94% 2.99% 3.56% 3.44% 3.52% 3.55

Yes Bank 3.00% 3.30% 2.26% 2.47% 2.72% 2.79% 2.72% 2.55% 2.60% 2.64

Source: Company, JM Financial. *Based on Bloomberg consensus estimates

Exhibit 19. Interest spread: Federal Bank vs peers


Federal Bank 3.05% 3.01% 2.95% 2.41% 2.92% 2.74% 3.13% 2.89% 2.79% 2.75South Indian Bank* 2.48% 2.67% 2.59% 2.01% 2.32% 2.08% 2.40% 2.43% 2.53% 2.56

ING Vysya Bank 2.51% 2.60% 2.33% 1.91% 2.02% 2.39% 2.51% 2.43% 2.50% 2.54

HDBC Bank 2.94% 3.28% 3.75% 4.10% 3.94% 3.62% 3.74% 3.42% 3.50% 3.51

ICICI Bank 1.79% 1.51% 1.48% 1.35% 1.39% 1.64% 1.78% 1.70% 1.84% 1.99

Axis Bank 2.24% 2.19% 2.21% 2.55% 2.48% 2.76% 2.77% 2.67% 2.72% 2.70

IndusInd Bank 2.90% 1.82% 1.19% 1.26% 1.70% 2.69% 3.10% 2.83% 3.04% 3.11

Yes Bank 2.66% 2.69% 1.57% 1.80% 2.10% 2.23% 2.17% 2.03% 2.15% 2.22



11/21



Strategic focus on fee income growth: The bank has been unable to make desired

headway into retail fee, insurance and treasury products. As a result, fee income growth

has been poor with CAGR of 10% (FY06-11) compared to balance sheet CAGR of 21%

over the same period. Identifying it a as a potential area of improvement, the bank has

made concerted efforts in recent past. It hired Mr. Abraham Chacko in May 2011. He

heads the wholesale banking at FB and has c.30 years experience in domestic and

international markets. The bank also hired Mr. Ashutosh Khajuria as President -

Treasury. He has treasury experience from his stints at IDBI Bank and SBI. The bank has

also opened specialised branches in metropolitan centres such as Mumbai, Delhi,

Kolkata and Bangalore. Though encouraged by these steps, these are still early days

and we build conservative core non-interest income CAGR of 16% (FY12E-14E).

Exhibit 20. Federal Bank: core non-interest income)

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY13E

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

1.0%

1.1%

1.2%

1.3%

Core Non-Int. Inc / Total Inc.(LHS) Core Non-Int. Inc /Assets

0

1

2

3

4

5

6

7

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY

Fee income Forex Treasury Others


Exhibit 21. Core non-interest income to assets: Federal Bank vs peers


Federal Bank 0.98% 1.07% 1.11% 1.11% 1.21% 1.03% 0.99% 0.83% 0.80% 0.80

South Indian Bank* 0.76% 0.75% 0.73% 0.72% 0.69% 0.57% 0.54% 0.50%*

ING Vysya Bank 1.20% 1.07% 1.45% 1.82% 1.78% 1.56% 1.58% 1.51% 1.48% 1.43

HDBC Bank 1.53% 1.88% 1.92% 1.82% 1.84% 1.79% 1.76% 1.72% 1.69% 1.65

ICICI Bank 1.96% 2.05% 1.96% 1.88% 1.62% 1.82% 1.79% 1.70% 1.70% 1.70

Axis Bank 1.38% 1.37% 1.54% 1.72% 2.03% 1.95% 2.02% 1.95% 1.87% 1.83

IndusInd Bank 1.26% 1.28% 1.38% 1.27% 1.33% 1.42% 1.67% 1.77% 1.77% 1.77

Yes Bank 2.44% 3.52% 2.49% 2.15% 1.44% 1.61% 1.40% 1.21% 1.13% 1.08

Source: Company, JM Financial. *As at 3Q12 end


12/21



e) Cost structure to stay competitive despite the expansion

FB has one of the best cost to income ratio among its peers (exhibit 23). A higher NIM

partly explains the lower CI ratio. However, even on cost to asset, FB compares very well

with its peers (exhibit 24). We believe the bank significantly benefits from its

concentrated dominant presence in the state of Kerala in keeping its costs under

control. However, the bank has an aggressive branch expansion plan outside Kerala

with associated pick-up in recruitment. This is likely to exert upward pressure on costs.

However, benefiting from productivity gain of existing large network, we estimate CIratio to increase only gradually to 39% by FY14 (FY11: 36.9%) and stay competitive

compared to its peers.

Exhibit 22. FB: Cost ratios (%)

1.0%

1.2%

1.4%

1.6%

1.8%

2.0%


25%

30%

35%

40%

45%

50%

55%

60%

Cost / Assets (LHS) C-I Ratio (RHS)

0

10

20

30

40

50

60

70

80

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

2

2

2

Assets/Employee (Rs mn) (LHS) Cost/Assets (%) (RHS)


Exhibit 23. Cost to income: Federal Bank vs peers


Federal Bank 43.9% 44.6% 39.9% 38.1% 34.5% 38.0% 36.9% 37.8% 39.1% 39.2


ING Vysya Bank 79.3% 86.4% 72.4% 66.5% 64.5% 56.9% 61.8% 58.7% 55.2% 50.4

HDBC Bank 48.4% 49.4% 48.6% 49.9% 51.7% 48.0% 48.1% 47.9% 45.7% 44.6

ICICI Bank 57.8% 56.5% 53.7% 50.9% 45.1% 38.3% 42.2% 45.1% 45.5% 46.2

Axis Bank 47.9% 47.3% 49.0% 49.2% 43.4% 41.4% 42.7% 43.9% 44.1% 44.7

IndusInd Bank 39.8% 62.8% 66.7% 67.2% 59.8% 51.1% 48.2% 49.0% 49.3% 49.4

Yes Bank 110.0% 46.5% 52.9% 49.4% 44.2% 36.7% 36.3% 36.9% 36.7% 36.2


Exhibit 24. Cost to assets: Federal Bank vs peers


Federal Bank 1.97% 1.95% 1.78% 1.67% 1.77% 1.79% 1.76% 1.70% 1.69% 1.67


ING Vysya Bank 2.68% 3.25% 2.82% 2.73% 2.70% 2.47% 2.82% 2.58% 2.45% 2.22

HDBC Bank 2.32% 2.71% 2.94% 3.34% 3.50% 2.93% 2.86% 2.68% 2.57% 2.50

ICICI Bank 2.50% 2.39% 2.24% 2.19% 1.81% 1.58% 1.72% 1.83% 1.90% 1.96

Axis Bank 1.88% 1.86% 1.98% 2.36% 2.22% 2.26% 2.26% 2.20% 2.22% 2.22

IndusInd Bank 1.73% 1.90% 1.78% 1.83% 2.17% 2.35% 2.50% 2.56% 2.61% 2.62

Yes Bank 3.17% 2.54% 2.43% 2.10% 1.69% 1.43% 1.35% 1.34% 1.31



13/21



f) Asset quality: Under pressure, but steps taken to normalisecredit costs

FBs gross and net NPL ratios have been on an upward trajectory since FY08 (exhibit

25). The bank has witnessed slippages in all its segments (SME, retail and corporates).

The new management team, introduced in 3Q11, has taken this issue as a key priority

and introduced comprehensive changes in risk management system (e.g. credit

origination and approval). The cleaning up of bad assets has coincided with worsening

of external environment with rising interest rates in the system and slowing economic

growth. As it stands, the asset quality challenge for Federal Bank revolves around two

aspects:

Exhibit 25. Federal Bank: Quarterly asset quality trends (%)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

70%

75%

80%

85%

90%

Gross NPLs (%) Net NPLs (%) Coverage (RHS) (%)


Exhibit 26. Federal Bank: Segment-wise gross NPL ratio and gross slippage ratio

0%

1%

2%

3%

4%

5%

6%7%

8%

4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12

SME Retail Corporate Total

0%

1%

2%

3%

4%

5%

6%

7%

8%

4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12

SME Retail Corporate Total


1) Bringing slippages down from current levels: Historically, keeping with its

regional mid-market model, the bank followed branch level origination, sanctionand monitoring processes. While the model was helpful at small scale in providing

local touch, it became increasingly insufficient as the bank expanded in size and

complexity.

The asset quality woes of last three years have mainly emanated from a)

managements reduced ability to monitor credit decisions being taken at ground

level, and b) some inopportune decisions taken by the management to become part

of syndicated deals (e.g. for some larger SMEs) where the bank had higher exposure

(relative to its B/S size) vis--vis its larger peers.


14/21



The new management has addressed these issues by overhauling its risk

management strategy. The bank a) separated centralised credit sanction and

monitoring from origination, and b) introduced credit monitoring cells to bolster

the recovery efforts. For smaller loans (e.g. gold loans) the bank continues with

more appropriate branch-level sanctioning. For corporate loans, the focus is now on

higher rated corporates and getting into full-range service relationships than one-

off deals.

For retail assets, managements strategy has reduced slippages by intensivelyfocusing on recovery efforts (Gross slippage 3Q12: `0.4bn, 2Q12:`0.7bn, 1Q12:

`1.4bn). According to management, recovery efforts have yielded similar results for

smaller SMEs (turnover < `50mn), even as bigger SMEs and corporate continue to

face legacy issues.

2) Managing exposure to critical sectors: The banks exposure to infrastructure

sector has risen substantially over FY09-11. At FY11 end, gross fund based and

non-fund based exposure stood at 7.4% (FY10: 6.9% and FY09: 4.6%). Within this

the bank has substantial exposure to power sector, in the form of SEB loans (Kerala,

Tamil Nadu and Rajasthan). Total power sector exposure stands at `19.5bn (FY11:

`23.6bn, FY10:`17.3bn). The banks exposure to troubled aviation sector is `4.1bn

(1.2% of net advances), with exposure to Kingfisher Airlines (KFA), reportedly, at

`1.0bn. The bank has not specified its exposure to KFA as NPL at 3Q12 end.

Exhibit 27. Federal bank: Key industrial exposures

Fund-based exposure Total Exposure

`bn Proportion `bn ProportionFY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY1

Infrastructure 17.1 30.8 40.8 4.4% 7.1% 7.9% 19.4 32.5 41.8 4.6% 6.9% 7.4

Metals 9.1 11.1 12.7 2.3% 2.5% 2.5% 10.7 11.6 13.0 2.6% 2.5% 2.3

Textiles 7.3 7.7 8.4 1.9% 1.8% 1.6% 7.9 7.8 8.4 1.9% 1.6% 1.5

Petroleum & fuels 6.1 4.7 7.3 1.6% 1.1% 1.4% 6.4 5.4 7.4 1.5% 1.1% 1.3

Food Processing 3.3 4.1 6.4 0.9% 0.9% 1.2% 4.1 4.2 6.4 1.0% 0.9% 1.1

Chemicals 9.9 4.6 5.3 2.6% 1.0% 1.0% 10.8 4.7 5.3 2.6% 1.0% 0.9

Total industry 73.8 83.7 99.8 19.0% 19.2% 19.4% 85.7 89.6 103.8 20.5% 19.0% 18.3

Total exposure 388.5 436.8 514.6 100% 100% 100% 417.6 471.6 567.6 100% 100% 100


Following the ageing of bad assets, the asset quality trends critically rely on

performance of assets written under new risk management system (over last 18

months) and success of recovery efforts for existing bad assets. Strong capital ratio

(Tier I at 15%) and coverage ratio (at 82%) place bank in strong position to face any

asset quality headwinds due to its exposure to stressed sectors. Going ahead, we

expect gross slippage to normalise to 3.00% in FY13 and 2.70% in FY14 (FY12E:

3.75%, FY11: 3.27%). Improved recovery efforts should lead to net slippages coming

down to 1.38% in FY13 and 1.27% in FY14 (FY12E: 1.45%, FY11: 2.17%). Given the

margins compression, it will be challenging for bank to maintain coverage ratio atcurrent high levels. Though, we estimate coverage ratio to decline, it would still

remain strong at 70% (FY14E). Adjusted credit cost will reduce to 1.25% in FY13E

(FY12E: 1.33%, FY11: 1.87%). Risk adjusted margin are thus estimates to remain

strong at 2.71-2.72% in FY13 and FY14 (FY12E: 2.81%, FY11: 2.57%).


15/21



Exhibit 28. Gross slippage: Federal Bank vs peers


Federal Bank 2.55% 1.85% 1.57% 1.77% 3.05% 3.35% 3.27% 3.75% 3.00% 2.70

South Indian Bank 2.29% 1.90% 2.31% 0.74% 1.65% 1.49% 0.68% 0.71%*

ING Vysya Bank 3.19% 2.57% 2.03% 1.66% 2.28% 2.48% 1.29% 1.15% 1.40% 1.50

HDBC Bank 1.46% 2.23% 2.23% 2.57% 3.65% 2.66% 1.13% 0.95% 1.50% 1.50

ICICI Bank 4.07% 1.33% 2.03% 2.02% 2.28% 3.00% 1.62% 1.35% 1.50% 1.50

Axis Bank 1.40% 1.17% 0.77% 1.05% 1.74% 2.22% 1.39% 1.30% 1.70% 1.70

IndusInd Bank 4.07% 1.24% 2.61% 1.44% 1.75% 1.42% 1.39% 1.40% 1.60% 1.60

Yes Bank 0.93% 0.92% 0.22% 0.35% 0.50% 0.60


Exhibit 29. Adjusted credit costs: Federal Bank vs peers


Federal Bank 1.30% 0.20% 0.26% 1.01% 1.80% 1.92% 1.87% 1.33% 1.25% 1.15

South Indian Bank 1.12% -0.24% 0.60% -0.17% 1.10% -0.26% 0.15% 0.12%*

ING Vysya Bank 0.79% 0.41% 0.02% 0.19% 1.33% 1.42% 0.12% 0.19% 0.57% 0.74

HDBC Bank 0.96% 1.58% 1.80% 2.03% 2.39% 1.56% 0.47% 0.50% 0.96% 0.95

ICICI Bank 0.22% 0.00% 1.38% 1.92% 2.18% 1.83% 0.27% 0.44% 0.69% 0.70

Axis Bank 0.86% 0.69% 0.41% 0.68% 1.24% 1.56% 0.77% 0.85% 1.10% 0.94

IndusInd Bank 1.21% 0.45% 1.32% 0.69% 0.15% 0.30% 0.57% 0.60% 0.83% 0.82

Yes Bank 0.82% 0.34% 0.13% 0.26% 0.38% 0.42


Exhibit 30. FB: NPA ratios, slippages and LLP

0%

1%

2%

3%

4%

5%

6%

7%

8%


60%

65%

70%

75%

80%

85%

90%

95%

Gross NPLs (%) Net NPLs (%) Coverage (RHS) (%)

-0.3%

0.0%

0.3%

0.6%

0.9%

1.2%

1.5%

1.8%

2.1%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY

Specific LLP (%) Adj. LLP (%)


Exhibit 31. Federal Bank: Risk adjusted margins

2.51%

3.12% 3.09%

2.50%

2.71%

2.57%

2.81%2.71%

2.32%

2.72%

1.8%

2.0%

2.2%

2.4%

2.6%

2.8%

3.0%

3.2%


Risk Adjusted Margins (%)



16/21



Exhibit 32. FB: LLP and slippages

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%


0.0

0.5

1.0

1.5

2.02.5

3.0

3.5

4.0

4.5

5.0

5.5

LLP (Rs bn) (RHS) Specific LLP (%)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%


Slippages (Rs bn) (RHS) Slippages (%)



17/21



g) ROE to improve to 15% by FY14, with high Tier-I of c.12.6%

We expect FB to register strong 21% CAGR in earnings for FY11-14E driven by broadly

flat provisions over FY12-14E. ROA would remain stable at healthy c.1.3% over FY13 and

FY14. The bank currently has surplus capital with strong tier I capital of 15%. We

estimate leverage to increase to 11.8 (FY14) and tier I to come down to healthy 12.6% in

FY14. As a result, ROE is expected to improve to 15.3% by FY14E (FY11: 12.0%).

Exhibit 33. FB: Return ratios and Tier I

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E

7%

10%

13%

16%

19%

22%

25%

ROA (LHS) ROE (RHS)

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY

Tier I Tier II

.


Exhibit 34. ROA: Federal Bank vs peersFY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14

Federal Bank 0.56% 1.20% 1.28% 1.28% 1.40% 1.13% 1.23% 1.33% 1.32% 1.32


ING Vysya Bank -0.27% 0.06% 0.50% 0.70% 0.66% 0.74% 0.88% 1.06% 1.15% 1.15

HDBC Bank 1.42% 1.39% 1.39% 1.42% 1.42% 1.45% 1.57% 1.66% 1.72% 1.73

ICICI Bank 1.35% 1.21% 1.04% 1.12% 0.96% 1.08% 1.34% 1.40% 1.42% 1.42

Axis Bank 1.08% 1.11% 1.07% 1.17% 1.41% 1.53% 1.60% 1.54% 1.49% 1.48

IndusInd Bank 1.37% 0.22% 0.35% 0.34% 0.59% 1.12% 1.43% 1.53% 1.49% 1.49

Yes Bank 2.03% 1.24% 1.42% 1.52% 1.61% 1.52% 1.42% 1.40% 1.39

Source: Company, JM Financial.*

Based on Bloomberg consensus estimates

Exhibit 35. ROE: Federal Bank vs peersFY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14

Federal Bank 13.3% 23.0% 21.4% 13.6% 12.1% 10.3% 12.0% 14.0% 14.7% 15.3


ING Vysya Bank -5.7% 1.1% 9.4% 13.0% 12.5% 12.7% 13.5% 14.3% 14.4% 15.4

HDBC Bank 18.5% 17.7% 19.5% 17.7% 16.9% 16.1% 16.7% 18.9% 20.5% 21.3

ICICI Bank 19.2% 14.6% 13.4% 11.7% 7.8% 8.0% 9.7% 10.8% 11.7% 12.4

Axis Bank 18.9% 18.4% 21.0% 17.6% 19.1% 19.2% 19.3% 19.9% 19.7% 19.9

IndusInd Bank 25.8% 4.3% 7.1% 6.9% 11.7% 19.5% 19.3% 19.0% 19.9% 20.7

Yes Bank 14.0% 13.9% 19.0% 20.6% 20.3% 21.1% 22.9% 23.4% 23.4


Exhibit 36. Tier I ratio: Federal Bank vs peersFY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14

Federal Bank 6.5% 9.7% 9.0% 19.1% 18.4% 16.9% 15.6% 14.3% 13.4% 12.6

South Indian Bank* 5.7% 8.4% 8.8% 12.1% 13.2% 12.4% 11.3%

ING Vysya Bank 5.2% 7.1% 6.4% 6.8% 6.9% 10.1% 9.4% 11.8% 10.8% 10.0

HDBC Bank 9.6% 8.6% 8.6% 10.3% 10.6% 13.3% 12.2% 11.3% 10.8% 10.5

ICICI Bank 7.6% 9.2% 7.4% 11.8% 11.8% 14.0% 13.2% 12.3% 11.6% 10.9

Axis Bank 8.9% 7.3% 6.4% 10.2% 9.3% 11.2% 9.4% 9.1% 8.9% 8.7

IndusInd Bank 7.2% 6.8% 7.3% 6.7% 7.5% 9.7% 12.3% 11.1% 10.4% 9.8

Yes Bank 18.6% 13.8% 8.2% 8.5% 9.5% 12.8% 9.7% 9.0% 8.8% 8.6



18/21



h) Valuation: Improvement in ROE to drive rerating

While the bank trades at significant discount to its new private sector bank peers,

the valuation vis--vis old private sector banks is undemanding as well. Federal

Bank is the largest old private sector banks with strong ROE improvement potential.

We value Federal Bank at 9x Dec13 earnings, to arrive at a Dec12 TP of`525. This

implies valuation of 1.3x Dec13 fwd. BV.

Exhibit 37. Relative Valuation: Federal BankP/E (x) EPS CAGR P/B (x) ROEMar. Cap.(`bn) Mar. Cap./ Assets FY11 FY12E FY13E FY14E FY11-13E FY11 FY12E FY13E FY14E FY12E FY

Federal Bank 72 11.7% 12.3 9.6 8.2 7.0 22.8% 1.4 1.3 1.1 1.0 14.0% 14

Old Private Sector

ING Vysya Bank 54 13.9% 13.7 11.8 9.0 7.4 23.1% 1.7 1.4 1.2 1.1 14.3% 14

Karur Vysya Bank 42 14.9% 8.7 8.8 7.3 n.a. 9.5% 1.9 1.5 1.3 n.a. 20.2% 20

J&K Bank 42 8.3% 6.5 5.3 4.7 4.0 17.0% 1.2 1.0 0.8 0.7 20.1% 19

South Indian Bank 31 9.5% 10.0 7.7 6.8 5.4 21.4% 1.6 1.5 1.2 1.0 20.0% 19

Karnataka Bank 21 6.6% 6.8 8.2 6.7 6.0 0.4% 0.8 0.8 0.7 0.6 9.9% 10

City Union Bank 20 13.7% 8.8 7.2 6.1 4.6 19.7% 1.9 1.6 1.2 1.1 23.6% 23

New Private Sector

HDFC Bank 1,249 36.2% 31.6 24.0 18.9 15.5 29.1% 4.9 4.2 3.6 3.0 18.9% 20

ICICI Bank 1,088 23.1% 21.1 17.7 15.1 13.2 18.2% 2.0 1.8 1.7 1.6 10.8% 11

Axis Bank 503 17.3% 14.8 12.6 10.8 9.2 16.6% 2.6 2.3 2.0 1.7 19.9% 19

IndusInd Bank 146 25.4% 25.3 18.5 15.1 12.3 29.3% 3.8 3.3 2.8 2.3 19.0% 19

Yes Bank 125 16.2% 16.9 12.7 10.2 8.3 28.9% 3.2 2.6 2.2 1.8 22.9% 23

Source: Bloomberg, Company, JM Financial. Note: We have used consensus estimates for South Indian Bank, Karur Vysya Bank, J&K Bank, Karnataka Bank, City Union Bank.

Exhibit 38. Federal Bank: One-year forward P/BV (x) & one-year forward PE (x)

0.0

0.2

0.4

0.6

0.8

1.01.2

1.4

1.6

1.8

Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

Fwd. P/BV (x)

0

2

4

6

8

10

12

14

16

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Sep-11

Fwd. PE (x)

Source: Bloomberg, Company, JM F inancial.

Exhibit 39. Federal Bank: 12 months forward P/B and P/E against peers

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.55.0

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

HDBK ICICIBK AXSB IIB YES VYSB FB

0

5

10

15

20

25

30

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

HDBK ICICIBK AXSB IIB YES VYSB FB

Source: Bloomberg, Company, JM F inancial.


19/21



Company Background

Incorporated in 1931, Federal Bank is one of the oldest private sector banks in India. It

is predominately based in Kerala and holds leadership position in the state along with

the SBI Group. The branch network has expanded from 552 (FY06) to 835 now and is

concentrated (c.60%) in kerala. The assets have seen a CAGR of 20% (FY05-11) and the

bank has delivered average ROA (FY06-11) of 1.25%. FB is the 5 th largest private sector

bank in India and largest among old private sector banks. Within Kerala, FB has strong

presence in semi-urban and rural parts (57% of total branches). Loan book mix has

remained fairly diverse across SME, corporate and retail segments.

Dilution history: The bank raised capital, first in FY06 through a GDR issue and later in

FY08 through a rights issue. The bank currently has strong capital at a tier I ratio of

15%.

Exhibit 40. Federal Bank: Capital raised by Federal Bank

Year Description Amount Raised (` mn) Price Dilution (%)FY05 Issue of Bonus share in the ratio of 1:2 NA NA NA

FY06 GDR issue 3,500 $3.97 30%

FY08 Rights issue 21,414 `250 100%

Source: Company, JM FinancialManagement profile

Mr. Shyam Shrinivasan took charge as Managing Director and Chief Executive Officer of

the bank on 23 September 2010. He worked with Standard Chartered Bank over 2004-

2010 and headed Consumer banking in India and Malaysia. He brings rich experience of

domestic and international markets in the field of retail banking, wealth management

and SME banking.

Mr. PC John, Executive Director, has been with Federal Bank since 1973 and has had

exposure to different areas of banking at branches, regional offices and corporate

office. He has headed Treasury, Credit, International Banking, Planning, Accounts.

Mr. PC John was first internal official to be made ED in May 2010.

Mr. Abraham Chacko took charge as Executive Director of the bank on 21 May 2011

and is in charge of Wholesale Banking. He has over 30 years of banking experience

across domestic and international markets with ABN Amro and HSBC. He oversaw

wholesale banking and transaction banking businesses in Middle East and Asia Pacific.

Key risks

Unionised staff:In the past, the bank has faced productivity challenges (e.g. strikes)

due to unionised staff. The management is addressing the issue by adopting a

gradual approach and introducing initiatives such as ESOPs.

ALM mismatch:There is c.20% mismatch in less than one year bucket as 55% of its

deposits back 35% of advances in that bucket. The bank is trying to address this by

reducing duration of its loan book.

Concentration in Kerala:Given significant concentration of advances (41%) in Kerala

the bank is exposed to any state-specific adverse economic event (e.g. share of

Kerala in national deposits/advances) has been on long-term decline. Long history of

Kerala focused business pose challenge in expanding outside kerala in a timely

manner.


20/21



Financial Tables (Standalone)

Profit & Loss (` mn)Y/E March FY10 FY11 FY12E FY13E FY14E

Net Interest Income 14,108 17,466 20,081 22,859 26,375

Profit on Investments 1,077 458 600 800 800

Exchange Income 446 572 801 905 1,068

Fee & Other Income 3,786 4,138 3,881 4,449 5,185Non-Interest Income 5,309 5,168 5,283 6,154 7,053

Total Income 19,417 22,634 25,364 29,013 33,428

Operating Expenses 7,369 8,361 9,594 11,336 13,106

Pre-provisioning Profits 12,048 14,273 15,770 17,677 20,322

Loan Loss Provisions 4,133 5,032 3,990 4,298 4,525

Provisions on Investments -977 111 400 -50 100

Other Provisions 297 111 50 125 100

Total Provisions 3,453 5,254 4,440 4,373 4,725

PBT 8,595 9,018 11,329 13,304 15,597

Tax 3,950 3,147 3,795 4,457 5,225

PAT (Pre-Extra ordinaries) 4,645 5,871 7,534 8,847 10,372

Extraordinaries (Net of Tax) 0 0 0 0 0

Reported Profits 4,645 5,871 7,534 8,847 10,372

Dividend 997 1,690 1,701 2,001 2,301Retained Profits 3,648 4,181 5,833 6,846 8,071

Source: Company, JM F inancial

Balance Sheet (` mY/E March FY10 FY11 FY12E FY13E FY

Equity Capital 1,710 1,710 1,710 1,710 1

Reserves & Surplus 45,136 49,320 55,153 61,999 70

Deposits 360,580 430,148 507,574 604,014 712

Borrowings 15,468 18,884 29,900 32,590 37Other Liabilities 13,804 14,446 20,946 22,831 27

Total Liabilities 436,697 514,507 615,284 723,144 849

Investments 130,546 145,377 183,927 214,529 249

Net Advances 269,501 319,532 373,597 442,167 521

Cash & Equivalents 27,234 37,483 40,523 48,910 58

Fixed Assets 2,839 2,842 3,183 3,596 4

Other Assets 6,577 9,273 14,054 13,941 16

Total Assets 436,697 514,507 615,284 723,144 849


Key ratios (%)

Y/E March FY10 FY11 FY12E FY13E FY14E

Growth (YoY) (%)

Deposits 12.0% 19.3% 18.0% 19.0% 18.0%

Advances 20.4% 18.6% 16.9% 18.4% 18.0%

Total Assets 12.4% 17.8% 19.6% 17.5% 17.5%

NII 7.3% 23.8% 15.0% 13.8% 15.4%

Non-Interest Income 2.9% -2.7% 2.2% 16.5% 14.6%

Operating Expenses 16.5% 13.5% 14.7% 18.2% 15.6%

Operating Profits 0.5% 18.5% 10.5% 12.1% 15.0%

Core Operating Profits -1.7% 25.9% 9.8% 11.3% 15.7%

Provisions -14.9% 52.2% -15.5% -1.5% 8.1%

Reported PAT -7.2% 26.4% 28.3% 17.4% 17.2%

Yields / Margins (%)

Interest Spread (%) 2.74% 3.13% 2.89% 2.79% 2.75%

NIM (%) 3.50% 3.76% 3.65% 3.51% 3.44%

Profitability (%)

Non-IR to Income (%)

Cost to Income (%) 38.0% 36.9% 37.8% 39.1% 39.2%

ROA (%) 1.13% 1.23% 1.33% 1.32% 1.32%

ROE (%) 10.3% 12.0% 14.0% 14.7% 15.3%

Assets Quality (%)

Slippages (%) 3.35% 3.27% 3.75% 3.00% 2.70%

Gross NPAs (%) 2.97% 3.49% 3.76% 3.58% 3.44%

Net NPAs (%) 0.48% 0.60% 0.78% 0.92% 1.06%

Provision Coverage (%) 84.3% 83.4% 80.0% 75.0% 70.0%

Specific LLP (%) 1.67% 1.66% 1.05% 0.97% 0.85%

Net NPAs / Networth (%)

Capital Adequacy (%)

Tier I (%) 16.92% 15.63% 14.34% 13.41% 12.62%

CAR (%) 18.36% 16.79% 15.27% 14.19% 13.27%

Source: Company, JM F inancial

DuPont Analysis (

Y/E March FY10 FY11 FY12E FY13E FY

NII / Assets (%) 3.42% 3.67% 3.55% 3.42% 3

Other income / Assets (%) 1.29% 1.09% 0.94% 0.92% 0

Total Income / Assets (%) 4.71% 4.76% 4.49% 4.34% 4

Cost to Assets (%) 1.79% 1.76% 1.70% 1.69% 1

PPP / Assets (%) 2.92% 3.00% 2.79% 2.64% 2

Provisions / Assets (%) 0.84% 1.10% 0.79% 0.65% 0

PBT / Assets (%) 2.08% 1.90% 2.01% 1.99% 1

Tax Rate (%) 46.0% 34.9% 33.5% 33.5% 3

ROA (%) 1.13% 1.23% 1.33% 1.32% 1

RoRWAs (%) 1.82% 1.95% 2.09% 2.04% 1

Leverage (%) 9.2 9.7 10.5 11.1

ROE (%) 10.3% 12.0% 14.0% 14.7% 1


Valuations

Y/E March FY10 FY11 FY12E FY13E FY

Shares in issue (mn) 171.0 171.0 171.0 171.0 1

EPS (`) 27.2 34.3 44.0 51.7

EPS (YoY) (%) -7.2% 26.4% 28.3% 17.4% 1

PE (x) 15.5 12.3 9.6 8.2

BV (`.) 274 298 332 372

BV (YoY) (%) 8.4% 8.9% 11.4% 12.0% 1

P/BV (x) 1.54 1.41 1.27 1.13

DPS (`.) 5.8 9.9 9.9 11.7

Div. yield (%) 1.4% 2.3% 2.4% 2.8%



21/21



Member, BSE Limited and National Stock Exchange of India LimitedSEBI Registration Nos.: BSE - INB011296630 & INF011296630, NSE - INB231296634 & INF231296634

Registered Office: 141, Maker Chambers III, Nariman Point, Mumbai - 400 021, IndiaCorporate Office: 51, Maker Chambers III, Nariman Point, Mumbai - 400 021, India

Board: +9122 6630 3030 | Fax: +91 22 6747 1825 | Email: [email protected] | www.jmfinancial.in

Analyst Certification

The research analysts, with respect to each issuer and its securities covered by them in this research report, certify that:

All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and

No part of his or her or their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

Analyst(s) holding in the Stock: (Nil)

Disclosure

This research report has been prepared by JM Financial Institutional Securities Private Limited (JM Financial Institutional Securities) to provide information about the companyand sector(s), if any, covered in the report and may be distributed by it and/or its affiliated company(ies) solely for the purpose of information of the select recipient of this reThis report and/or any part thereof, may not be duplicated in any form and/or reproduced or redistributed without the prior written consent of JM Financial Institutional SecuThis report has been prepared independently of the companies covered herein. JM Financial Institutional Securities and its affiliated companies are a multi-service, integrinvestment banking, investment management, brokerage and financing group. The affiliated company(ies) of JM Financial Institutional Securities might have provided orprovide services in respect of managing offerings of securities, corporate finance, investment banking, mergers & acquisitions, financing or any other advisory services tocompany(ies) covered herein. JM Financial Institutional Securities and/or its affiliated company(ies) might have received or may receive compensation from the companmentioned in this report for rendering any of the above services. Research analysts and sales persons of JM Financial Institutional Securities may provide important inputs taffiliated company(ies) associated with it.

While reasonable care has been taken in the preparation of this report, it does not purport to be a complete description of the securities, markets or developments referreherein, and JM Financial Institutional Securities does not warrant its accuracy or completeness. JM Financial Institutional Securities may not be in any way responsible for anyor damage that may arise to any person from any inadvertent error in the information contained in this report. This report is provided for information only and is not intendbe and must not alone be taken as the basis for an investment decision. The investment discussed or views expressed herein may not be suitable for all investors. The assumes the entire risk of any use made of this information. The information contained herein may be changed without notice and JM Financial Institutional Securities reserveright to make modifications and alterations to this statement as they may deem fit from time to time.

JM Financial Institutional Securities and its affiliated company(ies), their directors and employees may; (a) from time to time, have a long or short position in, and buy or sesecurities of the company(ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a mmaker in the financial instruments of the company(ies) discussed herein or act as an advisor or lender/borrower to such company(ies) or may have any other potential conflinterests with respect to any recommendation and other related information and opinions.

This report is neither an offer nor solicitation of an offer to buy and/or sell any securities mentioned herein and/or not an official confirmation of any transaction.

This report is not directed or intended for distribution to, or use by any person or entity who is a citizen or resident of or located in any locality, state, country or ojurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject JM Financial Institutional Securities and/oaffiliated company(ies) to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdicor to a certain category of investors. Persons in whose possession this report may come, are required to inform themselves of and to observe such restrictions.

For U.S. persons only: This research report is a product of JM Financial Institutional Securities, which is the employer of the research analyst(s) who has prepared the resereport. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S. regulated broker-dealetherefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or requirotherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held research analyst account.

This report is intended for distribution by JM Financial Institutional Securities only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the U.S. SecuritiesExchange Act, 1934 (the Exchange Act) and interpretations thereof by U.S. Securities and Exchange Commission (SEC) in reliance on Rule 15a-6(a)(2). If the recipient of this ris not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be coduplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor.

In reliance on the exemption from registration provided by Rule 15a-6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business with MInstitutional Investors, JM Financial Institutional Securities has entered into an agreement with a U.S. registered broker-dealer, Marco Polo Securities Inc. ("Marco PoTransactions in securities discussed in this research report should be effected through Marco Polo or another U.S. registered broker-dealer.

federal bank - jm - ic - feb 2012

Documents