Federal Bank: On a transformation drive

The economic slowdown over the last two years has severely impacted the performance of banks. However, with signs of recovery on the anvil, investors with a long-term horizon can bet on select banking stocks. Federal Bank, that has seen a structural transformation over the last few years, appears well placed to ride this recovery. A shift to high-yielding loans, mobilising low-cost deposits and increased lending to well-rated corporates are a result of the bank’s strategic focus over the past three to four years. This augurs well for the bank’s profitability over the long run.

At the current price, the stock trades at 1.3 times its one-year forward book, in line with its five-year historical average. Strong operational performance, backed by healthy growth in loans and steady margins, and stable asset quality should drive earnings growth for the bank.

Federal Bank has cut down its exposure to wholesale (corporate) loans over the last four years. The share of these loans has come down to about 34 per cent now from 44 per cent in 2011-12.

Within the wholesale segment, the bank has substantially improved the quality of its lending by focussing on higher rated corporates. From about 36 per cent in 2011-12, the AAA or AA rated segment now constitutes about half the corporate loans. The bank is principally focused on shorter tenure exposures; of the overall credit book, about 5 per cent is in longer tenure project finance for select infra projects.

While Federal Bank has been trimming its exposure to the corporate segment, it has been building its presence in the high-yielding SME segment over the past few years. From about 28 per cent four years back, SME (including agri) loans constitute around 36 per cent of total loans.

The share of the bank’s retail loans within the overall loan portfolio has more or less remained the same in the last couple of years. Constituting about 29 per cent of total loans, this segment, barring the gold loan portfolio, has also grown at a steady clip. Retail gold loans took a sharp knock since 2013-14, due to volatility in gold prices.

This segment continues to witness pain. However, the bank has substantially lowered its exposure to this segment in the last two to three years.

From 30 per cent in the beginning of 2013-14, retail gold loans now constitute about 13 per cent of the retail portfolio. Excluding gold, retail loans have grown by 17 per cent in the June quarter, compared with the same quarter last year.

Federal Bank has built a strong retail deposit base, focussing on the low-cost current account savings account (CASA) deposits as well as NRI deposits. The bank is well known for its strong non-resident clientele. Thanks to market share gains, non-resident deposits grew by 25 per cent in the recent June quarter, despite slowing pace of remittances into the country. However, if the employment situation in West Asia worsens, there may be some impact on the growth of these deposits.

That said, the bank has been able to garner a healthy low-cost CASA base, growing it by 16 per cent annually in the last four years. In turn, the share of high-cost deposits has shrunk substantially, from 14 per cent to just around 2 per cent. All these efforts have aided margins. In the latest June quarter, the bank’s net interest margin improved to 3.3 per cent from about 3.1 per cent during the same quarter last year.

In 2015-16, the performance of Federal Bank was impacted due to rise in provisioning for bad loans, just as in the case of most other banks. The gross non-performing assets for the bank went up to 2.8 per cent of loans from about 2 per cent in 2014-15.

However, there are some signs of the asset quality problem bottoming out. In the latest June quarter, fresh slippages into NPAs halved to ₹280 crore from about ₹530 crore in the March quarter.

Going ahead, the bank’s focus on high-rated corporates and secured portion of the retail and SME segments should minimise risk of delinquencies.

In the near term, though, the management has indicated that about ₹200 crore of restructured loans will come out of moratorium; this needs to be watched.

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