Federal Bank
A solid baseline offers opportunity to reset upper ceiling
We recently met Mr. Shyam Srinivasan, the outgoing CEO of Federal Bank (FB), to reflect on the bank’s evolution during his tenure and the key areas that need incremental attention for the bank to reset its ceiling. With its loan book at INR2.2trn and the deposit base at INR2.7trn, FB has broken through the midsized banks league and has steadily narrowed the gap with larger peers. FB has been focused on growing its mix of unsecured loans and building capabilities in the wealth management space, while simultaneously targeting better traction in its corporate book to drive productivity gains and stronger profitability. While FB has grown its high-yielding loans, our analysis of segmental yields suggests significant headroom for FB to better exercise pricing power in certain segments, thereby reflating blended yields. With its CEO-designate set to assume charge by Sep-24, we opine that the key challenge for the franchise lies in leveraging its formidable balance sheet strengths into sustainable P&L outcomes (better pricing power, superior efficiency, and productivity gains) to fortify its position as a credible alternative to larger private sector banks. We maintain BUY with a TP of INR225 (1.5x Mar-26 ABVPS).
▪ Granular deposit franchise offers a strong baseline: FB continues to boast of the most granular deposit franchise in the system (FY24: 69%), a formidable advantage, especially in a deposit-starved environment.
▪ Shock-proof balance sheet: FB has carefully crafted a shock-proof balance sheet, anchored on superior underwriting, reflecting in superior asset quality (credit costs averaging <70 bps over FY11-24), despite systemic shocks over the past decade. ▪ Priority 1: Fixing the deposit mix: Despite its best-in-class deposit franchise, FB has failed to translate this advantage into superior cost of funds, largely on account of a soft CASA ratio. As FB continues to improve its share of business, and product penetration in its wholesale banking relationships, the CA mix remains a key monitorable. ▪ Priority 2: Addressing the pricing power handicap: While blended yields have been improving over the past couple of years, we observe that FB has been adopting a loss-leader pricing strategy compared to larger peers, especially in new segments. While this augurs well for the bank’s superior asset quality, we believe that FB needs to demonstrate its ability to exercise pricing power, which is likely to be the biggest driver for RoA reflation ▪ Strategy tweaks essential to reset RoA ceiling: Given continued investments in tech, distribution, and people, we expect medium-term opex ratios to stay elevated, alongside margin pressures from a likely turn in the rate cycle. We believe that consistent exercising of pricing power and build-out of cross-sell capabilities are key to RoA and multiple reflation Federal Bank – Update – Sep24 – HSIE
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