Resilient Today, Readying for Tomorrow – Unlocking the Next Leg of Growth!
Summary
FY25 was the year of transition of the bank under the new management spearheaded by Mr KVS Manian. The bank’s strategic focus shifted towards scaling Federal Bank (FB) to new heights, placing it amongst the top banks over the next 3-5 years as the bank identified key growth drivers to ensure sustainable, strong growth as a part of its ‘Project Breakthrough’. Throughout the year, the bank continued to make progress on the strategy laid out, with green shoots visible as it exit FY25. With challenges persisting in the unsecured segments, the bank consciously slowed down growth in the higher-yielding segment and shifted focus towards midyielding secured segments, while effectively managing NIMs despite higher CoF. Asset Quality remained healthy, driven by controlled slippages and healthy recoveries.
Key Highlights
• Operational Performance: FB reported healthy credit growth of 12% YoY, led by the LAP (+20% YoY), Gold Finance (+21% YoY), CV/CE (+35% YoY), and Commercial Banking (+27% YoY). The mix of high and very-high yielding segments remained largely stable at ~5% in FY25. The bank shifted its focus to mid-yielding segments amidst asset quality challenges in unsecured segments, thereby improving its share in the portfolio to 47% vs 45% in FY24. Deposit growth replicated the credit growth at 12% YoY, driven by CA (+34% YoY), while CASA deposits grew by 16% YoY. As a result, the CASA ratio improved to 30.5% from 29.4% YoY. LDR remained comfortable at 82.8%, flat YoY.
• Financial Performance: NII growth was steady at 14% YoY in FY25, despite margin pressures, though controlled with focus on yield management. Margin compression of 7bps YoY was mainly led by the increase in the CoD (reported)/CoF (calc.). NIMs stood at 3.13% vs 3.2% in FY24. Non-interest income grew by 23% YoY, largely driven by healthy core fee income growth (+25% YoY). Opex growth was marginally ahead of business growth (+16% YoY), primarily driven by other expenses (+21% YoY), while employee expense growth was modest (+9% YoY). C-I Ratio remained largely stable at 54.0% vs. 54.5% in FY24. PPOP growth came in strong at 18% YoY, supported by strong non-interest income. Credit costs continued to normalise. During the year, the accelerated provision (one-off; entirely towards existing NPAs) was based on FB’s intent to strengthen the risk framework by changing its approach to NPA provisioning towards retail unsecured loans. Credit costs stood at 38bps vs 23bps, thereby weighing on earnings, which grew by 9% YoY.
• Asset Quality: In FY25, as stress in the unsecured segments, particularly in the MFI segment, surfaced, it remained better managed vs peers/industry. This can be credited to the bank’s cautious growth approach and lower approval rates vs the industry. Slippages remained under control with a slippage ratio at 0.8% vs 0.9% in FY24, except for higher slippages in MFI. GNPA/NNPA improved to 1.84/0.44% vs 2.13/0.60% in FY24.
• Operational Review: Risk-weighted Assets (RWA) constituted ~60/90% of total assets/advances vs 62/91% in FY24. The bank continues to remain well-capitalised with CRAR/Tier I capital of 16.4/15.0%. FB added 85 branches during the year, taking the total branch count to 1,589. The bank continued to deepen its presence in the South, while also growing in high-potential markets across the West, North and Northeast.
Key Competitive Strengths: (a) Robust distribution reach facilitating customer growth; (b) Stable asset quality across cycles; (c) Strong, diversified and granular liability franchise, (d) Diversified portfolio ensuring portfolio stability, (e) Strong network of fintech facilitating deposit growth amidst intense competition
Growth Drivers: (a) Focus on growing mid/higher-yielding portfolio to drive continued credit growth alongside supporting NIMs; (b) Leveraging the existing and forging new fintech partnerships to ensure healthy business growth; (c) Adequate Capitalization to fuel medium-term growth; (d) Strong risk management framework to help navigate asset quality challenges; (e) Strengthening fee income and cost optimization measures in place to drive RoA improvement.
Outlook & Valuation
The bank’s strategy re-orientation under the new management is seeing green shoots across most key metrics. We expect FB’s RoA/RoE to improve between 1.3-1.4%/13-15% over the FY27-28E, while navigating near-term headwinds. This improvement is likely to be driven by (1) Healthy risk-adjusted credit growth, (2) Margin improvement levers playing out with portfolio mix shift towards better-yielding segments and lower CoF, (3) Strong deposit franchise with improved CASA Mix, (4) Strengthened Fee income profile, and (5) Stable asset quality metrics, keeping credit costs under control. We believe the risk-reward is favourable at current valuations. We recommend a BUY on the stock with a target price of Rs 240/share, implying an upside of 20% the CMP.
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