Stock Recommendation | Federal Bank - BUY - Target price : 105

Loan growth maintains momentum at ~20%+ consistently for ~8-10 quarters
Federal Bank reported strong 24% yoy loan growth in 2QFY19, driven by growth in corporate advances (up 28% yoy). Corporate loan growth has been in the range of 30-40% over the past few quarters. The share of A and above-rated loans remains stable at ~71% in 2QFY19. Business banking grew 22% yoy while commercial banking grew 13% yoy. Retail advances maintained growth momentum with 20% yoy growth. Within the retail segment, housing loans witnessed strong growth at ~35% yoy; LAP growth was 21% yoy while gold loan book continued to decline at ~10% yoy. Federal Bank has maintained >20% yoy credit growth over the past 9 quarters, which is quite impressive in our view. The spike in retail loans has been a result of greater distribution franchise through relationship managers, larger feet-on-street and activation of the in-house NBFC channel (Fedfina). Additionally, there has been a significant increase in focus on brand recognition.
We forecast the retail and corporate segment to deliver robust growth going ahead. We forecast ~20% loan CAGR in FY2019-21E.

Asset quality stable; impact of Kerala floods negligible unlike what was feared
Asset quality was broadly stable with some of the impact of Kerala floods visible in slippages and some of it was/is getting restructured. GNPL increased 11% qoq and 63% yoy to ₹32 bn (3.2% of loans) while net NPL increased 11% qoq and 55% yoy to ₹18 bn (1.8% of loans). Provision coverage ratio was at 44% on calculated basis and 64% on a reported basis.
Slippages remained stable at 2% in 2QFY19 with ~45% of the slippages coming from Kerala and mostly from the SME segment. Unlike the previous quarter where the bulk of the slippages came from the corporate segment, corporate slippages declined to 0.3% of portfolio in 2QFY19 (0.5% in 1QFY19 and 1.7% in 4QFY18) whereas slippages in SME and agriculture portfolio has increased to 1.2% of loans from 0.8% in 1QFY19.
Retail GNPL (excluding agriculture loans) was stable at 1.6% of loans. Slippages were marginally higher but not too worrisome at 0.3% of loans. SME gross NPL increased ~70 bps qoq to 8% and corporate GNPL remained stable at 2% in 2QFY19. The bank has reported additional 15% slippages from normal trends from Kerala due to floods and one small SME account on account of fraud.
The outstanding stock of restructured loans is low at ~60 bps of loans and the outstanding security receipts where there is a risk of impairment have also declined to ~0.4% of loans. Security receipts saw a decline of 14% qoq as there have been repayments this quarter.
Impact of floods negligible
The management highlighted there were 12 PIN codes, which were to be restructured on account of floods. The total exposure in this region was only 1.5% of loans for the bank. Of this, ~33% of loans (exposure basis) was eligible for restructuring and the bank restructured ₹300 mn in the current quarter and another ₹700 mn would be completed in the next quarter as the restructuring exercise is likely to be completed by November 2018. Outside these 12 PIN codes, there has been some impact but these have already been reflected as slippages in the current quarter. Business is moving back to normalcy in this region.
The reported numbers are far lower than initially anticipated when we look at previous such experiences across India. We are pleasantly surprised that this is almost negligible. The management had guided that slippages of We expect GNPL to trend down to 2.8% by FY2021E. Slippages are expected to drop to 1.6% by FY2021E.

Deposit market share up 12 bps yoy; CASA ratio stable
Overall deposit growth was 22% yoy in 2QFY19 driven by strong CA growth at 32% yoy and SA growth at 21% yoy. Federal Bank reported 23% yoy growth in CASA in 2QFY19 (up 6% qoq). CASA ratio stood at 33% in 2QFY19 and has been stable over the past five quarters. NRE deposits maintained momentum reporting 22% yoy growth in 2QFY19. The share of NR deposits to total deposits increased to 40% from 34% in FY2015 (up 240 bps yoy).
We expect CASA ratio to remain in the range of ~33% over the medium term driven by 19% CAGR in CASA over FY2018-21E.
NIM stable qoq; outlook stable to positive
NIM (reported) was flat qoq at 3.2% on the back of marginal increase in lending yields and stable cost of deposits. The stable cost of deposits in this period could be a function of relatively easier access to funds as the overall demand environment for the industry is still sluggish and the busy season begins in the second half of the year. Positively, there is lower pricing pressure from what we see on the ground. Yield on loans saw a marginal improvement after seeing consistent compression for the past few quarters. The other tailwind is likely to emerge from the mix in loan book towards retail and SME where the yields are higher by 100-200 bps. The outlook on NIM is broadly stable to positive in the medium term.
We expect calculated NIM to range at 2.8-3% during FY2019-21E.
Cost pressure to moderate going ahead
Cost-to-income ratio improved to 48% in 2QFY19 (down 370 bps qoq and up 270 bps yoy) driven by modest increase in operating expenses at 7% yoy in 2QFY19 despite few one-offs like extending support to Kerala flood victims and employees (₹80 mn) and RBI penalty for non-compliance on data reporting (₹50 mn).
There has been additional investment to expand the digital channel; a trend observed over the previous quarters. We expect cost-to-income ratio to gradually moderate to 45% by FY2021E on the back of 9% CAGR in operating expenses over FY2018-21E (employee expense CAGR of 9% over the same period).
Other operational highlights for the quarter
? Non-interest income increased 12% yoy in 2QFY19 led by increase in forex gains at 49% yoy and sharp uptick in fee income at 30% yoy. Recovery from written-off assets and treasury gains, however, declined by 35% and 32% yoy, respectively.
? Tier-1 declined by 130 bps yoy to 13% as per Basel-3 norms, with overall capital adequacy at 13.3% observing a similar decline on yoy basis. Growth in RWA at 18% yoy was lower than loan growth at 24% yoy in 2QFY19.

Definitions of ratings

Our target prices are also on a 12-month horizon basis.

Other definitions

Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

Other ratings/identifiers

Copyright 2018 Kotak Institutional Equities (Kotak Securities Limited). All rights reserved.
1. Note that the research analysts contributing to this report may not be registered/qualified as research analysts with FINRA; and
2. Such research analysts may not be associated persons of Kotak Mahindra Inc and therefore, may not be subject to NASD Rule 2711 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
3. Any U.S. recipients of the research who wish to effect transactions in any security covered by the report should do so with or through Kotak Mahindra Inc and (ii) any transactions in the securities covered by the research by U.S. recipients must be effected only through Kotak Mahindra Inc at vinay.goenka@kotak.com.
This report is distributed in Singapore by Kotak Mahindra (UK) Limited (Singapore Branch) to institutional investors, accredited investors or expert investors only as defined under the Securities and Futures Act. Recipients of this analysis / report are to contact Kotak Mahindra (UK) Limited (Singapore Branch) (16 Raffles Quay, #35-02/03, Hong Leong Building, Singapore 048581) in respect of any matters arising from, or in connection with, this analysis / report. Kotak Mahindra (UK) Limited (Singapore Branch) is regulated by the Monetary Authority of Singapore.
Kotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distribution house.
Kotak Securities Limited is a corporate trading and clearing member of Bombay Stock Exchange Limited (BSE), National Stock Exchange of India Limited (NSE), Metropolitan Stock Exchange of India Limited (MSE). Our businesses include stock broking, services rendered in connection with distribution of primary market issues and financial products like mutual funds and fixed deposits, depository services and Portfolio Management.
Kotak Securities Limited is also a depository participant with National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL). Kotak Securities Limited is also registered with Insurance Regulatory and Development Authority as Corporate Agent for Kotak Mahindra Old Mutual Life Insurance Limited and is also a Mutual Fund Advisor registered with Association of Mutual Funds in India (AMFI). We are registered as a Research Analyst under SEBI (Research Analyst) Regulations, 2014.
We hereby declare that our activities were neither suspended nor we have defaulted with any stock exchange authority with whom we are registered in last five years. However SEBI, Exchanges and Depositories have conducted the routine inspection and based on their observations have issued advise/warning/deficiency letters/ or levied minor penalty on KSL for certain operational deviations. We have not been debarred from doing business by any Stock Exchange / SEBI or any other authorities; nor has our certificate of registration been cancelled by SEBI at any point of time.
We offer our research services to clients as well as our prospects.
This document is not for public distribution and has been furnished to you solely for your information and must not be reproduced or redistributed to any other person. Persons into whose possession this document may come are required to observe these restrictions.
This material is for the personal information of the authorized recipient, and we are not soliciting any action based upon it. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It is for the general information of clients of Kotak Securities Ltd. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients.
We have reviewed the report, and in so far as it includes current or historical information, it is believed to be reliable though its accuracy or completeness cannot be guaranteed. Neither Kotak Securities Limited, nor any person connected with it, accepts any liability arising from the use of this document. The recipients of this material should rely on their own investigations and take their own professional advice. Price and value of the investments referred to in this material may go up or down. Past performance is not a guide for future performance. Certain transactions -including those involving futures, options and other derivatives as well as non-investment grade securities - involve substantial risk and are not suitable for all investors. Reports based on technical analysis centers on studying charts of a stock's price movement and trading volume, as opposed to focusing on a company's fundamentals and as such, may not match with a report on a company's fundamentals.
Opinions expressed are our current opinions as of the date appearing on this material only. While we endeavor to update on a reasonable basis the information discussed in this material, there may be regulatory, compliance or other reasons that prevent us from doing so. Prospective investors and others are cautioned that any forward-looking statements are not predictions and may be subject to change without notice. Our proprietary trading and investment businesses may make investment decisions that are inconsistent with the recommendations expressed herein.
Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited.
We and our affiliates/associates, officers, directors, and employees, Research Analyst(including relatives) worldwide may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of 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 market maker in the financial instruments of the subject company/company (ies) discussed herein or act as advisor or lender / borrower to such company (ies) or have other potential/material conflict of interest with respect to any recommendation and related information and opinions at the time of publication of Research Report or at the time of public appearance. Kotak Securities Limited (KSL) may have proprietary long/short position in the above mentioned scrip(s) and therefore may be considered as interested. The views provided herein are general in nature and does not consider risk appetite or investment objective of particular investor; readers are requested to take independent professional advice before investing. This should not be construed as invitation or solicitation to do business with KSL. Kotak Securities Limited is also a Portfolio Manager. Portfolio Management Team (PMS) takes its investment decisions independent of the PCG research and accordingly PMS may have positions contrary to the PCG research recommendation. Kotak Securities Limited does not provide any promise or assurance of favourable view for a particular industry or sector or business group in any manner. The investor is requested to take into consideration all the risk factors including their financial condition, suitability to risk return profile and take professional advice before investing.
The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report.
No part of this material may be duplicated in any form and/or redistributed without Kotak Securities' prior written consent. Details of Associates are available on www.kotak.com
Research Analyst has served as an officer, director or employee of subject company(ies): No
We or our associates may have received compensation from the subject company(ies) in the past 12 months.
We or our associates have managed or co-managed public offering of securities for the subject company(ies) in the past 12 months: No
We or our associates may have received compensation for investment banking or merchant banking or brokerage services from the subject company(ies) in the past 12 months. We or our associates may have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company(ies) in the past 12 months. We or our associates may have received compensation or other benefits from the subject company(ies) or third party in connection with the research report. Our associates may have financial interest in the subject company(ies).
Research Analyst or his/her relative's financial interest in the subject company(ies): No
Kotak Securities Limited has financial interest in the subject company(ies) at the end of the month immediately preceding the date of publication of Research Report: Yes
Our associates may have actual/beneficial ownership of 1% or more securities of the subject company(ies) at the end of the month immediately preceding the date of publication of Research Report.
Research Analyst or his/her relatives has actual/beneficial ownership of 1% or more securities of the subject company(ies) at the end of the month immediately preceding the date of publication of Research Report: No.
Kotak Securities Limited has actual/beneficial ownership of 1% or more securities of the subject company(ies) at the end of the month immediately preceding the date of publication of Research Report: No
Subject company(ies) may have been client during twelve months preceding the date of distribution of the research report.
"A graph of daily closing prices of securities is available at https://www.nseindia.com/ChartApp/install/charts/mainpage.jsp and http://economictimes.indiatimes.com/markets/stocks/stock-quotes. (Choose a company from the list on the browser and select the "three years" icon in the price chart)."
Kotak Securities Limited. Registered Office: 27 BKC, C 27, G Block, Bandra Kurla Complex, Bandra (E), Mumbai 400051. CIN: U99999MH1994PLC134051, Telephone No.: +22 43360000, Fax No.: +22 67132430. Website: www.kotak.com/www.kotaksecurities.com. Correspondence Address: Infinity IT Park, Bldg. No 21, Opp. Film City Road, A K Vaidya Marg, Malad (East), Mumbai 400097. Telephone No: 42856825. SEBI Registration No: NSE INB/INF/INE 230808130, BSE INB 010808153/INF 011133230, MSE INE 260808130/INB 260808135/INF 260808135, AMFI ARN 0164, PMS INP000000258 and Research Analyst INH000000586. NSDL/CDSL: IN-DP-NSDL-23-97. Our research should not be considered as an advertisement or advice, professional or otherwise. The investor is requested to take into consideration all the risk factors including their financial condition, suitability to risk return profile and the like and take professional advice before investing. Investments in securities market are subject to market risks, read all the related documents carefully before investing. Derivatives are a sophisticated investment device. The investor is requested to take into consideration all the risk factors before actually trading in derivative contracts. Compliance Officer Details: Mr. Manoj Agarwal. Call: 022 - 4285 8484, or Email: ks.compliance@kotak.com.
In case you require any clarification or have any concern, kindly write to us at below email ids:
● Level 1: For Trading related queries, contact our customer service at 'service.securities@kotak.com' and for demat account related queries contact us at ks.demat@kotak.com or call us on: Toll free numbers 18002099191 / 1800222299, Offline Customers - 18002099292
● Level 2: If you do not receive a satisfactory response at Level 1 within 3 working days, you may write to us at ks.escalation@kotak.com or call us on 022-42858445 and if you feel you are still unheard, write to our customer service HOD at ks.servicehead@kotak.com or call us on 022-42858208.
● Level 3: If you still have not received a satisfactory response at Level 2 within 3 working days, you may contact our Compliance Officer (Mr. Manoj Agarwal) at ks.compliance@kotak.com or call on 91- (022) 4285 8484.
● Level 4: If you have not received a satisfactory response at Level 3 within 7 working days, you may also approach CEO (Mr. Kamlesh Rao) at ceo.ks@kotak.com or call on 91- (022) 4285 8301.
First Cut notes published on this site are for information purposes only. They represent early notations and responses by analysts to recent events. Data in the notes may not have been verified by us and investors should not act upon any data or views in these notes. Most First Cut notes, but not necessarily all, will be followed by final research reports on the subject. There could be variance between the First cut note and the final research note on any subject, in which case the contents of the final research note would prevail. We accept no liability for the contents of the First Cut Notes. For further disclosure please view https://kie.kotak.com/kinsite/index.php