Federal Bank: Ripe for re-rating despite guidance in run-rate of slippages

Strong growth is expected to counter the likely asset quality issues

Banking stocks have been on the rise since October. While Federal Bank — with 28 per cent gains in the last three months — has participated in the re-rating journey, gains seem muted when compared to IndusInd Bank or RBL Bank.

The Street may be worried that over 38 per cent of the bank’s loan exposure is to corporates and 19 per cent to small and medium enterprises (SMEs), which is comprehensible. 

Further, the fact that asset quality in the past two quarters may have been camouflaged by the moratorium, the bank’s provision of only Rs 590 crore towards likely Covid-induced asset quality pressures (less than 1 per cent of its total loan book), and the possibility of elevated slippages for most of FY21, may have turned investors’ attention away. 

More importantly, the bank has guided that slippages from the non-corporate book could be 40-50 per higher than the usual run-rate, going ahead.

Yet, analysts at Prabhudas Lilladher say the lender is well prepared for future eventualities, while those at Emkay Global say the shoring up of provision coverage to 66 per cent in the September quarter (Q2) is a positive. 

Analysts at Morgan Stanley have recently turned from ‘underweight’ to ‘equal-weight’ on the Federal Bank stock for its growth potential. 

While increasing their earnings estimates by 16 per cent and 43 per cent for FY21 and FY22, respectively, they say that the faster-than-expected economic recovery should help normalisation of credit cost by FY23, when the impact of restructuring will get fully absorbed into its book. 

There is a reason why these brokerages are betting on the bank’s growth. Compared to peer regional banks or even the mid-sized private banks, Federal Bank was ahead of competition in Q2. 

This was thanks to the 6 per cent overall growth rate and, more specifically, with retail assets growing at 14 per cent. 

Though the bank draws its strength from home loans and vehicle loans in its retail portfolios, given that most of them are in an early phase of maturity, it’s the more seasoned gold loan portfolio — which grew over 50 per cent year-on-year in Q2 — that played the part. 

Therefore, while the existing loan book may result in pain over the next financial year or so, the newly accumulated book is likely to cause less pain, given that gold loan delinquencies stand at less than 1 per cent.

Therefore, while asset quality concerns may be real, the stronger-than-anticipated growth should lead to a rerating of the stock. Valuation at 0.7x its FY22 estimated book, is also compelling.