Federal Bank earnings likely to improve as credit costs stabilise

Bank rebalancing its loan book to improve profitability, return ratios

The stock of Federal Bank had shed 20 per cent from mid-August to September, against a 10 per cent decline in the Nifty Bank index, in the aftermath of worries that floods in Kerala would have a significant impact on the company’s operations. 

What had hurt investors’ sentiment mainly was the worry over higher bad loan provisioning. In September quarter (Q2) also, a 63 per cent year-on-year rise in provisioning led to just 1 per cent rise in net profit to Rs 2.7 billion. 

However, Ashutosh Khajuria, executive director and chief financial officer of the bank, believes that bad loan recognition of Rs 1.5-2 billion on account of the floods would get over by FY19, and informed that the same has been already provided for. 

This reduces worries of additional credit cost (bad loan provisions as a percentage of average loans), going ahead. Khajuria believes credit cost will be within satisfactory levels of 70 basis points for FY19, improving the bottom line growth. 

This, along with improvement in other asset quality indicators such as stressed loan book (fell to 2 per cent of advances from 4.3 per cent three years back) provides further comfort, according to a domestic brokerage. Given the positive management commentary as well as favourable analyst outlook, the stock gained 4 per cent in trade on Thursday. 

Apart from this, strong loan book traction (over 20 per cent growth) amid issues at non-banking financiers, and the expected increase in demand for retail loans after the floods, will drive overall earnings. 

The bank has started rebalancing its loan mix to improve net interest margin from 3.2 per cent levels in Q2. 

“We are now focusing on the more profitable retail segments such as gold loan, personal loans, within our risk limits. Personal loans now stand at 0.5 per cent of our loan book from zero earlier,” says Khajuria, and expects at least 1 per cent return on assets and 10-11 per cent return on equity by Q4FY19. These ratios, till September, were 0.78 per cent and 8.6 per cent, respectively, on average.

Analysts expect 24 per cent upside in the stock over the next year. 

Even analysts at Motilal Oswal Securities believe the bank is well positioned to gain market share in the corporate and retail segments, and expect 24 per cent upside in the stock over the next year — with valuation improving from around 1.2 times its estimated FY20 book value to around 1.7 times.