Federal Bank stock gains 20%: Asset quality in Q1 surprises street

Expect further improvement in loan growth

The Federal Bank stock gained 20 per cent on Tuesday, after the bank surprised with a good set of numbers in its June quarter (Q1) results, thereby covering nearly half the decline from its May high of  Rs 101. Though some of the surge in share price was due to the correction in the past two months, analysts believe there are more gains ahead, given the better-than expected results and reasonable valuation. 

“At the current valuation, the stock seems to have factored in major negatives and we expect positive sentiments to stay. Valuations also appear reasonable,” says Kajal Gandhi, analyst at ICICI Securities. 

The key surprise in Q1 was improvement in asset quality. Fresh slippages (loan accounts turning bad) plunged 47 per cent sequentially, driven by the corporate segment. This helped the bank keep gross non-performing assets (NPAs or bad loans) ratio flat at the March 2018 quarter level of three per cent (absolute terms, it was up only 2.6 per cent sequentially). 

Credit cost, as a result, improved to 71 basis points (bps), from 123 bps in the previous quarter. The management expects asset quality to improve further, with a moderation in slippage and credit cost to be 65-70 bps at the end of FY19.

The bank’s stressed loan book, too, declined to 2 per cent of its average assets in Q1, from 2.3 per cent as of end-March 2018, the fourth consecutive quarter of such a reduction. Shyam Srinivasan, managing director & CEO of the bank said there was only one chunky account in the restructured book, limiting the impact of the Reserve Bank of India’s new NPA framework.

As asset quality deteriorates, banks have to reverse the interest earned on the loan. So, the improved asset quality (lowering interest reversal risks) and the 24 per cent year-on-year (y-o-y) growth in advances propelled revenue. Net interest income (NII, difference between interest earned and expensed) increased five per cent sequentially and a sharp 22 per cent y-o-y. 

However, NII remained flat at three per cent, owing to flat yield on advances (at 9.1 per cent). Return on equity is also expected to improve to around 10.5 per cent at the end of FY19, from 8.6 per cent in Q1. Better asset quality also meant lower provisioning, which helped post better-than-expected net profit of  Rs 2.63 billion (up 25 per cent year-on-year) in Q1.

Having said that, “Federal Bank’s performance has remained volatile in the past. Unless it shows consistent performance, valuation is unlikely to go up in the short term,” cautions Manish Oswal, analyst at Nirmal Bang. The management, however, believes the bank will continue posting 20-25 per cent annual loan growth, and profit.