Federal Bank - JM - IC - Feb 2012

24 February 2012
India | Banking & Financial Services | Initiating Coverage Price: `422 BUY Target: `525 (Dec12)
Federal Bank
| FB IN
A promising franchise with improving ROE

Robust and stable ROAs at 1.3%; normalising credit costs to catalyse rerating: Federal Bank has a formidable franchise with asset base of `579bn delivering healthy ROA of c.1.3%. Asset quality and scaling up of franchise are the key challenges for the bank. With its task cut out, the reconstructed management has taken definite steps in last eighteen months - It has overhauled banks risk management system and put forward a focused growth strategy, which leverages banks competitive skills in SME/mid-corporate segment, dominant position in Kerala and traction with NRI population. While near-term challenges emanates from a) NIM compression (arising out of de-risking of balance sheet and deregulation of NRE deposits interest rate), and b) ambitious branch expansion putting pressure on costs, ROA is likely to remain stable as credit costs normalise in coming years. Increase in leverage, from a very strong capital position (with Tier 1 ratio of c.15%), should nudge ROEs higher. Measured loans growth in select areas; margins moderate but remain strong at 3.5% (FY13, calc.): While new operational practices streamline, the bank looks to focus on areas of its competitive strength (of SME/NRI pedigree), and hence plans to expand outside Kerala, only where it can leverage its niche. We forecast loan book CAGR of 18% (FY11-14E) driven by SME, higher rated corporate and home loans and gold loans in retail segment. Margins are moderating from high levels (FY11: 4.0%) given a) de-risking of balance sheet to less riskier assets, b) leverage increasing to 12x by FY14E (FY11: 10.1x), and c) rising cost of deposits due to deregulation of NRE TDs. We forecast NIM to come down to 3.51% (calc.) in FY13 (FY11: 3.76%). Core non-interest income CAGR at 16% (FY12-14) is expected to slightly lag B/S growth. Asset quality under dual challenges; risk adj. margins and credit costs to improve: Asset quality faces challenges from a) continued high gross slippages (9M12: 4.48%), and b) exposure to critical sectors (e.g. aviation (`4.1bn) and power (`19.5bn)) in a slowing environment. However, we derive comfort from a) overhauled risk management system and ageing of legacy NPAs bringing credit costs under control, and b) high coverage (82%) and strong capital base providing buffer to withstand shocks. We estimate adjusted credit costs of c.1.2% in FY13 and FY14 (FY11: 1.87%, FY12E: 1.33%). Risk adj. NIM will thus remain stable at 2.72% over FY13 and FY14 (FY11: 2.57%, FY12E: 2.81%). Attractive valuation provides an entry point into a promising turnaround story; initiate with BUY and Dec12 TP of `525: The bank should maintain its ROA at healthy level of c.1.3%, as reduction in credit costs offset margin compression. ROE would improve to 15% by FY14 (FY11: 12%). We value the bank at 9.0x Dec13 EPS (1.3x fwd BV), arriving at Dec12 target price of `525. Initiate with BUY.
Exhibit 1. Financial Summary
Y/E March Net Profit Net Profit (YoY) (%) Assets (YoY) (%) ROA (%) ROE (%) EPS (`) EPS (YoY) (%) PE (x) BV (`) BV (YoY) (%) P/BV (x) FY10 4,645 -7.2% 12.4% 1.13% 10.3% 27.2 -7.2% 15.5 274 8.4% 1.54 FY11 5,871 26.4% 17.8% 1.23% 12.0% 34.3 26.4% 12.3 298 8.9% 1.41 FY12E 7,534 28.3% 19.6% 1.33% 14.0% 44.0 28.3% 9.6 332 11.4% 1.27 FY13E 8,847 17.4% 17.5% 1.32% 14.7% 51.7 17.4% 8.2 372 12.0% 1.13
Ravi Singh Ravi.singh@jmfinancial.in Tel: (91 22) 6630 3058
Puneet Gulati puneet.gulati@jmfinancial.in Tel: (91 22) 6630 3072 Karan Uberoi, CFA, FRM karan.uberoi@jmfinancial.in Tel: (91 22) 6630 3082 Amey Sathe, CFA amey.sathe@jmfinancial.in Tel: (91 22) 6630 3027 Sanketh Godha sanketh.godha@jmfinancial.in Tel: (91 22) 6630 3061
Key Data
Market cap (bn) Shares in issue (mn) Diluted share (mn) 3-mon avg daily val (mn) 52-week range Sensex/Nifty `/US$ ` 72.2 / US$ 1.5 171.0 171.0 ` 209.2/US$ 4.3 ` 480.0/322.1 18,073/5,483 49.2
Daily Performance
550 500 450 400 350 300 250 Jan-11 Sep-10 Sep-11 Mar-11 Nov-10 May-11 Nov-11 Jan-12 Jul-10 Jul-11 Federal Bank 50% 40% 30% 20% 10% 0% -10%
Federal B ank
Relative to Sensex (RHS)
% Absolute Relative* * To the BSE Sensex
1M 10.1 2.1
3M 24.1 8.9
12M 21.0 21.5
Shareholding Pattern
3QFY 11 Promoters FII DII Public / others 0.0 38.3 23.3 38.4
(%)
3QFY 12 0.0 41.2 20.2 38.6
(` mn)
FY14E 10,372 17.2% 17.5% 1.32% 15.3% 60.6 17.2% 7.0 420 12.7% 1.01
JM Financial Research is also available on: Bloomberg - JMFR <GO>, Thomson Publisher & Reuters. Please see important disclosure at the end of the report
Source: Company data, JM Financial. Note: Valuations as of 23/02/2012
JM Financial Institutional Securities Private Limited
Federal Bank
24 February 2012
Strong ROAs and stabilising asset quality provide a re-rating candidate

Changing face of the bank: Following the appointment of Mr. Shyam Srinivasan as MD and CEO of the bank in September 2010 and some subsequent key senior management changes, Federal Bank, has, in last eighteen months, focused on transforming its operations. Key features of these changes are: Risk management systems: The management team has overhauled its risk management system by separating credit origination and appraisal system and centralising the sanction to tackle legacy asset quality issues. Increased focus is being given to recovery of NPLs. Loans growth strategy: The bank is following a focused growth strategy, which revolves around its traditionally strong areas of mid-corporate/SME segments, dominant position in Kerala and healthy share of NRI customers. Overall, the loan book mix is likely to remain unchanged and diversified across corporate, SME and retail. Current focus on SME and mid-corporates will continue. For corporate loans, focus is on good quality credit; gold and housing loan are key products in retail segment. Branch strategy: The bank has an ambitious plan to take branch network from 835 currently to 1,000 in 2012. While Kerala still accounts for large share in existing and new branches, the bank has identified states, such as Tamil Nadu, Maharashtra, Karnataka, Gujarat and Punjab, for opening new branches. In these states, the bank can take advantage of its experience with SME/NRI customers. Fee income franchise: Fee income franchise has been weak. The bank has addressed the issue by hiring some experienced personnel at senior management level for wholesale banking and treasury. It has also opened specialised branches in Mumbai and New Delhi for this purpose. Culture at the bank: Being an old private sector bank, management needs to orient the culture to modern banking. This will be a gradual process and management has taken initial steps such as introducing employee stock options. Historically, the bank has delivered strong margins (helped by focus on high yielding mid-corporate/SME segments and low leverage) and kept a competitive cost base (FY11 CI ratio of 37%). Higher slippages in recent years (gross slippages FY11: 3.27%, FY10: 3.35%), however have kept credit costs relatively higher. Fee income growth (FY06-11 CAGR: 10%) has also lagged balance sheet growth. As a net result though, the bank has managed to generate healthy ROAs of c.1.3% (FY06-11 average). Stable ROA and increasing leverage to drive ROE improvement: We forecast NIM to moderate from 3.76% (calc.) in FY11 to 3.44% by FY14. Though the bank is trying to address weakness of its fee income franchise, we build core non-interest income CAGR of 16% (FY12-14), slightly lower than B/S growth. CI ratio is expected to rise to 39.2% by FY14 (FY11: 36.9%), as a result of branch expansion plan and associated recruitment. We expect gross slippages (FY12E: 3.75%, FY13E: 3.00%, FY14E: 2.70%) and net slippages (FY12E: 1.45%, FY13E: 1.38%, FY14E: 1.27%) to decline given banks initiatives in risk management and recovery efforts. Reduction in coverage ratio (FY14E: 70%, FY12E: 80%) should bring down LLP to c.1.0% (9M12: 1.14%, FY11: 1.71%). A strong core tier I ratio of 14.97% (Dec11) places bank in a strong position to withstand asset quality issues in an adverse external environment and to scale up operations. The bank is expected to thus deliver stable ROA of 1.33% over FY12-14 (FY11: 1.23%). As the bank deploys surplus capital to business, we expect leverage to increase and ROE to improve to 15.3% by FY14 (FY11: 12.0%).
Page 2
Federal Bank
24 February 2012
a) Expanding footprints; leveraging competitive strengths

Federal Bank commands a strong position in its home state Kerala, where it has c.11% market share in advances and c.12% in deposits, supported by c.10% market share in number of branches (exhibit 2). Behind the SBI Group, it is the largest bank in state of Kerala.
Exhibit 1.
Exhibit 2. Federal Bank: Market share in Kerala

FY09 Braches Deposits Advances
Source: RBI, Company, JM Financial
FY10 8.8% 11.6% 11.8%
FY11 9.5% 12.1% 10.7%
8.9% 13.3% 15.2%
Exhibit 3. Top five banks, by market share of branches, in Kerala

FY10 Branches State Bank of Travancore Federal Bank State Bank of India South Indian Bank Canara Bank
Source: RBI, JM Financial
FY11 Branches 642 457 409 366 314 Market share 14% 10% 9% 8% 7%
Market share 14% 9% 9% 7% 6%
616 400 391 324 290
Keralas share in total system deposits and advances has slightly declined over the long term. While Keralas share in system deposits was relatively higher in earlier years, it has gradually declined over the years. CD ratio has improved to 72% (FY03: 43%) and is now in-line with overall CD ratio of 75% for the system. CASA ratio of Kerala deposits (FY10: 38%) is in-line with system CASA ratio (FY10: 39%). However, it is skewed towards SA ratio (FY10: 32%) vs the system SA ratio (FY10: 27%) Exhibit 4. Banking system of Kerala
Kerala Share in national GDP Share in total branches Share in total deposits Share in total advances Kerala deposits growth Kerala advances growth CD ratio (Kerala) CD ratio (System)
Source: RBI, JM Financial.
FY01
FY02
FY03
FY04
FY05 4.0%
FY06 4.0% 5.2% 3.8% 3.2% 13% 25% 62% 73%
FY07 3.9% 5.2% 3.7% 3.1% 20% 23% 64% 75%
FY08 3.8% 5.2% 3.4% 3.0% 15% 18% 65% 74%
FY09 3.8% 5.1% 3.4% 2.9% 24% 15% 60% 73%
FY10 3.8% 5.0% 3.3% 2.9% 11% 17% 64% 73%
FY11 NA 5.1% 3.1% 3.0% 13% 28% 72% 75%
5.0% 4.8% 3.5%
5.0% 4.8% 3.3% 16% 15%
5.0% 4.7% 3.4% 14% 15% 43% 59%
5.1% 4.4% 3.5% 12% 22% 47% 59%
5.1% 4.0% 3.4% 6% 25% 56% 66%
43% 59%
43% 62%
Page 3
Federal Bank
24 February 2012
At c.40%, personal loans form relatively large proportion of advances in Kerala and indicate need for higher penetration of branch network in the state. Exhibit 5. Sectoral break-up of credit outstanding in Kerala
FY07 Agriculture Industry Transport Operators Professional & other services Personal loans -Housing -Others Trade Finance Others Total Bank Credit
Source: RBI, JM Financial.
FY08 16.5% 15.9% 1.2% 5.6% 38.6% 21.5% 17.1% 14.0% 2.2% 6.1% 100%
FY09 14.7% 14.6% 1.2% 6.2% 41.4% 22.4% 19.0% 13.3% 4.2% 4.3% 100%
FY10 17.3% 13.9% 1.4% 6.1% 40.0% 21.9% 18.1% 12.9% 5.4% 2.9% 100%
14.0% 16.4% 1.3% 6.0% 38.9% 22.6% 16.3% 14.2% 1.9% 7.4% 100%
In-line with other regional banks, FB has higher branch concentration in one particular state (Kerala in the case of Federal Bank). Exhibit 6. Branch concentration for south India-based banks
Branches States Kerala Tamilnadu Karnataka Andhra Pradesh Maharashtra Rest of India Total
Source: Company, JM Financial.
Federal Bank Dec11 491 62 60 26 77 119 835 % 59% 7% 7% 3% 9% 14% 100%
South Indian Bank Dec11 373 117 38 44 24 78 674 % 55% 17% 6% 7% 4% 12% 100%
Dhanlaxmi Mar11 161 38 14 18 25 17 273 % 59% 14% 5% 7% 9% 6% 100%
ING Vysya Dec11 23 39 125 170 48 122 527 % 4% 7% 24% 32% 9% 23% 100%
Karnataka Bank Dec11 11 32 296 36 35 79 489 % 2% 7% 61% 7% 7% 16% 100%
Karur Vysya Mar11 9 219 27 80 23 11 369 % 2% 59% 7% 22% 6% 3% 100%
Exhibit 7. Keralas market share in Federal Banks business

FY09 Braches Deposits Advances
Source: RBI, Company, JM Financial
FY10 58% 49% 42%
FY11 60% 48% 41%
61% 50% 46%
This regional focus has imparted two key characteristics to the banks customer profile: SME and mid-corporate: Regional south Indian presence has lent business focus to SME and mid-corporate loans. FB reports 32% of its loans as SME and 37% as corporate advances; significant part of corporate advances is mid-corporate in nature. The total share of mid-corporate/SME loans is thus estimated at c.41% of loans (32% SME and 9% mid corporate). As at Dec11 end, retail loans comprised 31% of overall advances. NRI customers: Given extensive diaspora (estimated at c.2.5mn, against state population of c.31mn) from Kerala to middle-east, FB has had good share of NRI customers. High remittance of this client base has been a steady source of deposits for FB. As at Dec11, NRI deposits formed 16% of FBs total deposits.
Page 4
Federal Bank
24 February 2012
Ambitious branch expansion; but focus on strategically important areas: The bank has opened 92 branches in 9M12 and opened 71 branches in FY11. Going ahead, it plans to continue its ambitious expansion plan, taking branch network from 835 (3Q12 end) to 1,000 by July 2012. Keralas share in total branches currently stands at 59%. This is down from 73% share in FY05, but in the last three years, the share has been stable around 60% Most of the new branches (c.45%) would still come up in Kerala as a) the NRI deposit base is fairly diverse across the state, b) many new branches are small, manned by 2-3 staff, c) incremental cost of opening new branch and brand building is low in Kerala, and importantly, d) it allows FB to open more tier III-VI centre branches in Kerala (to meet RBI guidelines) and branches in more attractive locations outside Kerala. Outside Kerala, the expansion is focused on states such as, Tamil Nadu, Karnataka, Maharashtra, Gujarat and Punjab, where bank relies on its traditional operational strength in mid-market SME and NRI population. Exhibit 8. Federal Bank: Branches opened since FY10 end
State Kerala Tamil Nadu Maharashtra Karnataka Gujarat Other Total
Source: Company, JM Financial
Branches opened 100 15 14 12 12 10 163
Mix 61% 9% 9% 7% 7% 6% 100%
Page 5
Federal Bank
24 February 2012
b) Measured loan book growth of c.18% over FY11-14E

Loan book to register measured CAGR of 18% for FY11-14E: FB has delivered healthy 5-years loan book CAGR of 22% (FY06-11) (exhibit 9). The loan book of `343bn, as at Dec11 end, is fairly well diversified across three segments of corporates (42%), SME (29%) and retail (29%). In recent years, the loans mix has changed slightly in favour of corporates (exhibit 10), a trend expected to continue in coming years. SME/midcorporate segment remains the mainstay for bank and is expected to see healthy growth. Growth in gold loans, up 110% YoY in 3Q12, has driven retail loans in recent quarters (exhibit 11). However, with gold loans still comprising 5.5% of total loans, there is significant room to grow this portfolio. Gold and housing loans are FBs key focus areas in retail the segment. Exhibit 9. Federal Bank: Growth trend for loans
Loans (LHS) 500 400 320 300 193 200 100 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E 62 77 88 117 8% 0% 153 270 230 16% 374 y oy grow th(%) 442 32% 521 40%
(`bn)
24%
Exhibit 10. Federal Bank: Break-up of the loan book by segment

FY10 Retail 31% Large & mid corporate 42% 3Q12 Retail 29%
Large & mid corporate 38%
SME 31%
SME 29%
Page 6
Federal Bank
24 February 2012
Exhibit 11. Federal Bank: Retail loans mix

Gross Advances Housing loans Gold loans Adv. Against deposits Vehicle loans Education loans Others Total gross retail advances Mix(%) Housing loans Gold loans Adv. Against deposits Vehicle loans Education loans Others Total gross retail advances
(` bn)
3Q12 55.3 18.8 10.9 4.9 3.9 4.9 98.7 YoY (%) -6% 110% 21% -3% 38% 4% 10% QoQ (%) -3% 29% 2% -15% 36% -15% 2% 57.1 14.5 10.6 5.8 2.9 5.8 96.7
3Q11 58.8 8.9 8.9 5.1 2.9 4.7 89.3
2Q12
66% 10% 10% 6% 3% 5% 100%
59% 15% 11% 6% 3% 6% 100%
56% 19% 11% 5% 4% 5% 100%
-10% 9% 1% -1% 1% 0%
-3% 4% 0% -1% 1% -1%
Management has guided for credit growth of 18-20% in FY13. We expect the bank to register 18% CAGR in loan book for FY11-14E, at marginal premium to system growth. The bank will benefit from geographical expansion, improving utilisation of branches and sufficient headroom provided by the surplus capital. Exhibit 12. Federal Bank: Business growth and CD ratio
Advances 750 650 550 450 350 250 150 50 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E 179 117 216 153 322 259 193 230 430 361 270 374 320 508 442 604 522 Deposits Business growth (% yoy) 713 28% 24% 20% 16% 12% 8% 4% 0%
C-D Ratio 76% 74% 72% 70% 68% 66% 64% 62% 60% FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E 65.6% 69.0% 69.5% 73.0% 74.7% 74.3% 73.6% 73.2% 73.2%
(`bn)
Exhibit 13. Loan book growth: Federal Bank vs peers

FY05 Federal Bank South Indian Bank* ING Vysya Bank HDBC Bank ICICI Bank Axis Bank IndusInd Bank Yes Bank
*
FY06 33% 19% 13% 37% 60% 43% 3% 216%
FY07 27% 24% 17% 34% 34% 65% 19% 161%
FY08 27% 32% 22% 35% 15% 62% 15% 50%
FY09 18% 13% 14% 56% -3% 37% 23% 32%
FY10 20% 34% 10% 27% -17% 28% 30% 79%
FY11 19% 29% 28% 27% 19% 36% 27% 55%
FY12E 17% 27% 22% 25% 18% 20% 29% 16%
FY13E 18% 22% 22% 23% 18% 19% 25% 27%
FY14E 18% 22% 21% 22% 18% 19% 25% 23%
15% 28% 31% 44% 46% 67% 23%
Source: Company, JM Financial. Based on Bloomberg consensus estimate.
Page 7
Federal Bank
24 February 2012
c) Deregulation has affected attractiveness of NRI deposits; CASA growth is key monitorable now
NRI deposits form a significant share: There is a large number of migrants from Kerala in the Middle East (estimated at c.2.5mn, against state population of c.31mn) and they send healthy remittances to their home state every year (on an average, remittance income is estimated to contribute c.22% to state income). FB has successfully exploited this opportunity over the years to support its deposit base (exhibit 14). At 3Q12 end, NRI deposits (NRE/NRO/FCNR) accounted for 16% of total deposits. This compares with share of NRI deposits in total system deposits at c.4.3%. Low cost NRI deposits formed 36% of these deposits (6% of total deposits). Along with CASA deposits of 28%, total low-cost deposits thus stood at 34% of total deposits at 3Q12 end. Deregulation of NRE deposits poses a challenge: On 16 December, RBI deregulated interest rates for NRE deposits (savings and term) and NRO savings deposits (term deposits were deregulated already). Before the deregulation, Federal Banks interest rate on one year NRE deposits was 3.82%. However, the deregulation led to rate-war, with almost all banks raising NRE term deposit rate to close to 10%. The Federal Bank has also now increased one year interest rate on NRE deposits to 9.5%. The revised rates apply to fresh deposits and on renewal of maturing deposits. While the impact on 3Q12 cost of deposits was negligible for Federal Bank, the attractiveness of NRE deposits, from low cost of deposits point of view, is now permanently reduced. Given that majority of NRE term deposits mature in a year, the bank will see rising cost of deposits, both from higher interest rates and migration of NRE savings to term deposits. Though low cost FCAB deposits (2% of total deposits) are still out of purview of interest rate deregulation, the direction of regulations indicates these could also be deregulated eventually. Management has guided cost of funds to rise by 10-15bps in FY13. NRI deposits however remain important for FB as differentiated set of relationships and source of forex transactions fee income. Exhibit 14. Federal Bank: Low cost deposits
40% 35% 30% 25% 20% 15% 10% 5% 0% 1Q11
CASA
5% 3% 4% 3% 4% 3%
FCAB
NRE TD
3% 3%
3% 3%
2% 3%
2% 3%
28%
29%
29%
26%
27%
26%
28%
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
CASA traction thus gains prominence to check cost of deposits: Given that attractiveness of NRI deposits has diminished, progress on CASA growth is critical for the bank now. Though the bank has an aggressive branch expansion plan and there is significant scope to improve current CASA per branch; we remain cautious and will wait to see the actual performance in current high interest rate environment. We expect CASA ratio of 26-27% over FY12-14E.
Page 8
Federal Bank
24 February 2012
Exhibit 15. CASA ratio: Federal Bank vs peers

FY05 Federal Bank South Indian Bank ING Vysya Bank HDBC Bank ICICI Bank Axis Bank IndusInd Bank Yes Bank 24.5% 24.8% 24.2% 60.6% 25.1% 38.0% 10.7% n.a. FY06 25.0% 26.4% 27.0% 55.4% 24.0% 40.0% 12.9% n.a. FY07 25.2% 23.9% 28.9% 57.7% 22.6% 40.0% 14.9% 5.8% FY08 25.1% 24.1% 31.5% 54.5% 26.9% 46.3% 15.7% 8.5% FY09 24.5% 23.8% 27.0% 44.4% 30.2% 44.1% 19.2% 8.7% FY10 26.2% 23.1% 32.6% 52.1% 43.8% 48.1% 23.7% 10.5% FY11 26.9% 21.5% 34.6% 52.8% 47.5% 42.6% 27.2% 10.3% FY12E 27.3% 21.5%* 32.0% 48.3% 44.6% 42.0% 28.0% 13.5% 31.5% 48.0% 43.5% 41.6% 30.5% 15.8% 31.5% 48.2% 43.1% 41.6% 33.0% 17.0% FY13E 26.6% FY14E 26.4%
Source: Company, JM Financial. *As at 3Q12 end.
Exhibit 16. CASA per branch: Federal Bank vs peers

FY05 Federal Bank South Indian Bank ING Vysya Bank HDBC Bank ICICI Bank Axis Bank IndusInd Bank Yes Bank
*
(` mn)
FY08 106 69 145 722 505 622 166 168 FY09 127 79 136 449 442 639 236 121 FY10 141 91 170 505 493 672 301 188 FY11 156 99 200 553 402 559 311 222 FY12E 163 113* 209 523 398 571 303 204 232 574 420 597 317 269 263 649 453 640 349 325 FY13E 169 FY14E 188
FY06 95 51 83 578 611 364 133 n.a.
FY07 99 58 101 576 665 431 155 118
78 46 72 472 431 355 113 n.a.
Source: Company, JM Financial. As at 3Q12 end.
Page 9
Federal Bank
24 February 2012
d) Margins to moderate but stay robust at 3.5% (FY13E, calc.); steps taken to enhance fee income franchise
De-risking of assets and higher cost of deposits to drive NIM compression of 32bps over FY12E-14E: FB has historically enjoyed strong margins thanks to a) high yield on assets on account of its SME focus, b) low leverage ratio, and c) controlled cost of deposits. Given the asset quality focus, FB is now looking to lend mainly to corporates with better credit ratings, albeit with lower yields. Cost of funds would come under some pressure due to deregulation of interest rate on NRI deposits and migration from savings to term deposits in a high interest rate environment. Leverage is estimated to increase to 11.8x (FY11: 10.1x) as surplus capital is deployed in the business. We forecast NIM (calc.) to reduce from 3.76% in FY11 to 3.51% in FY13 and 3.44% in FY14. The margins however remain strong compared to its peers (exhibit 18). Exhibit 17. FB: Margins and spread (%) and NII growth
NIM (% ) 4.0% 3.8% 3.6% 3.4% 3.2% 3.0% 2.8% 2.6% 2.4% 2.2% 2.0% FY05 FY06 FY07 Spread (% )
(`bn)
NII (Rs bn) 30 NIM (% ) (RHS) 4.3% 3.8% 3.3% 2.8% 2.3% 1.8% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E
3.78% 3.50% 3.21% 3.24% 3.25% 3.10%
3.76%
3.65% 3.51% 3.44%
25 20 15
3.05%
3.01%
3.13% 2.95% 2.92% 2.74% 2.41% 2.89%
10
2.79% 2.75%
5 0
FY08
FY09
FY10
FY11
FY12E
FY13E FY14E
Exhibit 18. NIM (calc.): Federal Bank vs peers

FY05 Federal Bank South Indian Bank* ING Vysya Bank HDBC Bank ICICI Bank Axis Bank IndusInd Bank Yes Bank 3.21% 2.76% 2.69% 3.53% 2.18% 2.36% 2.95% 3.00% FY06 3.24% 2.97% 2.86% 3.84% 1.98% 2.40% 1.83% 3.30% FY07 3.25% 2.94% 2.63% 4.42% 1.98% 2.49% 1.29% 2.26% FY08 3.10% 2.51% 2.36% 4.88% 2.06% 2.93% 1.46% 2.47% FY09 3.78% 2.85% 2.42% 4.90% 2.21% 2.96% 1.94% 2.72% FY10 3.50% 2.53% 2.70% 4.31% 2.34% 3.14% 2.99% 2.79% FY11 3.76% 2.78% 2.91% 4.44% 2.48% 3.19% 3.56% 2.72% FY12E 3.65% 2.88% 2.99% 4.24% 2.48% 3.14% 3.44% 2.55% FY13E 3.51% 2.96% 3.05% 4.26% 2.56% 3.16% 3.52% 2.60% FY14E 3.44% 2.97% 3.05% 4.23% 2.64% 3.13% 3.55% 2.64%
Source: Company, JM Financial. *Based on Bloomberg consensus estimates
Exhibit 19. Interest spread: Federal Bank vs peers

Page 10
Federal Bank
24 February 2012
Strategic focus on fee income growth: The bank has been unable to make desired headway into retail fee, insurance and treasury products. As a result, fee income growth has been poor with CAGR of 10% (FY06-11) compared to balance sheet CAGR of 21% over the same period. Identifying it a as a potential area of improvement, the bank has made concerted efforts in recent past. It hired Mr. Abraham Chacko in May 2011. He heads the wholesale banking at FB and has c.30 years experience in domestic and international markets. The bank also hired Mr. Ashutosh Khajuria as President Treasury. He has treasury experience from his stints at IDBI Bank and SBI. The bank has also opened specialised branches in metropolitan centres such as Mumbai, Delhi, Kolkata and Bangalore. Though encouraged by these steps, these are still early days and we build conservative core non-interest income CAGR of 16% (FY12E-14E).
Exhibit 20. Federal Bank: core non-interest income)

Core Non-Int. Inc / Total Inc.(LHS) Core Non-Int. Inc /Assets
Fee income 1.3% 1.2% 1.1% 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 1 0 FY03 FY04 FY05 FY06 FY07 7 6 5 4 3 2
Forex
Treasury
Others
28% 26% 24% 22% 20% 18% 16% 14% 12% 10% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY13E
FY08
FY09
FY10
FY11 FY12E FY13E FY14E
Exhibit 21. Core non-interest income to assets: Federal Bank vs peers

*
FY06 1.07% 0.75% 1.07% 1.88% 2.05% 1.37% 1.28% 3.52%
FY07 1.11% 0.73% 1.45% 1.92% 1.96% 1.54% 1.38% 2.49%
FY08 1.11% 0.72% 1.82% 1.82% 1.88% 1.72% 1.27% 2.15%
FY09 1.21% 0.69% 1.78% 1.84% 1.62% 2.03% 1.33% 1.44%
FY10 1.03% 0.57% 1.56% 1.79% 1.82% 1.95% 1.42% 1.61%
FY11 0.99% 0.54% 1.58% 1.76% 1.79% 2.02% 1.67% 1.40%
FY12E 0.83% 0.50%* 1.51% 1.72% 1.70% 1.95% 1.77% 1.21%
FY13E 0.80%
FY14E 0.80%
0.98% 0.76% 1.20% 1.53% 1.96% 1.38% 1.26% 2.44%
1.48% 1.69% 1.70% 1.87% 1.77% 1.13%
1.43% 1.65% 1.70% 1.83% 1.77% 1.08%
Source: Company, JM Financial. As at 3Q12 end
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Federal Bank
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e) Cost structure to stay competitive despite the expansion

FB has one of the best cost to income ratio among its peers (exhibit 23). A higher NIM partly explains the lower CI ratio. However, even on cost to asset, FB compares very well with its peers (exhibit 24). We believe the bank significantly benefits from its concentrated dominant presence in the state of Kerala in keeping its costs under control. However, the bank has an aggressive branch expansion plan outside Kerala with associated pick-up in recruitment. This is likely to exert upward pressure on costs. However, benefiting from productivity gain of existing large network, we estimate CI ratio to increase only gradually to 39% by FY14 (FY11: 36.9%) and stay competitive compared to its peers. Exhibit 22. FB: Cost ratios (%)
Cost / Assets (LHS) 2.0% 1.8% 1.6% 1.4% 1.2% 1.0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E C-I Ratio (RHS) 60% 55% 50% 45% 40% 35% 30% 25% 80 70 60 50 40 30 20 10 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Assets/Employee (Rs mn) (LHS) Cost/Assets (% ) (RHS) 2.4% 2.2% 2.0% 1.8% 1.6% 1.4% 1.2% 1.0%
Exhibit 23. Cost to income: Federal Bank vs peers

Exhibit 24. Cost to assets: Federal Bank vs peers

*
FY06 1.95% 2.23% 3.25% 2.71% 2.39% 1.86% 1.90% 3.17%
FY07 1.78% 1.79% 2.82% 2.94% 2.24% 1.98% 1.78% 2.54%
FY08 1.67% 1.62% 2.73% 3.34% 2.19% 2.36% 1.83% 2.43%
FY09 1.77% 1.75% 2.70% 3.50% 1.81% 2.22% 2.17% 2.10%
FY10 1.79% 1.60% 2.47% 2.93% 1.58% 2.26% 2.35% 1.69%
FY11 1.76% 1.59% 2.82% 2.86% 1.72% 2.26% 2.50% 1.43%
FY12E 1.70% 1.57% 2.58% 2.68% 1.83% 2.20% 2.56% 1.35%
FY13E 1.69% 1.50% 2.45% 2.57% 1.90% 2.22% 2.61% 1.34%
FY14E 1.67% 1.46% 2.22% 2.50% 1.96% 2.22% 2.62% 1.31%
1.97% 2.00% 2.68% 2.32% 2.50% 1.88% 1.73%
Source: Company, JM Financial. Based on Bloomberg consensus estimates
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Federal Bank
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f) Asset quality: Under pressure, but steps taken to normalise credit costs
FBs gross and net NPL ratios have been on an upward trajectory since FY08 (exhibit 25). The bank has witnessed slippages in all its segments (SME, retail and corporates). The new management team, introduced in 3Q11, has taken this issue as a key priority and introduced comprehensive changes in risk management system (e.g. credit origination and approval). The cleaning up of bad assets has coincided with worsening of external environment with rising interest rates in the system and slowing economic growth. As it stands, the asset quality challenge for Federal Bank revolves around two aspects: Exhibit 25. Federal Bank: Quarterly asset quality trends
Gross NPLs (% ) 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 0.0% 70% 75% 80% 85% 90% Net NPLs (% ) Coverage (RHS) (% )
(%)
Exhibit 26. Federal Bank: Segment-wise gross NPL ratio and gross slippage ratio
SME
8% 7% 6% 5% 4% 3% 2% 1% 0% 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12
Retail
Corporate
Total
8% 7% 6% 5% 4% 3% 2% 1% 0% 4Q10
SME
Retail
Corporate
Total
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
1) Bringing slippages down from current levels: Historically, keeping with its regional mid-market model, the bank followed branch level origination, sanction and monitoring processes. While the model was helpful at small scale in providing local touch, it became increasingly insufficient as the bank expanded in size and complexity. The asset quality woes of last three years have mainly emanated from a) managements reduced ability to monitor credit decisions being taken at ground level, and b) some inopportune decisions taken by the management to become part of syndicated deals (e.g. for some larger SMEs) where the bank had higher exposure (relative to its B/S size) vis--vis its larger peers.
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Federal Bank
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The new management has addressed these issues by overhauling its risk management strategy. The bank a) separated centralised credit sanction and monitoring from origination, and b) introduced credit monitoring cells to bolster the recovery efforts. For smaller loans (e.g. gold loans) the bank continues with more appropriate branch-level sanctioning. For corporate loans, the focus is now on higher rated corporates and getting into full-range service relationships than oneoff deals. For retail assets, managements strategy has reduced slippages by intensively focusing on recovery efforts (Gross slippage 3Q12: `0.4bn, 2Q12: `0.7bn, 1Q12: `1.4bn). According to management, recovery efforts have yielded similar results for smaller SMEs (turnover < `50mn), even as bigger SMEs and corporate continue to face legacy issues. 2) Managing exposure to critical sectors: The banks exposure to infrastructure sector has risen substantially over FY09-11. At FY11 end, gross fund based and non-fund based exposure stood at 7.4% (FY10: 6.9% and FY09: 4.6%). Within this the bank has substantial exposure to power sector, in the form of SEB loans (Kerala, Tamil Nadu and Rajasthan). Total power sector exposure stands at `19.5bn (FY11: `23.6bn, FY10: `17.3bn). The banks exposure to troubled aviation sector is `4.1bn (1.2% of net advances), with exposure to Kingfisher Airlines (KFA), reportedly, at `1.0bn. The bank has not specified its exposure to KFA as NPL at 3Q12 end. Exhibit 27. Federal bank: Key industrial exposures
Fund-based exposure `bn FY09 Infrastructure Metals Textiles Petroleum & fuels Food Processing Chemicals Total industry Total exposure
Total Exposure Proportion `bn FY11 7.9% 2.5% 1.6% 1.4% 1.2% 1.0% 19.4% 100% FY09 19.4 10.7 7.9 6.4 4.1 10.8 85.7 417.6 FY10 32.5 11.6 7.8 5.4 4.2 4.7 89.6 471.6 FY11 41.8 13.0 8.4 7.4 6.4 5.3 103.8 567.6 FY09 4.6% 2.6% 1.9% 1.5% 1.0% 2.6% 20.5% 100% Proportion FY10 6.9% 2.5% 1.6% 1.1% 0.9% 1.0% 19.0% 100% FY11 7.4% 2.3% 1.5% 1.3% 1.1% 0.9% 18.3% 100%
FY10 30.8 11.1 7.7 4.7 4.1 4.6 83.7 436.8
FY11 40.8 12.7 8.4 7.3 6.4 5.3 99.8 514.6
FY09 4.4% 2.3% 1.9% 1.6% 0.9% 2.6% 19.0% 100%
FY10 7.1% 2.5% 1.8% 1.1% 0.9% 1.0% 19.2% 100%
17.1 9.1 7.3 6.1 3.3 9.9 73.8 388.5
Following the ageing of bad assets, the asset quality trends critically rely on performance of assets written under new risk management system (over last 18 months) and success of recovery efforts for existing bad assets. Strong capital ratio (Tier I at 15%) and coverage ratio (at 82%) place bank in strong position to face any asset quality headwinds due to its exposure to stressed sectors. Going ahead, we expect gross slippage to normalise to 3.00% in FY13 and 2.70% in FY14 (FY12E: 3.75%, FY11: 3.27%). Improved recovery efforts should lead to net slippages coming down to 1.38% in FY13 and 1.27% in FY14 (FY12E: 1.45%, FY11: 2.17%). Given the margins compression, it will be challenging for bank to maintain coverage ratio at current high levels. Though, we estimate coverage ratio to decline, it would still remain strong at 70% (FY14E). Adjusted credit cost will reduce to 1.25% in FY13E (FY12E: 1.33%, FY11: 1.87%). Risk adjusted margin are thus estimates to remain strong at 2.71-2.72% in FY13 and FY14 (FY12E: 2.81%, FY11: 2.57%).
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Exhibit 28. Gross slippage: Federal Bank vs peers

Source: Company, JM Financial. *As at 3Q12 end
FY06 1.85% 1.90% 2.57% 2.23% 1.33% 1.17% 1.24%
FY07 1.57% 2.31% 2.03% 2.23% 2.03% 0.77% 2.61%
FY08 1.77% 0.74% 1.66% 2.57% 2.02% 1.05% 1.44%
FY09 3.05% 1.65% 2.28% 3.65% 2.28% 1.74% 1.75% 0.93%
FY10 3.35% 1.49% 2.48% 2.66% 3.00% 2.22% 1.42% 0.92%
FY11 3.27% 0.68% 1.29% 1.13% 1.62% 1.39% 1.39% 0.22%
FY12E 3.75% 0.71%* 1.15% 0.95% 1.35% 1.30% 1.40% 0.35%
FY13E 3.00%
FY14E 2.70%
2.55% 2.29% 3.19% 1.46% 4.07% 1.40% 4.07%
1.40% 1.50% 1.50% 1.70% 1.60% 0.50%
1.50% 1.50% 1.50% 1.70% 1.60% 0.60%
Exhibit 29. Adjusted credit costs: Federal Bank vs peers

Source: Company, JM Financial. *As at 3Q12 end
FY06 0.20% -0.24% 0.41% 1.58% 0.00% 0.69% 0.45%
FY07 0.26% 0.60% 0.02% 1.80% 1.38% 0.41% 1.32%
FY08 1.01% -0.17% 0.19% 2.03% 1.92% 0.68% 0.69%
FY09 1.80% 1.10% 1.33% 2.39% 2.18% 1.24% 0.15% 0.82%
FY10 1.92% -0.26% 1.42% 1.56% 1.83% 1.56% 0.30% 0.34%
FY11 1.87% 0.15% 0.12% 0.47% 0.27% 0.77% 0.57% 0.13%
FY12E 1.33% 0.12%* 0.19% 0.50% 0.44% 0.85% 0.60% 0.26%
FY13E 1.25%
FY14E 1.15%
1.30% 1.12% 0.79% 0.96% 0.22% 0.86% 1.21%
0.57% 0.96% 0.69% 1.10% 0.83% 0.38%
0.74% 0.95% 0.70% 0.94% 0.82% 0.42%
Exhibit 30. FB: NPA ratios, slippages and LLP

Gross NPLs (% ) 8% 7% 6% 5% 4% 3% 2% 1% 0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Net NPLs (% ) Coverage (RHS) (% ) 95% 90% 85% 80% 75% 70% 65% 60% 2.1% 1.8% 1.5% 1.2% 0.9% 0.6% 0.3% 0.0% -0.3% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Specific LLP (% ) Adj. LLP (% )
Exhibit 31. Federal Bank: Risk adjusted margins

Risk Adjusted Margins (% ) 3.2% 3.0% 2.8% 2.6% 2.4% 2.2% 2.0% 1.8% FY05
3.12%
3.09% 2.81% 2.72% 2.57% 2.32%
2.71% 2.51% 2.50%
2.71%
FY06
FY07
FY08
FY09
FY10
FY11
FY12E
FY13E
FY14E
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Federal Bank
24 February 2012
Exhibit 32. FB: LLP and slippages

LLP (Rs bn) (RHS) 1.8% 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Specific LLP (% ) 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E Slippages (Rs bn) (RHS) Slippages (% ) 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
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Federal Bank
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g) ROE to improve to 15% by FY14, with high Tier-I of c.12.6%

We expect FB to register strong 21% CAGR in earnings for FY11-14E driven by broadly flat provisions over FY12-14E. ROA would remain stable at healthy c.1.3% over FY13 and FY14. The bank currently has surplus capital with strong tier I capital of 15%. We estimate leverage to increase to 11.8 (FY14) and tier I to come down to healthy 12.6% in FY14. As a result, ROE is expected to improve to 15.3% by FY14E (FY11: 12.0%). Exhibit 33. FB: Return ratios and Tier I
ROA (LHS) 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E 22% 19% 16% 13% 10% 7% ROE (RHS) 25% 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Tier I Tier II
Exhibit 34. ROA: Federal Bank vs peers

*
FY06 1.20% 0.50% 0.06% 1.39% 1.21% 1.11% 0.22% 2.03%
FY07 1.28% 0.85% 0.50% 1.39% 1.04% 1.07% 0.35% 1.24%
FY08 1.28% 0.99% 0.70% 1.42% 1.12% 1.17% 0.34% 1.42%
FY09 1.40% 1.04% 0.66% 1.42% 0.96% 1.41% 0.59% 1.52%
FY10 1.13% 1.02% 0.74% 1.45% 1.08% 1.53% 1.12% 1.61%
FY11 1.23% 1.01% 0.88% 1.57% 1.34% 1.60% 1.43% 1.52%
FY12E 1.33% 1.07% 1.06% 1.66% 1.40% 1.54% 1.53% 1.42%
FY13E 1.32% 1.08% 1.15% 1.72% 1.42% 1.49% 1.49% 1.40%
FY14E 1.32% 1.09% 1.15% 1.73% 1.42% 1.48% 1.49% 1.39%
0.56% 0.09% -0.27% 1.42% 1.35% 1.08% 1.37%
Source: Company, JM Financial. Based on Bloomberg consensus estimates
Exhibit 35. ROE: Federal Bank vs peers

FY05 Federal Bank South Indian Bank* ING Vysya Bank HDBC Bank ICICI Bank Axis Bank IndusInd Bank Yes Bank 13.3% 2.1% -5.7% 18.5% 19.2% 18.9% 25.8% FY06 23.0% 9.6% 1.1% 17.7% 14.6% 18.4% 4.3% 14.0% FY07 21.4% 15.7% 9.4% 19.5% 13.4% 21.0% 7.1% 13.9% FY08 13.6% 16.4% 13.0% 17.7% 11.7% 17.6% 6.9% 19.0% FY09 12.1% 16.0% 12.5% 16.9% 7.8% 19.1% 11.7% 20.6% FY10 10.3% 17.0% 12.7% 16.1% 8.0% 19.2% 19.5% 20.3% FY11 12.0% 18.5% 13.5% 16.7% 9.7% 19.3% 19.3% 21.1% FY12E 14.0% 21.0% 14.3% 18.9% 10.8% 19.9% 19.0% 22.9% FY13E 14.7% 21.9% 14.4% 20.5% 11.7% 19.7% 19.9% 23.4% FY14E 15.3% 22.5% 15.4% 21.3% 12.4% 19.9% 20.7% 23.4%
Exhibit 36. Tier I ratio: Federal Bank vs peers

FY06 9.7% 8.4% 7.1% 8.6% 9.2% 7.3% 6.8% 13.8%
FY07 9.0% 8.8% 6.4% 8.6% 7.4% 6.4% 7.3% 8.2%
FY08 19.1% 12.1% 6.8% 10.3% 11.8% 10.2% 6.7% 8.5%
FY09 18.4% 13.2% 6.9% 10.6% 11.8% 9.3% 7.5% 9.5%
FY10 16.9% 12.4% 10.1% 13.3% 14.0% 11.2% 9.7% 12.8%
FY11 15.6% 11.3% 9.4% 12.2% 13.2% 9.4% 12.3% 9.7%
FY12E 14.3% 11.8% 11.3% 12.3% 9.1% 11.1% 9.0%
FY13E 13.4% 10.8% 10.8% 11.6% 8.9% 10.4% 8.8%
FY14E 12.6% 10.0% 10.5% 10.9% 8.7% 9.8% 8.6%
6.5% 5.7% 5.2% 9.6% 7.6% 8.9% 7.2% 18.6%
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Federal Bank
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h) Valuation: Improvement in ROE to drive rerating

While the bank trades at significant discount to its new private sector bank peers, the valuation vis--vis old private sector banks is undemanding as well. Federal Bank is the largest old private sector banks with strong ROE improvement potential. We value Federal Bank at 9x Dec13 earnings, to arrive at a Dec12 TP of `525. This implies valuation of 1.3x Dec13 fwd. BV. Exhibit 37. Relative Valuation: Federal Bank
Mar. Cap. (`bn) Federal Bank Old Private Sector ING Vysya Bank Karur Vysya Bank J&K Bank South Indian Bank Karnataka Bank City Union Bank New Private Sector HDFC Bank ICICI Bank Axis Bank IndusInd Bank Yes Bank 1,249 1,088 503 146 125 36.2% 23.1% 17.3% 25.4% 16.2% 31.6 21.1 14.8 25.3 16.9 24.0 17.7 12.6 18.5 12.7 18.9 15.1 10.8 15.1 10.2 15.5 13.2 9.2 12.3 8.3 29.1% 18.2% 16.6% 29.3% 28.9% 4.9 2.0 2.6 3.8 3.2 4.2 1.8 2.3 3.3 2.6 3.6 1.7 2.0 2.8 2.2 3.0 1.6 1.7 2.3 1.8 18.9% 10.8% 19.9% 19.0% 22.9% 20.5% 11.7% 19.7% 19.9% 23.4% 54 42 42 31 21 20 13.9% 14.9% 8.3% 9.5% 6.6% 13.7% 13.7 8.7 6.5 10.0 6.8 8.8 11.8 8.8 5.3 7.7 8.2 7.2 9.0 7.3 4.7 6.8 6.7 6.1 7.4 n.a. 4.0 5.4 6.0 4.6 23.1% 9.5% 17.0% 21.4% 0.4% 19.7% 1.7 1.9 1.2 1.6 0.8 1.9 1.4 1.5 1.0 1.5 0.8 1.6 1.2 1.3 0.8 1.2 0.7 1.2 1.1 n.a. 0.7 1.0 0.6 1.1 14.3% 20.2% 20.1% 20.0% 9.9% 23.6% 14.4% 20.4% 19.1% 19.8% 10.9% 23.5% 72 Mar. Cap. / Assets 11.7% P/E (x) FY11 12.3 FY12E 9.6 FY13E 8.2 FY14E 7.0 EPS CAGR FY11-13E 22.8% FY11 1.4 P/B (x) FY12E 1.3 FY13E 1.1 FY14E 1.0 ROE FY12E 14.0% FY13E 14.7%
Source: Bloomberg, Company, JM Financial. Note: We have used consensus estimates for South Indian Bank, Karur Vysya Bank, J&K Bank, Karnataka Bank, City Union Bank.
Exhibit 38. Federal Bank: One-year forward P/BV (x) & one-year forward PE (x)
Fw d. P/BV (x ) Fw d. PE (x )
1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
16 14 12 10 8 6 4 2 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11

FB
0 Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Source: Bloomberg, Company, JM Financial.
Exhibit 39. Federal Bank: 12 months forward P/B and P/E against peers
HDBK 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jan-09 Jan-10 Jan-11 Jan-12 Apr-08 Apr-09 Apr-10 Apr-11 Jul-08 Oct-08 Jul-09 Oct-09 Jul-10 Oct-10 Jul-11 Oct-11 ICICIBK AXSB IIB YES VYSB FB
30 25 20 15 10 5 0 Oct-08 Oct-09 Oct-10 Jan-09 Jan-10 Jan-11 Oct-11 Apr-08 Apr-09 Apr-10 Apr-11 Jul-08 Jul-09 Jul-10 Jul-11 Jan-12 HDBK ICICIBK AXSB IIB YES VYSB
Source: Bloomberg, Company, JM Financial.
Mar-11
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Federal Bank
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Company Background
Incorporated in 1931, Federal Bank is one of the oldest private sector banks in India. It is predominately based in Kerala and holds leadership position in the state along with the SBI Group. The branch network has expanded from 552 (FY06) to 835 now and is concentrated (c.60%) in kerala. The assets have seen a CAGR of 20% (FY05-11) and the bank has delivered average ROA (FY06-11) of 1.25%. FB is the 5th largest private sector bank in India and largest among old private sector banks. Within Kerala, FB has strong presence in semi-urban and rural parts (57% of total branches). Loan book mix has remained fairly diverse across SME, corporate and retail segments. Dilution history: The bank raised capital, first in FY06 through a GDR issue and later in FY08 through a rights issue. The bank currently has strong capital at a tier I ratio of 15%. Exhibit 40. Federal Bank: Capital raised by Federal Bank
Year FY05 FY06 FY08 Description Issue of Bonus share in the ratio of 1:2 GDR issue Rights issue Amount Raised (` mn) NA 3,500 21,414 Price NA $3.97 `250 Dilution (%) NA 30% 100%
Management profile
Mr. Shyam Shrinivasan took charge as Managing Director and Chief Executive Officer of the bank on 23 September 2010. He worked with Standard Chartered Bank over 20042010 and headed Consumer banking in India and Malaysia. He brings rich experience of domestic and international markets in the field of retail banking, wealth management and SME banking. Mr. PC John, Executive Director, has been with Federal Bank since 1973 and has had exposure to different areas of banking at branches, regional offices and corporate office. He has headed Treasury, Credit, International Banking, Planning, Accounts. Mr. PC John was first internal official to be made ED in May 2010. Mr. Abraham Chacko took charge as Executive Director of the bank on 21 May 2011 and is in charge of Wholesale Banking. He has over 30 years of banking experience across domestic and international markets with ABN Amro and HSBC. He oversaw wholesale banking and transaction banking businesses in Middle East and Asia Pacific.
Key risks
Unionised staff: In the past, the bank has faced productivity challenges (e.g. strikes) due to unionised staff. The management is addressing the issue by adopting a gradual approach and introducing initiatives such as ESOPs. ALM mismatch: There is c.20% mismatch in less than one year bucket as 55% of its deposits back 35% of advances in that bucket. The bank is trying to address this by reducing duration of its loan book. Concentration in Kerala: Given significant concentration of advances (41%) in Kerala the bank is exposed to any state-specific adverse economic event (e.g. share of Kerala in national deposits/advances) has been on long-term decline. Long history of Kerala focused business pose challenge in expanding outside kerala in a timely manner.
JM Financial Institutional Securities Private Limited Page 19
Federal Bank
24 February 2012
Financial Tables (Standalone)

Profit & Loss
Y/E March Net Interest Income Profit on Investments Exchange Income Fee & Other Income Non-Interest Income Total Income Operating Expenses Pre-provisioning Profits Loan Loss Provisions Provisions on Investments Other Provisions Total Provisions PBT Tax PAT (Pre-Extra ordinaries) Extraordinaries (Net of Tax) Reported Profits Dividend Retained Profits Source: Company, JM Financial FY10 14,108 1,077 446 3,786 5,309 19,417 7,369 12,048 4,133 -977 297 3,453 8,595 3,950 4,645 0 4,645 997 3,648 FY11 17,466 458 572 4,138 5,168 22,634 8,361 14,273 5,032 111 111 5,254 9,018 3,147 5,871 0 5,871 1,690 4,181 FY12E 20,081 600 801 3,881 5,283 25,364 9,594 15,770 3,990 400 50 4,440 11,329 3,795 7,534 0 7,534 1,701 5,833 FY13E 22,859 800 905 4,449 6,154 29,013 11,336 17,677 4,298 -50 125 4,373 13,304 4,457 8,847 0 8,847 2,001 6,846
(` mn)
FY14E 26,375 800 1,068 5,185 7,053 33,428 13,106 20,322 4,525 100 100 4,725 15,597 5,225 10,372 0 10,372 2,301 8,071
Balance Sheet
Y/E March Equity Capital Reserves & Surplus Deposits Borrowings Other Liabilities Total Liabilities Investments Net Advances Cash & Equivalents Fixed Assets Other Assets Total Assets FY10 1,710 45,136 360,580 15,468 13,804 436,697 130,546 269,501 27,234 2,839 6,577 436,697 FY11 1,710 49,320 430,148 18,884 14,446 514,507 145,377 319,532 37,483 2,842 9,273 514,507 FY12E 1,710 55,153 507,574 29,900 20,946 615,284 183,927 373,597 40,523 3,183 14,054 615,284 FY13E 1,710 61,999 604,014 32,590 22,831 723,144 214,529 442,167 48,910 3,596 13,941 723,144
(` mn)
FY14E 1,710 70,069 712,736 37,916 27,398 849,830 249,884 521,701 58,070 4,057 16,118 849,830
Key ratios
Y/E March Growth (YoY) (%) Deposits Advances Total Assets NII Non-Interest Income Operating Expenses Operating Profits Core Operating Profits Provisions Reported PAT Yields / Margins (%) Interest Spread (%) NIM (%) Profitability (%) Non-IR to Income (%) Cost to Income (%) ROA (%) ROE (%) Assets Quality (%) Slippages (%) Gross NPAs (%) Net NPAs (%) Provision Coverage (%) Specific LLP (%) Net NPAs / Networth (%) Capital Adequacy (%) Tier I (%) CAR (%) Source: Company, JM Financial 16.92% 18.36% 15.63% 16.79% 14.34% 15.27% 13.41% 14.19% 3.35% 2.97% 0.48% 84.3% 1.67% 3.27% 3.49% 0.60% 83.4% 1.66% 3.75% 3.76% 0.78% 80.0% 1.05% 3.00% 3.58% 0.92% 75.0% 0.97% 38.0% 1.13% 10.3% 36.9% 1.23% 12.0% 37.8% 1.33% 14.0% 39.1% 1.32% 14.7% 2.74% 3.50% 3.13% 3.76% 2.89% 3.65% 2.79% 3.51% 12.0% 20.4% 12.4% 7.3% 2.9% 16.5% 0.5% -1.7% -14.9% -7.2% 19.3% 18.6% 17.8% 23.8% -2.7% 13.5% 18.5% 25.9% 52.2% 26.4% 18.0% 16.9% 19.6% 15.0% 2.2% 14.7% 10.5% 9.8% -15.5% 28.3% 19.0% 18.4% 17.5% 13.8% 16.5% 18.2% 12.1% 11.3% -1.5% 17.4% FY10 FY11 FY12E FY13E
(%)
FY14E
DuPont Analysis
Y/E March NII / Assets (%) Other income / Assets (%) Total Income / Assets (%) Cost to Assets (%) PPP / Assets (%) Provisions / Assets (%) PBT / Assets (%) Tax Rate (%) ROA (%) RoRWAs (%) Leverage (%) ROE (%) Source: Company, JM Financial FY10 3.42% 1.29% 4.71% 1.79% 2.92% 0.84% 2.08% 46.0% 1.13% 1.82% 9.2 10.3% FY11 3.67% 1.09% 4.76% 1.76% 3.00% 1.10% 1.90% 34.9% 1.23% 1.95% 9.7 12.0% FY12E 3.55% 0.94% 4.49% 1.70% 2.79% 0.79% 2.01% 33.5% 1.33% 2.09% 10.5 14.0% FY13E 3.42% 0.92% 4.34% 1.69% 2.64% 0.65% 1.99% 33.5% 1.32% 2.04% 11.1 14.7%
(%)
FY14E 3.35% 0.90% 4.25% 1.67% 2.58% 0.60% 1.98% 33.5% 1.32% 1.99% 11.6 15.3%
18.0% 18.0% 17.5% 15.4% 14.6% 15.6% 15.0% 15.7% 8.1% 17.2% 2.75% 3.44%
39.2% 1.32% 15.3% 2.70% 3.44% 1.06% 70.0% 0.85%
Valuations
Y/E March Shares in issue (mn) EPS (`) EPS (YoY) (%) PE (x) BV (`.) BV (YoY) (%) P/BV (x) DPS (`.) Div. yield (%) Source: Company, JM Financial FY10 171.0 27.2 -7.2% 15.5 274 8.4% 1.54 5.8 1.4% FY11 171.0 34.3 26.4% 12.3 298 8.9% 1.41 9.9 2.3% FY12E 171.0 44.0 28.3% 9.6 332 11.4% 1.27 9.9 2.4% FY13E 171.0 51.7 17.4% 8.2 372 12.0% 1.13 11.7 2.8% FY14E 171.0 60.6 17.2% 7.0 420 12.7% 1.01 13.5 3.2%
12.62% 13.27%
Page 20
Federal Bank
24 February 2012

Member, BSE Limited and National Stock Exchange of India Limited SEBI Registration Nos.: BSE - INB011296630 & INF011296630, NSE - INB231296634 & INF231296634 Registered Office: 141, Maker Chambers III, Nariman Point, Mumbai - 400 021, India Corporate Office: 51, Maker Chambers III, Nariman Point, Mumbai - 400 021, India Board: +9122 6630 3030 | Fax: +91 22 6747 1825 | Email: jmfinancial.research@jmfinancial.in | www.jmfinancial.in Analyst Certification
The research analysts, with respect to each issuer and its securities covered by them in this research report, certify that: All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and No part of his or her or their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report.
Analyst(s) holding in the Stock: (Nil) Disclosure

This research report has been prepared by JM Financial Institutional Securities Private Limited (JM Financial Institutional Securities) to provide information about the company(ies) and sector(s), if any, covered in the report and may be distributed by it and/or its affiliated company(ies) solely for the purpose of information of the select recipient of this report. This report and/or any part thereof, may not be duplicated in any form and/or reproduced or redistributed without the prior written consent of JM Financial Institutional Securities. This report has been prepared independently of the companies covered herein. JM Financial Institutional Securities and its affiliated companies are a multi-service, integrated investment banking, investment management, brokerage and financing group. The affiliated company(ies) of JM Financial Institutional Securities might have provided or may provide services in respect of managing offerings of securities, corporate finance, investment banking, mergers & acquisitions, financing or any other advisory services to the company(ies) covered herein. JM Financial Institutional Securities and/or its affiliated company(ies) might have received or may receive compensation from the company(ies) mentioned in this report for rendering any of the above services. Research analysts and sales persons of JM Financial Institutional Securities may provide important inputs to its affiliated company(ies) associated with it. While reasonable care has been taken in the preparation of this report, it does not purport to be a complete description of the securities, markets or developments referred to herein, and JM Financial Institutional Securities does not warrant its accuracy or completeness. JM Financial Institutional Securities may not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. This report is provided for information only and is not intended to be and must not alone be taken as the basis for an investment decision. The investment discussed or views expressed herein may not be suitable for all investors. The user assumes the entire risk of any use made of this information. The information contained herein may be changed without notice and JM Financial Institutional Securities reserves the right to make modifications and alterations to this statement as they may deem fit from time to time. JM Financial Institutional Securities and its affiliated company(ies), their directors and employees may; (a) from time to time, have a long or short position in, and buy or sell the securities of the 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 company(ies) discussed herein or act as an advisor or lender/borrower to such company(ies) or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions. This report is neither an offer nor solicitation of an offer to buy and/or sell any securities mentioned herein and/or not an official confirmation of any transaction. This report is not directed or intended for distribution to, or use by any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject JM Financial Institutional Securities and/or its affiliated company(ies) to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to a certain category of investors. Persons in whose possession this report may come, are required to inform themselves of and to observe such restrictions. For U.S. persons only: This research report is a product of JM Financial Institutional Securities, which is the employer of the research analyst(s) who has prepared the research report. 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If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor. In reliance on the exemption from registration provided by Rule 15a-6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business with Major Institutional Investors, JM Financial Institutional Securities has entered into an agreement with a U.S. registered broker-dealer, Marco Polo Securities Inc. ("Marco Polo"). Transactions in securities discussed in this research report should be effected through Marco Polo or another U.S. registered broker-dealer.
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24 February 2012

A promising franchise with improving ROE

Ravi Singh Ravi.singh@jmfinancial.in Tel: (91 22) 6630 3058

Relative to Sensex (RHS)

% Absolute Relative* * To the BSE Sensex

12M 21.0 21.5

Source: Company data, JM Financial. Note: Valuations as of 23/02/2012

JM Financial Institutional Securities Private Limited

Strong ROAs and stabilising asset quality provide a re-rating candidate

JM Financial Institutional Securities Private Limited

a) Expanding footprints; leveraging competitive strengths

Exhibit 2. Federal Bank: Market share in Kerala

FY10 8.8% 11.6% 11.8%

FY11 9.5% 12.1% 10.7%

8.9% 13.3% 15.2%

Exhibit 3. Top five banks, by market share of branches, in Kerala

Market share 14% 9% 9% 7% 6%

616 400 391 324 290

FY06 4.0% 5.2% 3.8% 3.2% 13% 25% 62% 73%

FY07 3.9% 5.2% 3.7% 3.1% 20% 23% 64% 75%

FY08 3.8% 5.2% 3.4% 3.0% 15% 18% 65% 74%

FY09 3.8% 5.1% 3.4% 2.9% 24% 15% 60% 73%

FY10 3.8% 5.0% 3.3% 2.9% 11% 17% 64% 73%

FY11 NA 5.1% 3.1% 3.0% 13% 28% 72% 75%

5.0% 4.8% 3.5%

5.0% 4.8% 3.3% 16% 15%

5.0% 4.7% 3.4% 14% 15% 43% 59%

5.1% 4.4% 3.5% 12% 22% 47% 59%

5.1% 4.0% 3.4% 6% 25% 56% 66%

JM Financial Institutional Securities Private Limited

Federal Bank Dec11 491 62 60 26 77 119 835 % 59% 7% 7% 3% 9% 14% 100%

Dhanlaxmi Mar11 161 38 14 18 25 17 273 % 59% 14% 5% 7% 9% 6% 100%

Karnataka Bank Dec11 11 32 296 36 35 79 489 % 2% 7% 61% 7% 7% 16% 100%

Karur Vysya Mar11 9 219 27 80 23 11 369 % 2% 59% 7% 22% 6% 3% 100%

Exhibit 7. Keralas market share in Federal Banks business

FY10 58% 49% 42%

FY11 60% 48% 41%

61% 50% 46%

JM Financial Institutional Securities Private Limited

Branches opened 100 15 14 12 12 10 163

Mix 61% 9% 9% 7% 7% 6% 100%

JM Financial Institutional Securities Private Limited

b) Measured loan book growth of c.18% over FY11-14E

Source: Company, JM Financial

Exhibit 10. Federal Bank: Break-up of the loan book by segment

Large & mid corporate 38%

JM Financial Institutional Securities Private Limited

Exhibit 11. Federal Bank: Retail loans mix

3Q11 58.8 8.9 8.9 5.1 2.9 4.7 89.3

66% 10% 10% 6% 3% 5% 100%

59% 15% 11% 6% 3% 6% 100%

56% 19% 11% 5% 4% 5% 100%

-3% 4% 0% -1% 1% -1%

Source: Company, JM Financial.

Exhibit 13. Loan book growth: Federal Bank vs peers

FY06 33% 19% 13% 37% 60% 43% 3% 216%

FY07 27% 24% 17% 34% 34% 65% 19% 161%

FY08 27% 32% 22% 35% 15% 62% 15% 50%

FY09 18% 13% 14% 56% -3% 37% 23% 32%

FY10 20% 34% 10% 27% -17% 28% 30% 79%

FY11 19% 29% 28% 27% 19% 36% 27% 55%

FY12E 17% 27% 22% 25% 18% 20% 29% 16%

FY13E 18% 22% 22% 23% 18% 19% 25% 27%