Federal Bank rating: Buy — Performance in first quarter was steady

With moratorium still high at 24%, of which ~50% have not paid a single EMI in this period, we see them as harbingers of—as we expect—higher slippages/credit cost in H2FY21/H1FY22.

Federal Bank (FB) reported Q1FY21 PAT of Rs 4 bn, greater than anticipated due to higher treasury and lower opex (down 12% q-o-q) as well as credit cost. Slippages reduced, despite one corporate account souring, due to near-zero slippages in retail/agri/business banking segment—a natural and wholly expected corollary of the moratorium option. With moratorium still high at 24%, of which ~50% have not paid a single EMI in this period, we see them as harbingers of—as we expect—higher slippages/credit cost in H2FY21/H1FY22.

As argued in our recent report : (i) our prognosis of systemic asset quality remains rather bleak; and (ii) Federal Bank is below median in our coverage universe in terms of the gap between reported net worth and ‘true residual equity’. Moreover, uncertainty regarding a reshuffle in top management is key variable. That said, the stock’s valuation at 0.7x FY21e P/BV lends a modicum of comfort. Maintain Buy with a TP of Rs 65.

Slippages ebb; brace for spike in H2FY21/H1FY22: Slippages were low at Rs 1.84 bn, even as corporate slippages were higher yet again at Rs 1.74 bn (one account fully provided for). Besides, Covid-19 provisions of 62bps appear an inadequate cushion for smoothing over expected asset quality turbulence.

Core profitability steady: Loan growth softened to sub-9% y-o-y, which along with steady NIMs led to 12% NII growth (along expected lines but below trend). We believe FB’s cost curtailment could be key to improving core in absence of material growth-margin triggers.

Outlook: We believe concerns over asset quality will override core business performance for the foreseeable future given its higher exposure to vulnerable segments. While the stock’s valuation at 0.7x FY21e P/BV lends comfort, with 24% of book under moratorium, its transition rate into GNPL in H2FY21 and uncertainty on top management change need to be watched closely. Maintain ‘BUY/SO’.