India Ratings have affirmed The Federal Bank Limited’s (FBL) Basel III Tier 2 bonds rating at ‘IND AA’ with a stable outlook.
At around 10.26 am, Federal Bank was trading at Rs85.25 per piece up 2.4% on Sensex. The stock has touched an intraday high of Rs85.60 per piece.
In its rationale report, Ind-Ra highlighted key rating drivers for Federal Bank. These were:
Sizeable Franchise with Large Presence in the Southern States:
The rating reflects FBL’s continued large presence in the southern states of the country with a large asset and liability franchise. At 3QFYE21, the bank had a loan portfolio size of INR1,255 billion (of which 56.8% in Kerala, Tamil Nadu and Karnataka) and a deposit base of INR1,616.7 billion (64.9% in Kerala). Furthermore, the bank had a well-diversified advances portfolio across segments comprising: corporates (3QFYE21: 35.6%, 3QFYE20: 41%), retail (33%, 30.7%), small and medium-sized enterprises (SMEs; 19.2%,18.6%) and agriculture (12.2% ,10.3%).
Stable and Well-Diversified Granular Funding Profile:
FBL has a well-diversified granular deposit profile with a low reliance on bulk deposits. Its granular deposits (i.e., deposit lower than INR10 million) constituted 92% of the total deposits in 3QFY21 with the current account savings account constituting 34.5% of the total deposits. It had a 20.8% share in bank deposits and a 27.6% share in NRI deposits in Kerala as of 1QFY21. The large granular funding helps FBL maintain lower funding costs in line with large peers. The banks funding profile has been stable with deposits growing at a CAGR of 16.5% over FY15-FY20.
Strengthened Management Team:
The bank has had a significant number of lateral hires across key verticals who bring a significant amount of experience and knowledge with them, thus enhancing management capabilities. This also reduces the risk of possible disruptions in the event of a change in guard at the managing director level, whose scheduled tenor is till September 2021. As part of its strategy, management continues to focus on the retailisation of the loan book, with controlled risk at underwriting, and the adoption of digitisation to improve branch-level productivity and increase the wallet share with customers.
Liquidity Indicator - Adequate:
FBL’s asset-liability profile is matched factoring in the excess statutory liquidity reserve of around 3.89% as a percentage of net demand time liabilities in its investment book. FBL operated at a high liquidity coverage ratio of 269.5% and a net stable funding ratio of 159% in 3QFY21. The liability is largely retail-oriented and granular; the top 20 deposits to the overall deposit ratio was modest at 5.3% in 3QFY21.
Adequate Capitalisation:
FBL’s capitalisation (13% tier 1 ratio excluding 9MFY21 profit) should facilitate growth over the next two years. The bank raised equity of INR25 billion in 1QFY18. Ind-Ra states that FBL is likely to maintain a common equity tier 1 (CET1) ratio above the regulatory minimum and system average. However, the bank plans to raise capital in 2HFY22 and maintain the floor threshold of the CET1 ratio to 12% as per management.
Marginal Weakening of Asset Quality, Although Adequately Provided:
Ind-Ra believes slippages of INR8.6 billion shown as proforma slippages, leading to a rise in the gross non-performing assets to 3.38% in 3QFY21 (3QFY20: 2.99%), to continue to be moderate, considering the COVID-19 related challenges. The COVID-19 related challenges have largely impacted FBL’s retail and SME/micro, small & medium enterprises (MSME) portfolio, leading to a restructuring of about 0.54% of advances and providing support to certain accounts with Emergency Credit Line Guarantee Scheme worth INR26 billion, which supported borrowers with outstanding of around INR130 billion (benefitting 10.4% of total advances). The bank expects an additional 50bp of restructuring being implemented in 4QFY21. With the COVID-19 related challenges and the rising cost of inflation for SMEs, a portion of the loan book could be restructured and the restructured segment could witness slippages as the economic recovery moderates.
Improvement in Margin aided by Product Mix, Core Fee Income Growth:
FBL’s net interest margin (3QFY21: 3.22%, 3QFY20: 3.0%) is supported by its strong low-cost retail liability franchise, the shift in business mix and an increase in gold loan proportion in the overall book to 11.7% (7.4%). FBL’s profitability is moderate on a risk-adjusted basis; its profit after tax/risk-weighted assets stood at 1.3% at 3QFYE21 on a trailing 12-month basis (3QFYE20: 1.7%), largely due to the COVID-19 related provision in 9MFY21, which is comparable with peers’.
Diversity in Retail Franchise Remains Monitorable:
Over the last two-to-three years, the bank has focused on moderating growth in the large corporates segment. During the same period, growth on the non-corporate side has been higher and incremental; the focus would be to grow in the retail, SME and Agri gold loan segments. The bank has charted an increasing share of unsecured lending with a cap at 5% of the total assets under management in products such as credit cards, personal loan, fintech tie-ups and microfinance. The bank also plans to scale up its vehicle financing book in the medium term. However, on the retail side, the widening of the product basket across high-yield products with adequate size and seasoning needs to be demonstrated, thereby improving the margin profile in the medium-to-long term.
Overall, on the positive side, Ind-Ra said that the ratings could be upgraded on FBL’s improved visibility on diversification of asset and liability profile outside its core geographies, along with visibility on management continuity driving the bank’s overall growth strategy over the medium-to-long term, along with a sustained diversification in the retail product and geographical mix driving margin profile. The ratings also factor in maintaining a significant retail liability franchise on a continued basis, along with stable asset quality, and a sustained improvement in profitability buffers.