Federal Bank-Quarterly results update

Sector Outlook: Positive

• Net Interest Income (NII) reached Rs. 2,056 crores in Q2FY24, up 7.2% from the previous quarter and a substantial 16.7% year-on-year increase.
• Pre-provision operating profit (PPOP) stood at Rs. 1,324 crores in Q2FY24, reflecting a modest 1.7% growth compared to the previous quarter and a healthy 9.3% increase year-on-year.
• Provisions saw a significant decrease, falling to Rs. 44 crores in Q2FY24, compared to Rs. 156 crores in Q1FY24 and Rs. 268 crores in Q2FY23.
• The bank reported a quarterly net profit of Rs. 954 crores in Q2FY24, marking an impressive 11.7% growth from the previous quarter and a substantial 35.5% increase year-on-year, surpassing market expectations.
• Net Interest Margin (NIM) stood at 3.16% in Q2FY24, up 1 basis point from the previous quarter but down 14 basis points year-on-year, primarily due to higher funding costs.
• Gross Non-Performing Assets (NPAs) reached their lowest level in thirty-four quarters, standing at 2.26% in Q2FY24, down 12 basis points from the previous quarter and 2 basis points from the previous year, indicating an improvement in asset quality.
• Net NPAs were at 0.64% in Q2FY24, showing a 5 basis point decline from the previous quarter and a 14 basis point decrease from the previous year.
• Credit cost in Q2FY24 was at 0.13%, down 28 basis points from the previous quarter and 40 basis points from the previous year, reflecting reduced provisions.
• The Cost-to-Income ratio increased to 55.47% in Q2FY24, up from 50.87% in the previous quarter and 48.88% in the same quarter of the previous year, primarily due to the opening of new branches.
• Capital Adequacy Ratio (CAR) climbed to 15.50% in Q2FY24, up from 14.28% in the previous quarter and 13.84% in the same quarter of the previous year, driven by increased deposits following the withdrawal of Rs. 2,000 notes.
• Gross Deposits exhibited robust growth, reaching Rs. 2,32,868 crores in Q2FY24, up 4.7% from the previous quarter and a substantial 23.1% year-on-year increase.
• Gross Advances amounted to Rs. 1,92,817 crores in Q2FY24, showing a 5.1% growth from the previous quarter and a healthy 19.6% increase year-on-year.
• CASA (Current Account and Savings Account) declined to 31.20% in Q2FY24, down from 31.85% in the previous quarter and 36.41% in the same quarter of the previous year.

Key Highlights from the Conference Call:

• Federal Bank reported its highest-ever net profit in Q2FY24.
• The recent capital infusion has strengthened the bank’s financial position, enabling it to pursue aggressive business expansion.
• The bank’s smart focus on high-yielding business contributed to growth in net interest income and net interest margins (NIMs) in Q2FY24. Management is confident that this growth will continue in the medium term.
• The bank’s management has set a credit growth guidance of 18-20% for FY24.
• Plans are in place to increase the share of higher-yielding assets in the loan portfolio through business banking, commercial banking, commercial vehicles, and credit cards.
• Healthy deposit growth was observed in Q2FY24, with a slight repricing of the cost of funds by around 20 basis points. Further repricing is expected in the next one or two quarters, impacting NIMs. Efforts are underway to manage the blended cost of funds effectively.
• The bank’s aggressive business growth strategy has led to a rise in the cost-to-income ratio. This increase is attributed not only to the addition of 23 new branches in Q2FY24 but also to volume-related variable costs and additional marketing expenses. The bank anticipates that the cost-to-income ratio will continue to rise for a few quarters.
• Federal Bank is well on track to achieve a 1.4% Return on Assets (RoA) by FY25, and this target may be reached even earlier. As a result, they are willing to invest more in franchise expansion, potentially adding 100 branches or more in the current year.

Valuation and Outlook

Federal Bank has reported strong Q2FY24 results, surpassing market expectations. The bank’s emphasis on commercial lending and vehicle financing, as well as its non-resident deposits, contributed to advances. This approach helped mitigate the impact of narrowing net interest margins (NIMs), a trend affecting the broader banking sector. The bank experienced significant growth in vehicle financing, with a 67% YoY increase. Its focus on commercial lending also contributed to a slight improvement in NIMs compared to the previous quarter. While the bank’s cost-to-income ratio increased, this was mainly due to the opening of 23 new branches in the quarter.

Through partnerships with fintech companies, direct selling agents (DSAs), and collaborations with microfinance firms, the bank is on track to achieve its targeted 20% growth for FY24. This business strategy is proving effective. While NIM compression may occur in the coming quarters due to rising funding costs, the bank’s return ratios are expected to strengthen. Overall, our outlook for the bank remains positive as it concentrates on higher-yielding loan portfolios, which should help buffer the impact of increased funding costs in the medium term.

Key Takeaways:

• The bank’s focus on para-banking (insurance, investments, wealth management) led to strong growth sequentially and annually, and is likely to continue.
• There was no impact on NIMs due to the I-CRR
• The bank is very well on the path to achieving 1.4% RoA by FY25