Federal Bank - Improving asset quality franchise - Prabhudas Lilladher

(PT of Rs525/share, ~17% upside)

- Credit system overhaul done; positives to follow: The new management over the last two years has (1) centralized credit appraisal (2) consolidated FB's high delinquency mortgage book and (3) improved quality of underwriting in large/mid corporate and these initiatives will bring down slippages to <2% as the legacy corporate book runs off.

- Aggressive network expansion; some near-term cost implications: After overhauling their credit systems, FB is on a branch network expansion drive, especially in credit heavy states. Hence, there will be some inch-up in cost ratio, which, we believe, will be manageable.

- Lower credit costs to drive return ratios: With the asset quality initiatives, credit costs will come off to ~90bps from ~170bps in FY08-11. With margins to remain flat and cost expected to inch up in the near term, lower credit costs will help in maintaining ROAs at 1.3-1.4% range. Also, with the leveraging up process, ROEs will touch ~16% by FY14-15 after being stuck in a narrow band of 12-14% over the last 4-5 years.

- Valuations reasonable; BUY with a PT of Rs525/share: Lower normalized credit costs will drive re-rating for FB in the medium term as it is the only constraint for FB to deliver on return ratios. Improving asset quality will likely be the stock catalysts.

Source : Equity Bulls

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