God's own bank?

PENNY WISE

Federal Bank, one of the smaller private sector banks, has big things stored for the future. While it seems to be delivering applaudable returns, the stock price doesn't seem to reflect this fully.

Year-to-date, the bank's stock has surged 13 per cent to around Rs 312. Even at these levels it quotes at an adjusted P/BV (price-to-book value) ratio of around 0.8 times FY05 earnings.

According to analysts, a fair valuation of any bank is at least 2 times its P/BV ratio. That leaves lots of scope for gains as the bank has sound financials and is expecting a better growth rate.

Besides, it is not annoyed by any fundamental worries barring concerns over hardening of interest rates and limits to raising capital.

Takeover time?
The prime reason for interest in the stock stems from the fact that Federal Bank seems to be a favourable takeover target. Improving financials and decreasing NPA levels make it an attractive buy for any bank seeking to expand in the south.

Headquartered in Aluva, Kerala, it is the biggest commercial bank in the state. It has a network of 450 branches and 213 ATMs spread across all four states in the south.

The bank has a large NRI deposit base which allows it to derive healthy fee-based remittance income. It turned techno savvy ahead of most private banks - analysts feel a bit of hand-holding by ICICI Bank may have done the trick.

ICICI Bank (in its earlier avatar as a financial institution) picked up 20.44 per cent in Federal Bank in 1993, a year before the bank got listed, through a private placement.

Though many old private-sector banks look attractive at the moment (see table on peer comparison), analysts feel that Federal Bank scores in terms of technology.

"The biggest driver now is that ICICI Bank wants to offload its stake which makes it relatively easier for any scouting bank to approach Federal Bank," says an analyst from a domestic brokerage.

ICICI Bank has been looking to sell the stake on the ground that it is only a financial investment which is not strategic in nature. This follows the RBI's diktat that private sector banks' stake in other banks shall be capped at 5 per cent.

According to sources, ICICI Bank is looking at levels of Rs 600 (almost two times the current price level) to offload its stake.

"Any strategic investor looking at buying the stake may want a market price which justifies the amount," says an analyst from a foreign research house.

Also, there are sufficient cues that the north-based Oriental Bank of Commerce is looking to expand its operations in the south, especially in Kerala. Any takeover news will act as a major trigger for the price.

Also, if the proposal for removing the 10 per cent cap on foreign banks' voting rights in Indian private sector banks gets the government nod, foreign banks can acquire upto 74 per cent in domestic private banks. This will also be a key trigger for the stock.

Sound financials
The bank boasts of low costs of deposits which are expected to reduce further in FY05. Majority of its deposits (around 60 per cent) consists of NRI accounts where interest rates have fallen. The bank's cost of deposits stood at 6.2 per cent in FY04 compared with 7.6 per cent in FY03.

"We should be able to witness costs of deposits of 5 per cent by FY05," says an analyst with a domestic brokerage. The lowering of deposit rates could translate into savings of around Rs 70-75 crore for the bank which will help margin expansion.

Federal Bank has been able to cut its net NPAs to 2.9 per cent in FY04 from 4.9 per cent in FY03. It expects to lower the level further down to about 2 per cent by the end of FY05 and 1 per cent by FY06.

Given that NPAs are reduced mostly through provisioning (accrued from robust treasury gains), analysts feel that the bank is capable of recoveries which will aid in reducing bad loans.

The bank's financials, too, are strong. For Q1FY05, it posted a 38.52 per cent y-o-y increase in net interest income to Rs 128.21 crore on the back of lower interest expended.

Interest expended fell 7.89 per cent to Rs 177.72 crore while interest income rose 7.15 per cent to Rs 305.93 crore. The bank's interest expended to interest earned ratio, too, is improving - it has moved down to 0.58 in the Q1 this year from 0.67 in Q1FY04.

Other income was down 17.20 per cent at Rs 66.53 crore due to falling treasury incomes - but this has been the case across the board. Net profit has been growing steadily above 15 per cent - in Q1FY05 net profit increased 20.3 per cent to Rs 45.03 crore.

The company has a comfortable capital position. It is planning a bonus issue of 2:1 which is expected to increase its capital base with a capital adequacy ratio (CAR) of 15 per cent post-issue.

CAR for FY04 stood at 11.48 per cent compared with 11.23 per cent in FY03. Analysts contend that the bank needs to infuse more capital to sustain the growth it has recorded over the past two years.

"We expect a 13 per cent earnings growth for FY05," says an analyst with a domestic brokerage. Given that one can expect an EPS of Rs 77 for the year-end (against an EPS of Rs 62.65 in FY04), the stock currently quotes at a P/E of 4 times its forward earnings.

The book value of the bank at present is around Rs 368. Other private-sector banks, however, command a higher P/BV which in turn leaves scope for Federal Bank. Though the P/E is a tad higher than that of peers, the bank's exposure to NRI accounts makes it attractive.