Federal Bank is an old, private sector bank with a large network of 669 branches, concentrated in semi-urban areas in the southern states. The Bank’s strong Capital Adequacy, Operating Efficiency and technologically up-to-date network represent an attractive standalone franchise. The Bank’s deposit base includes a niche, low-cost NRI deposit base that contributes a meaningful 16.5% of total deposits and gives it a distinguishing cost advantage over several of its peers. At the CMP, the stock is trading at attractive valuations of 0.8x FY2012E Adjusted Book Value (ABV) – similar to South Indian Bank, its closest peer, compared to a 5-year average premium of 15%. While lower leverage is leading to low RoEs at present, at the core RoA level, the bank’s earnings quality is one of the best among peers. We recommend a Buy, assigning a multiple of 1.0x FY2012E ABV to arrive at a 12-month Target Price of Rs342.

Healthy Deposit Mix: Federal Bank’s CASA deposits grew at a CAGR of 20.6%
during FY2005-2009, leading to a stable 25% CASA ratio. Moreover, low-cost NRI deposits, a key differentiator, constitute 16.5% of the total deposits. Thus, effectively, low-cost deposits constitute 41% of the total, which is expected to underpin NIMs of about 3.3% in the next 2 years, even as the bank grows faster than the industry (23% credit growth in FY2011E) to leverage its large networth.

Concerns over Catholic Syrian Bank (CSB) and Dubai Crisis Overdone:
The proposed CSB acquisition, which was partly responsible for the stock’s underperformance during the last 11 months, is now unlikely to fructify, as the asking price substantially exceeds Federal Bank’s assessment. The stock has also been an underperformer due to concerns over the impact of the Dubai Crisis on the bank’s business model, which benefits from Middle-eastern NRI clients. However, as per the Management, the Bank has a very low direct loan exposure of about Rs350cr (1.3% of loan book) to NRIs dependent on Dubai. Hence, the impact of the crisis on asset quality is expected to be within manageable limits.

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