Detailed Rationale

CRISIL Ratings has revised its outlook on the fixed deposits of The Federal Bank Ltd to ‘Positive’ from ‘Stable’ while reaffirming the rating at 'CRISIL AA+’. The rating on the short-term fixed deposits and certificate of deposits has been reaffirmed at ‘CRISIL A1+’.

 

The revision in outlook is driven by expectation of sustained improvement in earnings profile and asset quality on a sequential basis, while capitalisation metrics remain healthy.

 

Apart from comfortable capitalization of the bank, the overall rating continues to reflect its healthy resource profile and strong brand among non-resident Indians (NRIs). These strengths are partially offset by average, albeit improving, profitability, a relatively modest scale of operations with regional concentration. .

 

Federal bank’s FDs are granular, with ticket size of below Rs 2 crore accounting for 77% of the overall FDs as on September 30, 2023. Also, the FD renewable rates were  at around 34%. Please refer to CRISIL’s criteria for rating fixed deposit programmes for further details.

 

The bank’s overall advances (standalone) registered a 5-year compound annual growth rate (CAGR) of 14% till fiscal 2023 whereas deposits grew at a 5-year CAGR of 13.8% for the same period. As on September 30, 2023, overall advances stood at Rs 2 lakh crore, which marks a y-o-y growth of 20% whereas deposits on the same date stood at Rs 2.33 lakh crore – higher by 23% on a y-o-y basis. With a market share of 1.1% and 1.3% based on deposit and advance base, respectively as on September 30, 2023, the bank remains a growing mid-sized bank with 32% of its advances and 61% of its deposit base being housed in Kerala.

 

Asset quality, after the momentary disruption witnessed in the aftermath of Covid-19, has been improving steadily. Gross non-performing assets (GNPAs) improved to 2.35% as on March 31, 2023, from 2.78% as on March 31, 2022. GNPA improved to 2.27% as on September 30, 2023, supported by lower slippages. The bank had 1.2% (Rs 2,341 crore) of its loan book as standard restructured book as on September 30, 2023, of which majority was retail and secured. While majority of the restructured book is well collateralised, its performance as well as overall asset quality will remain monitorable.

 

In July 2023, the bank raised Rs 3040 crore as capital via Qualified Institutional Payment (QIP). It also raised Rs 959 crore from International Finance Corporation (IFC) via preferential issuance done in the same period. Bolstered by this, the bank’s capitalisation metrics have remained comfortable with overall capital adequacy ratio (CAR) of 15.92% as on September 30, 2023.

 

The bank reported a profit after tax (PAT, consolidated) of Rs 3,165 crore in fiscal 2023 as against Rs 1,970 crore for fiscal 2022. Correspondingly, return on average assets (RoA) increased to 1.28% for the fiscal 2023 from 0.91% in fiscal 2022. For H1 2024, PAT was Rs 1,874 crore (RoA of 1.33%) as against Rs 1,368 crore (RoA of 1.16%) for the corresponding half of the previous fiscal.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of Federal Bank and its subsidiaries and associate concerns on a proportionate basis.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Comfortable capitalisation: Overall capital adequacy ratio (CAR, under Basel III) was 15.92% as on September 30, 2023 (15.24% as on March 31, 2023) against 16.33% as on March 31, 2022. Networth increased to Rs 26,802 crore from Rs 22,122 crore as on March 31, 2023, Rs 19,256 crore as on March 31, 2022, supported by higher internal accrual, Qualified institutional placement (QIP) of Rs 3,040 crore and Rs 959 crore from the World Bank arm, International Finance Corporation, in July 2023.

 

Networth coverage of net non-performing assets improved to 20 times as on September 30, 2023 (17 times as on March 31, 2023), from 13 times as on March 31, 2022. Capitalisation is expected to remain comfortable for the proposed scale-up in business over the medium term.

 

• Healthy resource profile with strong brand equity in Kerala: Resource profile is backed by the strong market position of the bank among NRIs, especially in Kerala. Deposits increased 17% on-year to Rs 2,12,989 crore as on March 31, 2023, out of which NRIs accounted for 36%. Over H1 2024, the deposit base further grew by 9.3% to Rs 2,32,833 crore as on September 30, 2023. The bank had a market share of 7% among NRI deposits; and 19.3% in India’s inward remittances in fiscal 2023, compared to 20.3% in the previous fiscal. These factors impart stability to the resource base and fee income.

 

Deposit base is granular with retail deposits accounting for 81% of the total deposits as on September 30, 2023. Furthermore, CASA (current account and savings account) deposits accounted for 31.2% of total deposits (standalone) as on September 30, 2023 (32.7% as on March 31, 2023), as against 36.9% as on March 31, 2022. Cost of deposit inched up to 5.12% in fiscal 2023 (5.52% for the three months ended September 30, 2023) from 4.28% in the previous fiscal. While the current deposit rates have inched up in-line with elevated interest rate environment, cost of deposit is expected to normalise in the medium term. 

 

Weaknesses:

• Average, albeit improving, profitability: Profit after tax (PAT) improved to Rs 3,165 crore in fiscal 2023 from Rs 1,970 crore previous fiscal due to lower credits cost, which reduced to Rs 799 crore from Rs 1,305 crore over the same period. Return on assets (RoA) improved to 1.28% in fiscal 2023 from 0.91% in fiscal 2022. For the six months ended September 30, 2023, PAT was Rs 1,874 crore and RoA was 1.34% (annualised). Net Interest margins (NIM) improved to 3.2% in fiscal 2023 from 3% in fiscal 2022. For half year ended September 30, 2023, NIM remained stable at around 3.1%. Credit costs to average total assets declined to 0.32% in fiscal 2023 (0.16% in the six months ended September 30, 2023) from 0.61% in fiscal 2022, in line with steady improvement in asset quality. Gross non-performing assets (GNPAs) improved to 2.35% as on March 31, 2023, and a further to 2.27% as on September 30, 2023, from 2.78% as on March 31, 2022. This was supported by lower slippages and higher recoveries/upgrades. The bank had 1.2% of its loan book as standard restructured book as on September 30, 2023, of which majority was retail and secured. Nevertheless, provision cover for GNPAs was healthy at 70.5% (excluding technical write-offs) as on September 30, 2023.

 

Going forward, the bank plans to increase focus on its credit card and personal loan portfolio. Improved diversity in loan book should support better net interest margin (NIM). However, ability to sustainably improve net interest margins (NIM)  and manage credit cost will be closely monitored.

 

• Relatively modest scale of operations with regional concentration: Although advances and deposits increased at  compound annual growth rates (5 year) of 14.4% and 13.7%, respectively, through fiscal 2023, the bank’s market share remains relatively modest at 1.28% and 1.14% in terms of advances and deposits, respectively, as on September 30, 2023. Advances grew 21.3% on-year in fiscal 2023, driven by growth in gold loans[1] (11% of the book), retail loans (32% of the book), and business banking loans (8% of the book), while deposits grew 17.2%.CV/CE and agriculture advances (including MFI) witnessed robust growth although on a small base.

 

While Federal Bank operates across the country, business continues to have sizeable presence in southern India, with Kerala, Tamil Nadu, Karnataka, Andhra Pradesh, and Telangana cumulatively accounting for 74% of deposits and 59% of advances, respectively, as on March 31, 2023. Its home state, Kerala, alone accounted for 61% and 32% of deposits and advances, respectively. The concentration risk is mitigated by the relatively better economic performance of this region. NRI deposits (majorly part of deposits in Kerala) are diversified by the location of the NRI customers.

[1] Gold loan book is spread over the retail and agriculture segments

Liquidity: Strong

Liquidity is supported by a healthy retail deposit base. Average liquidity coverage ratio was 124.8% as on September 30, 2023, against the statutory minimum of 100%. Liquidity also benefits from access to systemic sources of funds such as the liquidity adjustment facility from the RBI and access to the call money market.

 

ESG Profile

CRISIL Ratings believes that Federal bank’ Environment, Social, and Governance (ESG) profile supports its already strong credit risk profile.

 

The ESG profile of financial institutions typically factors in governance as a key differentiator between them. The sector has reasonable social impact because of its substantial employee and customer base, and it can play a key role in promoting financial inclusion. While the sector does not have a direct adverse environmental impact, the lending decisions may have a bearing on environment and other sustainability related factors.

 

Federal bank has demonstrated an ongoing focus on strengthening various aspects of its ESG profile.

 

Federal bank’ key ESG highlights:

• The bank has stated the target to grow the green financing book to Rs 13,000 crore by 2025 from Rs 3,222 crore as on March 31, 2023. Bank introduced green deposits, which are fixed deposits for 2,222 days at specialized interest rates, funds from which will be deployed to financing renewable energy, green building, smart agriculture and water or waste management projects among others. As of March 31, 2022, these amounted to Rs 265 crore in 3,674 accounts.
• Federal banks’ green loans meet the international standards of IFC through a Climate Assessment for Financial Institution (CAFI) tool, which helps assess the Green House Gas (GHG), reduction achieved through financing such proposals for FY23 was 1.8 Million tonnes of CO2e.
• It targets to increase its in-house solar power generation capacity to 500kW by 2025 from 300kW as on March 31, 2023. The bank targets to build in-house rain-water harvesting capacity to conserve 1 lakh liters of water by 2025.
• The bank targets to reduce coal-related sub project financing to nil by December 2030 from 13% of gross advances as on March 31, 2023.
• Bank had successfully installed rainwater harvesting units with a capacity of 84,000 litres, resulting in an estimated conservation of 2,00,000 litres of water. Furthermore, there are plans to install additional rainwater harvesting units on more premises.
• Women comprised 41% of the total workforce and 24% of bank’s branches are headed by women. Two out of 11 board members are female.
• The company has 73% of the board members are independent directors, with split in chairman and executive position, investor grievance redressal mechanism and disclosures are extensive.

 

There is growing importance of ESG among investors and lenders. Federal Bank’s commitment to ESG will play a key role in enhancing stakeholder confidence, given substantial share of foreign investors as well as access to domestic capital markets.

Outlook: Positive

CRISIL Ratings believes Federal Bank will maintain comfortable capitalisation and healthy resource profile. The improvement in its asset quality and earnings profile is also expected to continue.

Rating Sensitivity factors

Upward factors:

• Improvement in earnings profile with return on assets more than 1.4% on a sustainable basis
• Substantial improvement in asset quality with adequate coverage

 

Downward factors:

• Deterioration in asset quality, with rising gross NPAs and credit cost crossing 1.0% on a continuous basis
• Significant reduction in profitability

About the Company

Federal Bank is a mid-sized, private sector bank with advances of Rs 2,00,390 crore and deposits of Rs 2,32,833 crore as on September 30, 2023. It has a strong NRI customer base in the Middle East. The bank had 1,389 branches and 1,937 automated teller machines/cash recyclers as on September 30, 2023

 

In fiscal 2023, PAT was Rs 3,165 crore and total income (net of interest expenses) was Rs 10,273 crore, against Rs 1,970 crore and Rs 8,543 crore, respectively, the previous fiscal.

 

For the six months ended September 30, 2023, PAT was Rs 1,874 crore and total income (net of interest expenses) was Rs 5,841 crore, against Rs 1,368 crore and Rs 4,752 crore, respectively, in the corresponding period previous fiscal.

Any other information: Not applicable