By Jinay Gala

India Ratings and Research (Ind-Ra) has undertaken the following rating action on The Federal Bank Limited’s (FBL) Basel III Tier 2 bonds:

Instrument Type

Date of Issuance

Coupon Rate (%)

Maturity Date

Size of Issue (billion)

Rating/Outlook

Rating Action

Basel III Tier 2 debt*

-

-

-

INR5

IND AA/Stable

Assigned


*Limit stands unutilised

The ratings reflect FBL’s strong franchise in the southern states with well-established granular retail liability franchise and reasonable asset profile. The bank has well diversified advances portfolio across segments (retail and agriculture (38.8%), small and medium enterprises (21.6%) and corporate (39.4%) as on 2QFY18) with moderate concentration (top 20 exposures to risk weighted asset (RWA) at 15.2% as on FY17). The liability is largely retail oriented (top 20 deposits to total deposits ratio at 3.9% as on FY17 with steady flow of low cost NRIs funding). The bank has a seasoned leadership and strengthened its second-rung management line with people having strong industry experience and a proved track record.  

The ratings, however, are constrained by dependence of the bank on the state of Kerala for deposits (67.8% of the total deposit as on 2QFY18) as well as advances (36.2% of loan book as on 2QFY18) since its concentration in the total business still remains at a higher level. The rating factors in FBL’s moderate operating efficiency (FY17: 50.8% cost to income ratio as on 2QFY18), lack of significant contribution of third party distribution to the overall fee income, lower profitability (PAT to RWA stood at 1.1% as on FY17), higher total stressed assets vis-a-vis equity (net non-performing assets (NNPA) + standard restructured assets (SRA) + security receipts (SR) to net worth ratio in 2QFY18: 28%) and provision cover ratio (2QFY18: 45%) lower than that of higher rated peers.
 

KEY RATING DRIVERS

Strong Liability Franchise: FBL has one of the lowest deposit concentrations along with granular advances book. NRI CASA stood at 12.9% of the total deposit and total CASA stood at 32.9% as on 2QFY18, comparable to the higher rated peers’. FBL benefits from lower cost of funds due to a higher proportion of granular retail deposit i.e. the deposit lower than INR10 million which stood at 90% of the total deposit (including NRI deposits at 40.9% of total deposits) as on 2QFY18.

Although the bank has shown a stability in maintaining and gaining market share of NRI remittances in Kerala (22.9% in 2QFY18), especially from the Middle East countries historically, any pressure emanating from the uncertainty on remittances from the gulf region could pose challenges. Additionally, Ind-Ra expects the bank to face incremental competition from small finance banks for deposits over the near to medium term.

Seasoned Leadership and Management Profile: FBL, over the last 15-18 months, has seen expansion in the management bandwidth with strong lateral hiring from the competitors in the private banking space. The new leadership in the business acquisition segment and, credit underwriting division, chief operating officer, and others are focussing more on the retailisation of book, stronger internal system and process, adopting digitisation to improve branch level productivity and increasing the wallet share with customers. The new credit underwriting team along with strong risk management process would drive incremental loan book growth more towards better rated borrowers across sectors based on the strong internal rating framework.

Reasonable Capitalisation: FBL’s capitalisation (Tier 1 14.1% as on 2QFY18) stands at an adequate level, factoring in a moderate growth over the next two years after raising the capital of INR25 billion in 1QFY18. Liquidity for FBL stands comfortable with largely matched assets-liability tenors. The agency’s stress test indicates that FBL is likely to maintain a common equity Tier 1 ratio above the regulatory minimum and system average. Ind-Ra expects Ind-AS transition would have an impact of around 1% of the total RWA for FBL which could lead to a moderate fall in the capitalisation buffers.

Asset Quality Stress Moderating: Ind-Ra believes slippages (1.5% in 2QFY18) will moderate as stress in the legacy corporate book has been largely accounted for. However, there would be an elevated provision (provision coverage ratio in 2QFY18:45.3%, FY17: 45.5%) impact due to ageing of the non-performing assets, which could drive credit cost higher and impair profitability in the medium term. The bank plans to moderate concentration risk to certain sectors and borrowers with increased focus towards smaller exposures than large consortium borrowers.

The total impaired book (NNPA +SRA+ SR) stood at 4.1% of loan book as on 2QFY18. Ind-Ra expects this impaired book to moderate in the medium term, along with incremental loan growth in better rated corporates and increasing focus towards retail; however within SME exposures, there could be moderate level of slippages in the medium term due to the impact of demonetisation and goods and services tax on SMEs.

Stable Margin but Lower on Profitability: Stability in FBL’s net interest margin (2QFY18:3.3%, FY17: 3.4%) is supported by its strong low-cost retail liability franchise and a shift towards high-yielding SME assets, offsetting the impact of low-yielding corporate loans. However, FBL’s profitability is weaker than that of the higher rated private sector banks due to its weak fee income generation (majorly through third party distribution). The bank's pre-provision operating profit buffers (FY17:1.8%, FY16: 1.6% of average assets; FY15: 2.1%) have been improving to absorb the incremental credit losses but still stand lower (FY17: 3%) when compared to similar rated peers’.
 


RATING SENSITIVITIES

Positive: The ratings could be upgraded on FBL’s sustained diversification in the product and geographical mix, along with an increase in the fee income from the current levels through developing third party distribution channels, development of significant liability franchise outside of Kerala while maintaining the asset quality especially in the non-corporate segments and sustained improvement in the pre-provisioning buffers.

Negative: Deterioration in the funding profile due a fall in low-cost deposits, higher operating expenses, and a prolonged decline in the FBL’s profitability buffers, driven by asset quality pressures, above Ind-Ra’s expectations, could lead to a Negative Outlook.


COMPANY PROFILE

FBL was established in 1931 in Aluva, Kerala, and is classified as an ‘old private sector bank’ by the Reserve Bank of India. The bank has about 0.8% of the banking system’s deposits. FBL is the second-largest bank and the largest private sector bank in Kerala, with nearly half of its 1,252 branches located in the state. The bank has a strong retail funding franchise, which is composed of a stable base of NRI deposits, largely contributed by remittances from the expatriate Indian community in the Middle East.

 

FINANCIAL SUMMARY

 

Particulars

1HFY18

FY17

FY16

Total assets (INR billion)

1,217.5

1,148.8

914.3

Total net worth (INR billion)

117.3

89.4

80.6

Net profit (INR billion)

4.7

8.3

4.8

Return on assets (%)

0.9

0.8

0.6

Tier 1 ratio (%)

14.1

11.8

13.3

Capital adequacy ratio (%)

14.6

12.4

13.9

GNPA (%)

2.39

2.33

3.0

Impaired Asset (NNPA+SR+SRA) (%)

4.1

4.1

5.4

Source: FBL, Ind-Ra




COMPLEXITY LEVEL OF INSTRUMENTS

For details on the complexity level of the instruments, please visit https://www.indiaratings.co.in/complexity-indicators.

SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings. 

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

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Analyst Names

  • Primary Analyst

    Jinay Gala

    Associate Director
    India Ratings and Research Pvt Ltd Wockhardt Towers, 4th Floor, West Wing, Bandra Kurla Complex, Bandra East,Mumbai - 400051
    +91 22 40356138

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121