ICICI Securities Limited

Initiating Coverage
November 19, 2010
Rating Matrix
Rating : Strong Buy Federal Bank (FEDBAN)
Target : | 563
Target Period : 12-15 months | 455
Potential Upside : 24%
On the fast track…
Performance highlights The Federal Bank (FDB), a Kerala-based private sector bank, is perfectly
(| Crore) FY10 FY11E FY12E FY13E poised to enter into a high growth phase given the ongoing operational
NII
restructuring, strong focus on the high-margin retail and SME segment
1411 1707 2065 2564
and expanding geographical presence. We forecast FDB will grow its
PPP 311 377 443 526 business mix at 23% CAGR in FY10-13E. With the pick-up in the
PAT 465 584 724 957 domestic credit market and stable macroeconomic outlook for Middle
East countries, we expect the bank to improve its leverage. This will
Stock Data help FDB to increase its RoE to 18% in FY13E from a trough of 10% in
Bloomberg Code FB:IN FY10. We forecast NIMs will remain high at 4% in FY13E.
Reuters Code FED.BO
Process restructuring, change in management to improve return ratios
Face Value (Rs) 10
Market Cap (Rs cr) 7,780 FDB is rapidly changing into a new-age bank given the focus on
52 week H/L 501 / 223 diversified business portfolio, technology-driven operational processes
Sensex 19,865 and improvement in geographical presence. In our view, the stage is set
Average volumes (BSE) 1,058,391 for incumbent CEO Shyam Srinivasan to lead the bank into the next level
of high growth phase. We expect FDB to show a strong operational
Comparative return matrix (%) performance with NII growth of 22% CAGR over FY10-13E, supported by
Company 1m 3m 6m 12m high share of low cost deposits (~45% of total deposits). During FY10-
FDB 6.8 36 86.5 91.9 13E, we forecast loan growth of 23% CAGR to | 49,786 crore and deposits
South Indian Bank 1.3 30.8 86.5 91.9 posting 22% CAGR to | 66,256 crore.
Dhanalakshmi Bank -5.3 -2 21.3 22.5 Slippages likely to come down in FY12E-13E
Karnataka Bank 6.4 9.7 27.9 51.4
The management expects slippages to remain high in FY11E due to high
Price movement
system generated NPAs, leading us to forecast GNPA of 3.2% in FY11E
vs. 3.1% in FY10. However, we expect asset quality concerns to recede in
7000 500 FY12E-13E due to the revamping of the bank’s credit disbursal policy and
6000 improving loan monitoring system. As a result, we forecast GNPA of 2.7%
400
5000
in FY13E. Also, the high provision cover of 82% in H1FY11 provides
4000 300
strong support to balance sheet growth, going forward.
3000
200
2000 Valuations
1000 100 At the CMP of | 455, the stock is trading at 1.5x FY13E P/ABV. The bank
Oct-09

Dec-09

Feb-10

Apr-10

Jun-10

Aug-10

with higher return ratios (RoA of 1.3%) and branch profitability compared
to peers (Exhibit 33) commands a premium multiple. We expect FDB to
Nifty FDB improve its RoE and RoA to 18% and 1.4%, respectively, in FY13E by
Analyst’s name
leveraging its equity base and forecast NIM at 4%. We have valued the
bank at 1.8x FY13E ABV and initiated coverage with a STRONG BUY
Kajal Gandhi
kajal.gandhi@icicisecurities.com
rating and a target price of | 563.
Exhibit 1: Key Financials
Viraj Gandhi
viraj.gandhi@icicisecurities.com FY09 FY10 FY11E FY12E FY13E
Net Profit (| cr) 500 465 584 724 957
Mani Arora
EPS (|) 29.3 27.2 34.1 42.3 56.0
mani.a@icicisecurites.com
Growth (%) 36.0 -7.2 25.6 24.1 32.2
P/E (x) 15.5 16.8 13.3 10.7 8.1
ABV (|) 248.6 266.4 274.0 291.1 313.1
Price / Book (x) 1.8 1.7 1.6 1.5 1.4
Price / Adj Book (x) 1.9 1.7 1.7 1.6 1.5
GNPA (%) 2.6 3.0 3.2 3.0 2.7
NNPA (%) 0.3 0.5 0.6 0.4 0.4
RoNA (%) 1.4 1.1 1.2 1.3 1.4
RoE (%) 12.1 10.3 12.2 14.4 17.9
Source: Company annual reports, ICICIdirect.com Research, *Standalone financials

ICICIdirect.com | Equity Research

ICICI Securities Limited

Share
Shareholding
holding pattern
pattern (Q30)
(H1FY11) Company Background
Shareholders
Shareholder HoldingHolding
(%) (%) Incorporated in 1931 in Kerala, The Federal Bank (FDB) is a one of the
Institutional Investors
Promoters 60.7 - oldest private sector banks in India with a network of 719 branches and
Others
Institutional investors 39.3 51.3 761 ATMs. The bank has a total business mix of | 63750 crore (H1FY11)
General public 48.7 and derives a majority of its business from Kerala (~47% of business
Institutional holding trend (%) mix). FDB has employee strength of 7,896 (March 2010).

FII & DII holding trend (%) In September 2006, FDB acquired Maharashtra-based Ganesh Bank of
40 36 37 37 Kurundwad (with a branch network of 20) in order to diversify its
34
geographical base. Although the bank has improved its presence across
50
30 26 India, the majority of the branches are still concentrated in the southern
23 24
40
40
20
37 18 37 36 states (~77%).
(%)

FDB entered into the insurance business in November 2006 by acquiring a

(%)

30
10
26% stake in a joint venture (JV) with India-based IDBI Bank (48% stake)
20
0 14 14 13 and Belgium-based Ageas Insurance (erstwhile Fortis Insurance
12
Q3FY10 Q4FY10 Q1FY11 Q2FY11 International NV). The total amount invested by the three companies was
10
FII DII | 450 crore and the entity had issued over two lakh policies with
Q3FY10 Q2FY10 Q1FY10 Q4FY09
combined sum assured of ~| 9,160 crore (Q1FY11). Further, FDB
collaborated with Geojit BNP Paribas Financial Services (an India-based
FII DII
brokerage house) to introduce an online trading facility, Fed-e-Trade, for
its customers in September 2008.
Exhibit 2: Region-wise branch network (H1FY11) Exhibit 3: Region-wise ATMs network (H1FY11)

Metro Rural
Metro Rural
15% 17%
14% 11%

Urban
22% Urban
29% Semi-
Semi- urban
urban 46%
46%

Source: Company quarterly presentation,,ICICIdirect.com Source: Company quarterly presentation,,ICICIdirect.com

Research Research

Key management change

FDB received approval from The Reserve Bank of India (RBI) for the
appointment of Shyam Srinivasan as the new MD and CEO of the bank
after the retirement of M Venugopalan in July 31, 2010. Mr Srinivasan
joined FDB in September 2010. Prior to joining FDB, he was the country
manager at Standard Chartered Bank where he was responsible for its
consumer business division. Mr Srinivasan has considerable experience
in the consumer banking business such as retail lending, SME banking
(FDB’s forte) and wealth management in the domestic as well as
international market.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 4: Business segment – FDB

Tie

FDB

Core Business Life Insurance Capital Markets

2% stake each in 26% stake in a JV Tie-up with Geojit

South Indian, Catholic with IDBI and Ageas BNP Paribas for retail
Syrian and Laxmi Insurance broking
Vilas bank

5% stake in United
Stock Exchange

Source: Company quarterly presentation, ICICIdirect.com Research

Exhibit 5: Evolution of FDB

Acquired Ganesh Association with

Came with an IPO Bank of Kurundwad in M/s Geojit Financial
which was Sept 2006 and Services to provide
Became a oversubscribed 60 entered into Life online stock trading
Commenced Scheduled times, Started Insurance JV with facility in Sept
operation Commercial leasing business Bonus share of 2:1 IDBI & FORTIS in Nov 2008
Bank 2006

1931 1959 1970 1989 1994 2002 2002 2006 2006 2008 2008 2010

Licensed under Commenced All the 412 FDB issued 18 million Completed 1:1 Appointment of Mr.
Section 22 of the merchant banking branches were fully GDR (for US$ 71.5 rights issue in Shyam Srinivasan
Banking Companies operations computerised million) and 2 million January 2008 and (ex- Standard
Act, 1949 GDR with green shoe opened first Chartered) as CEO
option (for ~US$ 8.5 representative and MD
million) in Jan 2006. Office at Abu
Each GDR were priced Dhabi, UAE
at US$ 3.97 (| 175)

Source: Company quarterly presentation, ICICIdirect.com Research

ICICIdirect.com | Equity Research

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ICICI Securities Limited
Return ratios to gain significant traction in FY13E
after witnessing a slow down during FY08-10
PAT to grow at 27% CAGR during FY10-13E driven
by the strong business fundamentals, improvement
in leverage and new leadership on board
ICICIdirect.com | Equity Research
Investment Rationale
We believe FDB’s return ratios are set to improve during FY11E-13E
driven by the induction of a new CEO, improving credit standards and
the ongoing operational restructuring, which is expected to improve
product focus and enhance productivity. As a result, we forecast RoE
and RoA at 18% and 1.4% in FY13E, respectively. FDB witnessed a
healthy RoE of 23% during FY05-07, which successively deteriorated
during the next three years and bottomed at 10% in FY10. The decline
was triggered after the rights issue (worth | 2,142 crore in the ratio of
1:1) offered by the bank in January 2008.
With ~45% of total deposits as low cost deposits, high margins of 4%
and decline in GNPA to 2.7% in FY13E despite high dependence on retail
and SME sectors, FDB presents a significantly attractive franchise as
compared to its peers. We expect the business mix to grow higher than
industry at 23% CAGR to | 116,043 crore and PAT to grow at 27% CAGR
to | 957 crore in FY10-13E.
Improving return ratios backed by better business fundamentals
FDB enjoys superior business fundamentals vis-à-vis its peers in terms of
better RoA (1.3% in Q2FY11), healthy NIM (4.4%), low-cost deposits
franchise (~45% of the total deposits) and strong CAR (17.2%). Further,
the bank is currently undergoing operational restructuring. This is aimed
at streamlining business processes, improving the product focus and
strengthening credit quality, which is expected to fuel robust growth
starting FY12E.
Also, with the rising opportunities in the domestic market, a stable
macroeconomic environment in the Middle East and high C/D ratio (76%
in H1FY11), we believe the bank will be able to leverage its equity base
(asset to equity ratio to rise to 13% in FY13E vs. 9% in FY10). As a result,
we expect FDB’s RoE and RoA to improve to 18% and 1.4% in FY13E,
respectively.
Exhibit 6: Higher return ratio expected in FY13E due to improving leverage and…
25.0 1.5
20.0
1.1
15.0
(%)
(%)
0.8
10.0
5.0 0.4
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E
ROE (LHS) ROA (RHS)
Source: Company annual reports, ICICIdirect.com Research
FDB’s topline was negatively impacted by the global economic slowdown
(during 2009-10) and the subsequent Middle East crisis, which led the
bank to adopt a conservative growth strategy. With significant pressure
on the topline and rising taxes, FDB’s PAT declined by 7% to | 465 crore
in FY10. Now, with the induction of a new CEO and the bank’s aggressive
plans ahead, we see better capital utilisation in a growing economy. As a
result, we expect FDB’s PAT to grow at 27% CAGR to | 957 crore in FY10-
13E. This would push up the RoE to 14% in FY12E and 18% by FY13E.
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ICICI Securities Limited

Exhibit 7: …strong growth of 27% CAGR in PAT during FY10-13E

1200
957
1000

800 724

(| Crore)
584
600 500 465
368
400 293
225
200 90

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Source: Company annual reports, ICICIdirect.com Research

The bank always managed to maintain RoA of over 1% but the leverage
was high during FY05-07, which warranted dilution in FY08. The dilution
coupled with a slowdown in business growth during FY08-10 led to lower
RoE of 10%. We anticipate a turnaround in the business growth cycle and
expect RoA of 1.4% and RoE of 18% for FY13E.
Exhibit 8: RoE decomposition
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E
Net interest income/ avg total assets 6.0 3.2 3.1 3.0 3.7 3.4 3.6 3.6 3.7
Non-interest income/ avg total assets 2.5 1.2 1.3 1.4 1.4 1.3 1.2 1.1 1.1
Net total income/ avg total assets 8.5 4.4 4.5 4.4 5.1 4.7 4.8 4.7 4.7
Operating expenses/ avg total assets 3.7 1.9 1.8 1.6 1.6 1.6 1.7 1.7 1.7
Operating profit/ avg total assets 4.8 2.4 2.7 2.8 3.5 3.1 3.1 3.0 3.1
Provisions/ avg total assets 3.4 0.9 0.9 1.0 1.3 1.0 1.3 1.1 1.0
Return on avg assets 1.1 1.2 1.3 1.3 1.4 1.1 1.2 1.3 1.4
Leverage (avg assets/ avg equity) (x) 23.2 19.0 16.6 10.6 8.6 9.2 10.0 11.5 13.0
Return on equity 24.9 22.8 21.3 13.6 12.1 10.3 12.2 14.4 17.9
Source: Company annual reports, ICICIdirect.com Research

ICICIdirect.com | Equity Research

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ICICI Securities Limited

…supported by pick-up in business momentum

FDB is aiming to grow its business mix at a higher growth rate than the
industry in the next two or three years. We expect the bank’s business
mix to grow at 23% CAGR to | 116,043 crore in FY10-13E (vs. 19% CAGR
Business mix to grow higher than the industry
for the industry). This will be backed by 23% CAGR growth in advances
during FY10-13E
(vs. 20% CAGR for industry) to | 49786 crore and 22% CAGR growth in
deposits (vs. 18% CAGR for industry) to | 66256 crore.
Exhibit 9: FDB’s business mix to grow higher than industry at 23% CAGR in FY10-13E

120000 1.0

116043
0.9
90000

94161
(| Crore) 0.8

76840
60000

(%)
63008
0.7

54590
44818
30000

36484
0.6

29615
24015
0 0.5
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Business Mix (LHS) Market Share (RHS)

Source: Company annual reports, ICICIdirect.com Research

SME and retail segment to drive growth in advances

SME and retail segments are the primary growth During FY05-10, FDB’s net advances grew at 25% CAGR to | 26950 crore,
drivers of FDB’s loan portfolio which was higher than the industry credit growth of 24% CAGR. The
growth in advances was driven by the bank’s well-diversified loan
portfolio, primarily divided into large corporates (38% of gross advances
in FY10), SME (31%) and retail (31%) segments. According to the
management, the SME and retail segments are expected to drive the loan
book, going forward, given the bank’s strong focus on these high-margin
segments.
Exhibit 10: Loan book growth path Exhibit 11: Break up of loan book

105230
49786

60000 120000

86140
84970
84740
40331

100000
73820

50000
70510
69550
67630
60990
32810

56090

80000
(Rs crore)

40000
49710

49580
26950

42200
42130
(| Crore)

22392

60000
29960

30000
18905
14899

40000
11736

20000
8823

20000
10000
0
0 FY06 FY07 FY08 FY09 FY10
FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

Corporate SME Retail

Source: Company annual reports, ICICIdirect.com Research Source: Company annual reports, ICICIdirect.com Research

Further, we believe the significant effort by the bank to streamline its

credit disbursal mechanism through central processing centres will
improve its credit quality and facilitate better loan disbursement. Also,
FDB is planning to introduce specialised corporate credit branches in
metros primarily to improve its opportunity as lead banker (vs. traditional
role in consortiums) and increase its market share in the non-fund

ICICIdirect.com | Equity Research

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ICICI Securities Limited

business. The bank has already opened two corporate branches each at
Delhi and Mumbai and is planning to open more branches in other
Low cost deposit constitutes ~50% of the bank’s
metros. With the strong pick-up in the domestic credit environment and
total deposit franchise
comfortable CAR ratio, we forecast FDB’s loan book will grow at 23%
CAGR to | 49,786 crore in FY10-13E.

FDB’s retail loan portfolio is tilted towards the housing segment, which
constituted ~57% of the total retail portfolio in H1FY11. The high share of
housing loans provides stability to the bank’s retail portfolio as they are
considered to be secured loans. Unsecured retail loans such as personal
and credit card loans form a very small proportion (~1%) of the total
loans. Also, gold loans constitute 10.5% of the total retail portfolio, which
are secure loans and yield high-margin (~11-12% vs. ~9% on traditional
retail loans).
Exhibit 12: FDB’s loan book break up (H1FY11) Exhibit 13: Break-up of retail portfolio (H1FY11)

80
Retail Large 57 (%)
31% 60
High share of housing loans provides stability to the Corporate
bank’s retail loan portfolio 38% 40

20 11 8 7
5 4 6 3 1
0

Mortgage

Educational
AAS/AAD

Personal
Housing

Others
Overdraft
Gold

Car
SME
31%

Source: Company quarterly presentation, ICICIdirect.com Source: Company quarterly presentation, ICICIdirect.com
Research Research

Robust deposit franchise, dominated by low cost deposit

About 50% of the FDB’s total deposit accounted for low cost deposit,
(~28% CASA and ~22% NRI deposits). Traditionally, the bank has been
able to maintain low cost deposits in the range of ~45-50%. This helps
them to consistently maintain NIM of ~4% in the last few quarters.
Exhibit 14: Deposit base to expand by 22% CAGR in FY10-12E

75,000 66256 30

60,000 44031 53830

23
45,000 36058
(| Crore)

32198 15
(%)

25913
30,000 21584
17879
8
15,000

0 0
FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Total deposits (LHS) Growth YoY (RHS)

Source: Company annual reports, ICICIdirect.com Research

In our view, FDB’s deposit mobilisation will gather pace driven by rising
interest rates and the bank’s focus on retail customers through branch
expansion plans. The bank has added 60 new branches in FY10 and is
expected to add ~200 branches in FY11E-13E. According to the
management, the bank is concentrating on Tier II and Tier III cities in order
to diversify its deposit base. As a result, we expect FDB’s total deposit to
grow at 22% CAGR to | 66,256 crore in FY10-13E.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Strong branch expansion to expand CASA base

FDB expanded its branch network from 456 in FY05 to 672 in FY10 and
further to 719 by H1FY11. As the bank accounts for ~10% of the total
industry branches in Kerala, we believe further branch expansion in the
home state is limited. Also, FDB is highly susceptible to concentration risk
as ~60% of the bank’s branches are located in Kerala. According to the
management, the bank is planning to add ~200 branches in FY11E-13E.
Out of this, ~75-80% of the branches will be outside Kerala. This will
boost CASA accumulation as the state account for the lowest CASA per
branch. Consequently, we expect FDB’s CASA ratio to improve to 30% in
FY13E vs. 26% in FY10.
Exhibit 15: FDB’s CASA ratio to improve to 30% in FY12E

1000 40.0
872
822
772
750 672 35.0
603 612
(No of branches)

536
456 472
500 30.0

(%)
250 25.0

0 20.0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E
Branches CASA ratio (RHS)

Source: Company annual reports, ICICIdirect.com Research

Exhibit 16: Kerala accounts for lowest CASA per branch

35
The CASA ratio will improve by ~382 bps to 30% in 29
FY10-13E driven by a rising branch network outside
28
Kerala
Area of operation 20
21
(| Crore)

13 13 12 12
14
10

0
Kerala North-East East Central South North West

Source: RBI trend and progress, ICICIdirect.com Research

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 17: FDB has higher CASA ratio as compared to its peers
NRE deposit provides an inexpensive funding source
30.0
to the bank 28.5

27.5
25.6

25.0 24.2

(%)
22.5
21.4
20.4
20.0
FDB SIB* Karnataka DLB# City Union

Source: Company quarterly presentation, ICICIdirect.com Research, *SIB-South Indian, #DLB-Dhanalakshmi

The share of Kerala in FDB’s business mix is expected to decline steadily

as it moves out of the regional tag. We expect the share to decline in the
next two or three years as FDB is trying to improve its pan-India presence.
Exhibit 18: Contribution of Kerala in FDB’s business mix to reduce, going forward

80

60 53 54 54 53 53
47 46 46 47 47
(%)

40

20

0
Q2FY10 Q3FY10 FY10 Q1FY11 Q2FY11

Kerala Outside Kerala

Source: Company quarterly presentation, ICICIdirect.com Research

Declining share of Kerala in the bank’s total business
mix reduces concentration risk
NRE deposits as hidden CASA
FDB has significantly benefited from its presence in Kerala due to the
state’s large NRI population (~40% of India’s total NRI population) that is
primarily responsible for the huge remittances received by the state. As a
result, NRI deposits constitute ~22% of the total deposits of the bank on
which the interest costs are in the range of 1.8-3.1%. On the other hand,
FDB’s retail deposit costs ~7.5-8% at present. The cost savings from NRI
deposits coupled with high CASA deposits translates into a significant
source of inexpensive funds for FDB.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 19: Low deposit rates on NRE and FCNR deposits provides support to NIMs
FCNR (B) Deposit Rate (%)
Period USD GBP EURO
1 year to less than 2 years 1.8 2.5 2.4
2 years to less than 3 years 1.6 2.3 2.5
3 years to less than 4 years 1.9 2.5 2.6
4 years to less than 5 years 2.2 2.8 2.8
5 Years only 2.5 3.1 3.0
RFC Deposits (%)
Period USD GBP EURO
6 months to Less than 1 Year 1.8 2.5 2.4
1 Year to Less than 2 Years 1.8 2.5 2.4
2 Years to Less than 3 Years 1.6 2.3 2.5
3 Years only 1.9 2.5 2.6
NRE Term Deposit Rate (%)
Period
1 Year to less than 2 years 2.5
2 years to less than 3 years 2.4
3 years and above 2.6
Retail Deposit Rate (%)
Less than Rs.15 Between 15-100
Period Lakhs lakhs
1 Year to Less than 2 Years 7.5 7.5
2 Years to Less than 3 Years 7.5 7.5
3 years to less than 5 years 7.8 7.8
5 years and above 8.0 8.0
Source: Company quarterly presentation, ICICIdirect.com Research

The slowdown in the Middle East markets will
negatively impact the FDB’s NRE deposit base
With the slowdown witnessed in the Middle East countries (which
constitutes majority of the remittances in Kerala) and resultant job losses,
we are expect the growth of FDB’s NRE deposits to moderate in the next
few years. As a result, we expect the share of NRE deposits in FDB’s total
deposits to moderate to 15% in FY13E vs. 20% in FY10.

ICICIdirect.com | Equity Research

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ICICI Securities Limited
Strong initiative to streamline operating processes in
order to boost business parameters.
ICICIdirect.com | Equity Research
…driven by operational restructuring and quality of new management
In our view, FDB is in the process of successfully implementing the
business transformation roadmap suggested by the Boston Consultancy
Group (BCG), which is expected to help the bank in cementing its position
as a new generation private sector bank. The result of the key policy
changes are as follows:
• FDB has established six key business verticals in order to bring a
strong focus to business processes and products and also to
improve decision making standards. SME, retail and recovery
verticals are headed by PR Kalyanaraman and other verticals such
as NRI, large corporate and treasury are headed by PC John
• The bank has established a centralised loan sanctioning process
where each regional office is responsible for the credit
assessment and appraisal of loans between | 10and | 25 lakh. For
a loan amount greater than | 25 lakh, approval is taken from the
head office. This is in sharp contrast to the earlier system where
individual branches were disbursing every kind of loans without
any central monitoring system. This process was adopted
primarily to improve the appraisal and monitoring system in order
to reduce slippages. At the same time, product delivery
(disbursement and servicing) is managed at the branch level to
improve the turnaround time
• Specialised corporate banking branches have been established in
Delhi and Mumbai to focus on corporate clients and improve fee-
based income. According to the management, the bank is
expected to open ~11 new centres in different metros in FY11E
• FDB is planning to provide differentiated services to the large NRI
population in Kerala in order to tap the low-cost of deposits
• Plans to launch Esops and variable pay packages to inculcate a
performance-based culture. Also, the bank has started recruiting
locally for branches that are opened outside Kerala
Further, the appointment of Shyam Srinivasan as the CEO of the bank is
expected to complement FDB’s traditional strength in the SME and retail
segments as Mr Srinivasan has significant experience in retail, SME and
wealth management markets in India, Middle-East and South East Asia. In
our view, FDB is expected to leverage its strength under the new
leadership by aggressively focusing on the SME and retail sector. This will
drive the business mix growth of the bank in the next two or three years.
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ICICI Securities Limited

NIM to expand to 4% in FY12E

Higher yields on advances due to rising interest
rates and large source of inexpensive funds will help
FDB to maintain healthy NIMs
With higher focus on the SME and retail segment, we expect FDB’s yields
on advances to expand by 30 bps to 11.9% in FY13E (vs. 11.6% in FY10).
Although deposit rates are also expected to remain firm, the high share of
low cost deposit is expected to strengthen FDB’s margins, going forward.
As a result, we expect the bank’s NIMs to improve by 25 bps to 4% in
FY13E vs. 3.7% in FY10.
Exhibit 20: NIM expansion in FY11E-13E

4.8
4.1 4.0
3.7 3.8 3.9
3.6 3.4 3.3 3.3

2.4
(%)

1.2

0.0
FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Source: Company annual report, ICICIdirect.com Research

Exhibit 21: FDB has better NIM as compared to its peers (Q1FY11)

5.0
4.2
3.7 3.6
3.8 3.4

2.6
2.5
(%)

1.7

1.3

0.0
FDB LVB City Union KVB DLB Karnataka

Source: Company quarterly presentation, ICICIdirect.com Research, ^Lakshmi Vilas, ~Karur Vysya,
#Dhanalakshmi,

ICICIdirect.com | Equity Research

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ICICI Securities Limited
Asset quality concerns to remain high in FY11E.
However, the situation is expected to normalise
from FY12E onwards
High provision cover allays fear of asset quality for
the bank
ICICIdirect.com | Equity Research
Improvement in asset quality expected in FY12-13E
FDB’s loan book is dominated by SME and retail loans that collectively
accounted for ~61% for the total gross advances in H1FY11. During the
last few quarters, the bank has increasingly witnessed stress on its
advances. FDB’s GNPA deteriorated to 3.8% in H1FY11 vs. 3.0% in
H1FY10 and NNPA to 0.7% in H1FY11 vs. 0.5% in H1FY10. FDB reported
total gross slippages of | 327crore in Q1FY11, out of which ~40% (| 132
crore) was contributed by the retail segment and ~37% by the SME
segment. In the retail loan segment, higher slippages were reported in the
NRI housing segment primarily due to the negative fallout of the
slowdown witnessed in Middle East countries, resulting in job losses and
lower wages for NRI. Also, the slowdown witnessed in the domestic
market led to higher slippages in the SME segment.
The stress on the loan portfolio was aggravated by the loose credit
disbursal policy of the bank where individual branches were responsible
for sanctioning loans without adequate appraisal skills. This coupled with
the aggressive system-generated NPA, which resulted in early recognition
of bad loans, added further to the woes of the credit quality of the bank.
However, FDB has strengthened its credit disbursement system with
centralised processing centres (for better credit assessment) and is in the
process of revamping its recovery mechanism. According to the
management, the slippages will continue to remain high in FY11E system-
generated NPAs. However, the situation is expected to improve from
FY12E onwards. As a result, we forecast FDB’s GNPA will increase to
3.2% in FY11E (vs. 3.1% in FY10) and then improve to 3% in FY12E and
2.7% in FY113E (in line with the expectation of the management).
Exhibit 22: FDB’s GNPA ratio to improve to 2.7% in FY13E
5.0 100
4.0
75
3.0
50
(%)
(%)
2.0
25
1.0
0.0 0
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10
Q3FY10
Q4FY10
FY10
H1FY11
FY11E
FY12E
FY13E
GNPA (LHS) NNPA (LHS) PCR* (RHS)
Source: Company quarterly presentation, ICICIdirect.com Research, *Provision coverage ratio
As on H1FY11, FDB reported total restructured assets of | 1,140 crore,
representing ~4% of the total loan book. This is in line with the other
players in the industry. Additionally, the bank has maintained a
significantly high provision cover in order to adequately handle any shock
on the asset quality. We believe FDB will continue to maintain a high
provision coverage ratio (PCR) in FY11E-12E given high slippages
expected by the management in FY11E.
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ICICI Securities Limited

Core fee-based income to drive non-interest income

FDB has initiated tie-ups with non-life insurance and
financial services companies to boost its fee-based
income
Strong remittances inflow in India provides
opportunity in wealth management and forex
opportunity for FDB
During FY05-10, FDB’s non-interest income grew by 20% YoY to | 531
crore aided by high remittances inflow, healthy fee-based income and
strong trading gains. However, we expect the growth in non-interest
income to moderate to 12% CAGR to | 741 crore in FY10-13E due to
lower trading gains.
Nevertheless, we believe the core non-interest income (excluding trading
gains) will grow at a healthy rate of 15% CAGR to | 640 crore in FY10-13E
driven by improving fee-based income due to strong product focus on
corporate, SME and retail segment at the branch level. Also, FDB’s tie-up
with IDBI-Ageas Insurance and Geojit BNP Paribas Financial Services is
expected to augment the fee-based income for the bank in FY11E-13E.
Exhibit 23: Core fee-based income to grow at healthy 15% CAGR in FY10-13E
800 741
643
598
600 516 531

395
(| Crore)

400
303
212 217
200

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Source: Company annual report, ICICIdirect.com Research

Further, FDB is focusing its marketing efforts on the NRI segment

primarily to capture the huge remittances inflow in India and presents
significant wealth management and forex opportunities. According to the
World Bank, remittances inflows in the country increased to US$ 52 billion
in FY08 from US$22 billion in FY05. It declined in FY09 due to the global
economic slowdown. As reported by the World Bank, Indian expatriates
are expected to remit about $55 billion into the country in FY11 as the
number of emigrants rises to 11.4 million. The report expects India to be
the top receiver of remittances followed by China. We believe FDB will be
the primary beneficiary of remittances inflows into India due to its strong
presence in the southern states of the country, which traditionally receive
higher remittances inflow.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Ongoing operational restructuring and strong
business fundamentals to build the base for higher
growth after one or two years
Financials
CAGR growth of 22% expected in NII in FY10-13E
During FY05-09, FDB’s net interest income (NII) witnessed a robust
growth of 27% CAGR to | 1,315 crore driven by healthy NIMs at 3.6%
during the period. However, NII grew by merely 7% YoY in FY10 due to
the global economic slowdown and the subsequent Middle East problem.
As a result, FDB adopted a cautious business approach resulting in
moderate balance sheet growth of 12% YoY in FY10 vs. growth of 23%
CAGR during FY05-09.
We believe the ongoing restructuring, high C/D ratio (76% in H1FY11) and
strong capital base will put FDB into a higher growth trajectory starting
FY13E. We expect FDB’s business mix to grow higher than the industry
resulting in NII growth of 22% CAGR to | 2,564 crore in FY10-13E.
Exhibit 24: CAGR growth of 22% in NII in FY10-13E

5500

4400
2065
1707
3300
(| Crore)

1315 1411
2200 868
716
502 600
1100

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E

Interest Income Interest Expenses NII

Source: Company annual report, ICICIdirect.com Research

Investment in technology and people bearing fruit - controlling cost

Emphasis on technology has helped the bank to
FDB has immensely benefited from the continuous investment in
control its costs
technology in the last five or six years leading to lowest cost-to-income
ratio among its peers. FDB has been one of the earliest adopters of new-
age banking services such as core banking solutions (CBS), real time
gross settlement (RTGS) services and channels for online remittances
such as Fed India Remit Service and SWIFT. Also, the bank has
collaborated with Tata Communications Banking Infra Solutions for
deploying point-of-sale (POS) terminals at merchant locations in order to
improve its presence in the SME segment in a cost-efficient manner.
Exhibit 25: FDB leads in terms of cost efficiency among its peers (Q1FY11)
100 88.4

75
59.8
51.7 50.1
50 41.7
(%)

36.8 35.9

25

0
DLB# Karnataka LVB^ SIB* KarurVysya City Union FDB

Source: Company, ICICIdirect.com Research,, #Dhanalakshmi, ^Lakshmi Vilas,*South Indian, ~Karur Vysya

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 26: Business per employee Exhibit 27: Profit per employee
Introduction of performance based pay structure to
enhance employee productivity going ahead 1500
1203 12
9.7
1125 1030 10
915 7.7
778 832 8 6.9 6.6

(| Lakhs)
670 5.9

(| Lakhs)
750 5.4
562 6 4.4
461 3.5
4
375
2
0 0

FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E
Source: Company presentation, ICICIdirect.com Research Source: Company presentation, ICICIdirect.com Research

The cost-to-income ratio will increase in FY11E due

In order to shed its regional tag and improve its pan-India presence, FDB
to strong branch expansion plans and rising
is increasingly expanding its branch network outside Kerala (~75-80% of
recruitment expenses
200 branches in FY11E-13E to come outside Kerala) and is planning to
recruit ~1000 new employees in FY11E. Further, the bank has introduced
a new appraisal system for its employees that requires rigorous training
and skill development. In our view, the rising investment in people and
branch expansion plans will lead to a deteriorating cost structure in
FY11E. As are result, we forecast FDB’s cost-to-income ratio will inch up
to 36% in FY11E vs. 31% in FY09.
Exhibit 28: Cost to income ratio inches up in FY10 on lower income

50 44.6
43.9
39.8
37.1 36.0 36.2
38 34.9 35.1
31.2

25
(%)

13

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Source: Company annual report, ICICIdirect.com Research

Operating expenses on the rise in FY11E as a result of
strong expansion plans and investment in new
technologies
Operating expenses expected to inch up in FY11E
We expect FDB’s operating expenses to increase at 20% CAGR to | 1,159
crore in FY10-13E (vs. 17% CAGR to | 677 crore in FY05-10) primarily due
to the strong branch expansion plans (~200 new branches in FY11E-13E)
and business-related expenses such as establishment of centralised
processing centres in metros (~11 centres expected in FY11E) and point
of sale terminals (targeted at current account customers). Further, we
expect the employee costs to shoot up as the bank is planning to recruit
~1000 new employees in FY11E. As a result, we expect the bank’s cost to
income ratio to deteriorate to 36% in FY11E vs. 35% in FY10.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 29: Cost to income ratio to deteriorate to 36% in FY11E vs. 35% in FY10

1500 50

1200
38
900

(| Crore)
25

(%)
600
13
300

0 0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Employee costs (LHS) Total operating costs (LHS) Cost to income (RHS)

Source: Company annual report, ICICIdirect.com Research

Nevertheless, we believe the investment in technology and people is

yielding benefits to the bank as FDB has the lowest cost to income ratio as
compared to its peers. Also, the bank has witnessed a continuous
improvement in its business on a per branch and employee basis. We
expect this to continue in our forecast period.
Exhibit 30: Business per employee to improve ~1.4x in FY10-12E

120 15

12
90
9
(| Crore)

(| Crore)
60
6
30
3

0 0
FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Business/Branch Business/Employee

Source: Company annual report, ICICIdirect.com Research

MTM hit limited due to high share of HTM securities

Limited impact of rising interest rates in FDB’s
investment portfolio in FY10-12E
FDB is well-placed in the current rising interest rate environment due to
the high share of HTM securities (73%) in its investment book of |12,816
crore in H1FY11. The duration of HTM securities was reported at 2.5
years. The rest of the investment book is divided into AFS (23%) and HFT
(4%) categories where each has duration of ~1.6 years.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 31: HFT securities dominates FDB’s investment book in H1FY11

HFT, 554 , 4% (Rs Crore)

AFS, 2,890 , 23%

HTM, 9,372 , 73%

Source: Company, ICICIdirect.com Research, HTM-Held till Maturity, AFS-Available for Sale, HFT-Held for Trading

During January-July 2010, the WPI index rose at an average of 10% YoY
primarily driven by higher food prices. As a result, yields of government
securities (G-sec) have also spiked up during this period. However, we
have observed that the rise in the yields of 10-year government bonds
has been more prominent than the five-year bonds. In our view, the
movement in five-year bond yields will be stable as compared to the 10-
year government yields, leading to limited impact on FDB’s investment
book (~77% SLR securities).

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Risks and concerns

High concentration risk
With ~60% branches in Kerala, FDB faces high concentration risk.
Although the bank is planning to reduce its dependence on the home
state by planning to open new branches in other states, aggressive
expansion in other parts of India remains a challenge. Inability to develop
a branch network outside Kerala can make the bank vulnerable to region-
specific risks.

Asset quality concern remains

FDB’s management expects slippages to continue in FY11E and believes
it will reduce once the centralised loan appraisal system is fully
operational. Any delay in the implementation of the system is expected to
pose a significant challenge to the growth of the loan portfolio in our
forecast period.

Continuance of economic slowdown

A slower than expected improvement in the domestic as well as
international credit market can negatively impact our growth estimates for
FDB. Further, the bank is heavily dependent on the NRI population
primarily in Middle East countries. A delay in recovery in these markets
will impact the bank’s business growth and profitability.

Delay in implementing BCG growth plan

We have assumed that FDB will be able to successfully implement the
recommendation put forward by BCG in order to propel itself to a high
growth trajectory starting FY13E. Any delay in implementing the plan can
derail our assumptions resulting in lower growth prospects for the bank.

Regulatory measures may impact Insurance venture

FDB has 26% ownership in IDBI Fortis Life JV with its investment of | 117
crore. Currently the JV has done well on NBP (new business premium),
however with increasing pressure on products, cap on charges and
commission etc, the business may grow slower than anticipated. This
may hurt future returns from the venture.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

We have valued FDB at 1.8x FY13E P/ABV and arrived at a
target price of | 563/share
Valuations
At the CMP of | 455, the stock is trading at 1.5x P/ABV for FY13E. We
believe that the current operational restructuring will strengthen FDB’s
business fundamentals and propel it into the next level of growth phase.
We forecast RoE and RoA of 18% and 1.4%, respectively, for the bank in
FY13E. This is expected to improve further to ~20% in FY14E. Also, we
have assumed that asset quality concerns will decline, going forward,
driven by the implementation of a centralised loan sanctioning process
and a new credit appraisal system. This is expected to facilitate better
monitoring of loans and boost the asset quality. We expect GNPA of 2.7%
in FY13E (vs. 3.2% expected in FY11E). We have valued the bank at 1.8x
FY13E P/ABV and arrived at a target price of | 563. We initiate coverage
on the stock with a STRONG BUY rating.
Exhibit 32: P/ABV band chart

In our view, FDB commands premium valuation than its 500

peers given the bank’s strong business fundamentals.
Further, with the change in management and ongoing 400
operational restructuring, we expect the bank’s return 300
ratios to improve significantly from FY13E
(Rs)

200

100

0
Mar-05
Jun-05
Sep-05
Dec-05
Mar-06
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10
Price Average 1.8x 1.4x 0.8x

Source: Company, NSE, ICICIdirect.com Research

FDB is the fourth largest private bank in terms of asset size with a
dominant market position in Kerala. The bank is currently undergoing an
organisational restructuring, which is expected to put it into the next level
of growth trajectory from FY13E. With the huge low-cost deposits
franchise (~50% of the total deposits), strong capital base and ability to
generate high NIMs as compared to its peers, FDB is an attractive play in
the domestic banking space. In our view, the improvement in the
domestic credit environment and high C/D ratio (78% in Q1FY11) will help
the bank to optimise its leverage (asset to equity of 13% in FY13E vs. 9%
in FY10) in the next two or three years. As a result, we believe the bank
will be able to improve its RoE to 18% in FY13E and ~20% in FY14E.

Exhibit 33: Comparative matrix

Profit/branch (Rs crore) RoA (%) RoE (%) P/ABV (%)
Bank FY10 FY11E FY12E FY10 FY11E FY12E FY10 FY11E FY12E FY10 FY11E FY12E
South indian Bank 0.4 0.4 0.5 1.1 1.0 1.1 17.9 17.8 19.5 2.1 1.8 1.5
Federal bank 0.7 0.8 0.9 1.1 1.2 1.3 10.3 12.2 14.4 1.7 1.7 1.6
Dhanlaxmi Bank 0.1 0.2 0.3 0.3 0.4 0.6 5.4 6.5 11.5 2.9 2.0 1.9
IOB 0.3 0.5 0.6 0.6 0.7 0.8 11.5 14.6 16.4 2.0 1.5 1.2
Syndicate bank 0.4 0.5 0.6 0.6 0.7 0.8 15.3 18.2 20.5 1.9 1.6 1.5
Source: Company specific presentation, ICICIdirect.com Research

However, FDB faces significant asset quality concerns with GNPA

standing at 3.7% of total gross advances in Q1FY11 vs. 2.7% in Q1FY10.
Further, the bank also faces high concentration risk as ~60% of the bank’s
branches are located in Kerala.

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 34: Ratios*

FY09 FY10 FY11E FY12E FY13E
Valuation
No. of Equity Shares 17.1 17.1 17.1 17.1 17.1
EPS (Rs.) 29.3 27.2 34.1 42.3 56.0
BV (Rs.) 252.6 273.9 284.9 301.2 324.2
BV-ADJ (Rs.) 245.7 263.7 271.4 286.6 307.8
P/E 15.5 16.8 13.3 10.7 8.1
P/BV 1.8 1.7 1.6 1.5 1.4
P/ABV 1.9 1.7 1.7 1.6 1.5
Div. Yield (%) 1.3 1.3 1.5 1.9 2.5
DPS (Rs.) 5.9 5.8 6.7 8.5 11.4

Yields & Margins (%)

Yield on avg int earning assets 10.2 9.6 9.8 10.1 10.1
Avg. cost on funds 6.5 6.3 6.7 6.8 6.7
Net Interest Margins 4.1 3.7 3.8 3.9 4.0
Avg. Cost of Deposits 6.4 6.4 6.3 6.4 6.3
Yield on average advances 12.4 11.6 11.7 11.9 11.9

Profitabilty (%)
Interest expense / total avg. assets 5.6 5.5 5.6 5.8 5.7
Interest income/ total avg. assets 9.3 8.9 9.1 9.3 9.4
Non-interest income/ avg. assets 1.4 1.3 1.2 1.1 1.1
Non-interest income/ Net income 28.2 27.3 26.0 23.8 22.4
Net-interest income/ Net income 71.8 72.7 74.0 76.2 77.6
Cost / Total net income 31.2 34.9 36.0 36.2 35.1

Quality and Efficiency (%)

Credit/Deposit ratio 69.5 74.7 74.5 74.9 75.1
GNPA 2.6 3.0 3.2 3.0 2.7
NNPA 0.3 0.5 0.6 0.4 0.4
RoNW 12.1 10.3 12.2 14.4 17.9
RoA 1.4 1.1 1.2 1.3 1.4
Source: Company annual report, ICICIdirect.com Research *Standalone financials

Exhibit 35: ROE decomposition*

(%) FY09 FY10 FY11E FY12E FY13E
Net interest income/ Avg. assets 3.7 3.4 3.6 3.6 3.7
Non-interest income/ Avg. assets 1.4 1.3 1.2 1.1 1.1
Net total income/ Avg. assets 5.1 4.7 4.8 4.7 4.7
Operating expenses/ Avg. assets 1.6 1.6 1.7 1.7 1.7
Operating profit/ Avg. assets 3.5 3.1 3.1 3.0 3.1
Provisions/ Avg. assets 1.3 1.0 1.3 1.1 1.0
Return on Avg. assets 1.4 1.1 1.2 1.3 1.4
Leverage (Avg assets/ Avg equity) (x) 8.6 9.2 10.0 11.5 13.0
Return on equity 12.1 10.3 12.2 14.4 17.9
Source: Company annual report, ICICIdirect.com Research *Standalone financials

ICICIdirect.com | Equity Research

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ICICI Securities Limited

Exhibit 36: Profit and loss account*

Rs Crore FY09 FY10 FY11E FY12E FY13E
Interest Earned 3315 3673 4374 5387 6560
Interest Expended 2000 2262 2668 3322 3996
Net Interest Income 1315 1411 1707 2065 2564
growth (%) 51.5 7.3 21.0 21.0 24.2
Non Interest Income 516 531 598 643 741
Fees and advisory 101 105 126 149 179
Trading Gains 83 108 92 96 101
Other income 332 318 381 398 461
Net Income 1831 1942 2305 2708 3305
Employee cost 317 366 454 537 633
Other operating Exp. 254 311 377 443 526
Gross Profit 1260 1265 1475 1729 2147
Provisions 467 405 604 648 718
PBT 793 860 871 1081 1429
Taxes 293 395 287 357 472
Net Profit 500 465 584 724 957
growth (%) 36.0 -7.2 25.6 24.1 32.2
Source: Company annual report, ICICIdirect.com Research *Standalone financials

Exhibit 37: Balance sheet*

Rs Crore FY09 FY10 FY11E FY12E FY13E
Liabilities
Capital 171 171 171 171 171
Reserves and Surplus 4155 4519 4707 4986 5379
Networth 4326 4690 4878 5158 5550
Deposits 32198 36058 44031 53830 66256
Borrowings 1219 1547 1892 2287 2740
Subordinated Debt 0 0 0 0 0
Other Liabilities & Provisions 1108 1380 1559 1647 1761
Total 38851 43676 52360 62921 76307

Assets
Fixed Assets 281 290 348 384 432
Investments 12119 13055 15192 17721 20793
Advances 22392 26950 32810 40331 49786
Other Assets 622 658 709 471 437
Cash with RBI & call money 3437 2723 3301 4014 4859
Total 38851 43676 52360 62921 76307
Source: Company annual report, ICICIdirect.com Research *Standalone financials

ICICIdirect.com | Equity Research

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ICICI Securities Limited

RATING RATIONALE
ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns
ratings to its stocks according to their notional target price vs. current market price and then categorises them
as Strong Buy, Buy, Add, Reduce and Sell. The performance horizon is two years unless specified and the
notional target price is defined as the analysts' valuation for a stock.

Strong Buy: 20% or more;

Buy: Between 10% and 20%;
Add: Up to 10%;
Reduce: Up to -10%
Sell: -10% or more;

Pankaj Pandey Head – Research pankaj.pandey@icicisecurities.com

ICICIdirect.com Research Desk,

ICICI Securities Limited,
7th Floor, Akruti Centre Point,
MIDC Main Road, Marol Naka,
Andheri (East)
Mumbai – 400 093

research@icicidirect.com

ANALYST CERTIFICATION
We /I, Kajal Gandhi CA Viraj Gandhi MBA-CM Mani Arora MBA research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report
accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific
recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

Disclosures:
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The information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. The report and information contained herein is strictly confidential and
meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without
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board member of the companies mentioned in the report.

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