2 min read.Updated: 31 May 2020, 09:37 PM ISTAparna Iyer
The lender’s operating profit may come under stress on deceleration in loan growth due to the pandemic
Federal Bank’s fourth quarter performance showed mixed signs on what lies ahead. The mid-sized lender reported strong operating metrics, but the potential pressure on asset quality because of the coronavirus pandemic is something investors should watch out for.
First, the good news. The bank’s operating performance was strong with pre-provisioning operating profit growing by 27%. This was notable, as operating profit growth was in low single digits for the past two quarters. Deposits grew by a healthy 13%.
Treasury gains helped the bank increase provisions, which brought down its net bad loan ratio from a year-ago. Further, Federal Bank also set aside ₹93 crore towards specific risks expected from the covid-19 pandemic.
In the light of this, the 21% drop in net profit and the fact that it missed street estimates, was shrugged off by investors. In fact, Federal Bank shares have risen about 10% since its results were announced. However, this was also a function of how low the bank’s shares had fallen earlier.
That said, Federal Bank has several challenges ahead, primarily on the asset quality front. Provisions are unlikely to taper off in the coming quarter, said analysts at Morgan Stanley and some other brokerages.
“The bank also made covid-19- related provisions of ₹93 crore (0.08% of loans), which seem to be far lower than peers and, thus, would call for additional provisions in FY21," said Emkay Global Financial Services Ltd analysts. Even the operating profit may come under stress because of a sharp deceleration in loan growth due to the pandemic, the brokerage said.
Another worry is that Federal Bank’s loss absorption capacity is lower than its peers. To begin with, the lender’s provision coverage ratio at 53.39% is low compared to peers. Lenders such as ICICI Bank, Kotak Mahindra Bank, and Axis Bank have coverage ratios of above 70%.
What is more is that 35% of Federal Bank’s loan book is under moratorium, which is higher than its peer banks. It is clear that the bank needs to beef up its provisions.
As such, analysts expected earnings to be impacted in the coming quarters.
“We cut our FY21E estimates sharply by 19% as we factor in the higher credit cost and slight moderation in business growth while maintaining our FY22E projections," Motilal Oswal Financial Services Ltd analysts wrote in a note.
That said, valuations seem to reflect much of these risks, according to analysts. Despite the rally last week, the stock has lost 53% from its highs seen in January and trades at a discount to its estimated book value for FY21.