India's fifth-largest private sector bank, Federal Bank, is India Capital Growth Fund's largest holding, accounting for 5.2 per cent of assets. The bank has a loan book worth $6.9bn (£4.31bn) dominated by the small- and mid-enterprise sector, and retail lending, and a deposit base of $9.2bn. David Cornell, principal adviser to India Capital Growth Fund, explains the company's potential.
"Of the older private sector banks that have strong regional bases (Federal Bank has a dominant presence in Kerala) and tend towards a culture in tune with the public sector, Federal Bank offers most potential for healthy long-term returns," says Mr Cornell. "Its strength lies in its liability franchise, which derives a part of its deposits from a strong non-resident customer base. These customers form part of the Indian working population from the Middle East and, consequently, the bank has a high market share of inward remittances. In addition, it has a high capital base, and both factors support the growth strategy and will enhance returns on equity over time."
Historically, the bank's weakness has been a high level of non-performing assets, recently averaging 3.5 per cent against the banking system average of 2.7 per cent, and 1.9 per cent for older private sector banks.
A non-performing asset is a debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The non-performing asset is therefore not yielding any income to the lender in the form of principal and interest payments.
However, under the direction of a new managing director, non-performing assets have fallen from 4 per cent to 3.5 per cent and are forecast to reach 3 per cent in due course.
"This improvement in asset quality is in contrast to many of its private sector peers, which recently have chased growth with inevitable asset quality consequences," says Mr Cornell. "The bank has an improved risk management system in place and management is now focusing on quality loan growth in excess of the system. With a focused, conservative management and a clear achievable strategy, the stock has the potential to re-rate. The bank offers a credible, medium-term investment alternative to new private sector banks with a business model that is geared to sustain steady risk-adjusted returns."
