Federal Bank BUY

COMPANY INSIGHT FB IN EQUITY December 18, 2020 Reliable and steady BFSI Asset quality deterioration would be low for the bank. We expect credit Recommendation cost of only ~133bps in FY21/23E vs average 100bps in FY18-20 due to Mcap (bn): `134/US$1.8 prudent underwriting, negligible exposure to stressed segments 3M ADV (mn): `2,330/US$32 (unsecured loans/microfinance/CVs), higher share of secured loans and better-rated corporates. Higher share of retail deposits gives stability to CMP: `67 liability side and ~120bps lower cost of funds vs mid/SFBs/regional TP (12 mths): `102 peers should help the bank grow balance sheet without taking much Upside (%): 52 risk. Recent initiatives like product/geographic diversification, tie-up with third parties and RM-led model would result in yield/fee income Flags expansion. Experienced-cum-independent board and talent depth Balance sheet risk: GREEN would enable smooth transition if tenure of current CEO isn’t extended. We expect RoA/RoE to reach 1.3%/16% by FY23E (0.7%/9% in FY21E) and Predictability: GREEN raise valuation to `102 (1.1x FY22E implied P/B) Risks: Increase in Earnings Momentum: AMBER retail/SME NPAs and declining growth. Competitive position: MODERATE Changes to this position: POSITIVE Catalysts Low exposure to stressed sectors to keep credit cost <150bps . Not much spike in credit cost due to Federal Bank managed its asset quality well over the last 5 years (average credit COVID-19 (133bps in FY21-23E vs cost of 105bps) despite adverse corporate asset quality cycle and a major flood 100bps in FY18-20) in home state Kerala. Better underwriting, lower exposure to stressed segments . 50bps positive impact on yield/core (~1% to PL/CC/MFI/CV/CE), increasing share of high-rated corporates (A and fee to asset between FY22-23E due above: 79%/65% in 2QFY21/FY16) should limit credit cost increase to just recent measures 133bps over FY21-23E. Best-in-class franchise on liability side Performance (%) Retail deposit share of 88% and 34% CASA ratio make FB one of the best FB IN SENSEX (RHS) liability franchises in Indian banking. The bank has ~120bps cost of fund 140 50,000 120 advantage over mid-size/regional banks which should help grow its balance 40,000 100 sheet without assuming much risk. FB would maintain its liability strength due to 80 30,000 long operating history (~9 decades), higher share of branches in deposit-rich 60 rd 20,000 Kerala (3 highest after SBI/Canara) and increasing share in NRI deposits. 40 10,000 Income profile to improve on account of recent structural changes 20 0 - FB’s entry into some high yield segments like CV/CE, credit cards, business loans and micro loans would expand yields. FB has distribution network and captive customer base to succeed in some of these segments. On fee income, Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 increasing market share in payments, tie-up with third parties and focus on RM- led corporate banking model should help expand fee income. We expect Source: Bloomberg, Ambit Capital research ~70bps PPOP/asset-ratio expansion due to these initiatives during FY21-23E. RoA/RoE to expand; remain BUYers with TP of `102 FB currently trades at 0.8x 12M forward BVPS (~35%/26% lower than 10/3-year average), which is at ~54% discount to mid/small banks despite scoring on asset quality and liability side. As these strengths start manifesting in improving RoE, we expect valuation discount to close. We also prefer FB over CUBK at this point due to lower exposure to stressed segments and valuation comfort. Research Analysts Pankaj Agarwal, CFA Key financials +91 22 6623 3206 Year to March FY19 FY20 FY21E FY22E FY23E [email protected] Net Interest Income (` bn) 41.8 46.5 53.6 63.8 74.6 Operating Profits (` bn) 27.6 32.0 35.2 47.8 63.0 Ajit Kumar, CFA Net Profits (` bn) 12.4 15.4 13.6 20.9 31.4 +91 22 6623 3252 EPS (`) 6.3 7.7 6.9 10.5 15.8 [email protected] RoA (%) 0.84% 0.91% 0.70% 0.94% 1.25% Shreya Khandelwal RoE (%) 9.8% 11.1% 9.0% 12.3% 16.1% Tel: +91 22 6623 3292 P/B (x) 1.00 0.92 0.84 0.74 0.63 [email protected] Source: Company, Ambit Capital research

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Narrative in Charts

Credit cost trends – In line or even better trends for FB FB has lower exposure to stressed segments despite growing higher than major banks 2QFY21 (%) PL/CC MFI CV/CE Total Credit cost (FY16-FY20) BANDHAN 0% 65% 0% 65% 4.5% 60% Loan growth (FY16-FY20, RHS) IIB 7% 11% 19% 36% 4.0% 50% RBK 20% 14% 0% 34% 3.5% HDFCB 16% 0% 3% 19% 3.0% 40% KMB 6% 0% 9% 15% 2.5% AU 0% 0% 15% 15% 30% 2.0% 20% ICICIBC 9% 0% 4% 13% AXSB 10% 0% 0% 10% 1.5% 20% SBIN 8% 0% 0% 8% 1.0% 10% DCBB 0% 0% 6% 6% 0.5% 1.0% CUBK 3% 0% 0% 3% 0.0% 0% FB 1% 0% 0% 1% FB IIB SIB

UJJ Source: Company data, Ambit Capital research YES RBK KVB CSB KMB IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB ICICIBC Source: Company data, Ambit Capital research *For UJJIIVAN, data is for FY18-FY20

We expect credit cost <150bps in FY21/22E despite FB has lower cost of funds compared to all other COVID-19 regional/mid/SFBs and only higher than large banks Credit cost estimates (` FY19 FY20 FY21E FY22E FY23E bn) FY17 1HFY21 Large banks- Gross NPAs – Opening 28.0 32.6 35.3 43.6 63.7 Other banks- 6.6% average 4.3% average Regional Add : Gross Slippages 16.7 19.2 24.1 39.7 37.8 banks- 5.4% average 7.6%

Less : 7.5% 7.1% 9.6 9.2 8.8 10.9 15.9 7.0% 6.7% Recoveries/Upgradation 6.5% 6.1% 5.7% 5.7% 5.6% 5.3% 5.3% Less: Write off 2.4 7.3 7.1 8.7 15.9 5.1% 4.7% 4.4% 4.4% 4.2% 4.0% Gross NPAs – Closing 32.6 35.3 43.6 63.7 69.6

Net Addition 7.0 10.0 15.3 28.8 21.9

PCR 50% 54% 65% 60% 60% FB IIB SIB UJJ YES RBK KVB CSB

PCR (Inc. Std asset) 67% 73% 82% 73% 74% KMB SBIN IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB Overall credit cost (%) 0.85% 1.01% 1.33% 1.39% 1.28% ICICIBC Source: RBI, Company, Ambit Capital research Source: Company, Ambit Capital research

2QFY21 - Increasing market share of non-Kerala states in FB has been trading at a discount to peers despite higher various loan segments expected profitability

Kerala Non-Kerala 18% AU SFB 16% ICICIBC FY17 2QFY21 AXSB FB 14% HDFC 12% UJJ CUBK

49% KMB 50% EQUITAS 55% 56%

63% BANDHAN 66% 10% IIB 83% 85% KVB 8% DCB 51% 50%

45% 44% 6% 37% FY22E RoE (%) RoE FY22E 34% 17% SIB 15% 4% IDFCB

SME SME 2% RBK

Overall Overall YES 0% Corporate Corporate 0.0 1.0 2.0 3.0 4.0 5.0 6.0

Retail (Inc Agri) Retail (Inc Agri) FY22E P/B (x)

Source: Company, Ambit Capital research Source: Company data, Ambit Capital research *BBG estimates for uncovered companies

December 18, 2020 Ambit Capital Pvt. Ltd. Page 2 Federal Bank

Better than industry over the last decade FB’s performance has been better than the overall banking industry and private sector banks in the last decade with median RoA/RoE of 1.0%/11.5% vs sector’s 0.8%/10.4%. The bank has done well on asset quality (~95bps credit cost during FY11-20) and liability with one of the lowest cost of funds amongst small/mid-cap banks (5.1% in 1HFY21 vs average of 6.3% for midcap banks/SFBs). However, the bank has not done so well in the income generation side with NIMs contracting ~90bps over the last 10 years and fee income as a % of assets remaining muted at 0.9-1.1%. Hence EPS CAGR over the last decade has been ~11%, which is lower than asset CAGR of 15%. Better-than-industry performance FB’s performance over the last decade (FY11-20) has been better than industry with median RoA/RoE of 1.0%/11.5%. Balance sheet has grown at 15% CAGR over this period with EPS CAGR of 11%. Over the last last 5 years, median RoA/RoE has been 0.8%/9.8%. Exhibit 1: Du Pont analysis of FB in the last decade (FY11-20) 5 Yr 10 Yr Du Pont analysis FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 median median NII / Assets (%) 3.7% 3.5% 3.0% 3.1% 3.0% 2.8% 2.9% 2.8% 2.8% 2.7% 2.8% 3.0% Other income / Assets (%) 1.1% 1.0% 1.0% 1.0% 1.1% 0.9% 1.0% 0.9% 0.9% 1.1% 0.9% 1.0% Total Income / Assets (%) 4.8% 4.4% 4.0% 4.0% 4.1% 3.7% 3.9% 3.7% 3.7% 3.9% 3.7% 4.0% Employee Cost to Assets (%) 1.0% 1.0% 1.0% 1.1% 1.1% 1.2% 1.1% 1.0% 0.9% 1.0% 1.0% 1.0% Other Cost to Assets (%) 0.7% 0.8% 0.8% 0.9% 0.9% 0.9% 1.0% 1.0% 0.9% 0.9% 0.9% 0.9% Cost to Assets (%) 1.8% 1.7% 1.8% 2.0% 2.1% 2.1% 2.1% 1.9% 1.9% 2.0% 2.0% 2.0% PPP / Assets (%) 3.0% 2.7% 2.2% 2.0% 2.1% 1.6% 1.8% 1.8% 1.9% 1.9% 1.8% 2.0% Provisions / Assets (%) 1.1% 0.6% 0.4% 0.4% 0.1% 0.8% 0.6% 0.7% 0.6% 0.7% 0.7% 0.6% PBT / Assets (%) 1.9% 2.1% 1.8% 1.7% 1.9% 0.8% 1.2% 1.1% 1.3% 1.2% 1.2% 1.5% RoA (%) 1.2% 1.4% 1.3% 1.2% 1.3% 0.5% 0.8% 0.7% 0.8% 0.9% 0.8% 1.0% RoE (%) 12.0% 14.4% 13.9% 12.6% 13.7% 6.0% 9.8% 7.8% 9.8% 11.1% 9.8% 11.5% Loan growth (%)* 18.6% 18.2% 16.8% -1.5% 18.1% 13.3% 26.2% 25.4% 19.9% 10.9% 19.0% 16.3% Asset growth (%)* 17.8% 17.8% 17.2% 5.0% 11.1% 14.2% 21.6% 20.3% 15.2% 13.4% 16.9% 15.3% EPS growth (%)* 26.4% 32.3% 7.9% 0.1% 19.7% -52.9% 74.1% -7.5% 40.6% 23.6% 5.7% 11.0% Source: Company, Ambit Capital research * CAGR for loan, asset and EPS FB has generated better RoA/RoE than overall banking system in the last 5/10 years. Even compared to private sector banks, FB has performed broadly in line in the last 5/10 years. Exhibit 2: FB has performed better than the overall banking system 5 Yr Avg (FY16-20) Overall system* Private banks** FB Median RoA 0.1% 1.0% 0.8% Median RoE 0.9% 11.2% 9.8% Loan growth (%) 7.1% 15.2% 19.0% EPS growth (%) -38.9% 1.5% 5.7% 10 Yr Avg (FY11-20) Median RoA 0.8% 1.5% 1.0% Median RoE 10.4% 13.0% 11.5% Loan growth (%) 12.0% 18.8% 16.3% EPS growth (%) -20.4% 6.6% 11.0% Source: RBI, Company, Ambit Capital research. * For system, the data is till FY19. Median for private banks, which include HDFCB, ICICIBC, KMB, AXSB, KVB, SIB, CSB, IIB, RBK, CUBK, YES, DCBB & AU SFB If we break down the performance of the bank over the last decade, FB has done well on a few parameters while struggling on others.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 3 Federal Bank

Aspects where the bank has done well . Holding asset quality well: Bank has been able to hold its asset quality with average credit cost (total provision to loans) of only ~95bps during the last decade and within the narrow range of 50-180bps. During this period, most of Indian banking industry was struggling with huge NPA issues including many private sector banks. . Continues to gain on liability: Despite competition from large banks, FB has been able to build a strong liability side with one of the lowest cost of funds (5.1% in 1HFY21 vs average of 6.3% for midcap/small finance banks) in the banking system and the lowest amongst midcap/smallcap banks.

Aspects where bank has been a laggard . Below par lending yields: However, loan yields for the bank have been under pressure and 95bps/480bps lower than that of other regional and midcap banks. Hence, despite having one of the lowest cost of funds, FB’s NIMs are among the lowest in the banking system, at 2.9%/3.1% in FY20/1HFY21. . Weak fee income: Fee income as a % of assets at 1-1.1% has been much lower vs the private sector averge of 1.5-2%. Going forward, we not only expect the bank to maintain its asset quality but also expand NIMs and fee income to reach RoA of 1.25% by FY23E. Our optimism on FB is driven by factors given in the below sections.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 4 Federal Bank

Asset quality deterioration due to COVID to be limited FB’s average gross slippage ratio over FY16-20 at 2.5% is lower than large private/regional/mid banks’ 3.3%/3.7%/3.2%. Moreover, credit cost has been average 1% during the period within a limited range of 0.8-1.3%. We expect limited asset quality deterioration for FB due to COVID with average credit cost of 136bps in FY21-22E (vs 93bps in FY19-20) given: (i) shift from bulky corporate loans, which were the main source of NPA in FY16/FY18 (down from 42% in FY18 to 38% in 2QFY20); (ii) increasing share of high rated corporates (A and above) in the mix (~79%); (iii) decrease in balance sheet risks evident by RWA/asset, share of >=100% risk weight asset; and (iv) one of the lowest exposures to stressed segments like PL/CC/CV/CE/Agri/MFI (~13%). Furthermore, steps taken like separating credit risk and business teams, focus on cashflow-based lending and early detection/resolution of NPAs etc. will also help contain asset quality challenges in the near future. FB has displayed stable to improving asset quality trends since FY16 with gross “We will seek to remain the Island slippages coming down from 3.7% in FY16 to 1.8% in FY20. In FY16, the high gross of Calm, resilient and strong, but, slippages were due to fallout of asset quality review (AQR) driven by the RBI, leading looking ahead, we are building on to recognition of a large share of Indian banks’ standard stressed loans as NPAs. a theme, to be the FIRST CHOICE Slippages from a few corporate accounts and accelerated recognition of NPA from for all our stakeholders.”- MD & the restructured corporate book were the main reasons for spike in gross slippages in CEO in FY20 AR FY18. From FY18, gross slippages were low, in the narrow range of 1-2%.

Exhibit 3: Gross slippages have been on a downward trend Exhibit 4: GNPA ratio has also been in the narrow range 3.7% Gross slippages (%) GNPA (%) Due to Due to few fall out of 3.0% 3.0% corporate 2.8% 2.9% 2.8% 2.8% RBI-AQR accounts 2.3%

1.9% 1.8% 1.8%

0.7%

FY16 FY17 FY18 FY19 FY20 1HFY21 FY16 FY17 FY18 FY19 FY20 1HFY21 Source: Company, Ambit Capital research. * 2QFY21 gross slippages are Source: Company, Ambit Capital research without exemption given by the Supreme Court

The gross slippage trends for FB in general have been lower vs various sets of lenders. Average gross slippage for FB between FY16-20 was 2.5% vs 3.3% for large private sector banks, 3.7% for regional banks and 3.2% for other private banks. Exhibit 5: The gross slippages for FB are lower vs its peers

Gross slippage ratio FY16 FY17 FY18 FY19 FY20 20% Large private banks- Regional banks- Other banks- 3.2% average 3.3% average 3.7% average 15.7% 15%

10% 6.2% 3.6% 3.5% 3.5% 3.5% 3.2% 3.2% 2.8% 2.7%

5% 2.6% 2.3% 2.2% 1.8% 1.8% 1.7% 1.4% 0% FB IIB SIB UJJ YES RBK C KVB CSB KMB IDFC AXSB DCBB CUBK ICICIB Equitas HDFCB AU SFB AU Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 5 Federal Bank

Credit cost for FB has been in the narrow range of 85-130bps during FY16-20 (average 105bps in FY16-20 vs 85bps in FY11-15). The credit cost during FY16-20 has been lowest as compared to large private sector banks (1.9%), other regional banks (2.1%) and other private sector banks (1.8%). Even if we look at long-term cross-cycle credit cost of various players in Indian banking, FB has one of the lowest credit costs in the sector across various periods. Exhibit 6: Credit cost trends – in line or even better than various sets of peers FY16-FY20 Regional banks- Large private banks- Other banks- 1.8% average 4.1% 1.9% average 2.1% average 2.9% 2.9% 2.4% 2.2% 2.0% 1.9% 1.7% 1.5% 1.5% 1.4% 1.4% 1.1% 1.0% 0.9% 0.8% 0.7% FB IIB SIB UJJ YES RBK KVB CSB KMB IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research The underwriting quality of FB could also be seen from the fact that it also did not see any spike in credit cost after the Kerala floods in 2018 unlike its Kerala-based peers like South Indian Bank and Catholic Syrian bank. Exhibit 7: FB did not see a spike in credit cost during the Kerala Floods unlike other Kerala-based lenders SIB/CSB

CSB SIB FB

3.0% 2.6% 2.4% 2.5% 2.4% 2.1% 2.0% 2.0% 1.9% 1.7% 1.7% 1.4%

1.5% 1.3% 1.1% 1.0% 0.9% 0.9% 1.0% 0.8%

0.5%

0.0% FY16 FY17 FY18 FY19 FY20

Source: Company, Ambit Capital research

Tightening processes to control NPAs The reason behind FB maintaining its asset quality is the various steps taken to reduce risk and increase recoveries. Exhibit 8: Recent steps taken by the company to control NPAs and improve recoveries Area Steps taken . Centralized credit risk management division which is independent of its business function . A separate research and analytics sub-division within risk department which studies and analyses various sectors/Industries, latest market information and its impact on the loan portfolio Risk mitigation for loans . Intense monitoring using automated Internal tools (like Loan management system, Dashboard and customer 360 view) and external sources/platforms (like Save risks/Probe42, Watch out investors, CRISIL Qunatix) . Focus more on cashflow-based lending and WCL approach . Early recognition and resolution of NPAs using different strategies (Debulking/de-risking and exit if required well in advance) Resolutions & recoveries . Partnership with firms like magicbricks in FY20 for listing and e-auctioning of immovable properties repossessd by the bank through recovery proceedings. This will ensure faster recovery of NPAs. Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 6 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Going forward, as the Indian Banking sector grapples COVID1-induced asset quality deterioration, FB would see limited impact on asset quality as compared to its peers. Our belief is based on the following points: Low risk on corporate loans In FY16 & FY18, the corporate segment was the main driver of increased slippages for FB with ~50% new NPAs coming from it. Since then, the management has focused on de-risking the balance sheet from bulky corporate accounts. As a result, fresh corporate lending has been skewed towards better-rated corporate customers (rated A and above). The composition of A and above customers in the overall corporate mix stands at 79% (vs 65% in FY16). Exhibit 9: Corporate mix is now skewing towards A and above rating

Federal bank - Corporate rating mix A and above BBB Below BBB & Unrated

10% 9% 16% 11% 11% 28% 15% 11% 10% 19% 11% 7%

76% 73% 78% 79% 65% 71%

FY16 FY17 FY18 FY19 FY20 2QFY21 Source: Company, Ambit Capital research If we compare the rating profile of corporate segments of various lenders which provide this data, FB has one of the the highest shares of A and above corporates in the loan book mix. Exhibit 10: FB has higher share of better rated corporates

Corporate ratings mix - 2QFY21

67% 66% 75% 75% 70% 72% 82% 79%

20% 15% 28% 10% 12% 18% 26% 18% 11% 13% 15% 14% 7% 3% 6% AXSB FB SBI RBK Equitas ICICIB IIB SIB Below BBB & Unrated BBB A and above

Source: Company, Ambit Capital research. * 1QFY21 rating mix for Equitas Federal also has reduced its balance sheet risk as compared to other banks as evident from reduction in RWA/Asset ratio. Exhibit 11: Balance sheet risk is declining for Federal Bank Mar’17 Mar’18 Mar’19 Mar’20 Sep’20

RWA to assets ratio 62.9% 60.1% 58.8% 58.6% 55.8% Share of assets with 100% Risk weight 24.3% 22.9% 23.7% 24.3% 22.4% with >100% Risk weight 9.6% 10.7% 10.8% 9.1% 9.3% with >=100% Risk weight 33.8% 33.7% 34.5% 33.5% 31.7% Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 7 Federal Bank

The impact of lower balance sheet risk is visible as average corporate slippage in FY19-FY20YTD at 1.1% was lower than 3.2% during FY16-18. Exhibit 12: FB has posted moderation in corporate slippages in recent times

5.7% Corporate slippages

3.1%

1.3% 0.9% 1.0% 0.8%

FY16 FY17 FY18 FY19 FY20 FY21YTD Source: Company, Ambit Capital research *in 1QFY21, one corporate account having exposure of Rs1.8bn slipped into NPA despite moratorium. In 2QFY21, Rs0.4bn was the corporate gross slippages without exemption given by the SC. Both have been included in the calculation of corporate gross slippages ratio Lower exposure to riskier segments in retail The collection efficiency trends during 1HFY21 shows that retail loans have posted lower collection efficiency trends vs corporate loans. Also, within retail loans, unsecured retail loans, credit cards, microfinance, CV/CE etc. have lower collection efficiencies vs other retail categories. FB has low exposure to stressed retail segments like unsecured personal loans, credit cards and CV/CE business. This makes us believe that the asset quality deterioration for FB will be lower than peers in the retail segment. Exhibit 13: Federal Bank has lowest exposure to personal loans/credit cards/MFI and CV/CE segments Stressed retail loans-2QFY21 (%) PL/CC MFI CV/CE Total BANDHAN 0% 65% 0% 65% IIB 7% 11% 19% 36% RBK 20% 14% 0% 34% HDFCB 16% 0% 3% 19% KMB 6% 0% 9% 15% AU 0% 0% 15% 15% ICICIBC 9% 0% 4% 13% AXSB 10% 0% 0% 10% SBIN 8% 0% 0% 8% DCBB 0% 0% 6% 6% CUBK 3% 0% 0% 3% FB 1% 0% 0% 1% Source: Company, Ambit Capital research The impact of lower exposure to stressed retail segments is also visible as retail slippage has been low and in a narrow range of 1-2%. From FY18, gross retail slippages have come down consistently. Retail slippages for FB have been similar or lower than that of large private sector banks.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 8 Federal Bank

Exhibit 14: FB has clocked moderation in retail slippages Exhibit 15: Retail/Agri slippages of FB were one of the too lowest levels among major banks in FY19-20 Retail slippages Average retail & agri slippages - FY19 & FY20 3.1% 2.9% 1.9%

1.5% 1.6% 1.6% 1.5% 2.1% 1.8% 1.5%

FY16 FY17 FY18 FY19 FY20 ICICIBC FB SBI AXSB IIB Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Considering the impeccable track record in terms of asset quality over the last decade with very few hicupps, reducing risk on corporate loans & balance sheet, lower exposure to stressed retail segments and recent steps taken to contain asset quality challenges due to COVID, FB should positively surprise investors on asset quality. We expect asset deterioration to be limited for the bank compared to peers in FY21/23E. We expect credit cost to marginally inch up to 1.3%/1.4%/1.3% in FY21/22E/23E from 1.0% in FY20. Our average credit cost estimates for FB for FY21/FY23E is lower vs average credit cost estimates for our coverage universe. Our estimates of credit cost are based on the following assumptions: . We build in gross slippages of around `24/40/38bn in FY21/22/23E. The average gross slippage in FY21/22E of `34bn is ~75% higher than the historical average slippage of `19bn during FY17-20. We have taken higher gross slippage assumption on a conservative basis compared to management guidance of 40- 50% higher slippages than the usual run rate. As a percentage of opening advances, gross slippage assumption is 2.0%/3.0%/2.5% for FY21/22/23E or total of 7.5% in FY21-23E combined. Our segment-wise slippage assumptions are given below: Exhibit 16: Segment-wise slippage assumptions for FY21/23E Loan mix Slippages assumption Segments Comments (2QFY21) (FY21/23E) Higher than 4.5% assumed for large banks due to higher share of Large/mid Corporates 37.6% 7.5% CRE/NBFC/HFCs SME/Business banking 18.8% 7.5% In line with large banks assumption Home Loans/LAP 20.5% 4.5% Higher than 3.0% assumed for only home loans. The bank has ~6% LAP as well CV/CE 0.0% 7.5% Negligible presence in CV/CE Cars/Uvs 2.6% 3.0% In line with large banks assumption PL/CC 1.3% 7.5% In line with large banks assumption Microfinance 0.0% 22.5% Negligible presence in MFI Agri 11.9% 15.0% Higher than 7.5%-10.0% assumed for large banks Gold 0.0% 1.5% In line with large banks assumption Others 7.3% 3.0% In line with large banks assumption Overall slippages assumption for ~7.5% FY21/22E Source: Company, Ambit Capital research . We build in lower recoveries of ~`9bn in FY21 as recovery proceedings remain subdued due to COVID-19 before increasing to `11/16bn in FY22/23E. . The bank has increased PCR to 66% in 2QFY21 vs 60%/55% in 1QFY21/4QFY20. We assume 65%/60%/60% PCR in FY21/22/23E as FB will use additional COVID- 19 provision of ~0.5% of the loans that it created since 4QFY20.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 9 Federal Bank

Exhibit 17: We expect credit cost to remain <150bps in FY21/22/23E Credit cost estimates (` bn) FY18 FY19 FY20 FY21E FY22E FY23E Gross NPAs – Opening 17.3 28.0 32.6 35.3 43.6 63.7 Add : Gross Slippages 22.0 16.7 19.2 24.1 39.7 37.8 Less : Recoveries/Upgradation 6.9 9.6 9.2 8.8 10.9 15.9 Less: Write off 4.4 2.4 7.3 7.1 8.7 15.9 Gross NPAs – Closing 28.0 32.6 35.3 43.6 63.7 69.6 Net Addition 15.1 7.0 10.0 15.3 28.8 21.9 PCR 44% 50% 54% 65% 60% 60% PCR (Inc. Std asset) 60% 67% 73% 82% 73% 74% Overall credit cost (%) 1.15% 0.85% 1.01% 1.33% 1.39% 1.28% Source: Company, Ambit Capital Research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 10 Federal Bank

One of the best liability franchises among mid-sized banks FB has one of the best liability franchises amongst various sets of lenders. Its CASA ratio of 34% is higher than average of regional banks/mid-sized banks (~28%). Share of retail deposits (~88%) is even higher than that of large banks and shows granularity of its liability franchise. Hence, cost of funds for FB at 5.1% is ~30bps/150bps lower vs regional/mid-cap banks. The bank’s market share in deposits has been stable to improving despite cutting TD rates by 190bps since Aug’19, higher than ~110bps cuts by other mid-size banks and in line with ~200bps cuts by large banks. While market share of FB in deposit-rich Kerala has increased during FY15-2QFY21, FB has gained market share in non-Kerala states too. Strong brand name with ~9 decades of operating history, high share of branches in deposit-rich Kerala and increasing share of NRI deposits mean liability side advantages should sustain in future too. Standing tall on the liability side FB’s CASA ratio has remained broadly stable between FY17 and 2QFY21 at 33-34%. It has one of the highest CASA ratios among all mid-sized/regional banks/small finance banks and only behind the top large private sector banks and SBI. Exhibit 18: CASA ratio comparision - FB scores higher than regional/mid/small finance banks and only lower than large banks

FY17 2QFY21 Large banks- 46% average

57% Regional banks- 30% average Other banks- 27% average 51% 50% 48% 44% 44% 44% 44% 43% 42% 40% 40% 37% 36% 34% 34% 33% 31% 29% 28% 28% 26% 25% 25% 25% 24% 24% 23% 22% 22% 20% 18% 16% 5% 3% 0% FB IIB SIB UJJ YES RBK KVB CSB KMB SBIN IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research Apart from high CASA deposits, the bank also has a granular and retail deposit base with ~88% of deposits being retail. Share of retail deposits for Federal Bank is best in the banking system. Exhibit 19: Share of retail deposits - FB has highest share of retail deposits among all banks

FY17 2QFY21 Large banks- 64% average

Regional banks- 74% average Other banks- 46% average 88% 87% 78% 76% 75% 74% 73% 73% 72% 67% 67% 66% 65% 65% 63% 61% 60% 59% 57% 55% 54% 50% 49% 48% 42% 38% 37% 33% 32% 32% 31% 27% 26% 5% 3% 0% FB IIB SIB UJJ YES RBK KVB CSB KMB SBIN IDFC AXSB DCBB CUBK* Equitas HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research *For CUBK, FY20 data is given in place of 2QFY21

December 18, 2020 Ambit Capital Pvt. Ltd. Page 11 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

This higher share of CASA deposits and strength of liability franchise also get reflected in cost of funds at 5.1% (1HFY21) being lowest among all mid-sized banks/regional banks/small finance banks and closely tracking large private banks. Exhibit 20: Cost of funds comparison - FB has lower cost of funds compared to all other regional/mid/small finance banks and only higher than large banks

FY17 1HFY21 Large banks- 4.3% average Other banks- 6.6% average

Regional banks- 5.4% average 10.1% 11.2% 8.4% 8.3% 7.6% 7.5% 7.1% 7.0% 7.0% 6.9% 6.8% 6.7% 6.6% 6.5% 6.5% 6.5% 6.4% 6.2% 6.1% 6.0% 5.7% 5.7% 5.7% 5.6% 5.4% 5.4% 5.4% 5.3% 5.3% 5.3% 5.1% 4.7% 4.4% 4.4% 4.2% 4.0% FB IIB SIB UJJ YES RBK KVB CSB KMB SBIN IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research The lower cost of funds vs other regional banks and midcap banks gives a significant advantage to FB in the current risk-averse environment for banks. The funding cost advantage would help FB grow its balance sheet without compromising NIMs and asset quality. The strength of the liability franchise could also be gauged from the fact that FB has been able to cut its deposit rates in line with large banks and higher than midcap/smallcap bank since Aug’19 (PMC crisis). This is again because of strong operating relationship with depositors and rate insensitive granular deposits. Exhibit 21: FB has cut deposit rates more than other mid-size banks

1 Yr TD rate cut since Aug 19 SBIN ICICIBC AXSB HDFCB KMB Bandhan CUBK UJJ AUF RBK EQUITAS DCBB IIB YES FB 0.90% 0.95% - - 1.17% - 1.25% - 0.50% 0.50% - - 1.50% - 1.60% 1.60% - - 1.90% 1.90% 1.90% 1.95% - - - - 2.10% - 2.30% - Large banks- -2.0%% avg. cut Other banks- -1.1%% avg. cut

Source: Company, Ambit Capital research Even its share of top 20 depositors is one of the lowest in the industry, suggesting high granularity of its liability franchise.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 12 Federal Bank

Exhibit 22: Share of top 20-depositors - FB has one of the lowest shares of top 20 depositors among all banks

FY19 FY20 Other banks- 20.0% average 41.8%

Regional banks- 8.1% average 32.7% 32.0% 34.6% 29.0%

Large banks- 6.2% average 25.0% 24.3% 23.4% 22.8% 22.7% 18.8% 18.4% 12.4% 12.2% 12.0% 11.8% 11.4% 10.8% 9.9% 9.9% 9.3% 9.2% 9.1% 9.2% 7.1% 6.9% 6.1% 6.1% 6.0% 5.7% 5.7% 4.9% 4.0% 3.9% 3.1% 2.9% FB IIB SIB UJJ YES RBK KVB CSB KMB SBIN IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research On the system level, FB has increased its market share in the deposit base between FY15-2QFY21 as evident from the below exhibit. One of the key reasons for its liability strength is its strong presence in deposit-rich Kerala. The deposit richness of Kerala can be explained by remittances from its huge non-resident population. While Kerala accounts only ~4% of overall deposits at the national level, it accounts for a high ~64% of the deposit base in case of FB.

Exhibit 23: Overall deposit market share - FB has Exhibit 24: Kerala accounts for ~64% of FB’s deposit base increased its market share between FY15-2QFY21 1.6% FB- Kerala share in deposits 68.0% System- Kerala share in deposits (RHS) 4.1% 67.0% 1.1% 1.1% 1.1% 4.0% 0.9% 1.0% 66.0% 4.0% 0.8% 0.8% 65.0% 3.9% 64.0% 3.8% 63.0% 64.1% 3.7% 62.0% 61.0% 3.6% 60.0% 3.5% FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20 2QFY21 1QFY21 Incremental Source: RBI, Company, Ambit Capital research *Incremental market share Source: RBI, Company, SLBC, Ambit Capital research between FY15-2QFY21

If we look the data another way, the market share of FB in Kerala deposits has increased from 14% in FY15 to ~17% in 1QFY21. On an incremental basis, FB has captured ~23% of deposits in Kerala between FY15-1QFY21. In non-Kerala states’ deposits, FB has increased its share from 0.3% in FY15 to ~0.4% in 1QFY21. On an incremental basis, FB has captured ~0.6% of deposits in non-Kerala between FY15-1QFY21.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 13 Federal Bank

Exhibit 25: Increasing market share in Kerala deposits for Exhibit 26: Increasing market share in non-Kerala Federal Bank deposits too 22.6% 0.6% 17.5% 17.5% 16.4% 17.0% 15.4% 0.4% 0.4% 13.7% 14.6% 0.4% 0.3% 0.4% 0.3% 0.3% FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 1QFY21

Incremental Incremental Source: RBI, Company, SLBC, Ambit Capital research *Incremental market Source: RBI, Company, SLBC, Ambit Capital research *Incremental market share between FY15-2QFY21 share between FY15-2QFY21

Bank to maintain its deposit side strength, expect ~13% CAGR in deposit during FY20-23E The bank has maintained its leadership in the liabilities side in the last decade with last 3/5/10-year deposit CAGR of 16%/17%/15% vs 9%/9%/12% for the banking sector. We expect FB to maintain its leadership on the liability side. Our conviction is based on the following points: . Strong brand with long operating history: With long operating history of around ~9 decades, the bank has a strong brand name especially in deposit- rich Kerala. Its deep entrenched relationships can be seen from the fact the share of top-20 depositors remained in the range of only 3-6%, implying lower deposit ticket size. This indicates strong operating relationship with depositors irrespective of rate movement. Post PMC/YES moratorium, many mid/small banks with limited operating history witnessed deposits outflows. However, banks with strong national and/or regional brands gained market share and FB was one of the beneficiaries. . Granularity of deposit provides stability in times of crisis: As highlighted in exhibit 22, FB has the highest share of granular retail deposits (deposit with ticket size <`20mn) in the entire banking system. Banks with higher/lower share of wholesale/retail deposits should face higher impact on deposit growth during times of crisis, especially given deposit insurance being only up to `500k in India. . Higher share of branches in deposit rich Kerala: FB has ~600 branches in Kerala (~48% of FB’s total branches) as of 1QFY21, which is only lower than SBI and Canara Bank. High number of branches in deposit-rich Kerala helps FB in tapping the deposits, especially NRI deposits (~39% of total deposits) which requires customized attention rather than a templated approach. . Regular introduction of customized liability products: The bank has consistently introduced customized products for various customer segments aimed at improving wallet share and generating value for clients. For example, in FY18, the bank created a separate vertical for mobilizing corporate salary accounts. In FY20, the corporate salary portfolio jumped 38% YoY to `14.6bn. In FY19, the bank launched “Bespoke account” offering both better rates and liquidity compared to normal accounts. In FY20, the bank became one of only seven banks empanelled by NSE Clearing Limited for submitting e-FD` (Fixed Deposit Receipts) to clearing members as collaterals.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 14 Federal Bank

Exhibit 27: Top 6 players in terms of branches (1QFY21) in Kerala - FB has 3rd highest number of branches in Kerala helping on the liability side

Branches in Kerala Market share in Kerala in branches (RHS) 1,400 18% 20% 1,200 15% 1,000 11% 800 9% 7% 10% 600 6%

1,193 4% 400 5% 709 600

200 479 415 286 - 0% SBI Canara FB SIB Union Bank CSB Source: Company, SLBC, Ambit Capital research Overall, strong brand name, long operating history, high share stable retail deposits, high share of branches in deposit-rich Kerala to capture more market share and proactive introduction of customized liability solutions mean that deposit growth should sustain in the coming years too. On the conservative side, we expect FY20- 23E deposit CAGR of 13% (vs FY17-20 CAGR of 16%).

December 18, 2020 Ambit Capital Pvt. Ltd. Page 15 Federal Bank

Making strides on yields and fee income FB has taken several steps to improve its income profile (NII+fee). On yields, the bank recently entered high yield segments like CV/CE/MFI and plans to build these books gradually. The bank has made several changes in existing high-yield segments like RM-led model in business banking and doorstep loan services in gold loans. The bank is also planning to enter into credit cards in the next six months. Furthermore, given limited credit opportunities in Kerala, the bank is focusing on non-Kerala states. On the fee side, increasing market share in debit cards, tie-up with third-party players, focus on RM-led model having higher cross-sell opportunities are some of the key steps taken. A largely untapped customer base (>10mn) and maintaining a fine balance between existing and new customers according to segment riskiness means most of these steps should succeed. As a result, we expect ~50bps improvement in both yield and fee to asset during FY21-23E. One of the key concerns that investors have regarding FB is that it is unable to convert its strong liability strength and controlled asset quality issues into higher RoE (>15%) consistently. The reasons for lower profitability are one of the lowest yields, especially amongst mid/regional/small finance banks and weak fee income. Exhibit 28: Yield on advances comparison - FB has lower yield compared to regional/mid/small finance banks and broadly similar to large banks

FY17 1HFY21 Large banks- 8.8% average Other banks- 13.7% average Regional banks- 9.8% average 21.5% 21.2% 21.5% 19.0% 16.7% 14.2% 13.8% 12.1% 12.0% 11.5% 11.4% 11.2% 11.0% 10.8% 10.7% 10.5% 10.4% 10.4% 10.4% 10.2% 10.2% 10.0% 9.4% 9.4% 9.4% 9.3% 9.3% 9.3% 8.9% 8.9% 8.8% 8.7% 8.3% 7.6% 11.5% FB IIB SIB UJJ YES RBK KVB CSB KMB SBIN IDFC AXSB DCBB CUBK Equitas HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research Several steps taken in recent times to increase the yields FB has taken several steps to increase its yield. This includes diversification - both in “Staying true to our themes of terms of product and geography. It has launched various products which will act as ‘Presence to Prominence’ and margin enhancers and broaden the product suite. The bank plans to build these new ‘Prominence to Dominance’, we portfolios gradually so that pressure on asset quality is minimised. are well poised to up the ante and make the Dominant even stronger and strive to make the Prominent to Dominant”- FY19 AR

December 18, 2020 Ambit Capital Pvt. Ltd. Page 16 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Exhibit 29: Recent steps taken including foraying into high yield segments to improve yield/NIMs Probability Segments Steps taken Our view of success . Currently offer co-branded credit cards in tie up with SBI Cards . The bank’s large liability customer (>10mn) has remained broadly untapped till now due to bank’s Planning to roll out its own independent credit card in next six . absence from this segment. This implies huge months growth potential from its internal customers itself. . The bank has already tied up with global payment and service Credit Cards HIGH . The bank will be targeting internal liability provider Fiserv in Aug'20 to enable end to end digitisation of customers first in 1st year of its launch implying card issuance and processing cycle thus supporting in launch of lower risk compared to external customers its own credit card . Knowing track record of the bank, the growth in this . Initially, the bank is planning to target its existing customers segment will be gradual and over period of time to only for risk mitigation keep impact on asset quality under check . In late FY18, the bank carved out specialised vertical for high yield SME portfolio consisting of loans <`50mn from . Separate team for low ticket size will be highly overall SME book beneficial given the customised requirements of this . In FY20, the bank introduced relationship managers at a segment. few key locations to focus on acquisition of new customers . Further, the payoff from this segment is higher due Business Banking rather than only driven through the traditional branch HIGH to high yield (~18%) network . Deploying RMs rather than only focussing branch . The bank conducted extensive market study in FY20 to identify led banking will bring more focus to the customers. the gaps in product offerings and then introduced them. Like, This should lead to higher cross-sell opportunities Entering into tie-ups with partners for daily cash collection and better credit monitoring. arrangement for Business Banking customers . Gold loans continue to remain in demand due to COVID induced liquidity crunch in various households and increase in Gold prices. . Already existing high yield portfolio of ~`120bn (9.6% of the Bank loans becoming difficult for lower strata of loan book as of 2QFY21) . Gold loan HIGH society is also fueling gold loan as alternate source In FY20, the bank launched digitally enabled doorstep gold . of funding for households. loan services to enhance ease of availing gold loan . Its huge branch network along with this new initiative of doorstep gold loan service will only benefit this segment. . The bank has deep knowledge of operating in its . Forayed into CV/CE business in late FY19 starting with Tamil home state- Kerala. Further, Kerala has low credit Nadu and Kerala due to its strong presence in these states penetration. All these should help in growing its . Finances single unit owners, fleet operators and strategic book while minimising impact on its asset quality. clients for their purchase of new/used CV/CE . However, a calibrated approach towards . During FY20, they expanded their reach to entire geographic expansion in other states will be the key CV/CE Southern/Western India. They also hired new talent with MODERATE for superior execution. relevant industry experience in business acquisition, credit . For example, AUSFB started its journey in Rajasthan underwriting and collections in last 18 months or so. and built its business in the state in the first 10 . During FY20 only, the book size doubled to `5.9bn (~0.48% years. Then it began expanding in the adjoining of the loan book). The management plans to increase the book states, which allowed better control on its size to `50bn in next three years. operations/strategy benefiting due to familiarity with the local economies in these states. . Usage of Block chain ecosystem rather than manual loan processing for credit delivery . Tied up with six leading business correspondents in FY20 in . We are not convinced on the business model of selected geographies Micro loans LOW entire MFI lenders as whole. We have seen huge . Risk mitigation through flexibility in choosing geographies and losses during the time of distress (AP Crisis, Demon partners etc) leading to negligible RoEs in longer term. . In FY20, the bank has acquired 13,430 customers with total business of `0.6bn through BCs . New tie ups in dealer/auto financing will help the bank in giving solutions to the entire . The bank entered into agreement with Maruti Suzuki to provide ecosystem/value chain like large banks dealer financing and auto retail financing solutions . However, the dominance in retail lending using tie Others . Focussing more on tie up with various Fintech players for more MODERATE up with various Fintech players should materialise opportunity and access to the millennial segment with extra over a period of time considering high competition emphasis on salaried segment. in this segment from other banks/Fintech lending apps etc. Source: Company, Ambit Capital research

The other strategic shift has been in favour of growing more in non-Kerala states. Historically, Kerala has been a stronghold for deposits (as evident from high deposit to GDP ratio) while weak on credit opportunities (low credit to GDP ratio). As a result of this, FB had to compromise historically in overall income generation (NII and fee income) despite a better liability franchise. Realising this, the management has been focusing on growing more in non-Kerala states which will support the assets side of the balance sheet through better yields and fee income opportunities.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 17 Federal Bank

As evident from the below exhibits, the share of non-Kerala states in the loan book has increased between FY17-2QFY21. Specifically in high-yield segments like retail/SME/agri, the share of non-Kerala states has increased at a higher pace than the overall loan book. The other way to look at this is incremental market share. ~70% of incremental loan growth between FY17-2QFY21 has come from non- Kerala states. Similarly, ~70%/64% of incremental loan growth in SME/Retail (including Agri) between FY17-2QFY21 has come from non-Kerala states.

Exhibit 30: FY17 - Market share in Kerala/non-Kerala for Exhibit 31: 2QFY21 - Increasing market share of various loan segments non-Kerala in various loan segments Kerala Non-Kerala Kerala Non-Kerala

50% 49% 55% 56% 63% 66% 85% 83%

50% 51% 45% 44% 37% 34% 15% 17%

Corporate SME Retail (Inc Agri) Overall Corporate SME Retail (Inc Agri) Overall Source: Company, Ambit Capital research Source: Company, Ambit Capital research

The key for growing more in non-Kerala states has been focus on RM-led distribution, scaling up digital capabilities (more in digital section - Exhibit 53-56) and BC-led model for segments like micro loans. RM-led distribution can be seen from the fact that while the number of overall branches has remained stable in the last few years (1,271 branches as of 2QFY21 vs 1,252 as of FY18, of which ~48% is Kerala-based), the number of RMs has gone up from only 50 in 2010 to 900+ in 2020. High number of RMs spread across India is the main reason for higher growth in non- Kerala states vs Kerala. RM-led model of distribution is expected to be ramped up in the near future because of its multiple benefits – one-stop solution providing entire suit of banking products to clients, higher cross-sell opportunities and cost- effectiveness. Furthermore, increasing share of transactions through digital channels (86% of transactions through digital in 2QFY21 vs 63% in FY18) is also helping the bank in strengthening its loan franchise in non-Kerala states. We do belive these trends to continue in the near future due to high thrust on digitisation by regulators and banks. Foraying into high-margin businesses (CV/CE/micro/credit cards) and high growth in non-Kerala states, especially in high-yield retail/SME segments mean that overall yield and hence NIMs should improve for FB. Above initiatives to have cumulative ~50bps positive impact on yield during FY21-23E: We estimate ~50bps yield compression in FY21E on account of low CD ratio (78% in 2QFY21 vs 80-85% during FY18-20) and interest reversal on NPAs. However, we also believe the positive impact of the above initiatives like moving into high-margin businesses will start reflecting in yield from FY22E. The bank divided its SME division into two parts in late FY18 - commercial banking (>`50mn loans) and business banking (<`50mn loans). This was done to focus more on the high-yield business banking segment. As per bank’s classification, wholesale book includes corporate and commercial banking while retail includes retail, agri and business banking. According to this classification, the share of wholesale has decreased from 54% in 2QFY19 to 48% in 2QFY21 while share of retail increased from 46% in 2QFY19 to 52% in 2QFY21. Management highlighted its intention to take this ratio to 45:55 (wholesale: retail) in the coming two years.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 18 Federal Bank

Exhibit 32: Loan break-up (2QFY19) - Exhibit 33: Loan break-up (2QFY21) - Exhibit 34: Expected Loan break-up Focus more on wholesale Focus shifting towards retail (FY23E) - Retail share to go up

Retail (retail+agri Wholesale Retail Wholesale Retail Wholesale + business (corporate+ (retail+agri (corporate+ (retail+agri (corporate+ banking) commercial) + business commercial) + business commercial) banking) banking)

46% 54% 52% 48% 55% 45%

Source: Company, Ambit Capital research Source: Company, Ambit Capital research Source: Company, Ambit Capital research

Considering FB’s long history of risk-averse lending, this further increase in share of “We have been gaining share very high-yield loans will be slow and gradual to minimize the impact on asset quality. consistently. Our philosophy is not Assuming management target of ~300bps increase in share of retail loans (from to go gangbusters and do the current 52% to target 55% in FY23E) is spread evenly among five high-yield segments wrong thing, just keep very steady - credit cards, CV/CE, MFI, gold loans and business banking, we see ~50bps positive and keep growing. We are a big impact in yield in FY22/23E (~25bps each in FY22 and FY23E). Rahul Dravid fan”- 1QFY21 results concall Exhibit 35: Cumulative ~50bps positive impact on yield during FY22/23E Segments Indicative yield (%) Incremental share-FY22E Incremental share-FY23E Credit cards 22% 0.30% 0.30% CV/CE 12% 0.30% 0.30% MFI 24% 0.30% 0.30% Gold loans 12% 0.30% 0.30% Business banking 18% 0.30% 0.30% Overall increase in share 1.50% 1.50% Positive impact on Yield 0.26% 0.26%

Cumulative increase in share of retail loans in FY22/23E ~3.0% Cumulative positive impact on yield in FY22/23E 0.53%

Source: Company, Ambit Capital research As a result of these positive changes in yield, yield on advances should look like the following table: Exhibit 36: Yield on advances should inch up from FY22E % FY20 FY21E FY22E FY23E FY21 vs FY20 FY22 vs FY21 FY23 vs FY22 Yield on advances 9.18% 8.68% 8.93% 9.18% -0.50bps 0.25bps 0.25bps Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 19 Federal Bank

Recent initiatives taken to improve fee income as well FB’s fee income to asset of 1-1.1% has been historically lower than 1.5-2% for other banks. If we compare various banks wherever breakup of fee income is available, it is evident that roughly half of the gap in fee income comes from the cards business (~30bps only due to card business of 50-60bps gap in fee income). ~25% of the gap comes from weakness in distribution fee income and the remaining ~25% from other businesses. Exhibit 37: Lower fee income from cards/distribution is the key reason for overall low fee income for FB

FB HDFCB AXSB 1.7% 1.8% ~50% of the gap in core fee income comes 1.3%

1.3% from cards business only. 25% of gap comes from distribution fee income 1.1% 0.8% 0.7% 0.7% 0.5% 0.4% 0.3% 0.2% 0.1% 0.1% 0.05%

Fee income to Core fee income Cards fee Distribution fee Other core fee assets to assets income to assets income to assets income to assets

Source: Company, Ambit Capital research However, various initiatives (transactional banking and distribution of third-party products) should help in improving fee income. These initiatives are explained below one by one. Increasing market share in debit cards parameters & entry into credit cards: FB has increased its market share in all debit card parameters as evident from the below exhibit. This increasing market share in payment should help it in increasing its fee income. Exhibit 38: Increasing market share in debit cards parameters

FY17 2QFY21

1.5% 1.4%

1.0% 1.0% 0.9%

0.7%

No of debit cards Debit Cards - Spends (POS) Debit Cards - Spends (ATM) Source: RBI, Company, Ambit Capital research The bank is also planning to launch its own credit card in FY21E. All these will aid fee income in terms of card joining fees, annual fees and MDR charges. This should increase yields as well as fee income as credit card is a >25% RoE business if the issuer is able to contain asset quality. Federal Bank is targeting its own liability side customer base to start its credit card operations Data and commentary from big credit players (HDFC, SBI Cards etc) show that default rates are much lower from customers sourced internally vs those sourced from outside.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 20 Federal Bank

Progressing well on forex/treasury as well: FB has taken several strides on the treasury front as well. New products such as currency options, interest rate futures and calendar spread were launched in FY20. Some of the points highlighting progress made are: . There were five clients in FY20 (till Dec’20) dealing in swaps/options compared to NIL in FY18. . The bank started offering foreign currency loans in FY20. There were 22 clients in FY20 (till Dec’20) availing foreign currency loans vs NIL in FY18. . ~27% of the clients were actively hedging with the bank in FY20 (till Dec’20) compared to 20% in FY19. . FY20 also witnessed first online commercial paper (CP) for a corporate tie-up with NSDL. Traction on third-party fee income: The bank has focused on third-party fee income as well by deepening existing ties or forging new ties with new partners. . The bank entered into an agreement with Equirus Wealth in FY18. FY20 witnessed rapid increase in AUM to `8bn, bringing fee income of `24mn. The bank has set up its first dedicated wealth management centre attached to its Ernakulam Bypass Branch. . The bank partnered with SMC Global Securities and IIFL Securities for Fed e- Trade (online share trading). Geojit Financial Services was already a partner. . For the insurance business, FB partnered with IDBI Federal (Life Insurance JV), Max-Bupa, Bajaj-Allianz, HDFC-Ergo & TATA-AIG (non-life insurance). Focus on RM-led distribution rather than traditional branch banking: As highlighted earlier, the bank is focusing more on relationship-driven (RM) client management rather than traditional branch-led model. This helps in cross-selling of various banking products to clients. The number of RMs has gone up from only 50 in 2010 to 900+ in 2020. As this number further goes up, the cross-selling opportunities will increase. Other initiatives: FB became the first bank to launch a facility for instant opening of demat accounts. Furthermore, the bank has launched QR-based insurance and received tele-marketing license from IRDA for insurance sales. The bank started insurance tele-sales activity in Jan’20. Above initiatives to have cumulative ~50bps positive impact on core fee income to asset ratio during FY21-23E While we expect core fee income to asset ratio to decline by ~15bps in FY21E due to negative impact of lockdown in 1HFY21, the core fee income to asset ratio should at least improve by ~25bps in FY22E and another ~25bps in FY23E. The major driver of this improvement would come from the cards business. For large banks, the cards business contributes 30-40% of overall core fee income. The share of cards business in fee income has increased in recent years. Exhibit 39: Cards contribute 30-40% of overall core fee income Cards fee as % of overall fee FY17 FY20 3 Year CAGR AXSB 21% 30% 25% HDFCB 27% 37% 33% Source: Company, Ambit Capital research As highlighted earlier, nearly half of the gap in core fee income between FB and other large banks comes from the cards business. FB is expected to launch its credit card business in the next six months. The bank has already tied up with global payment and service provider Fiserv in Aug'20 to enable end-to-end digitisation of card issuance and processing cycle, thus supporting launch of its own credit card. The bank plans to target internal liability customers in the first year of its launch to minimize the impact on asset quality. As the bank gains experience in this segment, it will gradually open this product to external customers. We believe the credit card business will lead to ~5/10bps improvement in fee come to asset ratio in FY22/FY23E.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 21 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Exhibit 40: Credit cards business will contribute majority of fee income improvement Credit cards business FY20 FY21E FY22E FY23E Comments No of debit cards (mn) 7.7 8.4 9.3 10.2 Assuming 10% growth in every year Credit to debit ratio (%) 3% 8% ~15%/20%/44% for KMB/ICICIBC/HDFCB

No of credit cards (mn) 0.32 0.82

Annual spend per card (`) 100,000 130,000 91k/114k/156k for KMB/ICICIBC/HDFCB

Total annual spend (` mn) 31,506 106,010

Core Fee as % of spend 3.50% 3.50% Same as for SBI Cards

Fee Income (` mn) 1,103 3,710

Fee Income as % of avg. asset 0.05% 0.15%

Source: Company, Ambit Capital research In FY22E, ~25bps YoY improvement should be driven by 15bps YoY improvement due to normalization (as FY20 was impacted due to COVID), 5bps due to credit cards and remaining 5bps due to improvement in distribution/other businesses as a result of increasing tie-ups with third-party players. In FY23E, ~25bps YoY improvement would be driven by 15bps due to credit cards and remaining 10bps due to improvement in distribution/other businesses. As a result of these positive changes in yield, the yield on advances should look like the following table: Exhibit 41: Core fee to assets ratio should inch up from FY22E % FY20 FY21E FY22E FY23E FY21 vs FY20 FY22 vs FY21 FY23 vs FY22 Core fee to assets 0.72% 0.56% 0.82% 1.07% -0.16bps 0.25bps 0.25bps Source: Company, Ambit Capital research Keys for FB’s success in these initiatives FB would be successful in most of these initiatives related to improving yield and fee income. The bank has a strong >10mn existing customer base. Currently, the bank is not present in high-yield credit cards and has only 1% loan in personal loans, leaving the large customer base largely uptapped in these products. As the bank tries to grow more in high-yield/high-fee income segments, it can start with its existing large and untapped customers first, leading to more cross-sell opportunities and less risk of any asset quality issues. In its recent Investor day, the bank highlighted its strategy of maintaining balance between existing and new customers according to the risk profile of segments. For example, high-risk products like personal loans will be given predominantly to existing customers, while low-risk products like home loans will be given to existing as well as new customers in equal proportion. As the riskiness of product increases, the proportion of existing customers goes up. Exhibit 42: Maintaining a fine balance between existing and new customers calibrated with segment-wise risk

Existing to Bank New to Bank 1%

38% 35% 50%

99%

62% 65% 50%

Home loan LAP Auto Personal Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 22 Federal Bank

Addressing other investor concerns On transition risk, the CEO should get another extension in Sep’21 considering his eligibility to serve for at least another ~5 years. Furthermore, the strong board having ~3 decades of banking experience should smoothen the impact of a CEO change, if it happens. On unionized employees, the bank has cordial relations with the union and has hardly lost 2-3 days in the last decade to protest. The bank has freedom in hiring external talent and its ESOP policy is at par with large banks. Also, combination of older employees getting superannuated by FY23E and adoption of defined contribution plans for employees joining after Apr’10 should lead to reduction in pension liability. On impact of slowdown in Middle-East on NR franchise, despite NR deposit growth decreasing at the system level, growth for Kerala and FB NR deposit has remained robust, indicating market share gains. This trend should continue due to strong presence in Kerala and diversification away from Middle-East (110+ remittance arrangements worldwide).

Strong board should help in smoothening impact of CEO change In July’20, the RBI gave an extension of only one year up to Sep’21 to MD & CEO Mr. Shyam Srinivasan. This has been a key concern for investors as the bank might be exposed to transition risk if the current CEO does not get extension. However, we see no or minimal transition risk for Federal Bank as explained below: In June’20, the RBI in a working paper suggested capping the tenure of promoter CEO/wholetime directors to 10 years and non-promoter CEO/wholetime directors to 15 years. Furthermore, the upper age limit for CEO/wholetime directors of banks is 70 years. FB has board-driven process to appoint key personnel and does not have any promoter. Therefore, even assuming the suggestions for capping tenure of CEO/WTD getting accepted by the RBI, Mr. Shyam Srinivasan will have another ~5 years to serve as MD & CEO (he joined as CEO in Sep’10 and his current age is 58). We don’t see any material reason for him not getting extension further in Sep’21 by the RBI. Even if we leave aside issues surrounding the remaining tenure of the MD & CEO, the board is quite strong with rich banking experience. Most of the board members have around and above three decades of banking experience. Six of the eleven member board have more than 6 years of service left with them. Strong board should help in finding the right candidate if the need arises.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 23 Federal Bank

Exhibit 43: Strong board with over three decade of average banking experience. Name Designation Background . Joined the bank in Sep'10 as MD & CEO and has 20 years of rich banking experience across retail/SME banking and wealth management . Instrumental in increasing visibility of the bank at national level, improvement in underwriting, taking Managing Director Mr. Shyam Srinivasan initiatives to improve upon customer centric and HR related processes & CEO . Served as Chairman of IBA Committee, member of Financial Sector Legislative Reform Committee set by RBI etc. . Alumnus of IIM Calcutta and REC Tiruchirapally . Has over 38 years of banking experience working with State Bank of India, IDBI Bank etc. Executive Director Mr. Ashutosh Khajuria . Joined Federal Bank in 2011 as President and Head-Treasury and then worked on business development & CFO in the entire network of branches/offices outside Kerala . Post Graduation in Economics and Graduate in Science from Banaras Hindu University . Has over 28 years of banking experience working with Standard Chartered Bank earlier Executive . Joined Federal Bank in Nov-15 as Chief operating officer (COO) and then worked as head of retail Ms. Shalini Warrier Director banking products . Member of the Institute of Chartered Accountants of India and Certified Associate of Indian Institute of Bankers. . Has 36 years of rich experience in central banking in the Reserve Bank of India. Has served as charge of the Foreign Exchange Department in RBI Central Office from 2001-2004 Smt. Grace Elizabeth Koshie Chairperson . . Postgraduate in Economics from Bombay University, PG Diploma in Higher Education and Certified Associate of Indian Institute of Bankers. . Co-opted on the Board of the Bank in Jun'15. Also, served as mentor for startup ventures, community Independent development activities etc. Mr.C Balagopal Director . Earlier, served as the IAS between 1977-1983 . Post graduate in Economics from Madras University . Has rich banking experience of over 27 years across Technology and Payment Systems . Served as MD & CEO of the NPCI between 2009-2017 Independent Mr.A P Hota Director . Currently, also serving as Director on the Board of IDBI Intech Ltd, Motilal Oswal Asset Management Company and NSDL e-Gov Infrastructure Limited . Post graduate in English Literature and a Certified Associate in Indian Institute of Bankers . Has over 30 years of professional experience, of which ~25 years have been in the Financial Services business Mr.Balakrishnan Independent Earlier, served as Managing Director of Lazard LLC, Head of Corporate Finance and Advisory for HSBC Krishnamurthy Director . Investment Bank . A qualified Chartered Accountant and Company Secretary Independent Has over 36 years of banking experience with State Bank of India Mr.Siddhartha Sengupta . Director Served as Chairman of the Board of 5 overseas subsidiaries of SBI. Independent . Founding partner of Fadnis & Gupte , Chartered Accountants Mr.CA Manoj Fadnis Director . Elected as the President of Institute of Chartered Accountants of India (ICAI) for the year 2015-16 Independent . Has 36 years of rich experience in central banking in the Reserve Bank of India Mr.Sudarshan Sen Director . MBA in International Banking and Finance from the University of Birmingham, UK. . Has over 36 years of banking experience with State Bank of India Independent Ms.Varsha Purandare Director . Earlier, served as MD & CEO of SBI Capital Market Limited, Deputy Managing Director and Chief Credit Officer/ Chief Risk Officer (CCO/CCRO) of SBI Source: Company, Ambit Capital research The bank has also hired external talent in its various businesses in recent years. These people have deep expertise in their respective domains and have worked with large private/MNC banks like HDFC Bank, ICICI Bank, Standard Chartered Bank etc. This has also helped the bank in building its bench strength. Exhibit 44: Recent hires in various businesses - Building bench strength Appoint. Total banking Name Role Prior organisations year experience Shalini Warrier 2015 COO & Head- Retail Banking Products Standard Chartered Bank 28 Harsh Dugar 2016 Head of Wholesale Banking HDFC Bank 24 Kapil Bhatia 2017 Head - North and East Corporate and Institutional Banking HDFC Bank, BNP Paribas 21 Divakar Dixit 2017 Head - Credit (Commercial & Business Banking and Retail) HDFC Bank, ICICI Bank 23 Karur Vysya, DBS, ICICI Pitchai Mahalingam 2017 Head- Operations & Transaction Banking 32 & Barclays Bank Nilufer Mullanfiroze 2018 Head- Deposits, Cards & Personal Loans Standard Chartered Bank 22 HDFC Bank, Kotak Mahindra Sanjesh Kumar 2018 Head- Credit (Mid and Large Corporates) 20 & ICICI Bank V Lakshmanan 2018 Head- Treasury BNP Paribas 20 Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 24 Federal Bank

Incentive structure at par with large banks The compensation structure of higher management of FB is at par with large banks and better than its regional/mid-size peers. The compensation consists of fixed, variable and ESOPs. ESOP incentivises the management to work towards improving the bank’s performance. FB unlike other regional banks has ESOPs policy at par with the large banks. As evident from the below exhibit, the outstanding ESOPs as a proportion of outstanding shares for FB are at par with large banks and higher than regional/mid-size peers. Other regional banks like SIB/CSB/KVB have been laggards in this as aspect. Exhibit 45: Outstanding ESOPs (as % of outstanding shares) - FB has higher ESOP outstanding compared all other banks except RBK

Large private banks Regional banks Other banks 7.3% 4.7% 3.7% 2.6% 2.5% 2.4% 2.2% 1.3% 1.2% 1.0% 0.4% 0.3% 0.2% 0.1% FB IIB SIB UJJ RBK KVB CSB KMB AXSB DCBB CUBK HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research Even the ESOP grants in the last three years have been negligible to quite low for regional/mid-size banks. Whereas ESOP grants for FB has been higher compared to other banks. Exhibit 46: ESOPs granted (as % of outstanding shares) - FB has higher ESOP grants vs other banks except RBK

Other banks Large private banks Regional banks

FY18 FY19 FY20 4.0% 2.5% 2.2% 2.0% 1.9% 1.1% 0.9% 0.9% 0.7% 0.7% 0.7% 0.7% 0.7% 0.5% 0.4% 0.3% 0.3% 0.3% 0.3% 0.3% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% FB IIB SIB UJJ RBK KVB CSB KMB AXSB DCBB CUBK HDFCB AU SFB ICICIBC Source: Company, Ambit Capital research

Impact of union on expenses and productivity, ability to hire The other concern investors have is impact of unionized employees on expenses and other functions of the bank. However, there is not much difference in functioning style of unionized employees and non-unionised ones. We say so mainly because of the following reasons: . Liberty in hiring external talent: Despite having an employee union structure, it has all liberty of recruiting external talent whenever required. The MD & CEO of the bank is himself an external hire. As highlighted in exhibit 44, there are many other critical positions that have been filled from outside in recent years.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 25 Federal Bank

. No material impact on productivity: The relationship between FB and its union has been cordial, which can be gauged from the fact that hardly 2-3 days have been lost in union protest in the last 10 years. Furthermore, as highlighted in exhibits 45 and 46, the company pays variables/ESOPs like all other banks to incentivize employees to perform better and improve productivity. . Pension liability to reduce from FY23E as older employees superannuate: The only issue in this unionized structure is pension liability that needs to be calculated regularly depending on various variables like yield movement, expected salary hike etc. There as well, the bank expects pension liability to reduce considerably by FY23E as older employees superannuate from the bank gradually. The average age of the bank employees is only ~34 years and after considerable number of older employees having higher pension liabilities retires, it will become easier for FB to control this cost item as well. . Adoption of defined contribution pension scheme for late joiners to further reduce pension liability: According to the industry-level settlement dated 27th April 2010, the bank moved into defined contribution pension plans from defined benefit plans for those employees who joined the company after 1st April, 2010. This will reduce pension liability for the bank. In defined contribution pension plans, the bank has to make fixed periodic payments without taking care of investment risks. This means that the bank is not legally bound to make any additional contribution depending on the yield movement. Since the bank does not have any accountability towards the plan performance, this requires less work, thus is cost effective and poses low risk. Whereas, in the case of the earlier pension plan, i.e. defined benefit plan, the bank assumes the investment risks as well with the periodic payments. So, when yield goes down (which is the case worldwide now), the bank will have to make additional contribution apart from periodic payments depending on the actuarial valuation. This poses risk for the bank and is quite costly as well. Overall, most of the older employees (joined before Apr’10) on defined benefit plans (which are costly and riskier for the bank) are expected to superannuate by FY23E. Late joiners (joined after Apr’10) are on defined contribution plan (cost effective and less risky for the bank). These two points will drive the reduction in pension liability considerably. Slowdown in Middle-east would have limited impact on NR deposits and retail asset quality The other investor concern is impact of the slowdown in the Middle East on its NR deposit base (~39% of total deposit) and retail asset quality. With slowdown in the Middle-East, the general perception is remittances in the country should slow down considerably given most of it comes from the region. While there are multiple factors driving NRI remittance flow in a country and it is a complex subject in itself with wide academic literature written on it, we try to simplify and explain why it should not be that much of a concern in case of FB. Kerala constitutes ~96% of NR deposits for FB. While NR deposit growth at the system level has come down from 11% YoY in FY15 to no growth YoY in FY20/1QFY21, growth in Kerala state has remained strong from 17% YoY in FY15 to 10%/13% YoY in FY20/1QFY21. As a result, the market share of Kerala in NR deposit has increased from 15% in FY15 to 22% in 1QFY21.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 26 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Exhibit 47: NR deposit growth in Kerala higher than Exhibit 48: leading to market share gain for Kerala state overall system in NR deposit 30% System- YoY growth Kerala Non-Kerala 25% Kerala- YoY growth 20% 15% 13% 10% 85% 84% 80% 79% 79% 79% 78% 5% -1% 0% -5% 15% 16% 20% 21% 21% 21% 22% -10% FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 FY15 FY16 FY17 FY18 FY19 FY20

1QFY21 Source: Company, SLBC, Ambit Capital research Source: Company, SLBC, Ambit Capital research

If we look at the long term correlation between NR deposit growth at the system level and bank level, the correlation is strong at 0.5 in the last decade (1QFY10-1QFY21). From the outset, it suggests that NR deposit growth of FB should suffer in case remittances fall at the country level. However, the correlation has been consistently decreasing in recent years. During the last 5 years (1QFY16-1QFY21), the correlation has come down to 0.3 while in the last three years (1QFY18-1QFY21), the correlation has entered negative territory. The decreasing correlation coefficient implies market share gain for FB in NR deposits in recent years. While NR deposit growth at the system level has come down from 11% YoY in FY15 to no growth YoY in FY20/1QFY21, growth for FB has remained robust at 28% YoY in FY16 and 14%/19% YoY in FY20/1QFY21. Exhibit 49: Decreasing correlation in NR deposit growth between FB and system

FB- NR deposit growth YoY System- NR deposit growth YoY 100% 1QFY10-1QFY21 correlation coefficient-> 0.5

80% 1QFY16-1QFY21 correlation coeff.-> 0.3

60% 1QFY18-1QFY21 Negative correlation 40% coeff.-> -0.3 implying market share gain for FB 20%

0%

-20%

1QFY10 3QFY10 1QFY11 3QFY11 1QFY12 3QFY12 1QFY13 3QFY13 1QFY14 3QFY14 1QFY15 3QFY15 1QFY16 3QFY16 1QFY17 3QFY17 1QFY18 3QFY18 1QFY19 3QFY19 1QFY20 3QFY20 1QFY21 Source: RBI, SLBC, Company, Ambit Capital research Furthremore, the NR deposits market share movements for FB in Kerala/Non-Kerala states have been increasing consistently for 5 years as given below. In Kerala (constituting ~96% of FB NR deposit), the market share of FB has increased from 21% in FY15 to 27% in 1QFY21 as given below.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 27 Federal Bank

Exhibit 50: Increasing market share in NRE deposit across states

Kerala Non-Kerala Overall 26.5% 26.7% 25.4% 24.0% 22.9% 21.2% 21.7% 6.0% 5.9% 5.6% 5.2% 4.8% 3.7% 3.4% 0.2% 0.3% 0.3% 0.3% 0.3% 0.2% 0.2%

FY15 FY16 FY17 FY18 FY19 FY20 1QFY21 Source: RBI, SLBC, Company, Ambit Capital research If we look at the market share of top 3 players in Kerala (SBI/FB/SIB), FB has rapidly gained market share at the expense of SBI. Exhibit 51: Market share of top 3 players in Kerala NR deposit - FB gaining at the expense of SBI

37.6% SBI FB SIB 33.5% 28.7% 26.7% 22.9% 21.2%

10.0% 10.3% 8.5%

FY15 FY17 1QFY21 Source: RBI, SLBC, Company, Ambit Capital research With these recent steps, long operating history and strong brand in Kerala, we believe market share gain should continue in the near future. This should help FB even if remittances at the country level declines. Also, in FY20, the bank partnered with three new entities for remittances from three new geographies; Speed Money Transfer - Japan, Lulu Money - Hong Kong and Bank Al Jazira - Saudi Arabia. There have been more than 110 plus remittance arrangements across the globe. Hence, as per our primary channel checks, while remittance flow from the Middle-east has been growing, its share in the overall mix has been coming down (from ~90% 3-4 years back to ~75% now) and share of remittances from other geographies has been increasing in the past few years. Also, as per the management, the reason for robust growth in its NRE deposit despite stress in the Middle-East or remittances falling at the country level is that NRIs tend to send more money back home in time of stress. These are “must send home” kind of money rather than speculation money that flows into the bank at the time of stress. The other reason is FB’s strong presence in Kerala (~48% of its branches in Kerala) with third highest number of branches (~600 in Kerala as of 1QFY21) only after SBI and Canara Bank. On retail asset quality, too, we did not find any material correlation between NRE deposit growth and retail gross slippages. 25-30% of the retail portfolio is linked to NR. If NRE deposit growth holds up well for the reasons highlighted above, we believe impact on retail asset quality should also be limited.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 28 Federal Bank

No need of any immediate equity raise at current depressed valuations The Tier 1 ratio of FB stands at 13.3% as of 2QFY21/FY20 vs regulatory requirement of 8.9%. Although it seems relatively low as compared to its major private peers, we believe they have enough firepower to absorb the potential NPA shock if any and not in immediate need of capital raise at current depressed valuations. We did a rough calculation to see the provisioning level required to breach the statutory Tier 1 ratio of 8.9% by FY23E. Even assuming RWA/asset ratio increase by ~300bps by FY23E due to increasing share of high-yield loans (CV/CE/MFI/credit cards) having higher risk weights, the current capital base has enough cushion to absorb ~`138bn as provision for potential NPAs during FY21-23E or 3.1% credit cost on annualized basis. This is much higher than 1% average credit cost in FY18-20 and our average credit cost estimate of 1.3% during FY21-23E. Exhibit 52: Provisioning level required to breach the mandatory Tier 1 ratio ` bn FY20 FY23E Loans 1,223 1,776 Asset 1,806 2,679 RWA/Asset- Increasing share of high yield loans 59% 62% RWA 1,058 1,649 Tier -1 13.3% 8.9% Tier -1 Capital 141 146 Increase in requirement of Tier 1 capital in next 3 years 6

PPOP for next 3 years- FY21-23E 146

Implied provision required in next 2 Yr to breach required Tier 1 ratio 138

Provision as % loans (annualized) 3.1%

Source: Company, Ambit Capital research Building digital capabilities - Getting future ready The digital offering of the bank is another area which remained under-appreciated by investors. Over the years, the bank has scaled up its digital capabilities in line with large banks. The bank has made sure it remained relevant in this digital era. The share of digital transactions increased from 74% in 4QFY19 to 86% in 1QFY21. Exhibit 53: Increasing share of digital transactions

8.0 90% Transactions through Branch (mn) Transactions through Digital Channels (mn) 6.0 Digital Share (%) 86% 85% 6.0 5.1 5.1 4.8 82% 80% 3.9 3.9 4.1 80% 83% 4.0 77% 76% 75% 74% 2.0 1.4 1.2 1.2 1.2 1.1 1.1 1.0 70%

0.0 65% 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 2QFY21 Source: Company, Ambit Capital research A few digital capabilities built by the bank over the last few years: . Be Your Own Master (BYOM) app: Digital instant lending platform for personal loans launched in FY17. The loan book using this app stands at `14bn as of 2QFY21 (~86% of its personal loan book), registering 50% YoY growth in 2QFY21. In FY20, >90% of the personal loans were originated using this app. The app is also connected with Google Pay and Paisa Bazaar clubbed with HDFC Ergo insurance. There is EMI facility available through Pinelabs, Flipkart and Amazon.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 29 Federal Bank

. Mobile banking (FedMobile) app: Fedmobile is the official mobile banking app of FB. While the number of transactions using the mobile app has gone up by 75% YoY in 2QFY21, there was 35% YoY growth in mobile banking users. . Fed e-biz: Omni channel transaction banking platform for corporates. The loan book using this app stands at `62bn as of 2QFY21 (~13% of its corporate loan book), registering 97% YoY growth in 2QFY21. . First bank to launch several digital innovations: The bank has been at the forefront of digital innovation. For example:  QR code for insurance business  Blockchain-based cross-border remittance solution  FedRecruit- AI-based online recruitment solution  Fedbook Selfie- First mobile-based account opening app  FedAlert- First bank to launch highly secured alert app  FedNet- Instant online demat account opening . Other initiatives taken by the bank:  Lotza BHIM UPI- UPI app having flexibility of bundling all bank accounts in a single app  PayLite- Solution to uplod/process bulk transactions for corporates  FedCorp- Mobile banking app for corporate/SME customers

Exhibit 54: BYOM personal loan book Exhibit 55: Mobile banking numbers Exhibit 56: Fed E Biz-Corporate book

BYOM- Loan book (` bn) Mobile Banking Volume (in bn) Fed E Biz- Loan book (` bn) YoY growth in digital users (%, RHS)

100 50% 62 79 80 40% 14.2 13.5 35% 48 45 12.6 60 30% 11.0 9.5 35

40 20% 31 7.6

20 10% 24 5.2 13 - 0% 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 2QFY21 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 2QFY21 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 2QFY21 Source: Company, Ambit Capital research Source: Company, Ambit Capital research Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 30 Federal Bank

Poised for re-rating due to improvement in asset quality and profitability FB has de-rated in the last ten months due to concerns around asset quality pressure due to COVID-19 and weak income generation profile. The stock now trades at 0.8x 12M forward P/B which is ~35%/26% lower than the 10- year/3-year average. The discount is even more significant when seen against balance sheet size measured in terms of the bank’s loan and deposit book (MCap/Loan and MCap/deposit of 0.1/0.1 for FB vs 0.4/0.3 for CUBK). However, as explained in earlier sections, we believe asset quality concerns are overdone and FB has taken several steps to improve its income generation profile (both NII and fee income), resulting in long-term RoE of 14-15%. With limited downside in case of a negative surprise, we expect valuations to re-rate. Our TP of `102 implies 1.1x FY22E BVPS.

P/B and P/E have corrected to below historical mean FB has corrected in the past as well whenever any asset quality issues emerged in its book. However, this price correction has been deep (~55% decline between Jan’20- Mar’20 and 28% decline between Jan’20 till date). Given this share price underperformance, FB now trades at 0.8x 12M forward P/B, which is ~26% lower than its three-year rolling average of 1.1x. This deep correction was on the basis of expected asset quality issues arising out of COVID-19 and concerns regarding lower profitability. Exhibit 57: FB has de-rated whenever any asset quality issue has emerged

2.0 Stress due to few Due to fall out of corporate accounts COVID 1.5 RBI-AQR Induced asset quality worries

1.0

0.5 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20

12M FWD PB 3 year rolling average Source: Bloomberg, Company, Ambit Capital research Consensus RoE for FY21/22/23E is 8%/9%/10% (our estimates are 9%/12%/16%) vs FY19-20 average RoE of 10%. Consensus forecast for FY20-23E EPS CAGR is now ~5% (our estimate: 27%) vs FY18-20 CAGR of 32%. However, the fall in multiples has been faster than the reduction in RoE and EPS CAGR and thus multiples above the historical average is justified.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 31 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Exhibit 58: P/B multiples have fallen faster than RoE Exhibit 59: P/E multiples have also fallen faster than reduction reduction in consensus EPS CAGR

2.0 15.0% 20 35% 30% 13.0% 1.5 16 25% 11.0% 1.0 12 20% 9.0% 15% 0.5 8 7.0% 10% 0.0 5.0% 4 5% Jan-14 Oct-14 Jul-15 Apr-16 Jan-17 Oct-17 Jul-18 Apr-19 Jan-20 Oct-20 Jan-14 Oct-14 Jul-15 Apr-16 Jan-17 Oct-17 Jul-18 Apr-19 Jan-20 Oct-20

12M FWD PB 12M FWD RoE (%) 12M Fwd PE 2yrs EPS CAGR (RHS) Source: Bloomberg, Ambit Capital Research Source: Bloomberg, Ambit Capital Research Fundamentals don’t justify underperformance, discount to peers . FB has lower exposure to riskier segments like microfinance, CV/CE, unsecured loans vs IIB/RBL/Bandhan. Moreover, as highlighted in earlier sections, data till 2QFY21 does not suggest that FB would have higher NPA formation than IIB/RBL/Bandhan. . On strength of the liability franchise and cost of funds, FB is better than RBL/IIB/Bandhan. . However, FB lags peers in terms of interest yield and fee income compared to other mid-size/small banks Exhibit 60: Federal Bank is our top pick in mid-cap banks Income generation Bank Liabilities strength Asset quality Overall (NII+fee income) FB CUBK IIB RBK Bandhan Source: Company, Ambit Capital research. Note: - Highest; - Relatively high; - Average; - Relatively low The strength of its liability franchise, interest yield and fee income generating abilities and asset quality risk combined helps FB score over most of its peers. However, it trades at 0.7x FY22E P/B which is at ~54% discount to mid-size/small peers despite better profitability and franchise strength.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 32 Federal Bank

Exhibit 61: FB has been trading at a discount to peers despite higher expected profitability

18% AU SFB ICICIBC 16% AXSB 14% FB UJJ HDFCB 12% CUBK EQUITAS KMB 10% IIB BANDHAN KVB 8% DCB 6% FY22E RoE (%) RoE FY22E SIB 4% IDFCB

2% RBK 0% YES 0.0 1.0 2.0 3.0 4.0 5.0 6.0 FY22E P/B (x) Source: Bloomberg, Company, Ambit Capital research *BBG estimates for non-covered companies The discount is even more significant when seen against balance sheet size measured in terms of the bank’s loan and deposit book. This helps in comparing banks against its fundamental tangible attributes. Exhibit 62: FB is trading at a significant discount relative to its loan/deposit base

Mcap/Loan (x) Mcap/Deposit (x) 1.1 1.1 1.0 0.9

0.4 0.4 0.3 0.3 0.3 0.2 0.2 0.1 0.1 0.1

AU SFB Bandhan CUBK IIB RBK DCBB FB Source: Bloomberg, Company, Ambit Capital research The discount seems to be driven by the fact that all other banks are led by promoter CEOs and FB’s image of a regional bank. However, history has shown that promoter- run banks are not destined for success. In fact, both new private sector banks (Global Trust Bank, Yes Bank) that have been rescued by regulators over the last 20 years were run by promoters. On the other hand, three largest private sector banks (HDFC Bank, ICICI Bank, Axis Bank) have been run by professional management. Given all the advantages FB enjoys over other mid-cap banks, we don’t see any reason for FB to trade at such a discount to other mid cap banks. Amongst mid-cap banks, we have BUY on FB and City Union bank and SELL on RBL/Bandhan. FB is our top pick in the mid-cap space. Between FB and CUBK, our pecking order is FB followed by CUBK mainly because of FB’s lower exposure to SME/business banking than CUBK. Though, the liability side of CUBK is strong but remains lower than FB as evident from higher cost of funds (5.6% for CUBK vs 5.1% for FB as of 1HFY21) and lower share of retail deposits (75% for CUBK vs 88% for FB). Furthermore, FB’s valuation of 0.9x FY20 P/B vs 2.6x for CUBK provides comfort.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 33 Federal Bank

Detailed assumptions and estimates Exhibit 63: FB’s credit cost to remain <150bps in FY21/22/23E while yield/fee income should improve from FY22E ` mn FY18 FY19 FY20 FY21E FY22E FY23E Comments Assumptions

We expect loan growth to pick up materially in FY22 vs FY20/21E YoY loan growth 25.4% 19.9% 10.9% 9.5% 14.8% 15.5% given our expectation of some pick-up in system growth in FY22E and supported by strong retail deposit base. In FY21E, we expect pressure on yield due to negative impact of Yield on advances lower CD ratio and interest reversal on NPAs. However, FY22/23E 9.12% 8.99% 9.18% 8.68% 8.93% 9.18% (calculated) should see spike in yield as bank’s move to increase share of high yield retail loans (MFI/PL/CC/CV) materialises. Cost of funds 5.43% 5.44% 5.61% 5.04% 5.13% 5.33% We do expect bank to maintain its leadership on cost of funds side. (calculated) Net interest margins We expect NIMs expansion as a result of its leadership in liability side 2.97% 2.94% 2.88% 2.92% 3.05% 3.14% (calculated) coupled with yield expansion We expect fee income to decline YoY in FY21E due to negative impact of lockdown. We do expect substantial improvement in Core fee income to FY22/23E due to movement in high yield segments especially in 0.64% 0.70% 0.72% 0.56% 0.82% 1.07% asset Credit cards which are a major source of fee income. RM led model will also have positive impact on fee income due to higher cross sell opportunities. We expect cost to asset ratio to moderate due to branch light but distribution heavy through RM/digital channels strategy employed by the bank. Furthermore, superannuation of older employees by FY23E Cost to asset ratio 1.94% 1.86% 1.99% 1.86% 1.81% 1.78% and adoption of defined contribution plan for employees joining after Apr’10 will also reduce pension liability and thus leading to lower cost to asset ratio. Gross NPA ratio 3.00% 2.92% 2.84% 3.19% 4.04% 3.83% We expect gross NPA to inch up due to assumed muted recoveries We don’t expect much spike in credit cost due to COVID-19 due to Credit cost 1.15% 0.85% 1.01% 1.33% 1.39% 1.28% lower exposure to stressed segments and thus lower LGD. Outputs (` bn) NII 35.8 41.8 46.5 53.6 63.8 74.6 Operating profit 22.9 27.6 32.0 35.2 47.8 63.0 Net Profit 8.8 12.4 15.4 13.6 20.9 31.4 EPS (`) 4.5 6.3 7.7 6.9 10.5 15.8 BVPS (`) 61.9 66.9 72.9 79.7 90.2 106.0 RoA (%) 0.69% 0.84% 0.91% 0.70% 0.94% 1.25% RoE (%) 7.8% 9.8% 11.1% 9.0% 12.3% 16.1% Source: Company, Ambit Capital research Our FY21/FY22/FY23 EPS estimates are 9%/40%/77% higher vs consensus given lower credit cost estimates and higher income generation ability (NII+fee income), especially in FY22/23E. Exhibit 64: Ambit vs consensus - We are 9%/40%/77% above consensus Federal Bank (` bn) Consensus Ambit Difference (%) Net profit (` bn)

FY21E 12.5 13.6 9% FY22E 15.0 20.9 39% FY23E 17.8 31.4 77% EPS (`)

FY21E 6.3 6.9 9% FY22E 7.5 10.5 40% FY23E 8.9 15.8 77% BVPS (`)

FY21E 78.0 79.7 2% FY22E 83.8 90.2 8% FY23E 90.7 106.0 17% RoE (%) FY21E 8.3% 9.0% 0.7% FY22E 9.3% 12.3% 3.0% FY23E 10.2% 16.1% 5.9% Source: Bloomberg, Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 34 Federal Bank

Given strength of the liability franchise, recent initiatives on fee income/yield and controlled asset quality issues, we don’t see RoE going below 14-15% from a long- term perspective (from FY23E) after recording ~9%/12% in FY21/22E. Exhibit 65: RoA/RoE will expand in the long term Long term assumptions FY05-12 FY12-20 Phase 1 - FY20-23 Phase 2 – FY23-39 Median assets growth (YoY) 18.7% 15.2% 13.7% 14.0% Median RoA 1.3% 0.9% 0.9% 1.2% Median RoE 13.4% 11.1% 11.7% 14.1% Source: Company, Ambit Capital research The long-term RoE assumption is in line with other banks under our coverage. Exhibit 66: Long-term RoE should be >14% for FB Bank FY16-FY20 FY21-22E FY23-39E HDFCB 17.4% 13.3% 16.9% CUBK 14.1% 9.8% 16.9% AXSB 6.7% 13.0% 15.4% ICICIBC 7.7% 13.0% 15.1% KMB 12.0% 10.6% 15.1% SBIN 1.9% 8.2% 14.5% FB 8.9% 10.7% 14.8% Bandhan 22.4% 7.2% 13.0% RBK 10.4% 3.3% 12.3% Source: Company, Ambit Capital research Based on our assumptions described in the previous section and assuming cost of equity of 14%, our “excess return model” gives a target price of `102, implying1.1x FY22E BVPS and ~10x FY22E EPS. Our cost of equity assumption of 14% for FB is 50-100bps higher than that of large private banks. Taking above assumptions into account, we change our estimates from the last published numbers post the 2QFY21 results. We also introduce FY23 estimates. We factor in higher NIM and fee income assumptions as explained in earlier sections. We have also reduced our cost of equity assumption from 14.5% to 14% due to reducing risk on the balance sheet as explained. Exhibit 67: Change in estimates New Estimates Old Estimates Change FY21E FY22E FY23E FY21E FY22E FY23E FY21E FY22E Recommendation BUY BUY

Target price (`) 102 72 41%

Assumptions

YoY loan growth 9.5% 14.8% 15.5% 9.5% 14.1% NA 0bps 78bps Net interest margins 2.92% 3.05% 3.14% 2.87% 2.74% NA 5bps 31bps (calculated) Fee income to assets 0.6% 0.8% 1.1% 0.6% 0.6% NA -1 bps 21bps Cost to assets 1.86% 1.81% 1.78% 1.88% 1.78% NA -2bps 2bps Credit cost 1.33% 1.39% 1.28% 1.33% 1.39% NA 0bps 0bps Outputs (` bn)

NII 54 64 75 53 57 NA 2% 12% Operating profit 35 48 63 34 36 NA 4% 34% Net Profit 14 21 31 13 12 NA 7% 75% BVPS (`) 80 90 106 79 85 NA 1% 6% EPS (`) 7 10 16 6 6 NA 7% 75% RoA (%) 0.7% 0.9% 1.3% 0.7% 0.5% NA 5 40 RoE (%) 9.0% 12.3% 16.1% 8.4% 7.3% NA 58 507 Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 35 Federal Bank

Exhibit 68: Sensitivity of valuations to long-term growth and RoE assumptions FY23-39 Bear Case Base Case Bull Case Comments In bear case, we are assuming nominal GDP growth of 6% whilst in bull case Assets growth YoY 12.4% 14.4% 16.4% we expect nominal GDP growth of 8% and assuming a credit multiplier of 2x In bear case, we expect NIMs of <2.5% and credit cost of >2%. In bull case Average RoA 1.1% 1.2% 1.3% scenario, we expect FB to improve its NIMs by ~30bps by further increasing its share of high yielding loans Average RoE 12.7% 14.8% 16.3% Target Price 55 102 154 Implied FY22E P/E 5.3 9.7 14.7 Implied FY22E P/B 0.6 1.1 1.7 Source: Company, Ambit Capital research Exhibit 69: Banks - Valuation summary EPS P/B at CMP P/E at CMP RoA RoE Mcap Price Up/ CAGR Reco. TP (`) US$bn (`) Down FY19- FY20 FY21E FY22E FY20 FY21E FY22E FY20 FY21E FY22E FY20 FY21E FY22E 22E New Private

HDFC Bank 107.9 1,441 SELL 1,012 -30% 4.6 4.0 3.6 30.1 30.0 30.8 6% 1.89% 1.59% 1.32% 16.4% 14.3% 12.3% ICICI Bank (Consol) 47.9 510 BUY 570 12% 2.7 2.4 2.1 33.3 15.8 14.8 70% 0.76% 1.53% 1.48% 8.3% 16.4% 15.0% Kotak Mahindra 52.9 1,966 SELL 879 -55% 5.6 5.1 4.6 44.4 44.4 47.1 3% 2.03% 1.88% 1.61% 13.6% 12.2% 10.3% Bank (Consol) Axis Bank 25.2 605 BUY 580 -4% 2.0 1.7 1.6 105.0 16.0 11.9 41% 0.19% 1.20% 1.44% 2.1% 12.1% 13.8% RBL Bank 1.9 237 SELL 120 -49% 1.1 1.1 1.1 23.8 29.4 39.8 -34% 0.60% 0.44% 0.29% 5.6% 3.8% 2.7% Bandhan Bank 8.9 406 SELL 111 -73% 4.3 3.8 3.5 21.6 33.2 42.7 -17% 3.82% 1.89% 1.26% 22.9% 12.2% 8.5% Yes Bank 6.2 18 NA NA NA 0.2 1.3 1.3 -3.2 -18.7 93.6 -70% -2.82% -0.58% 0.21% -43.1% -5.7% 1.7% IDFC Bank 2.9 37 NA NA NA 1.2 1.2 1.2 NA NA 34.8 -67% -0.67% 0.12% 0.39% 11.3% 7.7% 9.2% DCB Bank 0.5 120 NA NA NA 1.1 1.1 1.0 10.4 14.1 10.9 2% 0.96% 0.68% 0.85% 11.3% 7.7% 9.2% Average 2.5 2.4 2.2 33.2 20.5 36.3 -7% 0.75% 0.97% 0.98% 5.4% 9.0% 9.2%

Small Finance Banks

Equitas Holdings 0.3 69 NA NA NA 0.8 0.8 0.8 8.6 9.2 7.2 15% 1.40% 1.10% 1.30% 12.6% 9.0% 10.8% Ujjivan Financial 0.5 290 NA NA NA 3.0 1.2 1.1 21.8 15.3 13.0 21% 2.20% 1.40% 1.60% 15.3% 9.1% 10.9% AU Small Finance 3.9 944 NA NA NA 6.7 5.7 4.9 39.6 37.9 32.6 30% 2.01% 1.69% 1.72% 18.9% 16.0% 16.0% Bank Average 3.5 2.6 2.2 23.3 20.8 17.6 22% 1.87% 1.40% 1.54% 15.6% 11.4% 12.6%

Large PSUs

State Bank of India 32.5 268 BUY 50% 0.9 0.9 0.8 13.2 11.7 7.3 120% 0.44% 0.46% 0.66% 7.3% 7.6% 11.0% (Consol) 402 Bank of Baroda 4.0 64 NA NA NA 0.4 0.4 0.4 -24.0 48.1 9.5 -24% -0.02% 0.03% 0.27% -1.1% 1.6% 4.7% Punjab National 4.7 37 NA NA NA 0.4 0.4 0.4 -35.6 -272.1 12.0 17% -0.06% 0.10% 0.24% -0.9% 1.1% 3.4% Bank Bank of India 2.2 50 NA NA NA 0.4 0.4 0.4 -5.9 33.3 12.5 -153% -0.43% 0.19% 0.31% -3.7% -0.7% 3.3% Union Bank of India 2.8 32 NA NA NA 0.3 0.3 0.4 -12.1 24.0 9.3 -162% -0.11% -0.02% 0.22% -1.3% 2.6% 5.4% Average 0.5 0.5 0.5 -12.9 -31.0 10.1 -40% -0.03% 0.15% 0.34% 0.1% 2.5% 5.6%

Old Private

Federal Bank 1.8 67 BUY 102 52% 0.9 0.8 0.7 8.7 9.8 6.4 19% 0.91% 0.70% 0.94% 11.1% 9.0% 12.3% City Union Bank 1.8 184 BUY 170 -8% 2.6 2.3 2.1 28.4 23.5 19.3 1% 1.00% 1.10% 1.20% 9.4% 10.4% 11.4% Average 1.7 1.6 1.4 18.5 16.6 12.9 10% 0.96% 0.90% 1.07% 10.3% 9.7% 11.9%

Source: Company, Ambit Capital research, Bloomberg *Bloomberg estimates for uncovered companies

December 18, 2020 Ambit Capital Pvt. Ltd. Page 36 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Catalysts & Risks Catalysts Credit cost to remain <150bps: Due to higher share of secured loans and limited exposure to stress segments (PL/CC/CV/CE/MFI), asset quality deterioration should be limited for the bank compared to its peers. As a result, credit cost should not materially inch up from historical levels. Our FY21/22E average credit cost estimate is 136bps vs 101bps in FY20. Impact of recent initiatives to reflect positively on overall income profile: Yield should be under pressure in FY21E due to lower CD ratio and negative impact of interest reversal. Similarly, fee income growth should decline YoY in FY21E due to negative impact of lockdown. However, we believe structural steps taken by the bank as explained in earlier sections should have positive impact on the overall income generation (NII + fee income) going forward. We expect yield and core fee income to asset both to improve by ~25bps in FY22E and then another ~25bps in FY23E.

Risks Higher-than-expected volatility in asset quality in its retail and SME book: While we are confident of FB’s ability to contain asset quality challenges due to COVID-19, a further slowdown in the economy can lead to elevated slippages, especially in retail/SME loans, and keep credit cost above 150bps. Risk from intensifying competitive intensity in a climate where overall bank credit growth stays weak: A slowdown in loan growth momentum due to continued weakness in overall credit demand from the banking system (overall banking system loan growth subdued at ~5% YoY) and increased competition from larger banks could hamper earnings growth. Potential for RoE expansion is limited if steps taken to improve the bank’s income profile does not fructify. Adverse changes in relationship: One major factor which has distinguished Federal Bank from other regional banks is its ability to attract professional management team from foreign and other private sector banks. Given uncertainty around extension of the current CEO, an adverse change in leadership is a key risk to our investment thesis.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 37 Federal Bank

Ambit’s HAWK Analysis Exhibit 70: Explanation of our flags on the cover page Segment Score Comments In our risk framework for banks on FY18 reported financials (note), Federal was in the 2nd quartile (Q2). There has not been any material change from then as evident in exhibit 74. Federal Bank has lower exposure to Balance sheet risks GREEN stressed assets, real estate, off-balance-sheet liabilities and concentration risks, and has a prudent ESOP accounting policy. Lower amount of stressed loans on the balance sheet and clean accounting on NPAs (no divergence in reported Predictability GREEN NPAs and RBI assessment) support earnings predictability. Earnings Momentum AMBER In the past six months, consensus has increased FY21 EPS by 4% while reducing FY22 EPS by 1%. Source: Ambit Capital research

HAWK Scores As highlighted in this note, FB features in Q2 quartile with Q1 indicating the best and Q5 indicates the worst. We use quantifiable ratios suitably grouped either under accounting checks or balance sheet risk parameters to identify top quality banks basis their accounting quality and balance sheet risk exposure. FB is in top 10 list among top 27 banks for which the analysis has been done. Though this analysis was done on the basis of FY18 numbers, we see there has not been any material changes since then as evident in the below exhibit. Exhibit 71: Accounting checks for FY20 Accounting checks for FY20 FY18 FY19 FY20 Accounting checks

Interest accrued as a % of Avg. loan book 0.9% 0.9% 0.9%

ESOP accounting

Impact on PAT 2.9% 5.7% 3.7%

Pension accounting

Discount rate assumption 7.8% 7.8% 6.8%

Expected return on plan assets 7.6% 8.0% 7.5%

Salary escalation ratio 5.0% 5.0% 5.0%

Divergence Nil Nil Nil

Balance Sheet risk

Contingent liabilities as a % of equity 220% 221% 237%

Risk weight 9.3% 9.6% 5.9%

Stressed sector exposure

CRE 7% 6% 5%

PL/CC 0% 1% 1%

Agri/MFI 10% 10% 10%

CV/CE NA NA NA

Total 17% 17% 17%

Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 38 Federal Bank

Financials Balance sheet

Year to March (` bn) FY18 FY19 FY20 FY21E FY22E FY23E Networth 122.1 132.7 145.2 158.8 179.7 211.2 Deposits 1,119.9 1,349.5 1,522.9 1,735.4 1,952.4 2,225.7 Borrowings 115.3 77.8 103.7 110.8 124.6 142.1 Other Liabilities 25.8 33.3 34.6 71.4 92.1 99.7 Total Liabilities 1,383.1 1,593.4 1,806.4 2,076.4 2,348.8 2,678.6 Cash & Balances with RBI & 92.0 100.7 125.7 203.1 186.9 189.4 Banks Investments 307.8 318.2 358.9 424.6 498.5 568.3 Advances 919.6 1,102.2 1,222.7 1,338.5 1,537.0 1,775.8 Other Assets 63.7 72.3 99.0 110.2 126.5 145.1 Total Assets 1,383.1 1,593.4 1,806.4 2,076.4 2,348.8 2,678.6 Source: Company, Ambit Capital research

Income statement Year to March (` bn) FY18 FY19 FY20 FY21E FY22E FY23E Interest Income 97.5 114.2 132.1 141.1 164.4 193.1 Interest Expense 61.7 72.4 85.6 87.5 100.7 118.5 Net Interest Income 35.8 41.8 46.5 53.6 63.8 74.6 Total Non-Interest Income 11.6 13.5 19.3 17.8 24.0 33.0 Total Income 47.4 55.3 65.8 71.4 87.8 107.7 Total Operating Expenses 24.5 27.6 33.8 36.2 40.0 44.6 Employees expenses 12.4 13.8 17.7 19.7 21.5 23.4 Other Operating Expenses 12.1 13.9 16.0 16.5 18.5 21.3 Pre Provisioning Profits 22.9 27.6 32.0 35.2 47.8 63.0 Provisions 9.5 8.6 11.7 17.0 20.0 21.1 PBT 13.4 19.1 20.3 18.2 27.9 41.9 Tax 4.7 6.6 4.9 4.5 7.0 10.5 PAT 8.8 12.4 15.4 13.6 20.9 31.4 Source: Company, Ambit Capital research

Ratio analysis Year to March (` bn) FY18 FY19 FY20 FY21E FY22E FY23E Credit-Deposit (%) 82.1% 81.7% 80.3% 77.1% 78.7% 79.8% CASA ratio (%) 33.3% 32.1% 30.5% 29.7% 29.2% 25.6% Cost/Income ratio (%) 51.7% 50.0% 51.3% 50.7% 45.5% 41.4% Gross NPA (` bn) 28.0 32.6 35.3 43.6 63.7 69.6 Gross NPA (%) 3.00% 2.92% 2.84% 3.19% 4.04% 3.83% Net NPA (` bn) 15.5 16.3 16.1 15.2 25.5 27.8 Net NPA (%) 1.69% 1.48% 1.31% 1.14% 1.66% 1.57% Provision coverage (%) 44.5% 50.1% 54.5% 65.0% 60.0% 60.0% NIMs (%) 2.97% 2.94% 2.88% 2.92% 3.05% 3.14% Tier-1 capital ratio (%) 14.2% 13.4% 13.3% 12.5% 12.3% 12.5% Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 39 Federal Bank

Du-pont analysis Year to March FY18 FY19 FY20 FY21E FY22E FY23E NII / Assets (%) 2.8% 2.8% 2.7% 2.8% 2.9% 3.0% Other income / Assets (%) 0.9% 0.9% 1.1% 0.9% 1.1% 1.3% Total Income / Assets (%) 3.7% 3.7% 3.9% 3.7% 4.0% 4.3% Cost to Assets (%) 1.9% 1.9% 2.0% 1.9% 1.8% 1.8% PPP / Assets (%) 1.8% 1.9% 1.9% 1.8% 2.2% 2.5% Provisions / Assets (%) 0.7% 0.6% 0.7% 0.9% 0.9% 0.8% PBT / Assets (%) 1.1% 1.3% 1.2% 0.9% 1.3% 1.7% Tax Rate (%) 34.6% 34.8% 24.1% 25.0% 25.0% 25.0% RoA (%) 0.69% 0.84% 0.91% 0.70% 0.94% 1.25% Leverage 11.3 11.7 12.2 12.8 13.1 12.9 RoE (%) 7.8% 9.8% 11.1% 9.0% 12.3% 16.1% Source: Company, Ambit Capital research

Valuation parameters Year to March FY18 FY19 FY20 FY21E FY22E FY23E EPS (`) 4.5 6.3 7.7 6.9 10.5 15.8 EPS growth (%) -8% 41% 24% -12% 53% 50% BVPS (`) 61.9 66.9 72.9 79.7 90.2 106.0 P/E (x) 15.1 10.7 8.7 9.8 6.4 4.3 P/BV (x) 1.08 1.00 0.92 0.84 0.74 0.63 Source: Company, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 40 Federal Bank

Institutional Equities Team

Research Analysts Name Industry Sectors Desk-Phone E-mail Nitin Bhasin - Head of Research Strategy / Cement / Home Building / Mid-Caps (022) 66233241 [email protected] Ajit Kumar, CFA, FRM Banking / Financial Services (022) 66233252 [email protected] Alok Shah, CFA Consumer Staples (022) 66233259 [email protected] Amandeep Singh Grover Mid-Caps / Hotels / Real Estate (022) 66233082 [email protected] Ashish Kanodia, CFA Consumer Discretionary (022) 66233264 [email protected] Ashwin Mehta, CFA Technology (022) 6623 3295 [email protected] Basudeb Banerjee Automobiles / Auto Ancillaries (022) 66233141 [email protected] Darshan Mehta E&C / Infrastructure / Aviation (022) 66233174 [email protected] Deep Shah, CFA Media / Telecom / Oil & Gas (022) 66233064 [email protected] Dhruv Jain Mid-Caps (022) 66233177 [email protected] Karan Khanna, CFA Mid-Caps / Hotels / Real Estate (022) 66233251 [email protected] Karan Kokane Automobiles / Auto Ancillaries (022) 66233028 [email protected] Mitesh Gohil Banking / Financial Services (022) 66233197 [email protected] Nikhil Mathur, CFA Healthcare (022) 66233220 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 66233206 [email protected] Prasenjit Bhuiya Agri & Chemicals (022) 66233132 [email protected] Prateek Maheshwari Cement (022) 66233234 [email protected] Ritesh Gupta, CFA Consumer Discretionary / Agri & Chemicals (022) 66233242 [email protected] Satyadeep Jain, CFA Metals & Mining (022) 66233246 [email protected] Shreya Khandelwal Banking / Financial Services (022) 6623 3292 [email protected] Sumit Shekhar Economy / Strategy (022) 66233229 [email protected] Udit Kariwala, CFA Banking / Financial Services (022) 66233197 [email protected] Varun Ginodia, CFA E&C / Infrastructure / Aviation (022) 66233174 [email protected] Vinit Powle Strategy / Forensic Accounting (022) 66233149 [email protected] Vivekanand Subbaraman, CFA Media / Telecom / Oil & Gas (022) 66233261 [email protected] Sales Name Regions Desk-Phone E-mail Dhiraj Agarwal - MD & Head of Sales India (022) 66233253 [email protected] Bhavin Shah India (022) 66233186 [email protected] Dharmen Shah India / Asia (022) 66233289 [email protected] Abhishek Raichura UK & Europe (022) 66233287 [email protected] Pranav Verma Asia (022) 66233214 [email protected] Shiva Kartik India (022) 66233299 [email protected] USA / Canada Hitakshi Mehra Americas +1(646) 793 6751 [email protected] Achint Bhagat, CFA Americas +1(646) 793 6752 [email protected] Singapore Srinivas Radhakrishnan Singapore +65 6536 0481 [email protected] Sundeep Parate Singapore +65 6536 1918 [email protected] Production Sajid Merchant Production (022) 66233247 [email protected] Sharoz G Hussain Production (022) 66233183 [email protected] Jestin George Editor (022) 66233272 [email protected] Richard Mugutmal Editor (022) 66233273 [email protected] Nikhil Pillai Database (022) 66233265 [email protected] Babyson John Database (022) 66233209 [email protected]

December 18, 2020 Ambit Capital Pvt. Ltd. Page 41 [email protected] 2020-12-21 Monday 13:35:12 Federal Bank

Federal Bank Ltd (FB IN, BUY)

140 120 100 80 60 40 20 0 Jun-18 Jun-19 Jun-20 Apr-18 Apr-19 Apr-20 Oct-18 Oct-19 Oct-20 Feb-18 Feb-19 Feb-20 Dec-17 Dec-18 Dec-19 Dec-20 Aug-18 Aug-19 Aug-20

Federal Bank Ltd

Source: Bloomberg, Ambit Capital research

December 18, 2020 Ambit Capital Pvt. Ltd. Page 42 Federal Bank

Explanation of Investment Rating - Our target prices are with a 12-month perspective. Returns stated are our internal benchmark Investment Rating Expected return (over 12-month) BUY We expect this stock to deliver more than 10% returns over the next12 months SELL We expect this stock to deliver less than or equal to 10 % returns over the next 12 months UNDER REVIEW We have coverage on the stock but we have suspended our estimates, TP and recommendation for the time being NOT RATED We do not have any forward-looking estimates, valuation, or recommendation for the stock. POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

Note: At certain times the Rating may not be in sync with the description above as the stock prices can be volatile and analysts can take time to react to development.

Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital Private Ltd. Ambit Capital Private Ltd. research is disseminated and available primarily electronically, and, in some cases, in printed form. The following Disclosures are being made in compliance with the SEBI (Research Analysts) Regulations, 2014 (herein after referred to as the Regulations).

Disclosures  Ambit Capital Private Limited (“Ambit Capital or Ambit”) is a SEBI Registered Research Analyst having registration number INH000000313. Ambit Capital, the Research Entity (RE) as defined in the Regulations, is also engaged in the business of providing Stock broking Services, Portfolio Management Services, Merchant Banking Services, Depository Participant Services, distribution of Mutual Funds and various financial products. Ambit Capital is a subsidiary company of Ambit Private Limited. The details of associate entities of Ambit Capital are available on its website.  Ambit Capital makes its best endeavor to ensure that the research analyst(s) use current, reliable, comprehensive information and obtain such information from sources which the analyst(s) believes to be reliable. However, such information has not been independently verified by Ambit Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information, opinions, views expressed in this Research Report are those of the research analyst as at the date of this Research Report which are subject to change and do not represent to be an authority on the subject. Ambit Capital and its affiliates/ group entities may or may not subscribe to any and/ or all the views expressed herein and the statements made herein by the research analyst may differ from or be contrary to views held by other businesses within the Ambit group.  This Research Report should be read and relied upon at the sole discretion and risk of the recipient. If you are dissatisfied with the contents of this Research Report or with the terms of this Disclaimer, your sole and exclusive remedy is to stop using this Research Report and Ambit Capital or its affiliates shall not be responsible and/ or liable for any direct/consequential loss howsoever directly or indirectly, from any use of this Research Report.  If this Research Report is received by any client of Ambit Capital or its affiliates, the relationship of Ambit Capital/its affiliate with such client will continue to be governed by the existing terms and conditions in place between Ambit Capital/ such affiliates and the client.  This Research Report is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied in whole or in part, for any purpose. Neither this Research Report nor any copy of it may be taken or transmitted or distributed, directly or indirectly within India or into any other country including United States (to US Persons), Canada or Japan or to any resident thereof. The distribution of this Research Report in other jurisdictions may be strictly restricted and/ or prohibited by law or contract, and persons into whose possession this Research Report comes should aware of and take note of such restrictions.  Ambit Capital declares that neither its activities were suspended nor did it default with any stock exchange with whom it is registered since inception. Ambit Capital has not been debarred from doing business by any Stock Exchange, SEBI, Depository or other Regulated Authorities, nor has the certificate of registration been cancelled by SEBI at any point in time.  Apart from the case of Manappuram Finance Ltd. where Ambit Capital settled the matter with SEBI without accepting or denying any guilt, there is no material disciplinary action that has been taken by any regulatory authority impacting research activities of Ambit Capital.  A graph of daily closing prices of securities is available at www.nseindia.com and www.bseindia.com Disclosure of financial interest and material conflicts of interest  Ambit Capital, its associates/group company, Research Analyst(s) or their relative may have any financial interest in the subject company. Ambit Capital and/or its associates/group companies may have actual/beneficial ownership of 1% or more interest in the subject company at the end of the month immediately preceding the date of publication of the Research Report. Ambit Capital and its associate company(ies), may; (a) from time to time, have a long or short position in, act as principal in, and buy or sell the securities or derivatives thereof of companies mentioned herein. (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company (ies) discussed herein or act as an advisor or lender/borrower to such company(ies) or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions. However the same shall have no bearing whatsoever on the specific recommendations made by the Analyst(s), as the recommendations made by the Analyst(s) are completely independent of the views of the associates of Ambit Capital even though there might exist an apparent conflict in some of the stocks mentioned in the research report. Ambit Capital and/or its associates/group company may have received any compensation from the subject company in the past 12 months and/or Subject Company is or was a client during twelve months preceding the date of distribution of the research report.  In the last 12 months period ending on the last day of the month immediately preceding the date of publication of this research report, Ambit Capital or any of its associates/group company or Research Analyst(s) may have: o managed or co-managed public offering of securities for the subject company of this research report, o received compensation for investment banking or merchant banking or brokerage services from the subject company, o received compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company of this research report. o received any compensation or other benefits from the subject company or third party in connection with the research report.  Ambit Capital and / or its associates/group company do and seek to do business including investment banking with companies covered in its research reports. Compensation of Research Analysts is not based on any specific merchant banking, investment banking or brokerage service transactions. Additional Disclaimer for Canadian Persons About Ambit Capital:  Ambit Capital is not registered in the Province of Ontario and /or Province of Québec to trade in securities and/or to provide advice with respect to securities.  Ambit Capital's head office or principal place of business is located in India.  All or substantially all of Ambit Capital's assets may be situated outside of Canada.  It may be difficult for enforcing legal rights against Ambit Capital because of the above.  Name and address of Ambit Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2 Canada.  Name and address of Ambit Capital's agent for service of process in the Province of Québec is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montréal, Québec H3B 2C3 Canada. About Ambit America Inc.:  Ambit America Inc. is not registered in Canada  Ambit America Inc. is resident and registered in the United States.  The name and address of the Agent for service in Quebec is: Lavery, de Billy, L.L.P., Bureau 4000, One Place Ville Marie, Montreal, Quebec, Canada H3B 4M4.  The name and address of the Agent for service in Toronto is: Sutton Boyce Gilkes Regulatory Consulting Group Inc., 120 Adelaide Street West, Suite 2500, Toronto, ON Canada M5H 1T1.  A client may have difficulty enforcing legal rights against Ambit America Inc. because it is resident outside of Canada and all substantially all of its assets may be situated outside of Canada.

Additional Disclaimer for Singapore Persons  Ambit Singapore Pte. Limited is a holder of Capital Market services license and an exempt financial adviser in Singapore, as per the approved agreement under Paragraph 9 of Third Schedule of Securities and Futures Act (CAP 289) and Paragraph 11 of First Schedule of Financial Advisors Act (CAP 110) provided to Ambit Singapore Pte. Limited by Monetary Authority of Singapore. In Singapore, Ambit Capital distributes research reports.  Persons in Singapore should contact either Ambit Capital or Ambit Singapore Pte. Limited in respect of any matter arising from, or in connection with this report/publication/communication. This report is distributed solely to persons who qualify as “Institutional Investors”, of which some of whom may consist of "Accredited Institutional Investors” as defined in section 4A(1) of the Securities and Futures Act, Chapter 289 of Singapore. Accordingly, if a Singapore person is not or ceases to be such an institutional investor, such Singapore Person must immediately discontinue any use of this Report and inform either Ambit Capital or Ambit Singapore Pte. Limited.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 43 Federal Bank

Additional Disclaimer for UK Persons  All of the recommendations and views about the securities and companies in this report accurately reflect the personal views of the research analyst named on the cover. No part of this research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research report. This report may not be reproduced, redistributed or copied in whole or in part for any purpose.  This report is a marketing communication and has been prepared by Ambit Capital Private Ltd. of Mumbai, India (“Ambit Capital”). Ambit is regulated by the Securities and Exchange Board of India and is registered as a Research Entity under the SEBI (Research Analysts) Regulations, 2014. Ambit is an appointed representative of Aldgate Advisors Limited which is authorized and regulated by the Financial Conduct Authority whose registered office is at 16 Charles II Street, London, SW1Y 4NW.  In the UK, this report is directed at and is for distribution only to persons who (i) fall within Article 19(5) (persons who have professional experience in matters relating to investments) or Article 49(2)(a) to (d) (high net worth companies, unincorporated associations etc.) of the Financial Services and Markets Act 2000 (Financial Promotions) Order 2005 (as amended).  Ambit Capital is not a US registered broker-dealer. Transactions undertaken in the US in any security mentioned herein must be effected through a US-registered broker-dealer, in conformity with SEC Rule 15a-6.  Neither this report nor any copy or part thereof may be distributed in any other jurisdictions where its distribution may be restricted by law and persons into whose possession this report comes should inform them about, and observe any such restrictions. Distribution of this report in any such other jurisdictions may constitute a violation of UK or US securities laws, or the law of any such other jurisdictions.  This report does not constitute an offer or solicitation to buy or sell any securities referred to herein. It should not be so construed, nor should it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. The information in this report, or on which this report is based, has been obtained from publicly available sources that Ambit believes to be reliable and accurate. However, it has not been prepared in accordance with legal requirements designed to promote the independence of investment research. It has also not been independently verified and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties.  The information or opinions are provided as at the date of this report and are subject to change without notice. The information and opinions provided in this report take no account of the investors’ individual circumstances and should not be taken as specific advice on the merits of any investment decision. Investors should consider this report as only a single factor in making any investment decisions. Further information is available upon request. No member or employee of Ambit accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of this report or its contents.  The value of any investment made at your discretion based on this Report, or income therefrom, maybe affected by changes in economic, financial and/or political factors and may go down as well as go up and you may not get back the original amount invested. Some securities and/or investments involve substantial risk and are not suitable for all investors.  Ambit and its affiliates and their respective officers directors and employees may hold positions in any securities mentioned in this Report (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). Ambit and its affiliates may from time to time render advisory and other services, solicit business to companies referred to in this Report and may receive compensation for the same. Ambit has a restrictive policy relating to personal dealing. Ambit has controls in place to manage the risks related to such. An outline of the general approach taken in relation to conflicts of interest is available upon request.  Ambit and its affiliates may act as a market maker or risk arbitrator or liquidity provider or may have assumed an underwriting commitment in the securities of companies discussed in this Report (or in related investments) or may sell them or buy them from clients on a principal to principal basis or may be involved in proprietary trading and may also perform or seek to perform investment banking or underwriting services for or relating to those companies.  Ambit may sell or buy any securities or make any investment which may be contrary to or inconsistent with this Report and are not subject to any prohibition on dealing. By accepting this report you agree to be bound by the foregoing limitations. In the normal course of Ambit and its affiliates’ business, circumstances may arise that could result in the interests of Ambit conflicting with the interests of clients or one client’s interests conflicting with the interest of another client. Ambit makes best efforts to ensure that conflicts are identified, managed and clients’ interests are protected. However, clients/potential clients of Ambit should be aware of these possible conflicts of interests and should make informed decisions in relation to Ambit services.

Additional Disclaimer for U.S. Persons  The Ambit Capital research report is solely a product of Ambit Capital Private Ltd. and may be used for general information only. The legal entity preparing this research report is not registered as a broker-dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and/or the independence of research analysts.  Ambit Capital is the employer of the research analyst(s) who has prepared the research report.  Any subsequent transactions in securities discussed in the research reports should be effected through Ambit America Inc. (“Ambit America”).  Ambit America Inc. does not accept or receive any compensation of any kind directly from US Institutional Investors for the dissemination of the Ambit Capital research reports. However, Ambit Capital Private Ltd. has entered into an agreement with Ambit America Inc. which includes payment for sourcing new MUSSI and service existing clients based out of USA.  Analyst(s) preparing this report are resident outside the United States and are not associated persons or employees of any US regulated broker-dealer. Therefore the analyst(s) may not be subject to Rule 2711 restrictions on communications with a subject company, public appearances and trading securities held by the research analyst.  In the United States, this research report is available solely for distribution to major U.S. institutional investors, as defined in Rule 15a – 6 under the Securities Exchange Act of 1934. This research report is distributed in the United States by Ambit America Inc., a U.S. registered broker and dealer and a member of FINRA. Ambit America Inc., a US registered broker-dealer, accepts responsibility for this research report and its dissemination in the United States.  This Ambit Capital research report is not intended for any other persons in the USA. All major U.S. institutional investors or persons outside the United States, having received this Ambit Capital research report shall neither distribute the original nor a copy to any other person in the United States. In order to receive any additional information about or to effect a transaction in any security or financial instrument mentioned herein, please contact a registered representative of Ambit America Inc., by phone at 646 793 6001 or by mail at 370, Lexington Avenue, Suite 803, New York, 10017. This material should not be construed as a solicitation or recommendation to use Ambit Capital to effect transactions in any security mentioned herein.  This document does not constitute an offer of, or an invitation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any security. The information contained herein has been obtained from published information and other sources, which Ambit Capital or its Affiliates consider to be reliable. None of Ambit Capital accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.  Ambit America Inc. or its affiliates or the principals or employees of Ambit Group may have or have had positions, may “beneficially own” as determined in accordance with Section 13(d) of the Exchange Act, 1% or more of the equity securities or may conduct or may have conducted market-making activities or otherwise act or have acted as principal in transactions in any of these securities or instruments referred to herein.  Ambit America Inc. or its affiliates or the principals or employees of Ambit Group may have managed or co-managed a public offering of securities or received compensation for investment banking services or expects to receive or intends to seek compensation for investment banking or consulting services or serve or have served as a director or a supervisory board member of a company referred to in this research report.  As of the date of this research report Ambit America Inc. does not make a market in the security reflected in this research report.

Analyst(s) Certification  The analyst(s) authoring this research report hereby certifies that the views expressed in this research report accurately reflect such research analyst's personal views about the subject securities and issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report.  The analyst (s) has/have not served as an officer, director or employee of the subject company in the last 12 months period ending on the last day of the month immediately preceding the date of publication of this research report.  The analyst(s) does not hold one percent or more securities of the subject company, at the end of the month immediately preceding the date of publication of the research report.  Research Analyst views on Subject Company may vary based on fundamental research and technical research. Proprietary trading desk of Ambit Capital or its associates/group companies maintains arm’s length distance with the research team as all the activities are segregated from Ambit Capital research activity and therefore it can have an independent views with regards to Subject Company for which research team have expressed their views.

Registered Office Address: Ambit Capital Private Limited, 449, Ambit House, Senapati Bapat Marg, Lower Parel, Mumbai-400013 Compliance Officer Details: Sanjay Shah, Email id: [email protected], Contact Number: 91 22 68601965 Other registration details of Ambit Capital: SEBI Stock Broking registration number INZ000259334 (Trading Member of BSE and NSE); SEBI Depository Participant registration number IN-DP-CDSL- 374-2006; SEBI Portfolio Managers registration number INP000002221, SEBI Merchant Banking registration number INM000012379, AMFI registration number ARN 36358.

© Copyright 2020 Ambit Capital Private Limited. All rights reserved.

December 18, 2020 Ambit Capital Pvt. Ltd. Page 44