Rating Rationale

Strengths:
* Comfortable capitalisation
Capitalisation is comfortable and should remain stable over the medium term. Overall capital adequacy ratio (under Basel III) was high and networth adequate at 14.1% and Rs 13,661 crore, respectively, as on June 30, 2019. Networth coverage for net non-performing assets (NPAs) was ~8 times. The bank raised Rs 2,500 crore in the first quarter of fiscal 2018.

* Healthy resource profile, with strong brand equity in Kerala
Resource profile is healthy with a strong brand presence among NRIs, especially in Kerala; this lends stability to the bank's resource base and fee income. Deposits from NRIs as a proportion of total deposits was sizeable at 39.4% as on March 31, 2019. Moreover, the ratio of current account and savings account deposits to total deposits improved to 32.4% as on June 30, 2019, from 25% as on March 31, 2010. The resource profile has strengthened with retail deposits forming 91% of total deposits as on March 31, 2019, and a relatively higher savings account deposits ratio (26%) compared with peers. Cost of deposit was 5.5% in fiscal 2019.

Weaknesses:
* Average asset quality and profitability
Asset quality is average with gross NPA ratio of 3% as on June 30, 2019. The bank has managed its asset quality through sale of high-ticket NPAs to ARCs (asset reconstruction companies) and high advances growth. It has focused on lending to better rated corporates over the past two years. It is also diversifying into the retail and SME (small and medium enterprise) sector, and strengthening its credit appraisal and risk management systems to improve asset quality. Incrementally, ability to manage SME and agriculture loan portfolios will remain a key rating sensitivity factor.

Return on assets (RoAs; on calculated basis) was 0.8% in fiscal 2019 (0.7% in fiscal 2018). Provisioning cover for NPAs was around 51% (excluding technical write-offs) as on June 30, 2019. Earnings are likely to remain average over the medium term.

* Growing scale of operations with regional concentration
Federal Bank is a mid-sized entity in India, with regional concentration in operations. Share in system advances and deposits was 1.13 and 1.07%, respectively, as on June 30, 2019. Also, about 73% of the deposits and 58% of advances were from five southern states as on March 31, 2019, with Kerala alone accounting for 63% and 34%, respectively. The bank had 1,251 branches as on June 30, 2019, most of which were in South India, particularly Kerala. Owing to its high regional concentration, Federal Bank's financial risk profile remains susceptible to changes in the economic and business environments in the region. However, the states in southern India are among the economically better performing states in India, thus mitigating the concentration risk. Nonetheless, asset quality in the retail and SME portfolio in Kerala will continue to be monitored.

Liquidity: Superior
Liquidity is superior supported by a healthy retail deposit base. Liquidity coverage ratio stood at 163.3% as on March 31, 2019, against the statutory minimum of 100%. Liquidity also benefits from access to systemic sources of funds, such as the liquidity adjustment facility from the Reserve Bank of India (RBI) and access to the call money market.

Rating sensitivity factors
Downward factors
* Deterioration in asset quality, with gross NPAs rising from current levels and credit cost crossing 1.0% on a continuous basis
* Significant deterioration in profitability