Federal Bank underperforms Nifty Bank sharply in 2025, but the best may be yet to come

Mint

4 days ago

Federal Bank shares haven't fared too well so far this year, yet some analysts are optimistic that it is poised for a re-rating as its transformation strategy kicks in over the next few years.
The lender is the second-biggest laggard on the Nifty Bank index, down almost 2% and trailing only IndusInd Bank, which plunged about 17% in 2025. Federal Bank shares lag far behind the Nifty Bank index, which has delivered returns of 9.3% to investors.
Even so, analysts said Federal Bank might just be a re-rating story in the making, one that could deliver stronger returns than most of its peers.
'Federal is the safest midsized bank with potential to deliver strong growth," Nuvama Institutional Equities said in a report dated 2 August, maintaining its 'buy' rating on the stock.
What sets Federal Bank apart from its midsized peers, according to Sunny Agrawal, head of fundamental research at SBI Securities, is the fresh leadership that stepped in last September, bringing with it a clear roadmap for change.
'If executed well, this blueprint could be the catalyst for a potential re-rating of the stock," Agrawal said.
KVS Manian, MD & CEO of Federal Bank, said on an earnings call with analysts on 2 August that the Federal 4.0 strategy launched in February wasn't just a slogan, but a transformation roadmap meant to redefine how the bank operates, competes and grows. The strategy hinges on three things: lowering CASA (current and savings accounts) costs, improving yields through a better loan mix and scaling up fee income through greater granularity and volume.
CASA is the portion of low-cost deposits in banks. Savings accounts earn lower interest than term deposits or fixed deposits, while current accounts earn no interest. Federal Bank's CASA ratio improved 12 bps to 30.35% in Q1 of FY26.
What also worked in its favour is the cost of funds, which is the rate at which the bank borrows. This fell to 5.85% during the quarter, from 6.06% previously. However, yields on advances – the average rate the bank earns on its loans – are yet to reflect any improvement and declined to 9.04% from 9.31% sequentially.
'In the quarter gone by, there is clear evidence that our execution is in sync with all these three objectives," Manian said.
On the valuation front, Federal Bank trades at about 1.4x P/B on a trailing 12-month basis, Agrawal said, adding that the stock is reasonably valued when compared with Karur Vysya Bank and City Union Bank, which are priced from 1.5 to 1.7 times.
'Most of the negatives are already priced in and with improving clarity on leadership and execution of Strategy 4.0, the stock is well-positioned for a potential re-rating," Agrawal said.
Flip side
However, if the bank's asset quality issues – lingering for the past few quarters – remain unresolved, they could continue to weigh on the stock, Agrawal said. While the bank appears confident across most segments, the microfinance space remains a bit of a sore spot due to elevated delinquencies.
Microfinance stress has been a pain point not just for Federal Bank but for most lenders, said Dnyanada Vaidya, BFSI research analyst at Axis Securities. However, microfinance accounted for less than 2% of the bank's loan book as of Q1 – which keeps the overall risk contained, she explained.
The bank's advances to unsecured segments, especially microfinance, is limited in the overall portfolio compared with those of some of its peers. Apart from the microfinance segment, Federal Bank does not see major asset quality headwinds in the secured segments.
Federal Bank's microfinance advances dropped 4% quarter-on-quarter to ₹3,939 crore in Q1 from ₹4,112 crore in the previous quarter. The lender said on the earnings call that microfinance stress peaked in May, and slippages – even in microfinance – came down in June and July.
'And we are hoping that the trend is there to stay," Manian said.
Some analysts said that while the strategic pivot is right for the long haul, it could dampen growth and returns in the near term. Federal Bank's roadmap is expansive and well-crafted. It is also ambitious, which means execution risks may outweigh the upside in the immediate future.
While commendable for long-term value creation, the strategy entails slower medium-term growth reflected in tepid growth numbers, Centrum said in a report on 3 August.
'Even banks with stronger brands and wider distribution networks are struggling to achieve substantial growth in low-cost deposits. This indicates an uphill task for the bank's recalibrated strategy," Centrum said.
While the bank seems committed to making the right strategic shifts, 'the ongoing transition is likely to bring near-term challenges and earnings variability," analysts at Elara Capital noted in a report dated 3 August.
How Q1 played out
Gross non-performing assets (NPAs) rose to 1.91% in Q1 after narrowing steadily for the past four quarters. In the previous quarter, gross NPA was 1.84%.
Federal Bank's slippage rate rose to 1.11% in the reporting quarter from 0.84% in the previous quarter. The lender said elevated slippages were largely driven by microfinance loans and added that incremental stress is seen in microfinance while the remaining book remains resilient.
Credit costs rose to 65 bps in Q1, a jump from the ~50 bps range the bank had held steady over the past two years.
Factors to watch
Some analysts said the bank's asset quality will need close monitoring in the near to medium term, particularly as the loan mix evolves, since there are few other levers left to sustain return on assets.
Investors should closely watch for a pickup in credit growth and margin improvement, driven by the shift in the mix towards better-yielding segments that can translate into a stronger return on assets. Vaidya of Axis Securities said credit growth could pick up in FY27, supported by improved consumption demand and favourable macros.
The bank's return on assets in Q1 stood at about 1%, weighed down by higher credit costs. However, Vaidya said she expects the bank to end FY26 with a return of about 1.1% compared with 1.2-1.3% reported in previous years. This can be attributed primarily due to net interest margin pressures and marginally higher credit costs.