ICICI Bank: Buy

Fresh investments with a three-year horizon can be considered in the stock of ICICI Bank. Though the stock has gained considerably in the last couple of months, it continues to remain attractive from a long-term perspective for many reasons.

Firstly, improvement in the bank's asset quality indicates that its strategies for capital preservation and exiting risky portfolios are paying off.

Secondly, having cleaned up its books and returned to growth, the bank is expected to grow at a faster clip than most of its peers. It also has significant core capital (one of the highest capital adequacy ratio) to support higher loan book growth. The capital adequacy of the bank was 18.9 per cent with a very high Tier-1 capital at 13.3 per cent. And, finally, the operational parameters such as cost-income ratio, profit per employee, are improving, thus highlighting the successful merger of Bank of Rajasthan's book with itself.

Excluding the value of its subsidiaries (Rs 240 per share), at the current price of Rs 928, the estimated price-to-adjusted book value for FY13 of ICICI Bank stands at 1.5 times. This is at a discount to its other new private bank peers.

With improved return on assets and leverage , the consolidated return on equity will also get better. Besides, reversal in interest rates would not only improve the bank's off take (its base rate is among the lowest in the system) but also reduce the pressure on its asset quality. That said, the asset quality concerns will not fully abate until the business prospects improve for the corporate sector.

Branch network

ICICI Bank has a network of more than 2,500 branches (largest branch network for a private bank) that is helping improve its retail deposits. The wholesale deposit dependence has come to around one-third of the total deposits, while the low-cost deposits currently account for 43 per cent.

But due to slower business growth during the last couple of years, and merger of Bank of Rajasthan, its branch network is currently under-utilised — business per branch continues to be lower than the industry average. Going forward, we expect the branches to contribute more to the business growth.

The bank plans to increase its branch network to 4,000 by 2015. This will not only improve penetration, and, thereby, its fee income sources, it will also aid its subsidiaries such as the life insurance, general insurance and AMC businesses.

Fee income contribution to the total income is among the highest for ICICI Bank. Though subdued activity in the corporate finance segment has put pressure on the fee income growth, it is still strong. This, along with other income, almost takes care of all the operating expenses for the bank.

As of December 2011, the loan book growth was at 19.1 per cent. The book was driven by corporate advances and international business. Going forward, the unsanctioned loans, working capital loans and secured retail loan portfolio are expected to drive growth.

Loan book and asset quality

Unlike other large banks, the retail book with 33.5 per cent share continues to have significant share in the loan book even after shedding unsecured assets. Higher share of retail loans and international loan book (accounts for 29 per cent of the loan book) reduces its exposure to stressed assets in domestic segment.

The bank's exposure to the troubled SME sector is low. While in the infrastructure sector, the bank claims to have no exposure to players with cancelled 2G licences, in the power sector, its exposure is to lower-risk clients.

According to the management, half its loan book exposure is to power projects which are already commissioned. Even its international book is majorly exposed to India-centric businesses thus reducing the risk of global defaults spill over.

The bank's gross NPA ratio, as of December 2011, stood at 3.82 per cent down from 5.06 per cent in March 2010. The bank has provided for most of the bad debt. The restructured asset proportion is also low at 1.5 per cent of the loan book. About Rs 1,300 crore or 0.65 per cent of the loan book is yet to be restructured.

Margins may improve

Rural Infrastructure Development Fund investments accounts for 7 per cent of the loan book as the bank missed some priority sector lending targets. If this happens, (which include loans to agriculture, small ticket housing loans, education loans and MSME loans), they may have to buy RIDF bonds to meet the short-fall.

Investments in low-yielding RIDF puts pressure on overall margins. A 2.7 per cent margin (partly influenced by international book) is relatively low when compared with other large banks.

Going forward, fall in wholesale deposit costs due to rate cuts would help in improving the margins. The international margins have risen in the December quarter and the management expects it to be maintained at those levels.

Additionally, the credit default swaps are on a decline. Sustained decline in swaps rates would allow the bank to raise funds abroad at a lower cost. ICICI Bank hasn't done any capital infusion into its subsidiaries this fiscal. This would allow it to invest more in its core business and improve margins.

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