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ICICI Bank (ICBK.BO)
Stability, Not Leadership, the New Mantra
Management in stable-growth, avoiding-risk mode — ICBK is now entering the
first phase of its build-up (post recovery and consolidation) - our recent meeting
with the management suggests: a) Growth likely to be stable, along industry levels,
and non-disruptive, b) Focus firmly on improving structural profitability – through
funding and product mix, and c) Willing to live with “lost opportunities”, but keen to
avoid all risks for now. This is an attempt to break from its past, and should
smoothen its return profile and reduce volatility, but also limit near-term upsides.
NIMs to remain structurally lower than peers — Management suggested some
near-term NIM pressures (10-15bps in next 2 quarters), but should improve
medium term (mostly in FY13) as drags from - a) securitization charges, b) NPLs
(high NPL base, increases denominator), and c) priority sector requirements
(should reduce as proportion of assets), become lower. However, structurally its
NIMs should remain lower than peers due to a) Loan mix – higher corporate,
mortgage bias; and b) Funding mix – lower CASA to total funding, wholesale bias.
Asset quality performance should reflect lower risks — ICBK’s low past
growth and lower risk appetite should also reflect in better-than-historical asset
quality performance. Incremental slippages should remain low and so should credit
costs (management expects less than 100bps across cycle). NPLs still remain
high and should reduce, but more gradually (loan growth, write-offs).
Return profile to remain challenging on excess capital, business breadth —
The key challenge for ICBK now is to improve its return profile - management
expects ~15% ROE (consolidated) medium term. This, however, remains lower
than peers and will likely remain so given its larger size, broader business mix and
excess balance-sheet capital. Bottom line, ICBK’s new path should lead to
smoother business cycles and lower stock beta, but will also cap its return profile
and valuations. We believe longer-term prospects for the business and stock are
healthy and (all else being same) would be more positive if stock corrects further.
Stability, Not Leadership
ICICI Bank is entering its first phase of growth (post the recovery and consolidation
phase) and our recent meeting with the management suggests: a) It is still a cautious
approach, with bank in a largely “risk-avoidance” mode (even if this means letting go of
some opportunities near term); b) Growth should come, but will be measured and clearly
not at the cost of profitability (even on individual products); and c) Focus on improving
the business mix (both asset and liabilities) and structural return profile medium term. In
sum, the focus is clearly on building a strong platform, stabilizing the existing businesses
and sweating them for higher returns – all this before embarking on a more ambitious
agenda.
The benefits of this approach are quite obvious medium term – a) lower business
volatility, b) greater balance sheet stability, and c) better structural return profile. But what
are the risks that management needs to guard against? Relatively lower returns and
possible lost opportunities.
Growth, but focus on Profitability
ICICI Bank has restarted on its growth path, initially modest, now gaining some
traction (+15% yoy in 3Q11) and likely to move slightly higher. This will however
remain close to industry levels over the next 12-18 months as management
focus is to re-establish the growth momentum, make sure risks are low and
profitability is improved on existing products.
Loan growth is likely to be led by the domestic book (international to also grow
but more slowly) with corporate and infrastructure segments growing relatively
faster within the domestic book. Retail growth is likely to lag (likely around 15%
growth) overall loan growth, unsecured loans are still largely taboo and
mortgage bias is to remain high within the retail piece.
Management is, however, more focused on profitable growth and balance sheet
stability rather growth – funding growth (especially CASA) will therefore
determine the extent of growth going forward. Management is willing to settle
for lower growth if funding does not keep pace with the asset growth. Similarly,
product profitability comes back to the top of the agenda, with growth again a
runner-up.
Management is targeting to improve the bank’s overall return profile to around
15% (excluding investments in subsidiaries) and, we believe, this is something
that is achievable over the next 12 months. The stated return profile however
will continue to be lower as returns from the subsidiaries do not get included in
the parent’s book (management targets consolidated ROEs of 15% as well).
However, given its excess capital base and cautious management approach,
we believe it will be challenging to improve its ROEs meaningfully beyond those
levels, at least over the medium term.
Net Interest Margins structurally lower
ICICI Bank’s net interest margins have stabilized around the 260bps levels for
the last few quarters – there is likely to be some near-term pressure –
management suggests possible decline of 10-15bps cumulative over next
couple of quarters. However, there is likely to be an improvement over the
medium term as some of the drags on margins are likely to reduce, namely – a)
ICICI bank currently takes a charge of Rs3-4bn p.a. on account of securitization
transactions done historically, and this is likely to wear off from FY13 onwards,
b) High current NPL base (4.9% of loans), which does not add to NII but
increases the denominator – this should also reduce as higher loan growth and
possible write-offs over the medium term reduce the drag from this, and c)
priority sector requirements (need to invest in low yielding bonds) – should
lessen slightly as proportion of total assets, but only modestly. Cumulatively,
however, there should be room for some improvements in NIMs, even apart
from any improvements in the liability mix
Structurally, however we believe ICBK’s net interest margins will remain below
peers, due to its: a) loan mix – higher corporate (55% of consolidated loans
including international subs) and mortgage bias (25% of loans); and b) funding
mix - lower proportion of CASA to total funding (25%) relative to peers. While
we expect there will be some improvements, its own balance-sheet structure
and mix will likely limit upside, and sustainable NIMs should remain below
peers.
Fee Income, Costs – In line with asset growth
ICICI Bank’s fee income has been a relative drag and running below asset
growth – largely due to slower retail lending and third-party distribution fees.
Management suggests that fee growth should improve with a pick-up in retail
lending and SME/corporate fees and should largely trend in line with asset
growth.
Operating expenses are likely to face some pressures as a) management will
need to leverage its enhanced branch network for liabilities as well as asset
growth and b) there have been high recruitment levels as well (around 10,000
employees added over last 12 months). While this is likely to increase pressure
on operating expenses, management is confident of maintaining cost income
ratio at 40-42% levels (close to current) and cost to average assets around 1.7-
1.8% levels.
Asset quality to improve gradually
ICICI Bank’s low risk threshold, combined with little fresh lending (consolidated
loans down 7% over March 2009) in last couple of years, should also reflect in
asset quality improvements medium term. We expect slippages to remain low
(close to nil currently) over the next 12-18 months as its loan book is possibly
the most seasoned in the industry.
Credit costs should also follow incremental delinquencies and decline from the
current high levels – management expects less than 100bps credit costs –
across the cycle – and could even be lower near term. However, its current high
NPL base will likely keep credit costs from going too low (as management will
likely take some write-offs medium term) and will be a bit of a drag.
Can “No Risks” lead to “No Gains”?
The benefits of ICBK management’s low-risk approach are quite obvious –
however, what about the risks? We believe the risks are more hidden and could
be reflected through – a) lower loan growth (relative to the industry), b) lost
opportunities in certain segments and c) loss of market leadership. A “no risk”
approach can often lead to lower growth and profitability levels – but these will
be harder to put a finger on as they will be conspicuous by their absence,
rather than be an overt drag on income. We believe management will need to
guard against this, as otherwise it is likely to reflect in lowering its overall return
profile.
ICICI Bank
Valuation
Our target price of Rs1,225 is based on our EVA, which we use as our primary
methodology for the Indian banking universe because we believe it better
captures the long-term value of a business. Our EVA value is based on: a)
Long-term Cost-Income ratio of 36%; b) Long-term loan loss estimates of
110bps; c) Rs183 as estimated value of subsidiaries (FY12E); and d) Risk Free
Rate of 8%.
We also benchmark our valuation based on a Sum-of-the-Parts analysis. This
equates to Rs1,217 per share. We value ICICI Bank's domestic banking
business on 2.5x 1yr Fwd PBV (FY12E) and international business at 1.5x,
translating into an overall PBV target multiple of 2.25x 1yr Fwd. Our target
multiple is based on stable asset quality, sustained improvements in the deposit
franchise and a loan growth revival. The 2.25x PBV multiple is at the lower end
of our target for comparable private banks (2.75x- 3.5x) given ICBK's still-lower
return profile. The rest of the value is driven by its subsidiaries: life insurance at
Rs108, general insurance at Rs25, AMC at Rs19, ICICI Securities at Rs18,
primary dealer at Rs3, and venture fund at Rs10. The subsidiaries are valued
based on industry benchmarks.
While ICBK's target multiple is relatively high relative to returns (its cost of
capital is higher than its ROE); we believe its large presence in the market, its
capital position, and the inherent leverage of the business, should enable it to
return to higher profitability and thereafter higher valuations.
Risks
We assign a Medium Risk rating to ICICI Bank. Our quantitative risk-rating
system, which tracks 260-day historical share price volatility, suggests Low
Risk. We view a Medium Risk rating as more appropriate given the bank's large
international portfolio and its relatively lower return profile. Downside risks that
could impede the shares from reaching our target price include: (1) continued
deterioration in asset quality; (2) low margins, with a limited cushion if there is
further downside pressure; (3) aggressive international operations where
returns appear low and risk levels relatively high; and (4) inability to leverage
capital, which keeps ROEs low. Upside risks to our target price include; (1)
quicker-than-expected asset improvements; (2) rapid improvement or
unwinding of the international book; and (3) capital markets momentum, which
could provide upside to its financial services businesses.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
ICICI Bank (ICBK.BO)
Stability, Not Leadership, the New Mantra
Management in stable-growth, avoiding-risk mode — ICBK is now entering the
first phase of its build-up (post recovery and consolidation) - our recent meeting
with the management suggests: a) Growth likely to be stable, along industry levels,
and non-disruptive, b) Focus firmly on improving structural profitability – through
funding and product mix, and c) Willing to live with “lost opportunities”, but keen to
avoid all risks for now. This is an attempt to break from its past, and should
smoothen its return profile and reduce volatility, but also limit near-term upsides.
NIMs to remain structurally lower than peers — Management suggested some
near-term NIM pressures (10-15bps in next 2 quarters), but should improve
medium term (mostly in FY13) as drags from - a) securitization charges, b) NPLs
(high NPL base, increases denominator), and c) priority sector requirements
(should reduce as proportion of assets), become lower. However, structurally its
NIMs should remain lower than peers due to a) Loan mix – higher corporate,
mortgage bias; and b) Funding mix – lower CASA to total funding, wholesale bias.
Asset quality performance should reflect lower risks — ICBK’s low past
growth and lower risk appetite should also reflect in better-than-historical asset
quality performance. Incremental slippages should remain low and so should credit
costs (management expects less than 100bps across cycle). NPLs still remain
high and should reduce, but more gradually (loan growth, write-offs).
Return profile to remain challenging on excess capital, business breadth —
The key challenge for ICBK now is to improve its return profile - management
expects ~15% ROE (consolidated) medium term. This, however, remains lower
than peers and will likely remain so given its larger size, broader business mix and
excess balance-sheet capital. Bottom line, ICBK’s new path should lead to
smoother business cycles and lower stock beta, but will also cap its return profile
and valuations. We believe longer-term prospects for the business and stock are
healthy and (all else being same) would be more positive if stock corrects further.
Stability, Not Leadership
ICICI Bank is entering its first phase of growth (post the recovery and consolidation
phase) and our recent meeting with the management suggests: a) It is still a cautious
approach, with bank in a largely “risk-avoidance” mode (even if this means letting go of
some opportunities near term); b) Growth should come, but will be measured and clearly
not at the cost of profitability (even on individual products); and c) Focus on improving
the business mix (both asset and liabilities) and structural return profile medium term. In
sum, the focus is clearly on building a strong platform, stabilizing the existing businesses
and sweating them for higher returns – all this before embarking on a more ambitious
agenda.
The benefits of this approach are quite obvious medium term – a) lower business
volatility, b) greater balance sheet stability, and c) better structural return profile. But what
are the risks that management needs to guard against? Relatively lower returns and
possible lost opportunities.
Growth, but focus on Profitability
ICICI Bank has restarted on its growth path, initially modest, now gaining some
traction (+15% yoy in 3Q11) and likely to move slightly higher. This will however
remain close to industry levels over the next 12-18 months as management
focus is to re-establish the growth momentum, make sure risks are low and
profitability is improved on existing products.
Loan growth is likely to be led by the domestic book (international to also grow
but more slowly) with corporate and infrastructure segments growing relatively
faster within the domestic book. Retail growth is likely to lag (likely around 15%
growth) overall loan growth, unsecured loans are still largely taboo and
mortgage bias is to remain high within the retail piece.
Management is, however, more focused on profitable growth and balance sheet
stability rather growth – funding growth (especially CASA) will therefore
determine the extent of growth going forward. Management is willing to settle
for lower growth if funding does not keep pace with the asset growth. Similarly,
product profitability comes back to the top of the agenda, with growth again a
runner-up.
Management is targeting to improve the bank’s overall return profile to around
15% (excluding investments in subsidiaries) and, we believe, this is something
that is achievable over the next 12 months. The stated return profile however
will continue to be lower as returns from the subsidiaries do not get included in
the parent’s book (management targets consolidated ROEs of 15% as well).
However, given its excess capital base and cautious management approach,
we believe it will be challenging to improve its ROEs meaningfully beyond those
levels, at least over the medium term.
Net Interest Margins structurally lower
ICICI Bank’s net interest margins have stabilized around the 260bps levels for
the last few quarters – there is likely to be some near-term pressure –
management suggests possible decline of 10-15bps cumulative over next
couple of quarters. However, there is likely to be an improvement over the
medium term as some of the drags on margins are likely to reduce, namely – a)
ICICI bank currently takes a charge of Rs3-4bn p.a. on account of securitization
transactions done historically, and this is likely to wear off from FY13 onwards,
b) High current NPL base (4.9% of loans), which does not add to NII but
increases the denominator – this should also reduce as higher loan growth and
possible write-offs over the medium term reduce the drag from this, and c)
priority sector requirements (need to invest in low yielding bonds) – should
lessen slightly as proportion of total assets, but only modestly. Cumulatively,
however, there should be room for some improvements in NIMs, even apart
from any improvements in the liability mix
Structurally, however we believe ICBK’s net interest margins will remain below
peers, due to its: a) loan mix – higher corporate (55% of consolidated loans
including international subs) and mortgage bias (25% of loans); and b) funding
mix - lower proportion of CASA to total funding (25%) relative to peers. While
we expect there will be some improvements, its own balance-sheet structure
and mix will likely limit upside, and sustainable NIMs should remain below
peers.
Fee Income, Costs – In line with asset growth
ICICI Bank’s fee income has been a relative drag and running below asset
growth – largely due to slower retail lending and third-party distribution fees.
Management suggests that fee growth should improve with a pick-up in retail
lending and SME/corporate fees and should largely trend in line with asset
growth.
Operating expenses are likely to face some pressures as a) management will
need to leverage its enhanced branch network for liabilities as well as asset
growth and b) there have been high recruitment levels as well (around 10,000
employees added over last 12 months). While this is likely to increase pressure
on operating expenses, management is confident of maintaining cost income
ratio at 40-42% levels (close to current) and cost to average assets around 1.7-
1.8% levels.
Asset quality to improve gradually
ICICI Bank’s low risk threshold, combined with little fresh lending (consolidated
loans down 7% over March 2009) in last couple of years, should also reflect in
asset quality improvements medium term. We expect slippages to remain low
(close to nil currently) over the next 12-18 months as its loan book is possibly
the most seasoned in the industry.
Credit costs should also follow incremental delinquencies and decline from the
current high levels – management expects less than 100bps credit costs –
across the cycle – and could even be lower near term. However, its current high
NPL base will likely keep credit costs from going too low (as management will
likely take some write-offs medium term) and will be a bit of a drag.
Can “No Risks” lead to “No Gains”?
The benefits of ICBK management’s low-risk approach are quite obvious –
however, what about the risks? We believe the risks are more hidden and could
be reflected through – a) lower loan growth (relative to the industry), b) lost
opportunities in certain segments and c) loss of market leadership. A “no risk”
approach can often lead to lower growth and profitability levels – but these will
be harder to put a finger on as they will be conspicuous by their absence,
rather than be an overt drag on income. We believe management will need to
guard against this, as otherwise it is likely to reflect in lowering its overall return
profile.
ICICI Bank
Valuation
Our target price of Rs1,225 is based on our EVA, which we use as our primary
methodology for the Indian banking universe because we believe it better
captures the long-term value of a business. Our EVA value is based on: a)
Long-term Cost-Income ratio of 36%; b) Long-term loan loss estimates of
110bps; c) Rs183 as estimated value of subsidiaries (FY12E); and d) Risk Free
Rate of 8%.
We also benchmark our valuation based on a Sum-of-the-Parts analysis. This
equates to Rs1,217 per share. We value ICICI Bank's domestic banking
business on 2.5x 1yr Fwd PBV (FY12E) and international business at 1.5x,
translating into an overall PBV target multiple of 2.25x 1yr Fwd. Our target
multiple is based on stable asset quality, sustained improvements in the deposit
franchise and a loan growth revival. The 2.25x PBV multiple is at the lower end
of our target for comparable private banks (2.75x- 3.5x) given ICBK's still-lower
return profile. The rest of the value is driven by its subsidiaries: life insurance at
Rs108, general insurance at Rs25, AMC at Rs19, ICICI Securities at Rs18,
primary dealer at Rs3, and venture fund at Rs10. The subsidiaries are valued
based on industry benchmarks.
While ICBK's target multiple is relatively high relative to returns (its cost of
capital is higher than its ROE); we believe its large presence in the market, its
capital position, and the inherent leverage of the business, should enable it to
return to higher profitability and thereafter higher valuations.
Risks
We assign a Medium Risk rating to ICICI Bank. Our quantitative risk-rating
system, which tracks 260-day historical share price volatility, suggests Low
Risk. We view a Medium Risk rating as more appropriate given the bank's large
international portfolio and its relatively lower return profile. Downside risks that
could impede the shares from reaching our target price include: (1) continued
deterioration in asset quality; (2) low margins, with a limited cushion if there is
further downside pressure; (3) aggressive international operations where
returns appear low and risk levels relatively high; and (4) inability to leverage
capital, which keeps ROEs low. Upside risks to our target price include; (1)
quicker-than-expected asset improvements; (2) rapid improvement or
unwinding of the international book; and (3) capital markets momentum, which
could provide upside to its financial services businesses.
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