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ICICI Bank: NPAs knocked off!
Oct 14, 2005

Performance summary:
ICICI Bank, in reporting its results for the second quarter ended September 2005, has registered a commendable performance declaring a 31% YoY growth in bottomline. Although the bank has witnessed a further expansion its retail asset base, net interest margins have remained flat on a YoY basis. Nevertheless, the final resolution of the Dabhol project (where the bank had an exposure) has proved to be especially benign, as this has helped a considerable paring of the bank’s net NPA levels. Improved asset quality and a well-hedged treasury portfolio place ICICI Bank on a relatively comfortable ground as compared to its peers.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 22,305 32,133 44.1% 44,263 62,110 40.3%
Other Income 8,354 11,115 33.1% 14,931 22,020 47.5%
Interest Expense 15,453 22,598 46.2% 31,105 44,063 41.7%
Net Interest Income 6,852 9,535 39.2% 13,158 18,047 37.2%
Net interest margin (%)       2.4% 2.4%  
Other Expense 7,688 10,209 32.8% 15,012 19,919 32.7%
Provisions and contingencies 1,947 3,037 56.0% 2,405 6,016 150.1%
Profit before tax 5,571 7,404 32.9% 10,672 14,132 32.4%
Tax 1,149 1,601 39.3% 1,942 3,032 56.1%
Profit after tax/ (loss) 4,422 5,803 31.2% 8,730 11,100 27.1%
Net profit margin (%) 13.8% 26.0%   19.7% 17.9%  
No. of shares (m)       734.7 740.8  
Diluted earnings per share (Rs)*       23.8 30.0  
P/E (x)         17.6  
* (annualised)            

Encashing retail
ICICI Bank, in terms of asset size, is the second largest bank in the country after SBI. At the end of 2QFY06, the bank had a franchise of over 1,790 ATMs and 583 branches spread across the country. Retail assets constituted 64% of advances in the quarter. The bank is focusing on loan origination in the retail and agriculture segments and on non-fund based products and services, as well as capitalising on opportunities presented by the domestic and international expansion of Indian companies.

What has driven performance in 2QFY06?
Retail swells, margins squeeze: Swelling retail asset portfolio continues to be ICICI Bank’s competitive advantage. The bank managed to grow its retail assets by a whopping 73% YoY in 2QFY06. Mortgage loans (53% of its retail loan book) continued to remain the prime growth driver despite the hike in interest rates. Also, apart from the quantum jump in advances, the bank has managed to sustain a proportionate growth in deposits (grew 68% YoY) that has led the credit deposit ratio to decline over that of the corresponding quarter of FY05. However, it must also be noted that the bank does not seem to be actually reaping the advantage of re-pricing of the erstwhile ICICI’s high cost borrowings. The higher cost of deposits (4.9% in 2QFY06 against 4.4% in 2QFY05) coupled with the time lag in passing on the interest rate rise to assets has led to net interest margins remaining flat (at 2.4%) for the fourth consecutive quarter.

Credit deposit ratio…on the decline
(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Advances 684,791   1,070,709   56.4%
Retail 396,090 57.8% 685,370 64.0% 73.0%
Corporate 288,701 42.2% 385,339 36.0% 33.5%
Deposits 715,979   1,204,523   68.2%
Credit deposit ratio 95.6%   88.9%    

Fee support: It is not just the growth in net interest income but also the 31% YoY growth in fee income and 95% growth in treasury income that has helped ICICI Bank to post strong growth in bottomline for 2QFY06. Fee income (constituting 63% of other income) has been a significant contributor to the bank’ profitability over the past few quarters. The bank has further clarified that while 60% of the fee income is derived from its domestic retail operations, 10% is derived from international operations and remaining 20% is garnered from the domestic corporate customers. It must also be noted that the bank stands well hedged in terms of its treasury portfolio of which 85% is in the HTM (held to maturity) basket besides having lower duration of investments in the AFS (available for sale) category (which needs to be marked to market).

Overheads beckon caution: The bank’s cost to income ratio, although stagnant at 50% at the end of 2QFY05, is close to that of SBI (56%) and one of the highest in the sector. Thus, the fact the operating overheads continue to grow at exponential rates (39% YoY) is a matter of concern as such high overheads may not be sustainable in the wake of lower net interest margins going forward. Also, the same are significantly higher than that of its peers in the private sector banking space.

Quality improves: Resolution of the Dabhol project led to ICICI Bank selling the underlying collateral and recovering a substantial proportion of NPAs in this quarter. Thus the net NPA to advances ratio of the bank contracted to 1% from 2.6% in 2QFY05. Retail net NPA ratio also stood at 0.5%, down from 0.6% earlier. The bank has net restructured assets of Rs 58 bn at the end of 1QFY06 against Rs 68 bn in 1QFY05. Coupled with this, higher provisioning has led to considerable improvement in the bank’s coverage ratio (70%) in 2QFY06.

Capital raising on the anvil: ICICI Bank has got the board approval for a follow-on public issue to the tune of Rs 70 bn (plus a 15% green shoe option) in FY06, 73% of which will be listed on the domestic bourses and the rest being in the form of ADRs. The bank’s CAR (capital adequacy ratio) has declined to 12% in 2QFY06 against 15% in 2QFY05. This is also because it has had to assign risk weightage of 75% on retail mortgage and 125% on other loans, commercial real estate and capital market exposure. As the RBI guidelines are not yet conducive for preferential issue, the bank is opting for the equity issue to fulfill its capital requirement and meet the Basel II guidelines. Besides, the bank plans to inject additional funds in its life insurance subsidiary (ICICI Prudential) with the capital raised.

What to expect?
At the current price of Rs 528, the stock is trading at 2.3 times our estimated FY08 adjusted book value (after considering the lower NPAs and without considering the proposed follow-on public issue). The bank’s life insurance subsidiary (although witnessing a 60% growth in premium income) is expected to continue to remain a drag on its valuations in the medium term. Due to the consistent margin pressures, we shall need to downgrade our net interest margin expectations for the bank. Given its unfavorable positioning on the risk return matrix, we re-iterate our cautious stand on the stock.

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