ICICI Bank: Has many bridges to cross - Outside View by Luke Verghese

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ICICI Bank: Has many bridges to cross
Jul 12, 2011

As ICICI Bank braces up for a long innings under the tutelage of Chanda Kochhar, it has many bridges to cross, not the least being the mess it has to clear up in the Retailing loan segment. This is a long and painful process, and a cross which she inherited as a necessary part of sitting on the hot seat. Whether she will change the emphasis from being primarily a non manufacturing sector lender to a more visible face in manufacturing is another moot point, given the low exposure levels in the latter segment, and the lower provisioning levels for such loans. Several paters

The ICICI Bank of today has two paters - it started life as The Industrial Credit and Investment Corporation of India Limited in 1955, as an all India development bank loaning out long term funds to the industrial sector. It was also an all India development institution which sported foreign capital in its voting stock - from the International Finance Corporation, Washington, and the Aga Khan Foundation. If my memory serves me right the then Rs 100 face value share was for some 2 decades quoting below par. In 1994 ICICI spun off a commercial bank sporting its present name, and at the turn of the new millennium the two engineered a reverse merger to form the present avatar.

Today the bank encompasses the whole swath of banking business streams - income from short term lending to long term lending, fee based, treasury income, lease and other income, the works. Though still firmly rooted in India shores the majority voting stock is today foreign held. A little over 66% of its voting capital is held by a gaggle of offshore shareholders including holders of American Depository Shares, FIIs, NRIs, Foreign banks, foreign companies, OCBs and foreign nationals. But the entire board of directors and the entire senior management staff is still of the 'desi' variety.

Undergoing a transformation?

The bank has undergone a transformation of sorts in the first full year under the helm of the new top gun Ms Chanda Kochhar. The bank gravitated through quite some 'unforced errors' in the last years of stewardship under the erstwhile CEO Mr. K.V.Kamath, who in his desire to retire in a blaze of glory stretched the institution to 'breaking' point on the retail lending front. Since Ms Kochhar was wised up on the travails that the bank faced, she knew what corrective action to take. The results of this effort are still in the making. She apparently also decided that the way forward was to take the bull by the horns. In tandem with the makeover that she initiated on the retail front, the bank also undertook a huge leap forward on the borrowing and lending front, which led to a piquant situation of the bank registering a negative cash flow of Rs 69 bn from 'operating activities', against a positive cash flow of Rs 18.7 bn previously. Not only that, the bank also went on an investment binge, buying fixed assets, securities, and pumping still more moolah into joint ventures and subsidiaries. So much so that it was out of pocket on cash flow from investing activities too, registering a negative cash flow to the tune of Rs 21 bn against a positive flow of Rs 62 bn previously. But since the bank had a massive reserve of cash and cash equivalents at the beginning of the year, and also by borrowing a cool Rs 45 bn through the issue of bonds, it was able to more than weather this desert storm.

The immediate net effect of these financial shenanigans did not quite set the Jamuna on fire, though the bank did the magic mantra of registering a 27% increase in pre-tax profits and a 28% increase in post tax profits. The point is that gross income from its core activities labeled under Interest Income grew a miniscule 1% to Rs 260 bn but the trick here was that there was a decline in interest expense which in turn led to a 11% increase in net interest income. Its merchant banking and leasing income clubbed separately under Non Interest Income rose an appreciable 14%. But with an increase in operational expenses here, the net income here rose a mere 0.5%. As a matter of fact overall operating profits fell 7% to Rs 90.5 bn. But a sharp reduction in 'provisions & contingencies' to Rs 22.9 bn in 2010-11 from Rs 43.9 bn previously did the Harry Houdini trick. This then was the first game changer. (Such provisions in a sense are a subjective expense entry, and ICICI Bank cannot therefore be said to have put on a better show. It is another matter that the bank hiked dividend to Rs 14 per share from Rs 12 per share). Chanda will have to try a little harder.

Its working economics

The bank has provided a number of schedules giving details of the innards of its working economics. The charts portraying the 'Net interest and spread analysis' and the 'Net Interest Income and Spread Analysis' do not make for very pleasant reading. It earns its bread on wafer thin margins for sure. The average interest bearing assets fortunately rose at a faster clip of 4.9% to Rs 3418 bn, while the average interest bearing liabilities grew more slowly at 3.7% to Rs 3168 bn. (One may add here that the cumulative total of cash in hand, with RBI, Balances with banks and money on call, Investments, and Advances at year end toted up to Rs 3,851 bn, against Rs 3,409 bn previously. In other words, and on a rough calculation, what it had 'lent out' as at year end amounted to 88.8% of the funds on hand, against a much higher 95.6 % previously). Why is there such an anomaly? At year end the interest earning assets also exceeded the interest bearing liabilities by a flimsy 7.9%.

The other important bit of information is that the average yield that the bank earned on its interest bearing assets fell to 7.6% from 7.9% previously, but it was compensated for by an average fall in the cost of funds to 5.4% from 5.8%.In other words the interest spread between what it makes and what it pays out grew by a mere 0.1% to 2.2%.The bank has to cover its administrative costs within this spread. It is the pure and simple volumes business at the end of the day that helps banks to keep their heads above water. Now you know why the banking industry is always chasing deposits, and why bank managers are given yearly targets for deposit collection, with the threat of negative consequences.

While its interest income from its several streams (interest/advances/bills/income from investments/balances with RBI, and others) grew only 0.07% to 260 bn, the Other Income component was a letdown. This income stream comprising of Commission/profit on sale of investments/forex calls/dividends / miscellaneous income and such like fell 11% to Rs 66.5 bn. The culprit for the fall was a book entry - the net loss on revaluation of its investments. The expense entry for the year was Rs 4.6 bn against a positive entry of Rs 1.8 bn previously. That is to say there was a cumulative negative turnaround in income to the tune of Rs 6.5 bn in 2010-11. In effect this was the second game changer. (But this entry will be an annual affair - as annual as the year-end profit and loss account - given the coupon rate, and yield rate changes that accompany the diktats of the Reserve Bank of India (RBI)). In reality there was a third game changer as we will see as we traverse along.

Putting its working in perspective

The company's working has however been put in the right perspective in the Business Segment Results schedule. Its cumulative income streams are clubbed under 4 subheads. They are Retail Banking/Wholesale Banking/Treasury and, Other banking Business. Surprisingly enough, for a commercial bank, the biggest income source was Treasury operations which brought in 40% of all gross income. This was followed by Wholesale Banking with 32.5%, Retail Banking with 26.8% and a piddling 0.7% from a stream called Other banking Businesses. Based on the segment results, the biggest contributor to the gross bottom-line was the smallest revenue generator. 'Other banking businesses' generated a segmental profit of 40.5%. Wholesale banking with a margin of 25.3% was next in line, with treasury operations bringing in a return of only 9.2%. But it is retail banking which raises eyebrows. In 2009-10 it recorded a segmental loss of Rs 13.3 bn. This loss was curtailed to Rs 5.1 bn in the latter year. In effect there was a turnaround of sorts to the tune of Rs 8.2 bn on this score. This then was the third game changer in the complex bottom-line generation scenario.

What is most revealing and simultaneously amusing to boot is that the 'profit generators', the 'revenue generators', and the 'segmental assets' that generate these streams are not quite in consonance. There is also the likelihood that the Retail banking operations will return to black ink in the current year after three years of efforts to right all the wrong doings. In which event the bank should see a surge in its pretax profit figure in the current year.

Shift in emphasis in lending

The schedule detailing the gross advances at year end shows the shift in emphasis from retail financing to other sectors in percentage terms. In end 2010, 44.4% of gross lending was to Retail Finance. The percentage share reduced to 39.7% by 2011 year end. The fall in the lending to the Retail Finance segment was more than countenanced by increased lending to a category labeled Services -Finance. The percentage share more than doubled to 7.2% from 3.4%. The shift to any other sector is not as pronounced. What is interesting in the emerging scenario is that cumulatively the lending to the Retail and Services sector (the latter comprising of Finance and non Finance) still accounts for 54.6% of all lending against 55% previously. It is just that the classification emphasis has shifted. It still very much prefers to put its eggs in the non manufacturing sector - that is for certain. The bank does spread its risk on its total lending - it caters to 15 industrial sectors in toto, including an omnibus category going by the name of 'Other Industries' which accounts for over 11% of all lending. The top five segments accounted for 66.8% of gross lending in 2011, against 67.7% previously.

It is easy to understand the de-emphasis on Retail finance in the present context. As stated earlier retail finance still accounts for close to 40% of gross advances. It also accounts for 66% of all non performing assets at end 2011 against a slightly larger 67% previously. So getting out of the rut is slow and painful process. It may not be out of place to state here that on the basis of statistics available, the percentage bad debts on lending to the manufacturing sector is infinitely lower than on lending to the services sector. But the bank obviously prefers the present status quo. Or it could be that the lesser the exposure the better the quality control checks. But each one to one's own I guess.

The future imperfect

From the available evidence, the bank still has much headwind to confront. One wonders what game changing accounting entries the current year will bring -but sure as hell there will be. One can possibly expect a further disengagement from retailing, and probably a return to sizeable profitability from this segment. But the difference in the margins that it makes from what it gets as interest receipts on the one hand and what it pays out as interest expenses on the other will be crucial. That is also the big factor of the additional sum that the bank can roll in from incremental deposits and tapping the primary markets for still more borrowings put together. There is also the functioning of its big ticket subsidiaries, which I have not touched upon - for then this diatribe will become a little too long winding.

Disclosure: I hold 1,962 shares in ICICI Bank

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.


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