The past three years have been one of the toughest periods for the Indian economy. With growth slowing for the third consecutive year, to 4.5%, the Indian financial sector has been facing problems on multiple counts, from asset quality issues to slowing credit demand. Inflation remaining elevated has also kept rates close to decade highs. During this period, Indian banks have focused on balance sheet consolidation, cleaning up the books and cost rationalisation to sustain profitability. ICICI Bank has followed the same formula and has transformed itself well during this period. Before looking at the future, it’s important to understand the transformation that has happened at the bank during this period.
Post FY07, ICICI Bank shifted its focus from aggressive growth and market share gains to improving profitability. This is reflected in the consolidation phase of FY08-10, during which the loan book declined by around 20%. Even post FY10, loan growth has been calibrated and CAGR was 17% over FY10-13, compared with an industry CAGR of 19%. The proportion of unsecured loans (a painful area in the previous cycle) now stands reduced at 1.7% of overall loans against a peak of 9.8% in FY08. Today, retail forms around 37% of the book and, within that, the exposure is well diversified.
The phase of consolidation was effectively utilised to improve the liability profile and the cost of funds. The long-term profitability of any efficient bank is dependent on current account savings account (CASA) ratio, as it brings significant stability to its funding costs. At the end of H1FY14, ICICI Bank’s CASA ratio had improved to 43% from a low of 22% at end of FY07. Importantly, the savings account deposit proportion, which was at a low of 12.5%, had increased 2.4 times and is now at 30% of overall deposits (among the best in the industry). This has led to the cost of funds being more competitive for the bank and, in turn, has helped improve net margin consistently, from a low of 2.2% in FY07 to a high of 3.3% in the first half of the current fiscal.
RoA is at an all time high and RoE is also moving north
Around FY10, the gross non-performing assets (GNPA) of ICICI Bank increased from a low of 2% to over 5% due to high delinquency in the unsecured personal loan segment. However, consolidation of the balance sheet, de-risking the loan book (reducing focus on riskier segments) and diversifying the exposure helped it turn the corner. GNPA has continuously trended lower since FY10 and currently stands at a low of 3%. During this period, the coverage ratio has also been significantly enhanced and has been in the 70-80% range for the past couple of years. The restructured loan portfolio has also been contained at 2.1% of loans.
While balance sheet CAGR over FY10-13 has been around 14%, profit has grown at 27%. Structural improvement in core operations has also driven return on asset (RoA) from 1% in FY09 to 1.6% in FY13, an all-time high. Return on equity (RoE), too, has almost doubled over the past five years to nearly 15%.
A new chapter
While these are changes that have already happened, investors would like to focus on what lies ahead. Given a market share of around 5% in banking, ICICI’s growth will surely be linked to that of the economy. Private banks, however, have room to outperform the industry and gain market share. ICICI is likely to benefit from this trend. It continues to invest in building infrastructure and today has a branch network of 3,500 compared with 1,700 in FY10. Among private banks, it has the highest network of branches and has reached a critical mass across India. This will help it expand its retail liability and asset size over the next few years.
ICICI is well-capitalised, with its Tier I ratio at 12.8%, the best in the system. Further, most of its subsidiaries have become self-sufficient and are now contributing to the standalone banking business (repatriation of capital from overseas subsidiaries/dividend income). In the medium term, listing of the life insurance business and further repatriation of capital from international subsidiaries will provide support and ensure dilution-free growth. We believe that banks that are well-capitalised at the beginning of any growth cycle will always get premium valuation, as their ability to leverage the upcoming growth cycle will be the highest. Moreover, with a significant branch network in place, asset growth will need minimal investments, driving up RoA and RoE.
Though asset quality has been managed well, the Indian economy and corporate sector profitability remains at the low point of the cycle. This will keep stress points high in banking. ICICI has shown strong growth in its domestic corporate loan portfolio (CAGR of 37% over FY10-13), especially power (CAGR of 36% over FY09-13), which remains vulnerable in the current economic context. The bank does not have any exposure to gas-based plants and ultra mega power projects, although the possibility of restructuring exists, it does not expect economic loss in this segment. Nearly 50% of the loans originated in the power segment have captive mines, with the rest depending on coal linkages. Based on the PLF sensitivity, the bank does not expect any significant pressure on this account. Meanwhile, iron and steel exposure is mainly to the larger players and the bank has not seen any material delinquency in this segment. While FY14-15 will be critical for the fate of a few large exposures, the bank is confident of tiding over this without any dent in its profitability.
Retail loan exposure as a % of total
book has come off over the years
The RoA has moved upwards to 1.6% and leveraging the high capital base will continue to drive RoE higher. We see the bank attaining a RoE of 18% over the next few years. Economic recovery and corporate sector profitability will remain the catalyst for assets and asset quality issues. However, improvement in all key parameters in the past few years have made it a much better banking franchisee than in earlier cycles. This will be a differentiating factor for long-term sustainable returns. We are very positive on ICICI Bank, which is trading at an estimated FY15 P/BV of 1.4X and is one of our top picks for the new year.
The brokerage has a buy call on the stock, but the writer in his personal capacity does not own the stock