‘Buy’ rating on ICICI Bank: Operating metrics look up

ICICI Bank’s Q4FY15 profit after tax at Rs 29 bn (up 10% year-on-year) came marginally below our estimate due to higher provisions. However, the quarter was characterised by improved operating performance, and incremental stress (albeit high) did not stray beyond guidance.

Key highlights were: (i) operating profitability (ex-treasury, lease, other income) clocked a healthy growth (>19% versus lower teens in Q3) on improving NIMs (up 11bps quarter-on-quarter to 3.57%) and controlled opex (up mere 8% y-o-y); (ii) fresh stress (fresh slippages and restructuring) was restricted to R22.5 bn, however, higher slippages from restructured book at 22.5 bn (R7.8 bn in Q3FY15) kept the stress elevated (but within guidance).

Multiple levers of RoA (return on assets) expansion, peaking out of fresh stress asset creation and current valuation of 1.5x FY17e (banking business) render risk-reward in ICICI’s favour. Maintain ‘Buy’ with a target price of R418.

Stress asset formation within guided range: In FY15, while fresh incremental stress creation was contained within guidance, slippages from restructured book were a major blip. Stepping into FY16, given: (i) reduced lumpy exposure (largest account contributes about 5% to restructured book); (ii) lower proportion coming out of moratorium; and (iii) improving macros, we expect NPLs (non-performing loans) from restructured book to taper. ICICI expects credit cost to be contained within 90-95bps in FY16e (109bps in FY15).

Core profitability supported by revenue traction, controlled opex: NII (net interest income) interest grew 16% y-o-y on improving NIMs (net interest margins), derivative of a tilt towards a higher yielding loan mix supported by strong liability franchise and healthy CASA (current account savings account) base (45.5%, up 15.5% y-o-y). This, coupled with controlled operational expenses (but up 8% y-o-y), aided core profitability. We expect stable/improving NIMs and benefits of operating leverage (given efficient use of technology) to lend further fillip to return ratios.

Outlook and valuations: Stress peaking out; maintain Buy. The bank’s well-capitalised position (Tier I: 12.8%), stable funding franchise and stressed assets at 4.5% lend comfort. Further leg up may come from re-rating of its capital market-linked businesses, viz., life insurance and asset management.

Asset quality improvement seen henceforth: Fresh slippages were controlled at R10 bn; this, along with fresh restructuring of R12.5 bn (pipeline of R15 bn), restricted fresh stress asset creation. But higher slippages from restructured book at R22.5 bn (versus R22.6 bn in 9mFY15) kept overall stress creation high. Stepping into FY16, the management sounded confident that stress asset creation will be lower than FY15, largely driven by: (i) improving macros; (ii) lower slippages from restructured book; and (iii) tighter control on underwriting practice (cap on large borrowers), among others. We do not foresee the repetition of FY15 performance in FY16 and see the improvement playing out gradually. The management expects credit cost to be contained within 90-95bps for FY16 (vs 109bps in FY15).

Loan growth maintains retail flavour:The bank’s loan book grew 14.4% y-o-y, with a 18% spurt in domestic loans. Domestic growth came on a 25% y-o-y surge in retail advances. Over the past few quarters, ICICI’s growth has been largely driven by retail book, owing to which its proportion has increased to 42.5% (from 35.5% in FY13). Within this, mortgages and auto loans jumped 26.4% and 23.7% y-o-y (on a low base). Personal loans grew 75% on an annual basis, but remained a small proportion of the loan book. Domestic corporate credit registered 10% y-o-y growth (but still below private peers).

CASA ratio improves: Improving liability profile has been the cornerstone of the management’s consolidation strategy. Savings account momentum remained on track, registering a healthy 15.9% growth y-o-y. Period-end CASA inched up to 45.5% (44% in FY13) with average CASA ratio improving to 39.9% (38.1% in FY14 and 39.3% in Q3FY15). Given the branch expansion, average CASA could sustain at 38-40%.

Core fee muted: Non-interest income came in at Rs 35 bn (up 17.5% y-o-y), aided by higher treasury income (at Rs 7.3 bn vs Rs 3.3 bn over five quarters), largely driven by the fixed income portfolio. Core fee income extended subdued performance registering single-digit growth for the fourth consecutive quarter (up 8% in Q1, 5.5% in Q2, 5.7% in Q3 and 8.3% in Q4). On the other hand, retail fee maintained traction, registering over 20% growth (contributing 60% to fees). Non-interest income was also supported by Rs 1.82 bn forex gain on repatriation of retained earnings from overseas branches (Rs 1.92 bn was repatriated in Q3).