ICICI Bank vs HDFC Bank: A tale of outperformance

What began as a series of unfortunate events at a rival bank has now turned into a story of personal outperformance.  

India’s top two private sector lenders, ICICI Bank Ltd and HDFC Bank Ltd, were born together in 1994 but diverged in their performance and path many times. 

When it comes to investors, ICICI Bank has reclaimed its position as the most favoured company in the banking space after a gap of many years. Indeed, most analysts now tag ICICI Bank’s stock a buy even though this seems to be the most crowded trade.  For perspective, ICICI Bank’s shares have risen by 18 percent over the past one year. The broad Nifty has gained about 5 percent. HDFC Bank has disappointed investors with a 3 percent fall. If we take their share price journey from pre-pandemic highs, the story doesn’t change much. 

Last month, Jefferies India Pvt Ltd highlighted the fact that ICICI Bank offers the best risk-reward mix among all global banks. It said the lender would report superior returns on assets on a consistent basis and has enough firepower to participate in India’s credit recovery without accidents of bad loans.  

“Our target multiple for ICICI is now on a par with HDFC Bank,” wrote analysts at Edelweiss Securities Ltd in a July 24 note. 

As said earlier, ICICI Bank’s valuation boost began more from HDFC Bank’s troubles than its own outperformance. But the first-quarter performance of both lenders shows that ICICI Bank’s outperformance is the main driver of valuations. The private sector lender has trumped its rival on almost all profitability metrics for the quarter. 

Bank in shining armour 

ICICI Bank’s strongest performance point has been its operating profit growth. The bank reported 19 percent year-on-year increase in core operating profit for Q1FY23, higher than HDFC Bank’s 15 percent. 

True, the bank’s operating profit growth has been volatile even as HDFC Bank’s has been more consistent. But operating profit growth has been consistent over the past four quarters.  

While operating expenses continue to remain relatively elevated, the bank’s core interest income leaves the rest of the private sector lenders ny the wayside. For Q1FY23, net interest income growth was a smart 21 percent versus HDFC Bank’s 15 percent and other banks’ single-digit or low double- digit growth.  

In a troubled quarter for treasury operations, ICICI Bank reported a small trading income unlike a trading loss by several lenders. That said, the bank too suffered a hit on its bond portfolio just like the others. 

The bank’s loan book has shown interesting changes. Post-pandemic, ICICI Bank’s book has turned retail heavy while HDFC Bank has ventured big into wholesale lending. The share of retail loans now stands at 53 percent in ICICI Bank’s book, mostly driven by secured lending.  

HDFC Bank’s loan portfolio is now corporate loan-heavy with a growing share of small business loans. With this divergence, the largest private sector lender’s margins are expected to remain superior to others. That said, low-cost deposits will help ICICI Bank too. 

Return on assets  

A key swing factor in investor sentiment towards ICICI Bank has been the sharp drop in dud loans. As the lender shed loans that were not generating income, the drag on core operating profit has stopped.  

Further, the lender’s need to set aside a large part of its profits as provisions has also come down. This double benefit has meant that the bank’s return on assets has expanded quickly. No wonder analysts have increased their expectations here.  

Those at Jefferies see an RoA increase of 2 percent for FY23. Motilal Oswal Financial Services Ltd expects 2.1 percent growth. Unlike a year ago, when 5.2 percent of loans were non-performing, only 3.4 percent of loans do not generate any income for ICICI Bank. The improvement has been because of the bank’s renewed focus on retail and a conscious effort to be cautious on wholesale lending.  

The management has indicated, though, that it would seek out opportunities in corporate lending during the current economic recovery. HDFC Bank continues to retain its premium as far as asset quality goes. The bank has been consistent in keeping its bad loan ratios low even during times of crisis. 

Verdict of the markets 

If one goes by the valuations, the markets favour ICICI Bank compared with HDFC Bank now. The rally in the former’s share price still has some steam left, according to analysts. At current price, ICICI Bank’s shares traded at roughly twice the estimated book value for FY24, similar to HDFC Bank’s multiple.  

The gap has been bridged largely because of HDFC Bank’s valuation erosion over the past two years owing to concerns over technology, uncertainty surrounding the merger with Housing Development Finance Corporation Ltd and a management change.  

However, from here on analysts believe that ICICI Bank’s performance, if sustained, could continue to keep it in favourable books of investors. 

“The stock return will be a function of earnings growth and re-rating over the coming years and ICICI Bank has all the ingredients in place to take over the pole position in the Indian banking space,” wrote Motilal Oswal analysts.