Lower slippages, improving core profitability and undemanding valuation makes the risk-reward extremely favourable for ICICI Bank
ICICI Bank reported a Rs 120 crore loss in the first quarter of FY19 on significantly higher provisions and lower treasury income. However, the core performance remained healthy with pre-provision operating profit increasing 17 percent year-on-year (YoY).
With a new successor at the helm, the result appears akin to that of a public sector bank wherein a management change leads to a clean-out act. With a bulk of problem assets already recognised till FY18, slippages or gross additions to non-performing assets (NPAs) were limited during Q1. The management stepped up provisions on bad loans. While the profit and loss statement bled, the balance sheet strengthened. This seems to be in continuation with the management’s earlier stated objective of improving provision coverage ratio (PCR) to 70 percent by June 2020.
The bank has had a rough run in the past few years with the piling up of bad loans arising out of its corporate exposure. While the asset quality pain might persist in the near term and FY19 may remain a year of consolidation due to higher credit costs, we expect the reported numbers to improve significantly from FY20. With the stock trading around 1 time FY20e book, current valuations seems to be pricing in the concerns. Lower slippages, improving core profitability and undemanding valuation are the 3 factors makes the risk-reward extremely favourable for ICICI Bank.Investors should use this consolidation as any opportunity to invest for the long term.
Net interest income (the difference between interest income and expense) increased 9 percent YoY as advances growth of 11 percent was partially offset by a slight contraction in margin. The fall in net interest margin (NIM) to 3.19 percent was due to margin compression in the international book. Going forward, the management is hopeful of maintaining margin as any increase in costs will get passed through an increase in marginal cost based lending rates (MCLR).
The bank’s treasury income was adversely impacted by mark-to-market losses of Rs 219 crore in the investment book while a gain of Rs 1,110 crore on sale of stake in ICICI Prudential Life Insurance provided some cushion. Fee income growth was healthy at 16 percent led by retail fees (75 percent of total).
Growth in operating expenses was contained at 9 percent. As a result, core pre-provision operating profit (excluding one-off treasury income) was up 17 percent YoY. Provisions spiked 129 percent as the bank made additional provisions on ageing of NPAs. The more than doubling of provisions significantly improved provision coverage ratio to 66.1 percent as compared to 55.2 percent a year ago, resulting in a net loss for the quarter.Retail continues to drive loan growth; High CASA is a competitive edge
Overall advances growth stood at 11 percent YoY as healthy 15 percent growth in domestic loan book was partially negated by 9 percent de-growth in international loans. A strong focus on retail lending has enabled ICICI Bank to grow its domestic loan book ahead of the system, despite cyclical weakness in the large corporate segment. Retail assets grew 20 percent YoY, while corporate loans growth was muted at 4.9 percent.
In the past few years, the bank has steadily diversified and de-risked its asset book which is reflected by the change in its advances mix. Retail now constitutes 58 percent of the bank’s total loan book as compared to 37 percent as at the end of March 2015. The proportion of international in overall loans continued to decline further and stood at 12.5 percent as compared to 25.3 percent as at the end of March 2015.
Performance on the liability side continues to be impressive. Overall deposits grew 13 percent YoY led by continued traction in low cost current and savings account (CASA) deposits, which grew 16 percent. CASA mix improved 150 bps YoY to 50.5 percent at the end of Q1.Credit cost to remain elevated in FY19
Gross slippages to NPAs that spiked in Q4 FY18 to Rs 15,737 crore, was curtailed in Q1 to Rs 4,036 crore, which was very encouraging. The bulk of slippages accrued in developer financing book and agriculture segment. Thanks to contained slippages and higher provisioning, gross and net NPAs declined in Q1 to 8.81 percent and 4.19 percent, respectively, as at June- end.
The bank’s exposure to list 1 and 2 of corporates undergoing resolution through National Companies Law Tribunal (NCLTL) stood at Rs 4,059 crore and Rs 9,292 crore, respectively. PCR on both lists improved to 88 percent and 61 percent, respectively, as at June- end.
The management disclosed a pool of loans to corporate and small and medium enterprises (SME) rated BB and below of Rs 24,629 crore (equivalent to 4.8 percent of the loan book), which can be in potential stress. This is substantially higher than stress assets pool of Rs 13,365 crore declared in the previous quarter. The bank has included an additional SME and smaller corporate exposure of around Rs 12,138 crore rated BB and below, over and above the stress pool declared in Q4 FY18.
While the management expects asset quality concerns to recede with relatively lesser slippages for FY19, the high pool of stress loans makes us cautious in the near term. An attempt to directionally increase PCR ratio to the targeted 70 percent by June 2020 will keep credit costs elevated in FY19. As such, we expect FY19 to be a soft year.Valuations compelling at current levelsIn Q4 FY18, the management articulated its strategy which it endeavours to achieve by June 2020. It aims to deliver consolidated return on equity (RoE) of 15 percent, while improving NNPA to 1.5 percent and maintaining provision cover above 70 percent by June 2020.
With its 2020 vision in place, investors should expect much lower NPA formation and normalised credit cost in FY20, mid-teen loan growth, steady interest margin and commencement of the journey to reach 15 percent RoE. With a strong capital adequacy (Tier I capital ratio at 15.84 percent), we don’t see many constraints in delivering its targets. There is not much clarity on impact of implementation of Ind-AS from April 2019 on credit costs and profitability.
With a potential improvement in return rations, the current valuation of its core book at 1 time FY20e P/BV looks compelling. While asset quality concerns have not completely abated, the risk-reward is extremely favourable. In fact, ICICI bank is trading at a discount of more than 30-40 percent relative to its closest corporate lending peer, which is also facing asset quality issues and uncertainty over impending management change.
While the lower slippages help in partially allaying investor concerns around asset quality, ICICI Bank’s Q1 earnings doesn’t decisively lift the cloud of uncertainty. Markets may have to wait for couple of more quarters for a clear sky. Depressed earnings as well as the ongoing inquiry of alleged corporate misconduct by the bank’s Managing Director and CEO will be a near term overhang for the stock. Nevertheless, long term investors should utilise the languishing stock price as an opportunity to accumulate the stock.Moneycontrol Research page