We have downgraded our long term recommendation on ICICI Bank Ltd. (IBN”>IBN) to Underperform from Neutral mainly on increasing operating expenses. Though the company’s net earnings for the second quarter of fiscal 2012 (ended September 30) improved as a result of higher net interest income and a much lower provision for loan loss, a substantial rise in operating expenses was the downside.
We expect synergies from ICICI Bank’s dependence on domestic loans, stable funding base and leadership position in the insurance business. However at the same time, we are concerned about the company’s highly competitive operating environment and below-average credit quality.
ICICI Bank has been expanding its branch network for quite some time, which is resulting in higher operating costs. The growth in operating expenses will likely drag down the company’s financials over the near term. In addition, the company is expected to face higher expenses due to the probable rise in inflation.
Though ICICI Bank has been witnessing a continuous improvement in asset quality, we anticipate near-term pressure on its asset quality. This is primarily due to the company’s increased proportion of higher margin (and higher risk) unsecured loans in its portfolio mix.
Furthermore, ICICI Bank operates in a highly competitive financial market, which includes many other Indian and international banks. Some of its heavyweight peers are UTI Bank, HDFC Bank Ltd. (HDB”>HDB), HSBC Holdings Plc (HBC”>HBC), IDBI Bank and IndusInd Bank.
However, with domestic loans representing a major portion of ICICI Bank’s loan portfolio, the company is less likely to be affected by sluggish international economic environment. The company has been marketing retail deposits on a large scale, mainly to bring down the cost of funds and create a stable funding base. All these will enable the company to efficiently deal with the challenging economic scenario.
Additionally, ICICI Bank has also been expanding overseas by offering technology-based banking services and opening additional offshore branches. The company has also been improving its services for offshore banking units by offering foreign currency deposits.
Currently, ICICI Bank retains its Zacks #5 Rank, which translates into a short-term Strong Sell rating.
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