ICICI Bank's asset quality stress may cap upsides in near-term

It is likely to eclipse the positives of well-capitalised book and inexpensive valuations

The stock of ICICI Bank was among the biggest gainers among banking sector peers, up over 3% in Monday's trade. But, as analysts point out, the sharper gains may not sustain for long given the pressure on the asset quality front.

For one, last week itself, in a report dated March 9, ratings agency Moody's said ICICI Bank's asset quality woes will spill over to FY17 as well. This view is echoed by most analysts as well given the bank's exposure to some larger, troubled groups in the steel and power sectors (10% of its domestic loans). 

The bank's management, too, had indicated, while announcing December 2015 quarter results, that it will account for similar slippages of Rs 6,544 crore in the March 2016 quarter as well - half of which will come in from the restructured books. 

In comparison, Axis Bank, which too has a similar business model, has seen a slower asset quality deterioration than ICICI Bank. This is evident in the fact that the latter's gross non-performing assets (NPA) ratio increased 160 basis points to 4.7% in the December 2015 quarter over June 2014 quarter, a period which marked the beginning of 

rising asset quality pressures for most banks. The addition for Axis Bank is much lower at 38 basis points to 1.68% in this period. Unlike ICICI Bank, Axis Bank's management expects slippages to be much lower in the on-going quarter (as compared to December 2015 quarter), an indication of lesser pain going ahead for the bank.

There are positives as well. Moody's has maintained its ratings as well as positive outlook on ICICI Bank and its financial instruments. One possible reason for this could be that the bank has sufficient capital adequacy and provisioning coverage. Also, ICICI Bank's management has stepped up focus on recoveries and is making all efforts to contain bad loans, which however, may take a couple of quarters to start bearing fruits.

Hence, even though the stock currently trades at inexpensive valuations of 1.3 times FY17 estimated book value (versus historical average of 1.8 times), it may not witness a sustainable uptick at least till asset quality pressures ease. In this scenario, its valuation discount versus Axis Bank (trades at 1.6 times FY17 estimated book value) is also likely to continue going forward.

Given its relatively high exposure to sectors such as infrastructure, steel, amongst others, ICICI Bank will be amongst the initial and biggest beneficiaries of any improvement 

in economic growth. Its well-capitalised book will enable the bank to adequately capture any uptick in credit demand going forward. Most analysts, thus, remain positive on the bank and expect the stock to gain about 30% from current levels over a 12 month period. But, all this hinges on a visible recovery in the economy, especially in some core sectors, which may not come soon. 

Aditya Narain of Citi perhaps explains it well. In a recent report on the two banks, he said, "ICICI Bank needs a stronger/longer upcycle, but with more to fix (asset quality, returns, risk appetite) and a valuation cushion, gains will likely be lagged but stronger than Axis Bank.”