Want A Strong Bank? Think ICICI

By Stephen D. Simpson, CFA | October 31, 2010 AAA

After spending a lot of 2009 and 2010 rebounding from freak-out lows, American banks like Citigroup (NYSE:C) and Bank of America (NYSE:BAC) are choking and sputtering. Not only are investors wrapped up in the negative headlines about potentially huge mortgage documentation risks, but loan growth is stagnant and the U.S. is still over-banked.

On the flip-side, the picture for banks outside of the U.S. and Western Europe is quite a bit brighter. In India, strong credit growth and surprisingly strong credit quality is providing a healthy environment, and ICICI Bank (NYSE:IBN) is making hay while the sun shines.


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The Quarter That Was
ICICI reported earnings for its fiscal second quarter that handily surpassed the analysts' targets. Bottom-line earnings rose 19% in the quarter, fueled by 8% growth in net interest income and a 40% drop in provisions. Growth was helped by margin expansion of 10 basis points, loan growth of 2%, and deposit growth of 13%, while a significant rise in expenses (10%) was a dampener. (For more, see The Bottom Line On Margins.)

Credit quality is getting better. As the 40% reduction in provisions might suggest, ICICI is feeling good about its balance sheet. Impaired loans were a bit more than 8% at the end of the quarter, continuing a multi-quarter sequential strength of improvement. As a percentage of loans, non-performing loans were 1.4% in the quarter on a net basis.

The Road Ahead
The outlook for Indian banking is quite strong now, with an overall expectation of credit growth of 20%. As one of the largest banks in India (sharing the stage with HDFC Bank (NYSE:HDB) and State Bank of India), ICICI is certainly poised to benefit from and participate in that growth. Beyond that, there is the macro-story - India is still a relatively poor country (or at a minimum, the distribution of wealth is highly uneven) with ample room for growth and improvement in standards of living (and the greater demand for banking services that goes with it) offers a very long runway for this story. (For more, check out The Indian Stock Market 101.)

On the other hand, double-digit growth is almost never stable growth. Even if the Indian government produces an unbroken record of enlightened, sober fiscal management (and how many governments manage that?), there are going to be ups and downs in the economic development of India. That, in turn, will fuel some volatility in the financial performance of ICICI that will play out in the stock. This is especially concerning for ICICI, as the company's history with underwriting and disclosure has been problematic.

Investors can look anywhere else around the world - Brazil's Itau (Nasdaq:ITUB) and Bradesco (NYSE:BBD), Korea's Shinhan (NYSE:SHG) and Kookmin (NYSE: KB), Turkey's Akbank and Garanti - all of these banks have had wild rides as their home countries go through their growing pains, and India is unlikely to be an exception.

The Bottom Line
India is a popular destination for investors again, and that is bad news for those who would like to buy ICICI shares. Although most analysts like to use P/E or book value-based valuation approaches for banks, a return-on-equity model gives a more accurate sense of how a bank can grow and what that growth is worth. Unfortunately for ICICI, allowing for a high-teens return on equity only delivers a price target of about 80% of the current price. As a result, unless investors believe that ICICI can build to (and maintain) a level of return on equity in the range of 20% or better, these shares are probably too pricey for today. (For more, see Banking Introduction.)

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