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Management Speak: ICICI Bank (Outperformer) - External benchmark impact may be gradual, BB may rise

We met with ICICI Bank. Key highlights: 1) Impact of external benchmarking will likely be gradual and will depend on the proportion of existing borrowers that want to convert to external benchmark based rates. 2) BB portfolio will rise after falling for three quarters (but we do not see this as a major concern because ICICI’s share of new stress loans that have surfaced since May is low). Negative impact of deferred tax will come in forthcoming 2QFY20.

External benchmarking: The conversion from MCLR to repo could be gradual just like the conversion from base rate to MCLR: 34% of outstanding loans qualify for external benchmarking

• While the worst is being feared on external benchmarking, the conversion from MCLR-linked loans to repo rate loans may be gradual like it was for conversion from base rate to MCLR. The differential between MCLR and base rate when MCLR was first introduced was higher than the difference between current MCLR and the new repo linked lending rate for SBI. The impact on spreads will depend upon the quantum of loans that come up for conversion from MCLR to external benchmarks
• The difference between MCLR based home loan rates of SBI and ICICI is 40 bps. (8.4% for SBI and 8.8% for ICICI)
• Banks were waiting to see how SBI prices its home loans under the new external benchmark regime. SBI’s repo linked home loan rate (of 8.2% for the prime borrower for loan value upto Rs3M) is higher than the feared 8.05% which is relieving for the industry.
• The repo rate will apply to the variable rate mortgages of ICICI Bank not to the fixed-rate LAP or top up loans. Of the total 30% of home loans, variable rate home loans are 80%, while LAP / top loans of 18-20% are fixed rate and will not come under the external benchmark.
• Outstanding loans of ICICI Bank that can be converted to repo linked at the choice of the customer account for 34% of total loans including variable home loans of INR1.4 trn, MSME loans of INR 360bn and business banking loans of 193bn.

BB loans / stress pool – Could see an increase after 3 quarters of decline

• Due to a weak macro, we could start seeing additions to the BB portfolio for the next 2-3 quarters after 3 quarters of decline. The size of the BB portfolio is INR 115bn and the size of the total standard stress pool is Rs154bn.
• The ratings presented in public disclosures are internal ratings. ICICI Bank’s internal ratings are one to two notches stricter than comparable external ratings. As such a large proportion of  the external ratings downgrades are already captured in the BB pool  in advance.
• The DHFL pools bought by ICICI Bank are now fully serviced by ICICI Bank so there is no originator risk that investors have been worried about.
• The NBFC exposure has only increased since the liquidity crisis but the incremental exposure is to very well rated NBFCs.
• The real estate exposure is also to sound names like Prestige, RMZ and is not a cause of concern for them.
• They are not on top of the DHFL resolution plan because they are not amongst the large lenders.
• The pace of resolutions which was slow to start with has slowed down even further (Even the Essar  Steel hearing has been postponed to October)
• The bank has not disclosed its exposure to ADAG. Based on NCD filings and MCA, we believe it is Rs33bn mostly to RInfra and RPower.
• The bank also has exposures to Essel operating companies.
• While there would be additions to the BB pool, given that ICICI’s name has not surfaced in a big way in new stress loans, we do not see this as a major concern. Our assessment (not management guidance) is that there could be additions of Rs10-15bn per quarter to the BB pool over the next 2-3 quarters.

Deferred  tax: One time revaluation in 2Q

• The markdown to DTA due to lower taxation will happen in the forthcoming 2Q earnings.
• ICBK’s net DTA stands at Rs104bn. This will have to be revalued at a tax rate of 25% versus 35% earlier.

Co-lending: - With Indostar Capital Finance and Magma Fincorp

• ICICI Bank has tied up with NBFCs for co-lending. They tied up with Indostar in July for CVs and recently with Magma.
• The bank has two models for co-lending - one based on a first loss arrangement and the other where 70% risk is on the NBFC  and 30% on ICICI Bank.

PPOP and provisions more relevant than loan growth

The CEO monitors PPOP and provisions more than loan growth. That said, the bank is on track to deliver mid-teens loan growth. The credit cost guidance remains unchanged – which is tapering of credit cost from 2Q.

Outlook: ICICI Bank’s name has not surfaced as a lender to the incremental stress loans that have come up since May. With credit cost likely to fall to 1.3% in FY20, higher loan growth and improving asset quality, we see a sharp turnaround in earnings. We expect RoE of 15% by FY21. Acceleration in earnings, strong CAR and a high PCR will drive the stock’s re-rating. Our TP is INR525 (2xfair PBV multiple). How margins behave following the adoption of an external benchmark and the quantum of increase in the BB book in the next few quarters are two key monitorables. While there would be additions to the BB pool, given that ICICI’s name has not surfaced in a big way in new stress loans, we do not see this as a major concern.   2Q earnings will likely see the one-time negative impact of DTA revaluation.