The fortunes of the banking sector are closely linked to the state of the economy as a revival in the investment cycle can translate into higher loan growth and better asset quality.
Given that all banking stocks have moved up sharply in the last six months betting on this revival, it is best to be selective while investing in banks.
ICICI Bank, the largest private sector lender, is a good pick from this sector. It has weathered the economic downturn well. In 2013-14, it delivered 18 per cent growth in earnings on the back of a 17 per cent growth in loan book, driven by the retail segment.
The bank improved its net interest margin (NIM) by 20 basis points to 3.3 per cent in spite of the volatility in interest rates, and sports a healthy return on assets of 1.8 per cent. ICICI Bank is well-capitalised, with tier-I capital at 12.7 per cent, to drive the next leg of growth. The overseas subsidiaries have ample capital as well (ICICI Bank UK at 21.8 per cent and ICICI Bank Canada at 29.7 per cent), giving the bank sufficient capital cushion to improve returns.
At the current market price of ₹1,418, core banking business (after adjusting ₹250/share towards value of the subsidiaries) is trading at 1.7 times its one-year forward adjusted book value. This is still lower than its historical average of 1.8 times. Investors with a two- to three-year horizon can invest in the ICICI Bank stock.
Retail pushRetail loans, which grew 23 per cent in 2013-14, have been the key driver of loan growth. The bank has remained cautious on lending to the medium and large corporate segment and has, instead, focussed on secured lending, such as home and auto loans, which grew 23 per cent and 38 per cent respectively. After writing off its unsecured retail loans over the last few years, the bank is now aggressively trying to regain market share in the secured portfolio. The bank recently lowered its home loan rates, bringing it on a par with SBI, which offers the lowest rates. The management has indicated 2-4 per cent faster growth than industry in its loan book, primarily driven by retail lending.
The CASA ratio continues to remain healthy at 42.9 per cent as of March 2014. This should help the bank maintain its NIM at current levels.
The one weak link in the bank is its pressure on asset quality. ICICI Bank has gross NPAs of 3 per cent as of March 2014. The bank has also stepped up its loan recasts. From 1.8 per cent last year, ICICI Bank’s restructured book currently accounts for 3 per cent of its loans. But asset quality pressure could have peaked in 2013-14, and can ease as the economy starts to revive. Moreover, ICICI Bank holds adequate capital to absorb additional stress without impairing its pace of growth.