How ICICI Bank Bridged The Gap With HDFC Bank On These Key Metrics

India’s two largest private lenders have bitten at each other’s ankles for decades now. If ICICI Bank Ltd. led India’s retail growth story in the late 1990s and the early 2000s, then HDFC Bank Ltd. was the pick of the pack in the post financial crisis period for more consistent performance.

It is now increasingly looking like it is ICICI’s moment in the sun once again.

The fourth-quarter earnings have thrown up a convergence in key metrics between the two lenders. Where HDFC Bank has led for years now, ICICI Bank is catching up.

The convergence even prompted Macquarie analysts to say that ICICI Bank may be the “next HDFC Bank”, implying it may be the new “best in class”.

One key metric where ICICI Bank has caught up with its larger peer is net interest margins. This is the difference between the interest earned and interest paid by a bank. Simply put, it captures the effectiveness of a bank’s lending and eventually feeds into the net interest income or core income it earns.

A number of factors ranging from the mix of loans to the non-performing assets go into the final NIM earned by a lender.

Over the past three years, ICICI Bank has steadily seen its NIM improve from 3.19% to 4%. In contrast, HDFC Bank’s NIM has fallen from 4.40% to 4% now.

What’s changed?

One factor has been good traction in ICICI Bank’s chosen growth areas. ICICI Bank has chosen to grow its retail book more aggressively than HDFC Bank during the pandemic. Much of this growth has come from mortgages. Retail loans, excluding rural credit, make up 43.8% of ICICI Bank’s loan book. HDFC Bank’s retail loan book is at 39%.

In addition, ICICI has also reduced share of the lower margin international business to under 10% of its portfolio now.

This altered loan mix has aided margins.

“Retail growth (ex-rural) was strong at 20% on a yearly basis, driven by secured mortgages and unsecured cards/personal loans. SME and business banking has also clocked strong growth, though on a low base,” said Anand Dama, senior research analyst at Emkay Global Financial Services, in a report on Monday. “Thus, NIM improved 16 basis points yearly to 4% including domestic NIM at an all-time high of 4.1%.”

Ashutosh Mishra, head of research-institutional equity at Ashika Stock Broking, attributed the convergence in margins to three factors. These include a substantial decline in gross non-performing assets, improvement in cost of funds and change in loan mix.

“ICICI has reached close to HDFC Bank’s NIM. Their NIMs were around 2.5-3% in the past and has now leapfrogged to 4%,” said Mishra, adding that margins may peak at 4.1-4.4%.

Alongside an improved loan mix, ICICI Bank has also steadily improved its deposit mix.

Share of lower cost current account and savings account deposits for the bank has risen to 45% as of the fourth quarter. This, too, is close to HDFC Bank which has a CASA ratio of 48%.

The improvement in margins has contributed to better return on assets and equity. The former shows how profitable a bank’s assets are, while the latter measures how efficiently shareholder funds are put to use.

ICICI Bank, which has seen swings in both metrics over the years, has now seen them settle at higher levels comparable to HDFC Bank’s. Robust loan growth, lower non-performing assets, improved operating profits and a strong deposit franchise have helped improve the bank’s return on assets and return on equity.

The bank’s return on equity could rise further to 16-17%, said Dama. This is based on the expectation of healthy credit growth of 19-21%, improved margins and lower loan loss provisions. “Any potential one-off gains from the ICICI Lombard stake sale to meet regulatory guidelines could further prop up RoEs,” Dama said.

According to Motilal Oswal, ICICI Bank will be able to deliver a return on assets of 1.9% and a return on equity of 16.3% by FY24.

With key metrics improving, ICICI Bank has also managed to close the gap with the largest private sector bank on valuations.

Since the pandemic low of Rs 287 per share on April 3, 2020, ICICI Bank’s stock has risen to Rs 755 as on Monday. HDFC Bank has seen more muted gains from Rs 814 apiece then to Rs 1,370 now.

This has meant that the price-to-book ratio at which ICICI Bank trades at is now is also converging with that of HDFC Bank. It could trade at even better multiples, according to Macquarie Research.

Improved management may also impact ICICI Bank’s valuations favourably.

“ICICI Bank under Sandeep Bakhshi has consistently outperformed peers on all business metrics and has weathered the asset quality storm during Covid, despite being heavy on retail. Bank has delivered all-time high margins, RoA and RoE, which has been an outcome of a differentiated management approach to focus on profitable growth,” said Dama.