ICICI Bank Downgraded to Neutral

We have downgraded our long-term recommendation on ICICI Bank Ltd. ( IBN - Analyst Report ) to ‘Neutral’ from ‘Outperform’ based on the recent ratings and outlook revisions. Though the company’s net earnings for the fiscal fourth-quarter (ended March 31) improved as a result of higher top line and a much lower provision for loan loss, a substantial rise in operating expenses was the dampener.

We expect synergies from ICICI Bank’s reliance on domestic loans, stable funding base and leadership position in the insurance business. However, we remain concerned about the company’s highly competitive operating environment and rising operating expenses.

With domestic loans representing a large part of ICICI Bank’s loan portfolio, the company is less likely to be affected by the sluggish international economic environment. The company has been marketing retail deposits on a large scale, mainly to bring down the cost of funds and create a stable funding base. All these will enable it to efficiently deal with the challenging economic scenario.

Additionally, ICICI Bank is expanding overseas by offering technology-based banking services and opening additional offshore branches. Moreover, the company has been improving its services for offshore banking units via foreign currency deposits.

On the flip-side, ICICI Bank has been expanding its branch network for quite some time, which is resulting in higher operating costs. Higher operating expenses will likely drag down its financials over the near term. In addition, the company is expected to face higher expenses due to the probable rise in inflation rate as well as the recent ratings and outlook downgrades by Moody’s, a ratings arm of Moody's Corp. ( MCO - Analyst Report ) , S&P and Fitch Ratings.

Though ICICI Bank has been witnessing a continuous improvement in asset quality, we anticipate near-term pressure on its asset quality. This is primarily due to the company’s increased proportion of higher margin (and higher risk) unsecured loans in its portfolio mix.

Currently, ICICI Bank retains its Zacks #3 Rank, which translates into a short-term Hold rating.