Sunday, June 1, 2008

ICICI Bank - NYSE - IBN Stock Analysis

Story Slide:
The obvious question that investor's have regarding banking stocks is, what if the story of US banks' asset write downs and earnings losses is repeated in emerging markets such as India.
However, there are a few subtle differences between Indian banks and their US counterparts and that is what makes Indian banks less likely to follow the path of asset write downs.

First, Indian banks have very low exposure to structured finance investments in the US market. The next issue is about home loans and credit card loans that the Indian banks originate in the Indian market. At this point, it is important to understand the difference between a home loan originated by a US bank vs. a home loan originated by an Indian bank.

A home loan issued by a US bank is typically pooled as a MBS and sold to investors which leaves the risk of default with the MBS investors (typically a group of financial institutions) while the bank that originated the loan only services the loan and the loan doesn't show on the originating banks' balance sheet. The originating bank is not liable in case of a home loan default and hence has little to no incentive in checking the ability of the home loan borrower to repay the loan. To make matters worse, the originator bank is paid for originating the loan which means that the banks are incentivized to originate as many loans as possible without checking the credit quality of the borrower.

This is not true for banks in India since the home loans originated by banks are serviced and carried on their balance sheet as well as accounted for in NPA estimation. It is this very subtle difference that makes all the difference in the quality of home loans issued by Indian banks. In this case, the originator (Indian bank) is liable for default and hence has an incentive to check the ability of the borrower to repay the loan. Nationalized banks in India such as SBI, Central Bank of India etc. issue loans to poor credit customers owing to political pressure and also have to write off some debt every year to certain classes of customers as a part of government programs to help those classes, however, private sector banks such as IBN are under no such obligation and hence have better performing loan portfolios compared to their nationalized counterparts.