RBI discussion paper suggests getting approval will be a challenge

The RBI has placed in public a discussion paper on Holding Company Structures in the Indian Financial system; is seeking the market's views and suggestions, before finalizing it into policy. Its key takeaway, Financial structures akin to ICICI Financial services are not desirable. This suggests ICBK is unlikely to get, in the near term at least, a regulatory go-ahead for IFS. SBI, with a similar proposal, is likely to face the same problem. v RBI's concerns with such structures are

a) Potential regulatory oversight – multiple regulators, without an adequate legal structure in place, could carry risks;

b) Foreign Holding cap - there could be a breach of the 26% ownership cap, and even if approved by a regulator, could be subject to legal challenge. RBI’s inference - desirable to avoid intermediate holding company structures. v Near-term regulatory OK seems unlikely

While this is a discussion paper and policy finalization will follow market feedback, an early approval does not appear to be around the corner. This would be the second regulatory block for IFS; the FIPB initially rejected it, though it was subsequently approved recently. The Insurance regulatory, the only other approval needed, had okayed it earlier.

Business as usual, for the Insurance businesses

The current impasse on the structure and planned capitalization ( USD 650 investment for 5.9% capital, valuing business at about USD11billion) is, however, unlikely to affect business. ICBK has enough capital for any near-term requirements; and underlying businesses continue to demonstrate robust growth. Investment thesis Our Buy/Low Risk (1L) rating is premised on:

(1) ICBK's broad exposure to the strong momentum in the Indian economy, and its strong market position in the Indian market;

(2) a broad asset mix, which should reduce the risk and profitability strain from concentration;

(3) the growing value of its subsidiary businesses;

(4). the bank, in our view, offers one of the best exposures to the consumer finance and financial services opportunity in India, and has been at the forefront of building market leadership in most products; and

(5) its strong and deep management team. ICICI Bank also offers large exposure to the corporate lending and capex cycle, which should be viewed against the economy’s bright prospects.

Valuation

We are raising our target price to Rs1235 (from Rs1,125) as we are rolling forward to FY09E valuations and due to increased value of its subsidiaries. Our target price is based on our EVA methodology, which captures the long-term value of the business and is a standard valuation measure for our India banking universe. Our target price is premised on the following:

(1) a risk-free rate of 8%;

(2) a long-term loan loss of 100bps; and

(3) subsidiary value of Rs313 per share (Rs216 earlier). We prefer to use EVA as our primary methodology because we believe it better adjusts for the relatively dynamic cost of capital and better captures the long-term value of the business. On our sum-of-the-parts methodology, our fair value for ICICI Bank is Rs1,200 (up from Rs1,051 previously). We value ICICI Bank’s banking business on a 2x FY09E PBV (3xFY08E PBV earlier) post capital raising and factor in reduced returns on equity over the medium term as the extent of capital raising was large, moderate slow down in incremental retail growth and slightly increased provisioning requirements. We value the subsidiaries at Rs313 based on FY09E multiples. Risks Our risk rating is Low based on our quantitative risk-rating system, which tracks 260-day historical share price volatility.

The downside risks that could impede the shares from reaching our target price include:

(1) continued deterioration in asset quality;

(2) low margins; with limited cushion if there were to be further pressures on them; (3) aggressive growth in a range of business areas raises the risk of some failures;

(4) aggressive international operations - where returns appear low, and risk levels relatively high; and

(5) inability to leverage large capital, which keeps ROEs low.