ICICI Bank's exposure to global financial risk through its international subsidiaries does not appear material. A scenario analysis indicates that potential losses in the international assets portfolio (largely comprising global banks and financial institutions) are less than 2% of the bank's FY09F net worth, even in a worst-case scenario. In the past, the cumulative default rate of banks globally over a five-year period has been less than 1%, according to Fitch. We see value in ICICI Bank's stock and reiterate our Buy rating.
International subsidiaries - exposure to global financial risk exists, but does not appear material
We believe the market’s reaction to ICICI Bank’s exposure to global financial risk is overdone. In our base case scenario of a 2% default rate, we estimate that the risk is 1.2% of FY09F net worth. Even in our worst case scenario of a 3.0% default rate, losses in the international asset portfolio (largely comprising exposure to global banks and financial instituions) would not exceed 1.8% of FY09F net worth. However, the risk is that near-term earnings could surprise negatively due to mark-to-market losses arising from the decline in value of securities held.
Note that our scenario analysis is based on cumulative failure rates of all banks as per Fitch ratings (1990-2006). According to Fitch, the probability of a bank failing is significantly greater than it defaulting. For instance, the cumulative default rate for all banks over a fiveyear period is less than 1.0%, compared with a failure rate of 5.94%.
ICICI Bank has investment paper that is generally rated ‘A’ and above in the international subsidiaries. According to Fitch, the failure rate is lower for banks with higher ratings. For instance, for banks rated A, the failure rate is 0.0%.
We believe ICICI Bank offers value at this price and we reiterate our Buy rating. The stock trades at 14.2x FY09F earnings and at 1.4x FY09F adjusted book value after writing off 100% pre-tax net NPLs.
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