Why is the valuation gap between ICICI Bank and HDFC Bank narrowing so sharply?

In the last few quarters, it looks like ICICI Bank has suddenly become the favourite of most individual and institutional investors. Till 2016, it was HDFC Bank that led the way in terms of valuations, though ICICI Bank had a bigger top line. Since 2016, HDFC Bank took a clear lead on business volumes while keeping a tight check on NPAs.

With the exit of Chanda Kochhar and the induction of Sandeep Bakshi as the CEO some 3 years back, a lot appears to have changed for ICICI Bank. The new management has brought in aggression, focus and a greater focus of asset quality discipline. The proof of the pudding lies in the eating and the valuation convergence is happening for genuine reasons.

In terms of outcomes, just look at the net interest margins (NIMs). Normally, the NIM of HDFC Bank would be around 4.5% and ICICI Bank a tad above 3%. That gap ensured that HDFC commanded premium valuations. In last 7 quarters, the NIM of HDFC Bank has come down from 4.3% to 4% while the NIM of ICICI Bank grew sharply from 3.55% to 4%.

The main reason for the valuation convergence is the NIM convergence. ICICI Bank has focussed heavily on its retail book and that has made a huge difference to NIMs and the valuations of ICICI Bank. In fact, domestic NIMs are still better at 4.1%. The second big shift is convergence of ROE; HDFC Bank from 15% to 16.8% and ICICI Bank from 8.8% to 16.8%.

ICICI Bank has also seen an improvement in asset quality. ICICI Bank provisions and slippages have fallen sharply. The gross NPAs of ICICI Bank are well under 4% with most of these NPAs provided for. Net NPAs of ICICI Bank and HDFC Bank are now almost comparable. Even if you look at P/BV it is now 2.3 times for ICICI Bank and 2.5 times for HDFC Bank.