ICICI beats HDFC on growth, margins in Q1. Is the lead sustainable?

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The June quarter (Q1FY27) earnings of private banking heavyweights ICICI Bank and HDFC Bank show the former pulling further ahead of its larger rival on loan growth, margins and return ratios.

ICICI reported nearly 20% year-on-year loan growth to ₹16.3 trillion, comfortably ahead of the industry's 18.6% credit growth (as of 30 June) and HDFC's 16% growth to ₹30.4 trillion.

Its net interest margin (NIM) expanded 4 basis points sequentially to 4.36%, though primarily aided by higher interest on tax refunds. Net profit grew 16% year-on-year to ₹14,800 crore, while return on assets (ROA) improved from 2.4% in Q4 to 2.5% in Q1.

Meanwhile, HDFC continued to grapple with the after-effects of its July 2023 merger with HDFC Ltd. Despite faster deposit growth of 15% versus ICICI's 14%, HDFC's loan-to-deposit ratio (LDR) of 96% continued to constrain its credit growth. ICICI's LDR stood at 89%.

Moreover, "(HDFC's) LCR remained at 115% (114% in Q4FY26), lower than Kotak Mahindra Bank (144%) and ICICI (122%), which, along with its lowest-ever CASA ratio of 32%, will continue to constrain retail-led growth," said a report by JM Financial Institutional Securities.

Margins remain one of the biggest concerns, with high-cost borrowings inherited from HDFC Ltd weighing on profitability. NIM declined about 10 basis points in Q1 to 3.4%. Thus, net profit grew just 5% to ₹19,060 crore, continuing to lag balance-sheet growth, while ROA slipped to 1.9%, widening the gap with ICICI.

On asset-quality, HDFC’s gross NPA of 1.2% was better than ICICI’s 1.4%. ICICI’s 50 bps credit cost, adjusted for chunky recoveries, was comparable with HDFC’s. Adjusting for largely secured agriculture portfolio, HDFC’s 70% provision coverage was comfortable.

Still, HDFC's post-merger baggage and recent governance issues have shaped the Street's verdict. HDFC shares have declined nearly 22% over the past year, while ICICI has remained largely flat.

HDFC's biggest drag on margins—its high-cost borrowings are expected to reduce by ₹40,000-50,000 crore over the next couple of years. As these borrowings mature, replacing them entirely with retail term deposits could lower the bank's cost of funds (CoF) by 100-125 basis points.

Plus, 40% of HDFC's 9,700 branches are less than 5 years old. Young branches typically take time to build low-cost current account and saving account (CASA) deposits. As these branches mature, CASA ratio can improve from 32% currently, versus ICICI's almost 40%. This should help bring down the CoF further. The management expects a 40-50 basis point reduction in CoF over time.

Faster deposit growth is another tailwind from maturing branches. That, along with a high share of FCNR deposits, can help moderate HDFC's LDR. This will allow faster credit growth without straining margins.

The management expects the share of high-yielding retail loans to expand from 52% currently to 60%. Lower funding costs and higher loan yields could meaningfully narrow the NIM gap with ICICI over the next few years.

Governance issues, which have lately weighed on investor sentiment, have eased with the appointment of former finance secretary Rajiv Kumar as part-time non-executive chairman, following Atanu Chakraborty's resignation. But, CEO Sashidhar Jagdishan's reappointment before his October term-end remains an important milestone.

Nuvama values HDFC at 2x FY28 book value, lower than ICICI's 2.5x. HDFC's valuation discount could narrow after leadership uncertainty is resolved and if execution holds up on legacy borrowings.

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