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We are maintaining our Neutral recommendation on ICICI Bank Limited (NYSE:IBN). Though we are concerned about ICICI’s highly competitive operating environment and below-average credit quality, we anticipate continued synergies from the company’s increased dependence on domestic loans, an almost stable funding base and market leadership in the insurance business.

ICICI Bank’s fiscal first quarter 2012 (ended June 30, 2011) profit came in at INR13.32 billion (US $298 million), up 29.8% from INR10.26 billion (US $230 million) in the year-ago quarter.

Improved results were primarily driven by higher net interest and fee incomes, and a substantial decline in loan loss provisions. However, higher operating expenses and lower other non-interest income were the headwinds. Asset quality continued to show signs of betterment and capital ratios remained strong during the quarter.

Though ICICI still has wide international loan coverage, domestic loans represent the major portion of its overall loans. As a result, the company is now more secure with respect to loans and will be less affected by international dejection. Furthermore, it has been marketing retail deposits on a large scale, chiefly to reduce its cost of funds and create a stable funding base. This makes the company well positioned to deal with a more challenging rate environment in the upcoming quarters.

ICICI Bank has succeeded in leveraging its technology to augment contribution of fee income to its bottom line, a priority for the company. Fee income growth has picked up in the recent quarters. Also, an improvement in asset mix and an enhanced pricing power are expected to support margins in the upcoming quarters.

On the flip side, ICICI Bank operates in the highly competitive banking industry. The company primarily competes with other private banks in India, such as HDFC Bank, UTI Bank, IDBI Bank and IndusInd Bank. It also competes with foreign banks that have a notable presence in India, such as HSBC Holdings plc (HBC) and Standard Chartered PLC (STAN).

Increasing operating expenses are expected to drag the company’s bottom line in the upcoming quarters. Operating expenses increased 24% year over year during the first quarter of 2012. We expect increasing branch network to keep operating expenses high in the near term. Also, the expected rise in inflation will keep operating costs high.

Currently, ICICI Bank retains a Zacks #4 Rank, which translates to a short-term Sell rating.

Source: ICICI Bank's Domestic Loan Holdings Balance Out Competitive Risk