After the July liquidity tightening measures, when short-term borrowing costs shot up sharply, the market was particularly unkind to banking stocks that had a high dependence on short-term borrowings and wholesale deposits.

This is because such banks would have witnessed a sharp rise in cost of funds impacting their net interest margins (NIMs).

YES Bank is one such bank that has lost over 50 per cent of its stock value after the July measures in one month. Also, as fallout of these measures, other risks of slower loan growth, higher mark-to-market losses on its corporate bonds and risk of rising bad loans, emerged. However, there has been some reprieve to the bank as some of these measures have been reversed.

The stock has recouped 50 per cent of its losses so far. As the RBI continues to reverse these measures, YES Bank will continue to benefit.

That said, there will be some impact of these measures on its loan growth and earnings for 2013-14. Taking into account all these concerns, and revising earnings estimates down by 6 per cent, the stock still trades at 1.6 times one-year forward adjusted book value, lower than its historical average of 2.5 times.

Cost of funds to moderate

The bank continues to have a high return of equity of 26 per cent and clean asset quality. Investors with a two-to-three year horizon should use the correction as an opportunity to buy the stock.

YES Bank has close to 73 per cent of its deposits and borrowings in the less-than-one year category. Hence, the RBI’s measures would have increased its cost of funds by 25-30 basis points. But the bank also raised its base rates by 25 basis points in August.

Hence, the NIMs decline is expected to stay within 15-20 basis points for the full year.

The bank has 86 per cent of its loans either linked to base rate or is short term (less than one year), allowing re-pricing of loans. As the July measures continue to reverse, there will be additional savings on cost of funds.

The special swap facility for FCNR deposits and the move to allow overseas borrowing up to 100 per cent of Tier-I capital, will also help lower costs — these funds are now accessible at a lower 8.25 per cent cost as against the bank’s domestic deposits of 9-9.5 per cent. YES Bank so far has been able to mobilise close to $300 million. So, while pressure on margin persists in the interim, improving low-cost current account savings account (CASA) ratio will aid NIMs in the long run. Following the deregulation of interest on savings account from October 2011, YES Bank was the first to offer higher rates, and was able to increase its share in savings accounts significantly.

The CASA ratio increased from 15 per cent in 2011-12 to 20.2 per cent in the recent June quarter.

Incremental growth in CASA will aid margins. The retail term deposits comprise 18.6 per cent of total deposits. Being stickier in nature, these lend stability to the bank’s liquidity.

Diversifying risks

In response to the July measures, YES Bank raised its base rates by 25 basis points. This raised concern on the impact this will have on its loan growth as well as asset quality.

Notwithstanding the slowdown in the banking sector, YES Bank delivered loan growth of 24 per cent in 2012-13, when the industry grew only by 14 per cent.

That said, the loan growth is expected to moderate in view of the ongoing economic slowdown. YES Bank is now expected to grow 18-20 per cent in 2013-14 from the earlier estimate of 24 per cent.

But this will still be above the industry growth. As liquidity measures reverse, the possibility of a steep hike in the bank’s base rate will reduce. This will limit further moderation in growth estimates. YES Bank has thus far been able to maintain good asset quality, thanks to its well-diversified exposure to various sectors.

While lending to large corporates accounts for 64 per cent of the bank’s loans, maximum exposure to any single sector is capped at around 5 per cent.

Also, 65-70 per cent is working-capital financing, and project finance is less than 6 per cent; this reduces the risk. The gross non-performing assets stood at 0.22 per cent of loans in the June quarter. The restructured loans are low at 0.3 per cent of loans.

However due to the stress in the sector, the bank may see some pressure on its asset quality. However, the YES Bank’s provision coverage of 89 per cent lends comfort.

Also, the bank has maintained additional provision for standard assets at 40 basis points of loans over and above the regulatory requirement. This will act as a buffer in case of rising defaults.

Corporate bond portfolio

YES Bank has high exposure to the corporate bonds in its investment portfolio. The corporate bond market also saw rates go up sharply after the July measures. The rates for the AAA rated corporate bonds, went up by 100-160 basis points by August.

As price and yields move in opposite direction, this sharp correction in bond price is expected to lead to high mark-to-market losses on the bank’s corporate bond portfolio in the September quarter.

However, as short-term rates have started to cool off with some reversal of previous measures, these losses will moderate.

The rates on corporate bonds have already declined by 50-100 basis points since the September monetary policy.

YES Bank’s Tier I capital adequacy ratio stands at 9.5 per cent against the regulatory requirement of 8 per cent. This is very close to the mandated level, which has been a concern.

However, the return on equity at 26 per cent along with profit retention of around 85 per cent should continue to sustain its growth.

(This article was published on October 19, 2013)
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