YES Bank: Buy

Banking industry, for the second time in three years, finds itself grappling with asset quality issues, which are expected to exacerbate due to rise in interest rates and demand moderation in the economy. Given this backdrop, we re-iterate buy on YES Bank with a three-year investment horizon.

YES Bank has best-in-class loan book quality with negligible net non-performing assets (0.01 per cent) and low proportion of restructured assets (0.26 per cent).

At current price of Rs 262, the stock is trading at 1.65 times its FY13 adjusted book value and 7.8 times its FY13 earnings. On price-to-book value basis, YES Bank is trading inline with Axis Bank while it is at a discount to IndusInd Bank and HDFC Bank.

Strong profitability

Strong growth in business coupled with a return on equity of 21.4 per cent (annualised, as of June 2011) in spite of lower leverage supports our recommendation. Low credit costs (NPA provisions) have historically helped the bank. However, these costs may rise given the economic scenario and with the increase in the bank's scale of operations.

That said, the market is discounting a very high rise in credit costs which may not be warranted. The current valuation is almost a quarter lower than its historic average book value (from the beginning of 2008). The net profit growth of YES Bank was 53 per cent on an annualised basis during the period FY2008-FY2011.

Apart from low valuation, healthy growth prospects, low cost-income ratio (37 per cent), improving fee income contribution and high levels of core equity are key positives for the bank. YES Bank also scores in terms of operating efficiency as it enjoys best-in-the-industry business-per-employee and profit-per-employee despite scaling up the workforce at a high rate over the last couple of years.

On the flip side, low current account-savings account deposit proportion and high dependence on bulk deposits have dragged YES Bank's net interest margin (NIM). To counter this, the bank is rolling out branches aggressively to improve its retail deposit profile.

It increased its network from 153 branches in June 2010 to 255 branches in June 2011. Yes Bank's low-cost deposit proportion at 10.9 per cent is among the lowest in the banking sector.

As the bank embarks on the new strategy ‘Yes Bank version 2.0', it plans to add 750 branches and increase its low-cost deposit proportion to 30 per cent by 2015. This would entail large operating expenditure especially given that the branch rollout norms have changed since the bank has formulated their strategy.

YES Bank has improved its market share in loans from almost negligible levels in 2004-05 and 0.35 per cent in 2007-08 to 0.8 per cent as of March 2011. This positions it only after the big three private banks (ICICI Bank, HDFC Bank and Axis Bank) on a standalone basis. The market share was gained due to its focus on knowledge-based banking (offering a complete product suite to customers as well as structured loans). This improves fee income opportunities for the bank as well.

YES Bank has to grow at a little over 30 per cent compounded annually, to achieve its Rs 1,00,000 advances target it set out for itself by 2015. Going by the historic rate of growth (53 per cent annualised growth between March 2008 and March 2011), the planned growth rate seems achievable. However, the recent slowdown in advances growth (26 per cent growth year-on-year as of June 2011) due to sharp deceleration in credit demand, slowing economy and expanding base may make the task challenging for the bank.

Yet, the targeted growth can still be possible as the bank plans to increase its loan book exposure to retail and SME segments while the current loan book is heavily skewed towards the large and medium corporates. Branch roll-out will aid YES Bank towards this.

As of June 2011, 63.2 per cent of the loans were given out to large and mid sized corporates, followed by 24.4 per cent to SME clients (commercial banking) and 12.4 per cent to retail segment. The bank plans to improve SME and retail segment's share to 30 per cent each by 2015.

Low yields (due to large corporate loan book) coupled with high cost of funds, has been subjecting YES Bank's NIM to high degree of volatility. Despite witnessing a fall in margins from 3 per cent during the first half of FY11, the bank managed to maintain its NIM at 2.8 per cent during the last three quarters, thanks to base rate hikes. Close to 95 per cent of the bank's loans are either floating-rate or short-term in nature which improves the transmission of any interest rate hikes.

The bank will be key beneficiary of the savings rate de-regulation, given that its current cost of funds is higher than the present savings deposit rates.

Asset quality

YES Bank has historically underperformed on the bourses despite negligible NPAs due to its exposure to infrastructure, telecom and microfinance sector. The bank has since de-risked its loan book to some extent. However, as the book has expanded aggressively in recent times, it remains unseasoned increasing the asset quality risk in a scenario such as the current one. Its SME exposure also increases the risk profile of YES Bank.

That said, these concerns seem to be overdone by the market as the bank has already provided for 95.2 per cent of its NPAs. YES Bank has general loan loss provision of more than 300 per cent of gross NPAs in addition to the specific provision coverage. The Net NPA ratio sequentially came down from 0.03 per cent in March 2011 to 0.01 per cent in June 2011.

COMMENT NOW