A strong quarter driven by healthy business growth

No slowdown as yet; financial advisory contribution remains high: Q4FY13 was strong for Yes Bank with earnings (33% year-on-year) driven by healthy business/revenue growth. Loan impairment was negligible but the management outlook is cautious. The contribution of volatile financial advisory income remains high (45% of profit before tax/non-interest income)?a key disappointment. Quality of earnings is likely to deteriorate with higher reliance on treasury income while low tier-I ratio remains a key risk in the light of possible normalisation of credit costs. Maintain Reduce.

Financial markets continue to provide strong earnings support: Yes Bank reported another quarter of strong performance with earnings growth (33% y-o-y) driven by balance sheet growth (35% y-o-y), NIM (net interest margin) expansion (40% NII growth) and strong fee income. Treasury income contribution was high at 8% of PBT or 10 bps of investments. Low loan impairment and favourable phase of the interest rate cycle are giving a strong foundation to focus on growth, but we remain cautious on the ability to maintain NPLs (non-performing loans) at these levels (net NPL at 0.01%). Non-interest income continues to be driven primarily by volatile financial markets (investment banking and corporate finance advisory business).

Issues persist?earnings to see deterioration: We expect subdued earnings growth (8% CAGR for FY13-15e) despite moderate NIM expansion as risk of loan impairment remains high. The contribution from non-interest income could see a slowdown from financial advisory but partially offset by higher income from treasury. We do not have a positive view on loan impairment which should result in credit costs normalising from current low levels, as stress emerging from large corporate loans remains high (management outlook for FY14e is at 50-60 bps versus our estimates of 100-120 bps by FY15e). We maintain our fair value of the bank (12 months forward) at 450 (unchanged) which implies 2.3X (times) book value and 12X EPS (earnings per share).

Transaction banking income subdued: Fee income continues to surprise positively. The contribution from financial advisory has increased to 45% of non-interest income/PBT as compared to 20% of fee income a few years ago. We expect a decline in contribution from this business given the lumpy nature of these transactions and a higher contribution in FY2013. Growth in transaction banking (33% y-o-y) is slower than expected despite strong investments by the bank and healthy client additions in the previous few years.

Shift in business driving subdued NIM performance: NIM for the quarter was stable at 3% even though funding costs continue to ease. Lending yields increased by 10 bps, yet the improvement was not visible as a larger share of underwriting was made in the investment portfolio. Our calculations indicate investment yields could have declined 30 bps q-o-q.

Traction on liability profile continued with overall CASA (current account savings account) ratio at 19% of deposits (60 bps improvement q-o-q and 400 bps y-o-y). However, we do note that the slowdown in the improvement has been led primarily by a higher share of term deposit growth as compared to earlier quarters. Overall CASA deposits grew by a healthy pace at 70% y-o-y.

Cost of funds is currently at 8.3%, and the short-term maturity of the bank?s liability profile could result in a faster decline of interest rates. However, the bank is likely to pass a higher share of this benefit to its corporate book. Internal targets to improve the liability profile would result in Yes Bank keeping its savings rate at 7% as it focuses on building its low-cost deposit business. This could emerge as the floor to deposits rates. Given this backdrop, we do not see a material improvement in NIM from these levels. Further, any possible deterioration could impact its NIM profile as the bank has a high share of corporate loans.

Loan growth strong at 24% y-o-y: Loans (including loan substitutes) continue to grow ahead of industry average at 31% y-o-y, led by healthy growth in loans (24% y-o-y) and substitutes (64% y-o-y). The slowdown in credit substitutes has again picked up after a muted performance in previous few quarters. Large corporate exposure is 65% of loans while mid-corporate exposure is 17% of loans. Retail loans (18% of loans, including SME) increased primarily from priority lending exposure.

We expect overall loan growth at 20% CAGR for FY2013-15e. The bank could see a shortfall in meeting its internal targets on loan growth for FY2015e as it would need to double the balance sheet from current levels.