Business in a sweet spot; valuations are comforting

Some key investor queries after an unsuccessful QIP (qualified institutional placement): what happens to its core business, valuation multiples and likely further growth? Our views are: (i) current Tier 1 capital of 10.3% with RoEs at 20%+ is comfortable for the next 12-18 months, after which Yes will have to enter capital conservation mode, (ii) the core business is in a sweet spot, well positioned on growth (25%+), NIMs (expect 15 bps improvement) and with a net earnings CAGR of 28%, and (iii) after the recent correction, we find valuations comfortable at 2.5x FY18e P/BV and 12x FY18E P/E, given its strong growth, high RoEs and improving retail franchise, even as the capital raising is delayed somewhat. Retaining Buy.

Yes worked with low capital in the past; expect raising over three to six months

Yes bank had a sub-10% Tier 1 from FY11 to FY15, when its loan CAGR was 23% and total asset CAGR was 23%. With RoEs at 20% (post-dividend, accretion is 16%), Yes Bank will lose about 70-75 bps of Tier 1, assuming asset growth of 25%+. This allows Yes at least 12-18 months’ strong growth, beyond which it will have to slow growth and enter capital preservation mode. The recent setback seems temporary and business remains as usual. We expect capital raising over the next three to six months. We maintain our growth assumptions (a 28% loan CAGR in FY16-18). We would worry only if it were unable to raise money beyond 12 months, a low probability event.

Strong tailwind for its core business

We see strong tailwinds for Yes Bank: (i) corporate growth to remain steady at ~25%. Its pricing power is due to weaker competition, resulting in better NIMs and fees, (ii) strong retail growth from a very low base will enable the bank to grow at >25% for the next three years; adequate investment was made in the last few years in branches and people etc., (iii) NIM improvement due to better CASA percentage, declining SA rates, internal PSL generation and lower wholesale rates etc., and (iv) asset quality likely to remain stable. We expect credit costs of 70 bps in FY17
and FY18. It also has 30 bps of floating provisions.

Expect a loan CAGR of 30% over FY16-18

Yes Bank reported a loan CAGR of 22% for FY11-FY15. This growth was sustainable, despite the bank reporting a Tier 1 ratio of <10% and that it was consuming capital at 30 bps. It raised capital in FY15, pushing its Tier 1 ratio to 11.5%. We forecast a loan CAGR of 28% for FY16-18, which we believe should be possible at current Tier 1 levels. However, if there are capital raising issues beyond this point, it could be a challenge for the bank.

Business granularity is improving

The bank is picking up fast in terms of CASA, driven by a strong CASA branch expansion and higher rate offerings. The CASA ratio, which was in the mid teens four to five years ago, has now almost reached the 30% level. With the bank adding 29% to its network, we believe that the CASA franchise will continue to
improve for Yes Bank.

Retail banking liabilities growing with each quarter

Yes Bank has been steadily improving its share of retail banking liabilities (CASA + retail term deposits). It is now at 55%, having been c.32% two years ago. There has been strong growth in both current accounts and savings accounts (CASA). SA grew by 62% y-o-y in FY16 while CA grew at 26% y-o-y. The CASA ratio has improved to ~30% from 19% in 2013.

Asset quality under control; credit costs at 60-70 bps

Yes Bank’s asset quality remains impeccable, with the gross NPL ratio at 0.79% and net NPL ratio at 0.29%, remaining among the lowest in the sector. Although there has been some uptick in NPLs, it has been from a very low base and is not a matter of concern for now.

Credit costs have also remained under control, with the bank reporting credit costs (including standard assets) of 61 bps for FY16. In Q3FY16, the bank had a significantly higher provision due to RBI AQR. For FY17, we do not expect a significantly higher credit cost as compared to FY16 and factor in 65 bps, and 70bps for FY18.

Valuation and risks

We value Yes Bank on a two-stage residual income model.
Assumptions for the model: an income CAGR of 17%, a dividend payout of 20%, cost of equity = 14.7% (Deutsche Bank estimate), terminal growth rate = 5% (the nominal growth rate for developed countries). This gives us a March 2018e based target price of R1,400, which results in a target P/BV of 2.96x .