Accumulate Yes Bank – 3QFY2011 Result Update - Angel Broking

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Yes Bank – 3QFY2011 Result Update

Angel Broking recommends an Accumulate on Yes Bank with a Target Price of Rs. 313.

For 3QFY2011, Yes Bank reported robust net profit growth of 51.8% yoy and

8.4% qoq to `191cr above our estimates of `176cr on account of better-thanestimated

increase in non-interest income and stable asset quality. However,

NIMs were compressed due to an increase in the cost of funds. We recommend

an Accumulate on the stock.

Slower business growth with lower NIMs, asset quality stable: Advances grew by a

modest 2.5% qoq (66.3% yoy) v/s industry growth of 9.2% qoq. Deposits de-grew

1.4% qoq (79.0% yoy) v/s industry growth of 4.7% qoq. NIMs were compressed

by 20bp to 2.8% due to an increase in the cost of funds by 40bp, leading to a

marginal 3.2% qoq growth in NII to `323cr. Non-interest income increased by a

healthy 23.4% qoq and 26.5% yoy to `162cr mainly on account of strong traction

in the financial market and branch banking income. During the quarter, the

bank’s asset quality remained stable with Gross and Net NPA ratios at 0.23% and

0.06% (0.22% and 0.06% in 2QFY2011), respectively.

Outlook and Valuation: With rising interest rates, the bank’s cost of funds is

expected to rise at a faster rate (as witnessed in 3QFY2011 – 40bp qoq rise) due

to the bank’s wholesale-based funding mix. Post the recent sharp correction, the

stock is trading at 2.1x FY2012E ABV. We recommend an Accumulate on the

stock, with a revised Target Price of `313 (`353), based on a reduced target

multiple of 2.4x FY2012E ABV owing to the external environment being relatively

adverse for growth of wholesale-funded banks like Yes Bank.

Advances growth below industry, deposits de-grew sequentially

During the quarter, the bank registered slower growth in advances sequentially of

2.5% (66.3% yoy) to `31,112cr compared to the industry sequential growth of

~9%. Deposits de-grew sequentially by 1.4% to `39,453cr (grew 79.02% yoy)

compared to sequential industry growth of ~4.7%. Corporate and institutional

banking accounted for 67.6% of the portfolio, while commercial banking

accounted for 22.3% and branch banking 10.1%. The corporate and institutional

banking loan book de-grew by 0.7% qoq v/s growth of 9.9% in 2QFY2011 and

25.7% in 1QFY2011. CASA deposits declined marginally by 0.4% on a qoq basis,

while CASA ratio improved marginally to 10.2% v/s 10.1% in 2QFY2011 on

account of slower term deposits growth. The credit –deposit ratio increased to 79%

in 3QFY2011 (76% in 2QFY2011).

Muted NII growth, NIM compressed sequentially

NII posted muted growth of 3.2% qoq and a moderate 53.2% yoy to `323cr in

3QFY2011. Reported NIM compressed by 20bp sequentially and by 30bp yoy

basis to 2.8% in 3QFY2011. This was mainly on account of 40bp qoq rise in cost

of funds. Going forward, with the interest rates on the rise the bank’s cost of funds

is expected to increase at a faster rate due to its weak CASA ratio of 10.2%.

Stable asset quality, higher provisioning expenses

On the asset quality front, the absolute Gross NPAs increased by 7.5% sequentially

to `73cr and Net NPAs increased marginally by 1.3% qoq to `17.4cr. During the

quarter, the Gross and Net NPA ratios of the bank were stable at 0.23% and

0.06% (as against 0.22% and 0.06% in 2QFY2011), respectively. Provisioning

expenses were higher by 43.1% qoq to `25cr, however they were below our

estimates. The bank’s provision coverage ratio excluding technical write-offs

improved to 76.1% from 74.7% in 2QFY2011. The restructured advances

(excluding NPAs) were `83.7cr in 3QFY2011 as against `69.0cr in 2QFY2011,

representing 0.27% of the gross advances.

Non-interest income growth healthy

In 3QFY2011, non-interest income exceeded our expectations increasing by a

healthy 23.4% qoq and 26.5% yoy to `162cr. This was on account of healthy

traction in fees from the financial market segment (grew by 46% yoy to `41cr),

transaction banking segment (grew by 34% yoy to `50cr) and branch banking

segment (grew by 205% yoy to `17cr). However, fees from financial advisory

segment declined by 6% yoy to `54cr.

Operating expenses rise, cost-to-income ratio lower

Operating expenses were up by 41.6% yoy to `174cr on the back of the 44%

increase in employee costs and 39.1% increase in other operating expenses.

Employee costs increase was primarily driven by increase in the headcount by 969

(a rise of 34.4%) yoy. As the bank’s operating income grew at a faster rate than its

operating expenses, the cost-to-income ratio improved to 35.8% (36.6% in

2QFY2011 and 38.7% in 1QFY2011).

In 3QFY2011, the bank opened 14 branches taking its branch network to 185

branches. Management plans to take the branch network to 250 branches by

1QFY2012, with new branches directed towards improving its retail franchise.

Management stated that it is on track to achieve the target of 250 branches in the

remaining five and half months.

Capital adequacy continues to be strong

The bank’s capital adequacy ratio (CAR) continued to be strong at 18.2% with tier-I

ratio at 10.4% providing significant headroom for growth. Total capital funds grew

by 82.1% to `6,832cr as at 3QFY2011 v/s `3,752cr as at 3QFY2010.

Investment Arguments

A-list Management and ability to raise capital

Yes Bank has an A-list top management team, which brings to the table rich

experience from the best banks in India, including Bank of America, ABN AMRO,

Citibank, ICICI Bank, Rabo India and HDFC Bank. The bank’s performance also

benefits from management’s ability to raise equity capital (at increasing,

book-accretive premiums).

Stable asset quality

During the quarter, the bank’s Gross and Net NPA ratios were stable at 0.23%

and 0.06% (as against 0.22% and 0.06% in 2QFY2011), respectively. Provisioning

expenses were higher by 43.1% qoq to `25cr, however they were below our

estimates. The provision coverage ratio excluding technical write-offs improved to

76.1% from 74.7% in 2QFY2011. The restructured advances (excluding NPAs)

were `83.7cr in 3QFY2011 as against `69.0cr in 2QFY2011, representing 0.27%

of the gross advances.

Investment Concerns

Medium-term downside risks to RoAs

The bank’s credit market share has steadily increased on the back of robust credit

CAGR of 52.2% over FY2008-10, but this still represents a relatively small 0.7% of

the market. Given the small loan book, the bank has so far managed to source

loans with relatively above-average profitability, keeping its NIMs above 2.7%

since FY2009, in spite of just 10% CASA ratio. Going forward though, as the size

of the balance sheet increases, we believe that RoA compression remains a risk for

the bank. Moreover, with interest rates rising, even cyclically, the cost of funds

would rise at a faster rate for the bank, given its largely wholesale funding mix.

Slower business growth

During the quarter, the bank’s business momentum slowed down considerably,

with advances growing by a marginal 2.5% and deposits de-growing by 1.4%.

Management stated that they do not wish to compromise on profitability for growth

to ensure that there is no over-heating of their balance sheet due to excessively fast

growth. They maintained their guidance of 35% CAGR in balance sheet over the

next 3-4 years (v/s 76.6% yoy currently).

Faster increase in cost of funds leading to NIMs compression

During the quarter, the bank’s NIMs compressed by 20bp to 2.8% v/s 3.0% in

2QFY2011. This was on account of faster increase in the cost of funds by 40bp in

3QFY2011 and the bank’s very low CASA ratio of 10.2%. Moreover, with rising

interest rates, the bank’s cost of funds is expected to rise at a faster rate (as

witnessed in 3QFY2011) due to its wholesale-based funding mix. Hence, going

forward, we believe that the bank may continue to face margin/growth challenges.

Execution risks in retail expansion plans

The bank has expanded its network at a fairly rapid pace from 67 branches in

FY2008 to 185 branches as of 3QFY2011. Management is planning to take the

branch network to 250 branches by 1QFY2012, with new branches directed

towards improving its retail franchise. In our view though, considering the

experience of the past several quarters, the inherent challenges of building a retail

franchise are substantial despite management’s high pedigree.

Outlook and Valuation

Amidst a rising interest rates regime, the bank’s cost of funds is expected to rise at

a faster rate (as witnessed in 3QFY2011 – 40bp qoq rise) due to the bank’s

wholesale-based funding mix. Post the recent sharp correction, the stock is trading

at 2.1x FY2012E ABV. We recommend an Accumulate on the stock, with a revised

Target Price of `313 (`353), based on a reduced target multiple of 2.4x FY2012E

ABV owing to the external environment being relatively adverse for growth of

wholesale-funded banks like Yes Bank.