Yes Bank: Prime bond yield play - CFO meeting takeaways: JPMorgan

We reiterate Yes Bank as OW and our top pick, on the back of falling
bond yields and wholesale rates. The front-ended expansion in NIMs and
treasury profits should help absorb higher credit costs. We expect the
rerating to continue as ROAs hold up, and we raise PT by 15% to Rs560
on better growth prospects. We have reviewed the annual report after
meeting with the CFO and marginally adjusted earnings.

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 Margin trend positive. Wholesale deposits rates have come off sharply
and should benefit Yes’ margins in the short term. The management did
caution that loans will offset some of these gains. We forecast NIMs to
rise 14bp y/y in FY14, though the near term spike in 1HFY14 could be
sharper. Our conservatism is partly driven by incremental credit being
concentrated in the low-yield space, given the weakness in the economy.
 We forecast a sharp spike in non-interest income - 148% y/y in
financial markets (essentially bond profits) and 33% y/y in core fees as
we see continued momentum in the loan syndication space. Trading
profits will be driven by a combination of its now-large corporate bond
book (~Rs10bn) as well as significant duration risk sitting on the SLR
portfolio. The share of revenues is expected to rise to 39% in FY14 (a
one-off) before reverting to the more normalized level of ~37% from
FY15 onwards. Fees and trading profits, we expect, will be a significant
buffer to the slightly slower asset growth of 27% in FY14.
Credit costs – upwardly mobile. We expect credit costs to almost
double to 102bp in FY14. This could be driven either by a) increased
delinquencies as the economy stays weak and the SME/mid-corporate
book starts to show strain or b) higher provisioning requirement imposed
by the RBI when the final dynamic provisioning guidelines are imposed
later this year. If Yes Bank can absorb these higher provisions without
impacting ROA (we believe it can), we see that as a significant positive
as the perception of earnings quality would substantially improve. To
that extent, some of the “windfall" gains from the bond rally could be a
very timely long-term positive

We maintain our OW rating on Yes Bank and raise our PT to Rs560 from Rs475,
mainly on revising our stage-2 growth assumptions. We think the decline in bond
yields and wholesale rates is a significant positive for earnings. The front-ended
expansion in NIMs and treasury profits will help absorb the inevitable rise in credit
costs.
Valuations
Our new PT values the bank at 2.7x PBV, which is at the higher end of the historic
range. This may look optimistic, given the weak economy – however, given the
improvement in the return ratios and strong balance sheet growth we believe the
stock deserves to trade at higher multiples. The stock is quoting at a significant
discount to some of its peers on P/B basis though some of this is warranted due to
low ROA but we think the differential could narrow in the medium term.