Yes Bank : Long road to redemption :Macquarie Capital Securities (India)

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Yes Bank (YES IN) Long road to redemption Key points  Incoming CEO flags large stressed pool, aggressive accounting practices and weakness in retail franchise. Targets 1% RoA by FY22E.  We and street both underestimated risks in structured finance. We cut EPS by 45% and TP by 40% to Rs165. Double-downgrade to Underperform.  Loan book clean-up, investments in retail business and pivoting of business model within corporate segment should keep return ratios subdued for long. A double-downgrade to Underperform  Over the past eight years we have been constructive on YES Bank’s ability to not just survive, but to thrive in a risky business segment like structured finance. Despite our anxious scepticism at times, YES has built a track record of handling multiple challenging accounts well. RBI’s clean chit in FY18 divergence audit seemed to ratify our understanding of the business model.  Thus, the new CEO’s flag of a 3x QoQ increase in BB & below rated accounts, despite aggressive slippages (Rs3.5bn) in 4Q19, comes as a material negative surprise. In addition, flagging off of aggressive accounting practices in fee income (Rs3bn reversal in 4Q) and weakness in retail franchise (only ~30% branches break even) further dampen our fundamental view on the robustness of the business model.  We must eat humble pie today and admit we underestimated risks in structured finance. We got the call wrong. We draw upon our learnings from how Axis Bank handled its watchlist disclosures, and now built in a significantly more conservative slippage and credit cost estimate over FY20-22E, more than double the management’s guidance (Fig 3-5). Our FY22E RoA is ~0.85%. Note that Axis first reported a watchlist of Rs226bn in FY16 and stated it expected only ~60% of this to slip. What eventually transpired was consistent re-statement and additions to it to the tune of ~1.2x the original size (Fig 6).  We downgrade the stock to Underperform with a 40% lower TP of Rs165. Summarizing 4Q19  Yes Bank reported its first loss in 4Q19 (Rs15bn) driven by a reversal of interest and fee income and a sharp uptick in provisions and slippages. Loans declined QoQ as YES remained strapped for capital and liquidity. GNPA rose to 3.2% from what we think are Jet Airways and IL&FS slippages.  Mgmt. guidance: Watchlist of ~Rs100bn (which we think includes only some part of the exposures in ADAG group, Omkar Group and Essel Group and 3 others); 125bps credit costs in FY20; 20-25% loan growth led by retail and SME loans; ~50% decline in corporate fees; 1% RoA in 3 years. Earnings and target price revision  We cut FY20-21E EPS by ~45% each and TP by ~40% to Rs165. We have built capital raise of Rs 35bn at Rs200/share in FY20. Ref Fig 3-5 for details. Price catalyst  12-month price target: Rs165.00 based on a Gordon growth methodology.  Catalyst: Equity capital raise, lower than expected slippages Action and recommendation  We double-downgrade the stock to Underperform with 30% downside.