KP Singaravelu

In the middle of 2013, concerns emerged on the US Federal Reserve tapering, with international markets fearing that the Fed would start pruning its monthly bond purchase of $85 billion, which had found its way to emerging markets. This led to a free fall in the currencies of markets that had high current account deficits, including India. The Reserve Bank of India (RBI) countered this by sucking out liquidity, leading to an increase in short-term interest rates for a few months. The markets corrected sharply and banking stocks plummeted as they were perceived to be impacted by higher borrowing costs. 

Many a times, one does not get an opportunity to buy into high growth stocks, which are favoured by growth investors, at a reasonable price. In this case we have Yes Bank, which has corrected along with other banks, since they were believed to see an increase in borrowing costs and losses in their bond portfolio. The concern with Yes Bank centred on its relatively lower share of current account and savings account (CASA) of 20.5% compared with 40%-plus for HDFC Bank and ICICI Bank. Banks that borrow in bulk were expected to be impacted more as borrowing costs quickly get re-priced up or down. 

In addition, Yes Bank’s exposure to credit substitutes (investing and holding corporate bonds and non-convertible debentures instead of lending directly to corporates), at 22% of assets, was expected to lead to losses in the investment book following a sharp rise in yields, as bond prices have an inverse correlation with yields. This led to a violent correction in the stock price, but the concerns proved exaggerated as the stock bounced back sharply from its lows. Currently the stock trades at a forward FY15E price to book value (P/BV) of 1.4 times, which is at a discount to the five-year average forward P/BV of 1.61 times, and this provides an opportunity to buy a quality bank at a discount to the long-term average.

Interestingly, there were boardroom battles between the promoter family members in the recent past, on a board seat not being offered to the representative of a main shareholder. While the MD and CEO, Rana Kapoor, mentioned that the other shareholder (his sister-in-law’s daughter) does not qualify under the RBI’s ‘fit and proper person’ criterion, the issue is currently in court. However, the stock did not correct in a big way despite the much-publicised issue since the market correctly deduced that the development would not affect the bank’s performance.

Play the GDP revival card

While the best way to have played India’s growth from the 2003 to early-2008 bull phase was through infrastructure and capital goods stocks, the same might not be the case for the next bull market, as heightened competitive pressures, regulatory issues and excessively leveraged balance sheets dampen the sectors’ performance.

In other words, one of the best and safest ways to play the ensuing high growth in the economy will be through the banking and financial services sector. As a thumb rule, the Indian banking sector grows by 2.5-3 times of real GDP and there are banks that grow faster than the sector by gaining market share, higher fee income etc. Going forward, the economy, aided by falling interest rates (interest rates are close to peaking out, if not having already peaked out) and more reforms, should bounce back close to 8% levels over the next couple of years. 

The banking sector should also grow at a rate higher than the broader market and Yes Bank is likely to grow faster than the banking industry growth. It will also be a major beneficiary of falling interest rates owing to its bulk borrowing and high investment in corporate bonds in the form of credit substitutes. 

Good metrics

Post de-regulation of savings rates, the bank has reported robust traction in CASA mobilisation aided by strong growth in savings deposits. The proportion of savings accounts has grown from a minuscule 1.5% of total deposits in FY11 to 10.4% in September 2013. The branch network, which is crucial to grow low-cost CASA deposits, is currently at 500 with plans to increase the number to 600 by end-FY14 and 750 branches by end-FY15. This will also aid in decreasing the dependence on wholesale funding where funding costs are volatile, and will improve valuation.

Within the banking sector, Yes Bank is one of the best quality banks with a net interest margin (NIM) of close to 3% and a low cost to income ratio of 36%. It has a high provision coverage ratio of 85% and 1.3% return on assets. And, while the asset quality of many public sector banks and smaller private sector banks has deteriorated in the past few quarters, Yes Bank’s asset quality continues to be robust with next to nothing gross and net non-performing assets of 0.3% and 0.04%, respectively. At 0.29%, restructured assets were lower compared with the banking system, and credit costs are expected to remain within a band of 50-60 basis points. The diverse book with minimal exposure to stressed sectors and the high exposure to credit substitutes that are secured rated papers and mostly liquid, giving the option to exit in case of any stress, have helped contribute to the asset quality.

Yes Bank has consistently earned a high fee income at around 30% of total income, while other income (fee and treasury) continues to be one of the highest for the sector at 40% of total income. A high fee income and other income contributes directly to a higher return on equity, the best indicator of profitability, which at around 23% for Yes Bank is one of the highest for the sector. 

To sum up, with easing liquidity, expansion of bank branches and CASA proportion expected to increase to 25% by end-FY15, Yes Bank is primed for a strong re-rating. With the bottoming out of the economy in FY14, the bank’s PAT should grow close to 25% CAGR over the next three years from FY15, aided by high NIM and other income. With the FY15 P/BV at 1.4 times and the five-year average P/BV at 1.61 times, there is a case for reversion to mean, which will lead to re-rating of the stock. If not now, a couple of years down the line, the bank will be a strong M&A candidate for a foreign bank that is looking to open its account in India.

The writer holds the stock in his personal capacity