Yes Bank Ltd - Stock Valuation and Financial Performance

Yes Bank has approached the market with Follow on Public offer (FPO) of Rs. 15,000 Cr. It has priced it FPO at Rs. 12/share.

Yes Bank’s financial performance has been very poor amongst other private sector peers going into the economic slowdown. Elevated NPA, lower profit margins and risk of dilution at lower prices to stay in business are some of the concerns in Yes Bank.

On the other hand, not so bad banks like Axis Bank and ICICI Bank are available at very attractive valuation. We may even get HDFC Bank at lower valuation during market volatility. These banks have much better returns ratios, low starting NPA and well diversified loan book to weather the storm.

If your investment horizon is more than 3-5 years, top 3-4 private sector banks are good buys throughout this year as we will be getting good valuation. We do not suggest adding other financials stocks in the current environment, you may hold on but do not add.

Yes Bank went bankrupt after reporting Q3FY20 results of 18,000 Cr in loss. Before results RBI came to rescue and convinced SBI and other private sector banks to chip in capital to save the bank from contagion.

What’s next for Yes Bank?

We expect Yes Bank to report even higher NPA in FY21. Resolution of the assets is in progress but recovery of loans looks dim as they were lent against assets and underlying asset value has depreciated (Shares/telecom assets/real estate). 

Yes Bank will require another round of infusion to provide for NPAs. We expect private equity players to join the fund raising program as they have anchor investors in form of largest banks of India. We believe this big contagion has been averted by the government, especially when there is risk aversion and market sell-off from CoronaVirus.

Why is there dichotomy between Yes Bank share price versus fundamentals?

As part of resolution, the RBI has disallowed sell of more than 25% share held until next 3 years. This means 75% of the shares are locked for 3 years. So very few shares are available for selling in the market.

Prior to ban on sell of shares, there were lot of short positions in Yes Bank. To cover the position, the short sellers have to buy from the market. This will lead to sharp rally in share price temporarily as they can’t buy enough shares. Ultimately the share price will collapse to atleast Rs. 10/share – a price at which large banks have infused the capital. (Infused capital to get bank out of bankruptcy, not bought stake as its fair value is zero on bankruptcy)

We have often seen similar price moves in stocks that go bankrupt like DHFL, Jet Airways, etc. One can’t profit from bankrupt business as their fair price based on fundamentals is zero. 

What should one do now?

Today’s price of Yes Bank Rs.61/share, its market capitalization is Rs. 91,500 Cr. with Rs. 10,000 Cr in capital (new capital from banks). 

Existing shares 500 Cr, new shares 1,000 Cr. 

Market Cap = Total 1,500 shares * Price 61 = 91,500 Cr.

This means Yes Bank trades at 9.1x Price to Book value. 

We had advised to sell Yes Bank since Rs. 250/share and various prices as it fell. For those who haven’t sold yet are stuck with atleast 75% holding locked in for three years. We advise taking advantage of this price move (not sustainable as no new capital can come at these prices), start liquidating that 25% holding slowly and use that capital to buy other stocks which have come down substantially. If you have liquidated prior to ban on selling, you got lucky to free up your capital which can be put to better use as rest of the market has become very cheap.

We are revising Yes Bank share price to Rs. 10/share i.e. price at which fund infusion happened by large banks.

We recommend to add HDFC Bank, ICICI Bank and Axis Bank at current prices. These banks trade at very attractive prices from long term growth prospects. 

We had advised in several of our notes (Link 1, Link 2, Link 3, Link 4) that we find Yes Bank has no future with high NPA, limited access to funds and subpar governance. 

In lines with recent developments, we revise price of Yes Bank to Zero. We suggest to sell at every possible price to recover whatever funds one can. 

Results: Net interest income declined by 10% in Q2FY20, CASA declined to 30% from 33%. 

Key highlights: 

• Net NPA shot up to 4.5% from 1% in same quarter last year. Even quarter on quarter the Net NPA jumped by 1.5%. 
• Provision coverage is very low around 43% which means Yes Bank will report back to back steep decline in profits as most of it will go into provisioning.
• Fee income declined in lines with previous quarters as Yes Bank now recognizes fee income as per conventional accounting like other banks.

Outlook: Outlook is very poor over next 4-6 quarters as Yes Bank will need high provisioning, mostly funded through its own profits as it won’t be able to raise enough capital at reasonable price. New defaults (Slippages) are escalating with every passing quarter. Credit cost i.e. provisioning guidance is increased in lines with increase in slippages. This bank is not facing a usual cyclical downturn but whole new set of challenges.

1)    Yes Bank didn’t lend normal loans like others wherein there was underlying collateral.

2)    Yes Bank’s profitability was bloated from lending to risky companies in return of high fee income and high interest rate, this income is not accruing anymore.

3)    Its loan book is not granular meaning only handful of loans are leading to large NPA

4)    The management has been guiding “worst is over” to raise funds from new investors. However, quarter after quarter the commentary is getting worse versus its previous quarter. For now we can’t read too much into management’s guidance.

5)    While it may provide for its loan from existing profits, it will find it difficult to grow its advances book. Rather we may see decline of 10-20% in advances as the company looks to reduce exposure to riskier loans.

6)    Stress loan as a percentage of loan book is at 14%. Given the quality of these loans, there could be more defaults from this bucket.

We have been very cautious on Yes Bank since 8 years due to its aggressive lending practices and never found any reason for market’s euphoria around the stock. We do notice many investors having exposure to Yes Bank from past or new exposure bought thinking of it to be a bargain.

Like in our previous notes, we reiterate to move funds to better stocks for now and take a loss temporarily. One can always buy Yes Bank again after 1-2 years when all the bad news will be known and already priced. While we find it hard to believe that Yes Bank would default but from shareholder’s point of view, the bank may experience capital erosion due to dilution happening at lower and lower prices. We are not yet confident on the management’s ability to pull the bank out of current turmoil, but we are tracking the public filings and performance closely.

We heard Yes Bank MD Ravneet Gill’s interview on CNBC today morning.

Ravneet Gill refuted that stressed loans are not close to 10% of their loan book as believed by many analysts. He is positive that there is some movement towards resolution in three large accounts, i.e. DHFL, Essel and ADAG group. According to him, Indiabulls Housing Exposure is still standard exposure and services all interest on time.

Ravneet Gill highlighted that they are in talks with large, reputed PE player and family offices for new fund raising. He is of opinion that this will bring back sentiment and remove skepticism of many market participants. He also rebutted rumors of his resignation.

The management sticks to 29,000 Cr amount of loans rating of BB and below exposure and 10,000 Cr out of that is stressed. This is around 4% of loan book. These numbers were given at the time of quarterly call. New setbacks like McLeod or Alitco or Cox & Kings is not mentioned.

Many of our customers asked us whether is it a good time to add to Yes Bank. We are right now in complete darkness in terms of what is the actual NPA numbers for Yes Bank. We await 2-3 quarters to identify real stress on Yes Bank’s balance sheet.

Secondly, we do not believe that even if the NPAs are recognized, the bank will start performing immediately. This is definitely not a Nestle’s Maggi type of episode that it will bounce back in just 2 quarters. Banks need capital to grow that in turn in raised from the market. The growth capital won’t be available immediately till bank shows consistent performance over 4-6 quarters. We will have many opportunities to add Yes Bank over time if it shows strong performance coming out of temporary pain.

Staring at Rs. 150/share investors thought how low can it go, but its 80% down from there. At Rs. 60/share some thought it can’t go lower from here, it is down 50% from there too. Now if it were a company that didn’t have leverage or we had known all the possible stress accounts, there was no point to be afraid since stock price is temporarily down and eventually recover completely. But with limited information on new NPAs, we suggest avoid bottom fishing in Yes Bank.

We await more clarity on asset quality and some greenshoots before we make a bet on Yes Bank. Just low price is not enough to jump at it as valuation is also falling with fall in price as equity dilution will be larger if funds are raised at such low prices.

We had asked most of our clients to reduce or switch to better banks. We had been cautious on Yes Bank for past several years. We continue to remain so. We recommend to buy Axis Bank, SBI and ICICI Bank. 

Our opinion from the past

We have recommended ‘Avoid’ Yes Bank in the past. We had said that the bank has shown stellar growth backed by large corporate loans. This has happened when the rest of the banks were not growing equally fast in these loans. At the same time, it was not reporting significant in NPAs versus peers. We had said that in our MRP computation, we have assumed certain NPAs basis of industry average NPA in corporate book.

What is so different about Yes Bank (also some NBFCs)?

Bank’s business model is to borrow from savers at favourable interest rate and lend it to needy at higher interest rate and keeping the spread in interest rate as profit. The amount of loan given will be dependent on borrowers earning and interest servicing capability. A bank is not supposed to lend money just because the borrower has asset/property as collateral. Collateral is just a backup if interest paying ability of the borrower worsens in an unfortunate event and he defaults.

Collateral based funding is not very profitable as one, it’s difficult to determine till when the interest will be serviced (bank’s source of profit) and two, to recover principal a) underlying asset may lose value or b) it might be illiquid or c) the time taken to liquidate will reduce time value of money.

Besides, the banking regulations ask to make provisioning for default which blocks capital. Add to that, if profits are inadequate, fresh equity needs to be raised at unfavourable valuation thereby diluting value of the bank. (This had happened with most PSU banks)

Barring retail loans & SME loans, collateral for corporate loans is usually low. This works out well because the underlying business generates robust cash flows to service interest payments and never defaults. A good bank is the one which assess the quantum and sustainability of these cash flows from the business and lends money only in proportion to that. It has no interest in collateral or value of that collateral as its primary motive is i) lend, ii) collect interest and iii) collect principal.

Yes Bank’s loan book consists large portion of Collateral based loans meaning the underlying asset may not be generating enough cash flows to service the interest payment.This asset backed loan must be raised by the beneficiary to invest/increase his shareholding in some other business. The interest servicing was happening from other sources of the beneficiary. When the times were good and liquidity was sloshing around (money was available from the market, nbfc, mutual funds), the beneficiary may have raised more money from elsewhere to fund the interest payment.

What has changed?

It is only now that the NPA recognition has started as liquidity crisis brought out the real NPAs, probably hidden from everyone’s sight as they were being rolled over in good times.

We assumed (< 5%) of loan book under stress and potential NPA, however the payment irregularity from various borrowers is hitting news and most of these borrowers also enjoy loan facility from Yes Bank.

Apart for higher concentration of collateral based loans, Yes Bank also has a large exposure to Real Estate & NBFCs. These companies are also facing incremental pressure from liquidity crisis that have started early May’18 and more prominently since Sept’18.

At current stage, the new management is taking account of loan exposures and its servicing capability. We may see more NPA recognition in subsequent quarters.

We have seen the pattern in banks that if some pressure point is observed, the management chooses to flush out all of past wrongdoings as well to start on a clean slate. This is especially true when a new management takes over as it will want to show the investors that the irregularities were the doings of previous management and they should not be blamed for past sins.

Right time to buy?

NO!

One can argue that can we not take an estimate of bad loans and arrive at adjusted book value to make a buy decision? We agree, we have valued banks doing this exercise. We bought those stocks cheap because most investors couldn’t look beyond next 24 months. However, in this case because it is an unconventional loan book, it is harder to have anchor number. In past when we did estimate potential NPAs for other banks, we had several estimates from RBI, other similar sized banks.

Besides, Yes Bank would go to market for fund raising through equity as it has to provide for NPAs. Stock price has already fallen due to mis-governance and uncertainty over size of NPA. Fund raising at such discounted prices, dilutes the existing equity shareholders. Higher the NPAs, more the equity required and higher the dilution.

We suggest not to get anchored to Yes Bank’s previous highs. We do not believe that the bank would start enjoying a high P/B ratio anytime soon. Besides, book value itself will be shrinking after provisioning. So double whammy leaves lower upside than what appears prima facie.

We stay with our ‘Avoid’ recommendation. Our MRP is subject to revision depending on equity raising plans and NPA recognition.

If you have taken a position, keep it bare minimum, even if it means selling it at a loss. Don’t go on averaging. Let more information come out. 5-10% price moves in either direction doesn’t say anything about fundamental situation. Most of the trading in Yes Bank is on speculation. Only when 2-3 quarterly reports come out, we will have more clarity.

P.S. For those who act on their own analysis, do ask us before you make a transaction. It always helps to seek an opinion or understand risks that we might know due to experience or access to more information. Then you can build a position keeping in mind those risks.