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Yes Bank: Is it a 'yes'?

Sep 19, 2005

Performance summary
In its maiden disclosure of quarterly results (1QFY06), Yes Bank, the youngest player in the Indian private banking sector, registered a positive bottomline for the first time after three quarters of lending operations. Although the bank continued to maintain a healthy mix of interest and non-interest income, margin pressures are very apparent.

Rs (m) 1QFY06
Income from operations 290
Interest Expense 156
Net Interest Income 134
Other Income 190
Other Expense 155
Net interest margin (%) 2.6%
Provisions and contingencies 3
Profit before tax 166
Tax 54
Profit after tax/ (loss) 113
Net profit margin (%) 38.8%
No. of shares (m)** 200
Diluted earnings per share (Rs)* 2.3
P/E (x) 31.5
* (annualised)
**No. of shares pre IPO as IPO process not completed by 1QFY06

The latest entrant to private sector banking
Yes Bank, which received its banking license (the only greenfield license given by RBI in the last 10 years) in May 2004, commenced its lending operations in October 2004. The bank, at present, is operating through 5 branches and is largely concentrated on the corporate segment for its advances portfolio. Yes Bank has adopted a knowledge-based product delivery, wherein it has put together a team of experienced professionals with sector and banking product knowledge that would develop relationships with customers and deliver sector focused advice in food and agri-business, life sciences, infrastructure, telecommunications, media and technology (TMT), engineering, textiles and retailing sectors. Netherlands based Rabobank is one of the major stakeholders(16%) in the bank, which had its IPO in 1QFY06.

What has driven performance in 1QFY06?
Truncating margins: Yes Bank witnessed a healthy 34% YoY growth in advances (corporate loans) coupled with doubling of the investment portfolio in FY05 (i.e. November 2004 to March 2005). Although the bank's deposit base grew by 122% during the same period, the proportion of low cost deposits (CASA) remained at a marginal 2.3% of total deposits. With more branches expected to come on stream, this proportion is expected to improve going forward.
Segmental breakup
(Rs m) Dec-04 Jun-05 Change
Advances 5,671 7,610 34%
Investments 1,161 3,949 240%
Credit deposit ratio 190% 115%  
Deposits 2,985 6,630 122%
Borrowings 2,146 3,697 72%
Deposit to borrowing ratio 139% 179%  

Nevertheless, while the bank enjoyed a yield on advances of 9.1%, the high cost of funds (5.7% in 1QFY06) enforced pressure on the bank's net interest margins that dipped from 3.5% in 4QFY05 to 2.6% in 1QFY06. The bank's current sources of funding (other than equity capital) are primarily short-term borrowings such as inter-bank borrowings and certificates of deposit. Failure to rollover these sources of funding or replace them with fresh borrowings or deposits could have a material adverse effect on its business and financial performance going forward. Also, the cost of funds in such a case is subject to interest rate fluctuations, which exposes the bank to the risk of reduction in spreads. Yes Bank entered into a strategic alliance with SIDBI to provide financial products and services to SMEs in 1QFY06. This initiative is expected to improve its yields going forward.

Fee cushion: Yes Bank saw its non-interest income nearly double (186% YoY higher) in 1QFY06. The bank's non interest income to total income ratio increased from 39% to 59% on account of strong fee income generated from financial advisory and transaction banking services along with the recently launched wealth management advisory services. The agreement with Bajaj Allianz (for bancassurance) is expected to further aid this cause.

Higher realisations: Yes Bank's returns on assets (RoA) improved from 0.4% in 4QFY05 to 2% in 1QFY06. Since the institution witnessed a contraction in the average spread on lending, the increase in RoA can be largely attributed to the profits realised on equity investments and a higher contribution of fee based income. The return on equity also increased from 2% in 4QFY05 to 20% in 1QFY06.

Clean assets: The bank has put together a team of experienced industry and banking professionals who have the necessary knowledge and skills sets in the chosen sectors. It is also actively working with industry associations, government bodies and chambers of commerce in various capacities and is offering products and services to clients in these sectors. Another point worth noting is that, in each of the focus sectors the bank has been able to largely restrict itself to the top 10 companies. Due to this, Yes Bank had nil gross and net NPAs at the end of 1QFY06. However, here one must note that the period of operation of the bank is too short to judge the quality of longer-term loans.

What to expect?
Yes Bank is yet in its formative stages and has not yet rolled out its entire suite of products. It is therefore difficult to evaluate its business prospects, as its operating history is very limited and not indicative of the future operational results and financial condition. Also, the bank has high cost of operation (cost to income ratio 48% in 1QFY06) that may weigh heavy on profit margins if the bank is not able to sufficiently grow its business volumes. We believe that the bank holds potential for effectively catering to a niche corporate segment (especially due its novel strategy) and focus on low operating overhead approach (by not venturing too much into retail) to bolster its operating margins. It would be a matter of time before the bank's credentials are established.

The Bank had its IPO for 70 m shares in 1QFY06 (funds received in 2QFY06) at Rs 45 per share and infused Rs 3.2 bn into its networth. At the current price of Rs 71, the stock is trading at 3.5 times its adjusted book value post IPO. Given our discomfort with the bank's lack of operating history and sustainability of margins, we believe investors need to exercise caution at the current levels.

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