Hereās my take on what has gone wrong (again) with Yes Bank since the new CEO took over
1. Change in accounting policy for corporate banking fees. Corporate banking fees were the bread and butter of Yes Bankās profits. New CEO has changed the accounting policy of recognizing fee income from upfront recognition to recognition over term of the loan. As per the bank, new fee income will be about 50% of the past fee income. In FY 19, corporate banking fees were close to 2000 Cr. This will drop to 1000 Cr going by the bankās guidance. This loss of 1000 Cr will flow straight to operating profit of the bank and will result in a drop of 25-30% in operating profit. In Q1 FY 20, corporate banking fees were only 62Cr compared to 682 Cr in Q1 FY 18 so in reality corporate banking fees are down 90%. Some of it will recover but it may take time given that bank is reducing focus on corporate banking and increasing focus on retail banking.
2. Worsening credit quality - Bankās provisions have gone up substantially as NPAās have gone up and provision coverage ratio continues to be low. Some of this trouble is external to the bank (e.g. crisis with Dewan and credit crunch in the NBFCs etc) but it is hitting the bank anyway. One silver lining is that there is no widespread weakness in bankās asset book and the weakness comes from few concentrated exposures so any resolution in one or more of these accounts will have a material impact on asset quality. Investorās are not taking any chances though, they are pricing the worst having lost faith in the bank.
Some of these asset quality issues come from aggressive growth that bank pursued in last 5-6 years which in turn was to boost the corporate banking fee income. So with the change in accounting norms, bank will be less aggressive in growing the corporate book and consequently will avoid further damage to loan book. However, any benefit will be seen only after few years, not immediately. While other banks have seen NPAs rise and then top out, Yes Bankās NPAs have only recently started to rise but this is not due to cycle in the economy. Yes should see a quicker resolution than other banks.
3. Focus on building liabilities franchisee - Yes Bank has always been an asset franchisee while most other banks (even the worst PSU banks) are a liabilities franchisee. Yes is now falling in line with what other banks have been able to do (i.e. build a liabilities franchisee) but it is not something it can do overnight. At best it will take 2-3 years before we see the effect of that (in terms of lower cost of funds) in the income statement. In the interim, operating costs will go up to fund this initiative. Reality is itās CASA ratio dropped in Q1 so itsās liability franchisee is actually weakening but I expect this to be temporary.
4. Short term outlook has become cloudy - With all this, near term (next 4 to 6 quarters) outlook is cloudy and thatās exactly what makes markets nervous. No wonder institutional ownership has gone down from 65% to 50%. When large institutions unload shares to retail investors who in turn are struggling to raise liquidity, we can see the impact on price.
5. Long term investors are taking a wait and watch approach - When a company goes though such a fundamental change in its strategy, long term investors take a wait and watch approach to see how this strategy is playing out and some clarity on earnings power emerges. some investors have decided to get out and watch from the sidelines which has pushed the price lower.
6. Lower growth outlook - Yes was one of the fastest growth medium size bank in the country. With focus shifting from corporate to retail and increased reliance on internal sources of funds to grow, growth will be hard to come by in the next few quarters and recovery will only be gradual.
To be fair, bankās book value is still intact at 114 rs and itās capital adequacy ratio is still adequate. Bank is looking to raise capital to fund growth but market is thinking that it is raising capital so that it can take another big write down. We wonāt know that for sure but when sentiments turn bad, every decision is interpreted in a way that justify the current price. Media is always trying to justify current stock price with instant analysis but the real issue could be different (in both directions) so itās better to ignore all the chatter in the market and focus on the long term.
Most of these issue are priced in the stock already so this post is more like trying to rationalize the market reaction. Market could very well be overreacting on the downside but we will know that in about couple of years. I have not sold a single share of Yes Bank and donāt intend to sell as I do believe bank will recover from this mess sooner or later. I donāt intend to buy anymore though until I see some of these issues bottom out and bankās earning power become visible while there are so many other bargains available in the market.
In a growing economy like India, a bank will always be valuable. Yes Bank is no so badly run that it will collapse due to internal weakness or that itās fundaments will always be poor. Its retail banking franchisee is intact and in fact bank is planning to grow it further, corporate banking is strong and actually quiet profitable and the bank is large enough to attract professional talent to grow the bank profitably over the coming years. Canāt say the same thing about some of the smaller private and PSU banks that are selling at similar valuation.
What are some of the triggers that can cause the market to rerate this stock?
- A capital raise at decent valuations from ordinary investors and not vulture investors. This will give needed confidence to the market that banks problems are close to bottom. At 0.8 times book value, a capital raise will be hugely dilutive.
- Corporate banking fees come back to new normal which should be around 300 Cr per quarter.
- Final resolution on some of the large NPAs.
- A rating upgrade
I have no idea if or when any of these events will happen but I will be looking out for them. Anyone with willingness to hold the stock for 3 to 5 years and ability to ignore noise will see decent returns.
