Investors in Yes Bank have had a torrid two and a half years. Once considered as India’s paragon for successful high growth banking, Yes Bank is now entirely at the mercy of larger external forces. It has essentially been bailed out by an SBI led consortium of India’s largest financial institutions.
Yes Bank’s story sums up the stock market’s cycle of euphoria and disappointment. From a high of INR 404, the stock lingers at INR 18 today. Several investors tried to average out their prices, but all they really did, was try to catch a falling knife.
To one’s dismay, it has been reported that Yes Bank is worth INR 1 today (some argue it is worth INR 0)!
Today, I will attempt to value Yes Bank on a going concern basis to estimate its intrinsic value.
Before we attempt to build a narrative for Yes Bank’s future, let us try to briefly understand what led to Yes Bank’s current situation.
In simple terms, Yes Bank’s downfall can be attributed to:
- Large exposure to multiple large corporates (Anil Ambani Group, Essel Group, IL&FS, DHFL, Vodafone) defaulting within the same timeframe along with aggressive lending practices
- Overstretched safety buffer due to rapid growth in loan book and failure to assess and cover risk appropriately (Although the bank did maintain capital adequacy levels above the minimum stipulated requirement, it was growing several times faster than its peers whilst maintaining peer like capital adequacy ratios, this is evident from the table below)
CAR1 – Tier-1 Capital Adequacy Ratio – It is a measure of a bank’s core Tier 1 capital (equity and reserves) against the total risk adjusted/weighted assets. A higher CAR1 generally indicates better financial strength (ability to absorb losses).
Highlighted boxes indicate the start of Yes Bank’s decline
Now that we have understood the fracture points for the bank, we will try to understand where the bank stands today and where it is likely to be in the future.
Yes Bank now stands as the 6th largest private bank in India, but also happens to be one of the weakest.
Being an opaque business, ‘Banking’ is entirely based on ‘trust’, the ‘quality and philosophy’ of the management team, and the ‘work culture’ that permeates through the bank.
Banks tend to enjoy significantly strong economic moats and have high barriers to entry due to:
- (1) Economies of Scale
- (2) Ability to construct diverse portfolios thereby reducing unit risk and lowering borrowing costs across the board
- (3) Ability to borrow at below market rates
- (4) Tendency to form oligopolies
- (5) High customer switching costs due to high integration with one’s daily life
- Depositors are a cheap source of capital for a bank and can be thought of as the fuel that keeps the banking engine ticking
- (6) Massive balance sheet requirements
- (7) Regulated nature of the industry
Unfortunately, in the case of Yes Bank, there was systematic failure in building a resilient portfolio (2) and the company lost depositors due to a loss of trust (5). The loss of the cheapest source of capital and increased risk (due to rising NPAs) means that the bank’s cost of borrowing will move higher (3).
Hence, moats (2), (3), and (5) have deteriorated. I will not talk about the failure of regulators in this article.
It is important to note that Yes Bank has been bailed out by other banks (SBI, HDFC, Axis, ICICI, Kotak, Bandhan etc). Hence, going forward, the weakness of the moats for Yes Bank will show up in lower growth, higher provisioning, and lower profitability.
Loan Book Profile:
The bank has significant exposure to bad loans in the corporate banking segment and one must keep an eye on these numbers going forward.
For the bank to recover it must:
- Cut down on growth in corporate banking and focus on continuing to win back the trust of retail customers (Recently, low-cost deposits have seen an increase which is a positive sign)
- Control worsening of asset quality in SME and MSME segment which is likely to arise because of the Covid-19 pandemic (The bank has undertaken provisioning for Covid-19 in the last two quarters)
- Control and try to recover corporate assets (The bank has been able to recover some corporate assets)
- Improve the Deposits to Advances ratio towards 1 to 1.05 (Currently stands at 0.81 as of Q2 FY21, a stark improvement from 0.61 in FY 2019-2020)
Infrastructure and Network:
Yes Bank has 1106 branches, 56 BCBOs (these are mobile correspondents who help rural areas get access to banking transactions), and 1402 ATMs across India.
These points of presence are well distributed across geographies.
The bank’s only way out of this mess is through a strong focus on the retail segment.
Luckily, the bank’s long term debt instruments have been upgraded following multiple successful capital raises and hence borrowing costs should head lower gradually. However, this has come at the expense of significant equity dilution.
Yes Bank has turned profitable again since the last 2 quarters. Having a closer look at their recent disclosures reveals significant provisioning for ‘Covid-19 related impact’. Hence, going forward, provisioning for Covid-19 impact should not be too significant (I hope).
I believe that the bank has received substantial financial support and may have won back some degree of trust. I will attempt to value Yes Bank today with the assumption that there is a 95% chance that the bank survives and improves its health gradually. For the 5% chance that the bank doesn’t survive (as an independent entity), the equity will be worthless.
Scenario 1: Slow Recovery
Adjusted Value per Share (5% probability of failure) = INR 9.47
Scenario 2: Fast Recovery
Adjusted Value per Share (5% probability of failure) = INR 14.86
My valuations don’t paint a very bright picture for Yes Bank today. The company seems to be on the path to recovery based on the last two quarters and I look forward to their Q3 disclosures secretly hoping for positive surprises!
However, Yes Bank’s current price seems to be factoring in these expectations of ‘positive surprises’ and hence does not offer much comfort!