YES Bank FPO: Asset quality overhang to weigh on the stock

About four months after SBI and seven other lenders stepped in to bail out the crisis-hit YES Bank, the bank is looking to raise additional capital of ₹15,000 crore through its follow-on public offer (FPO).

With the bank’s capital ratios slipping below the regulatory requirement during the March quarter (despite ₹10,000-crore capital infusion by various lenders and the writing down of AT-1 bonds amounting to ₹8,415 crore), it was expected to take speedy steps to shore up its capital.

At the price band of ₹12-13 per share, the asking price of YES Bank’s FPO is at a steep discount to the market price — nearly half the market price on Friday (the stock has lost 13 per cent today in trade). This may appear attractive to retail investors looking to make some quick gains on the price arbitrage.

But investors are advised not to take the bait and avoid the FPO issue.

For one, investors must consider the valuation at which they would be acquiring the shares of YES Bank (and not the price). At the upper band of the FPO price, YES Bank is valued at about 0.9 times price to book (FY20 post issue). While this may appear cheap, it is important to note that there are other private bank stocks that are available at their historical lows, with better fundamentals — Axis Bank (trades at 1.5 times FY20 book), IndusInd (1 times) and Federal Bank (0.7 times). Rather than betting on a bank that is just emerging out of existential crisis, investors can pick strong capitalised banks, with a resilient performance and well-proven governance record.

Two, investors need to consider the adjusted book value (adjusted for net NPAs and portion of stressed book that can be written off) in the case of YES Bank, owing to the sharp deterioration in its asset quality in recent times and the persisting risk of steep mark-down in its stressed book, given its concentrated corporate exposures. If we consider the adjusted book (taking into account possible slippages from loans under moratorium), the asking price of the FPO would work out to 1.6-1.7 times adjusted book (post issue), which is quite expensive given the weak finances of the bank.

Above all, the Covid-19-induced disruption and the six-month moratorium on loans has cast a huge uncertainty over asset quality for all banks. In the case of YES Bank, the trouble is accentuated by the fact that the bank has made modest provisions to deal with the Covid-related stress. YES Bank made ₹238 crore provisions in the March quarter (against moratorium NPA standstill accounts of ₹2,713 crore). A steep rise in YES Bank’s provisions in the coming quarters is highly likely, which can erode earnings and capital.

Risks galore

In the December 2019 quarter, YES Bank’s bad loans had spiked to ₹40,709 crore from ₹17,134 crore in the September quarter. The bank reported loss of ₹18,560 crore and its CET 1 capital ratio plummeted to 0.6 per cent. Even as SBI and other lenders subsequently pumped in ₹10,000 crore of capital as per the reconstruction plan, the bank’s CET 1 ratio and Tier 1 capital ratio slipped to 6.3 per cent (regulatory requirement of 7.375 per cent) and 6.5 per cent (regulatory 8.875 per cent) in the March quarter.

The management believes that the ₹15,000-crore capital raise through the FPO can not only help meet the bank’s regulatory requirement and absorb incremental bad loan provisioning but also be sufficient to fund growth for the next two years.

But there are several risks to capital and we believe that the bank may need additional capital to fund growth over the next one year.

One, the bank would need sizeable portion of the freshly raised capital to absorb bad loan provisions in the coming quarters. This is because, while in the March quarter, the bank’s bad loans moderated to ₹32,878 crore, it was mainly due to moratorium granted on various loans as per the RBI’s directive; 35-45 per cent of the bank’s loans were under moratorium (according to March quarter results). After the RBI’s extension of the moratorium until August 31, there could be some increase in the bank’s loans under moratorium. Slippages from these accounts (when the moratorium is lifted) could lead to increase in provisions. The modest provisions made by the bank to tide over the impact of Covid offer little leeway to absorb losses on account of this.

Two, the bank has SMA 1 book (where payments are overdue by 31-60 days) of ₹10,781 crore as of March 2020. Sharp downgrades from the corporate book can also lead to increase in provisions. YES Bank’s concentrated exposures is an added risk.

Currently the bank is in breach of exposure limits with respect to five groups. While the management has stated that much of the earlier stress has been recognised, the worsening economic situation owing to the pandemic can lead to sharp downgrades.

The continual capital raising by the bank can lead to dilution for existing investors in the bank. Remember, the FPO price set at a huge discount to the market price has already led to steep dilution in equity base for existing shareholders in the bank (50 per cent). At every step of additional capital infusion, there could be more dilution for existing shareholders.

Long road to recovery

Aside from asset quality risk, the bank’s liquidity position will also need a close watch. Since the December quarter, the bank had seen massive outflows of deposits — ₹72,000 crore until March 5 when moratorium on deposits was placed. Even after the moratorium was lifted on March 18, there were outflows of nearly ₹35,000 crore until May 2. With the bank’s liquidity coverage ratio (LCR) falling below the mandated requirement, the bank was granted a short-term special liquidity facility for 90 days from the RBI on March 17; this has been extended till September 12. While the bank is currently not in breach of the LCR requirement (and has been able to stem deposit outflows according to the management), it could come under pressure after the special liquidity facility ceases.

Above all, YES Bank’s revival could take a long while, with interim shocks and volatility in financial performance. YES Bank has been predominantly a corporate lender (about 65 per cent of its overall book). The new management expects to transition the loan mix in favour of retail and SME (60 per cent of loans), which could take time. Growth could be a challenge in the near term.