Elevator Pitch 

o In 2008 during GFC liquidity dried up in the banking system with investors fearing a run on Yes Bank given they were mostly wholesale funded and hence depositors could withdraw rapidly. Yes Bank was unaffected as they had strong relationships with their large wholesale depositors, while there was a run on ICICI Bank from retail depositors. 

o In 2013 during the US Taper Tantrum short term interest rates suddenly rose 300bps and the market believed Yes Bank could become insolvent given the bank was mostly short term wholesale funded and NIMs were <3%. The impact on Yes Bank was minimal as they ran a matched asset & liabilities book – hence loans repriced in line with deposits. 

o In 2015 during the RBI’s Asset Quality Review the regulator mandated banks to recognize loans to 150 large corporate borrowers as non-performing, leading to fears Yes Bank would suffer large write downs. However Yes Bank emerged with minimal impact while other corporate lenders suffered surges in non-performing loans. 

Yes Bank has proven their capabilities over the past 12yrs, and what is very exciting is they are the bank which still has most room to improve & enhance value going forward. YES has the opportunity to grow faster than other banks given they are small and only now entering into much of the retail banking space (YES has achieved ~25% earning assets growth over the past 5yrs vs. 14-21% for the larger private banks). YES has the opportunity to grow NIM (currently 3.4%) whereas other banks are already at high levels (4%+). YES has the opportunity to grow non-interest income as % assets given they are lowest of all banks. Yes Bank also has the opportunity to enhance its valuation ratios through building retail loan mix. 

Yes Bank should expand NIM to 4.0% by FY20 

YES currently has the lowest Net Interest Margin (NIM) among the six private banks at 3.4% (vs. ~4%+ for other banks on their domestic loan books). This is a result of Yes Bank having a higher cost of funds (COF) given a low proportion of CASA deposits relative to peers (currently ~30% of total deposits, vs. peers at 40%+), and a higher cost of SA deposits as YES hiked SA rates to 7% in 2012 in order to win market share

o I believe a 40% CASA ratio is a very reasonable target for Yes Bank to achieve as they continue to roll out their branch network and improve CASA per branch. YES are targeting 2500 branches by FY20 – a very reasonable target given HDFC & ICICI Bank have ~4500 branches each today, Axis Bank has ~3000 and these banks continue to expand. Branches are also becoming smaller and require less staff given increased share of digital transactions (mgmt say branches today are only required to give customers a psychological comfort that if they need to access a branch they can do so easily – the actual usage of branches by customers is low). With 2500 branches, YES would require ~INR480M of CASA deposits per branch in order to achieve a 40% CASA ratio by FY20 – which again seems very reasonable given Axis Bank today has ~INR580M, HDFC Bank has ~INR520M. 

o Yes Bank has started to reduce their SA interest rates over the past year (7% has been reduced to 6%), and plan to reduce to 4% once they reach 40% CASA ratio. The controversy is whether SA deposits will flow out in response to rate cuts. Yes Bank’s experience so far has not shown significant loss of customers in response to rate cuts – though this could be because YES is still paying the highest rate of any bank. Mgmt say the high interest rate on SA was a great way to win customers whom YES is now selling loans / other financial products to, which creates barriers to switching and hence customer stickiness is high. There is also no incentive for a customer to switch to another bank which is offering the same interest rate, and other banks may cut SA rates to 3% given the current low interest rate environment. IndusInd and Kotak Mahindra are the only banks who also offer a rate higher than 4% currently, both of whom have done so in order to raise CASA and both have also begun to reduce rates.

Yes Bank should grow mix of retail loans to 35% by FY20 which should lead to multiple expansion 

Retail loans currently make up just 21% of Yes Bank’s loan book, of which 13% is branch business banking and just 8.5% is consumer loans (this was close to zero in FY14). This is very low relative to other private banks, who have 40-55% retail mix, given YES chose to build their commercial banking business first. 

Fundamentals of banking industry are attractive – system should grow 10-20% over mid-long term with private banks growing faster 

India’s banking system has a very long runway for growth, given leverage levels are low and the economy continues to grow. Household debt is ~9% of GDP – one of the lowest levels of all comparable developing economies (Mexico ~15%, Indonesia ~17%, Russia ~20%, Brazil ~25%, China ~36%). Credit to the private sector is also relatively low at 53% of GDP. Recent political initiatives in India have also created a vast opportunity for growth in the banking sector – the Prime Minister’s financial inclusion drive and recent demonetization scheme has led to ~400M people entering the banking system.

Banking credit typically grows 1-2x nominal GDP growth. Over the past 4yrs it has been closer to 1x as loans to industry have fallen off in response to the weaker economy and hence lack of investment by the private sector in new projects, though this has been offset somewhat by consumer credit which continues to grow strongly at ~20% annually. The government is also trying to kick-start private sector investment through public sector spending on infrastructure.

It is reasonable to assume India’s real GDP should grow 6-8% p.a. over the medium term. The government is targeting inflation of 2-6%, which implies nominal GDP should grow 8-14%. The mid-point is 11%, but assuming a lower 10% and applying the 1-2x from above implies the banking system should grow 10-20% annually over the medium term. There are downside risks to this estimate (for example corporates have been increasingly tapping the bond markets recently), but there are tailwinds which can offset this such as acceleration of growth in consumer lending given low penetration and the government’s recent initiatives.

Private banks should grow faster than the overall banking system. Public banks have been losing share for many years, a trend which has accelerated since FY15 given the public banks are dealing with a high level of non-performing loans and are running low on capital. Assuming 50-60bps of annual share gains for private banks continue, with the banking system growing at 15% p.a. on average, private banks should grow ~18% while other banks should grow ~14%. Note other banks also include foreign banks (just 4- 5% market share) which have been pulling out of India post GFC to preserve capital and focus more on their home markets.

Very experienced & stable management team, strongest alignment of incentives with shareholders

CEO, Rana Kapoor, is also the founder / promoter of Yes Bank and holds ~11% of shares outstanding. His deceased brother-in-law’s family also own ~11%. This is the only bank in India, other than Kotak Mahindra Bank, which is managed by such a large shareholder – providing heavily aligned interests with shareholders. He is a relatively young promoter at 59 years and hence likely to remain in place for many more years. Prior to founding Yes Bank in 2004, he spent 5yrs launching an investment banking / corporate finance firm in partnership with Rabobank, two years working at ANZ Grindlays Investment Bank as Country Head, and 15 years with Bank of America where he was head of the wholesale banking business.

CFO, Rajat Monga: was also a founding member of Yes Bank, and has been CFO since 2004. Prior to this he was working with Rana Kapoor at Rabobank. He currently owns 0.21% of shares outstanding (worth ~$16M at today’s share price, while his annual salary is ~$1.2M).

Head of Retail, Pralay Mondal: joined Yes Bank in 2012 after spending 12yrs with HDFC Bank where he was Head of Retail Assets (no details on compensation).

Yes Bank has ~20M stock options outstanding (5% of market capitalization). 

Valuation – base case yields ~85% upside from current share price

YES should grow EPS at ~22% CAGR until FY2020, after factoring in dilution due to equity raises (assuming $500M equity raised before FY20). Applying 15.5x P/E (discussed above) yields  ~85% upside over ~3yrs. Valuing using 2.85x P/B (discussed above) yields similar returns. 

Downside is limited on a 3-yr view since lower growth assumptions removes the need for a further equity capital raise in FY20, providing downside protection to EPS.