YES Bank trades at 10% premium over IndusInd Bank, 15% discount to Axis Bank. Is risk-reward favourable?

Shares of YES Bank at 1.2 times one-year forward book are trading at 10 per cent premium over IndusInd Bank’s valuation, but a 15 per cent discount to Axis Bank’s valuation. Kotak Institutional Equities in its latest note is all praise of YES Bank, given the bank's remarkable work on coming of its crisis in the past three years. The brokerage said it had concerns on the bank's post-moratorium capital structure, its ability to improve liability franchise and retaining of existing employees, but the bank performed much better than its expectations.

That said, the current valuations appear to be unsustainable, it said, adding that the risk-reward is not justified to be positive at current levels. This comes after Morgan Stanley this week said valuations are already pricing in post positives.

Kotak said the capital infusion of Rs 8,900 crore would help increase YES Bank's net worth by 25 per cent, which would move its Tier 1 ratio closer to 15 per cent. The bank has indicated that it would look to close the deal with JC Flowers, which would result in a significant transfer of its bad loan portfolio to the ARC, with no earnings impact.

"This would provide YES Bank the much-needed headroom to shift focus to growth from any asset quality issue," it said.

Kotak also agrees to the compelling argument that YES Bank could have a period of low credit costs or even negative if its recovery rate is higher than what is forecasted today. However, "there is much more that Yes Bank needs to do to sustain at these valuations," it said.

Kotak said the bank needs to improve its liability franchise further, as the cost of funds differential with frontline banks is high.

This, it said, requires significant investments and usually takes a much longer time. Its loan book is targeting segments where there is no real advantage from their side.

"Consequently, we should expect YES Bank to deliver lower returns than the frontline banks. From that context, we would prefer to maintain our SELL call, with its FV at Rs16 (from Rs 14 earlier), valuing the bank at 1.2 times book We believe that the risk-reward is not justified to be positive at current levels," it said.

Morgan Stanley earlier this week said YES Bank is moving in the right direction post 2020 NPA crisis. Unlike the previous cycle, the bank has focused on increasing the share of retail on both sides of the balance sheet, it noted.

Having cleaned its balance sheet, Morgan Stanley expects YES Bank's loan growth and margin profile to improve as the macro recovery gains pace. It expects loan growth to accelerate to a 20 per cent CAGR over FY23-25 against an expected 15 per cent in FY23. This, along with an improving share of retail/SME loans should help offset rising funding costs and drive higher margins to 3.2 per cent by FY25, it said. The bank is expected  to report a margin of 2.6 per cent in FY23, it said.

That said, YES Bank valuations, at 1.6 times F24 book, are already pricing this in, Morgan Stanley said this week.

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