Accumulate Indusind Bank, Reduce Yes Bank - Arihant Capital Markets

Indusind Bank (IIB) represents a classic exemplar of metamorphosis of a new generation private sector bank brought about by the new Management team w.r.t. turnaround in business and profitability. YES Bank (YES) on the other hand is a case of weak balance sheet structure and unsustainable earnings. Currently, YES bank continues to struggle on all parameters and notwithstanding grandiose expansion plans, we believe core metrics are unlikely to improve markedly.

We present here the highlights of two banks wherein we find Indusind superior to YES Bank.

Indusind Bank v YES Bank:

- Capital strength: With adequate Tier I capital at 11.4%, IIB stands in the comfortable zone and better utilization of excess capital is stronger. YES Bank on the contrary stands at Tier I ratio of 9.9% as at the end of FY12 and it continued to drop to the levels of 9.2% by Q1FY13. Though, total CAR for YES looks strong, we concede that the aggressive growth strategy and the continuous balance sheet funding would add pressure to the bank's capital adequacy.

While IIB remains capital sufficient by FY14, YES would require to raise capital time and again which means pressure on RoEs cannot be ruled out.

Balance sheet and business strength: The balance sheet structure of YES indicates that the deposit growth is slower than the balance sheet growth and borrowings continue to move northwards. Additionally, the growth in customer assets is supported by credit substitutes rather than the core advances which have kept the loan growth subdued. The loan growth of YES only continues to drop each quarter. Moreover, increased borrowings also weigh on the balance sheet.

On the other hand, IIB's loan book remains equally divided between corporate and consumer finance. The loan growth target for IIB remains above systemic levels, well supported by consistent deposit growth translating into healthy balance sheet.

Branch banking: YES liability franchise appears to be weak since the branch incrementality stands lower. Despite increased rates, garnering of SA deposits is not on expected lines. With lowest market share of the total branch pie in the system, branch network expansion and building a full-fledged distribution network in competitive environs is quite challenging. This coupled with higher costs and higher proportion of bulk deposits has dented bank's margins. YES' declining margins since past 4-years are a cause of worry. Not to forget, besides the above facts, YES operating efficiency stands weak with one of the highest cost-income ratios with no signs of containment.

IIB's liability strength, on the other hand, stands promising. IIB's compounded CASA growth over the past 4-years stands double the growth of its balance sheet. This comes on the back of growing branch network that doubled under the stewardship of new Management. Improved CASA strength has enabled IIB to solidify its NIMs. While we anticipate certain margin pressures for the forthcoming quarter, we do see margins hovering around 3.5% levels which stands amongst the best in the industry.

Earnings visibility: The lack of strategic direction and constant pressure of capital does not inspire our confidence in YES bank's healthy earnings sustainability. We believe, core structural ratios are unlikely to match competing banks and given the asset profile and pricing, flexibility to push yields further implying margins would remain weak for YES. Also, the plausible asset quality deterioration would increase the credit costs for the bank resulting into profitability pressures. Consequently, RoA compression stands imminent. Notwithstanding the fact that the historical profitability numbers continue to be powerful, they are backed by concentrated other income growth and not the core income.

IIB's earnings visibility remains candid backed by sturdy core income growth driven by competent vehicle finance portfolio. The core fee income performance also remains solid and both the above factors have contributed to the earnings traction. IIB also witnessed improvement in return ratios.

Asset quality: The fact that YES bank is expanding the high yielding retail+SME portfolio, it calls for asset quality risks going ahead. The high non-fund based exposure and exposure to sensitive sectors indicate asset quality deterioration is in offing for YES. While historical numbers stood good, the build-up of bad assets stands imminent for YES with exposure to certain stressed corporates. It is interesting to note that in the current environment, the potential for further corporate slippages is high which may only weaken the balance sheet further.

Talking about IIB, IIB has demonstrated good show on asset quality despite the tough environs. While we do sense certain pressures in CV portfolio, IIB will sail through with improvement in provision coverage. The NPA ratios continue to decline. Further, the restructured pipeline stands negligible for IIB.

Investment outlook: YES bank balance sheet structure, underpinned by increased credit substitutes rather than core advances and increased borrowings rather than meaningful growth in deposits particularly low-cost deposit balances, leave limited scope for upside in the near term. Also, with the core Tier I standing at lower end at 8.6-8.7% would restrict growth for the current fiscal. In our opinion, the concern areas for the bank are the sustainability of SA traction given the competitive environs and margin pressures, imminent spike in operating costs (with aggressive network expansion), plausible asset quality deterioration (with aggressive loan book expansion), divergence from priority sector lending and the stock being a high beta play.

Indusind Bank's turnaround business strategy under the helm of experienced Management has been a key enabler for the bank's robust growth, stable asset quality and enduring operational matrix. Comfortable capital adequacy, focus on niche retail products, robust core fee income performance in commensurate with balance sheet growth and improvement in liability franchise make it a convincing bet on fundamental grounds.

Valuation Outlook: While the valuations look attractive for YES vis-a-vis IIB, but we concede these are transitory and do not offset the inherently weak bank fundamentals. On account of the strong fundamentals and candid earnings visibility for IIB vis-a-vis YES, market has attributed higher valuations to IIB. At current price, IIB is trading at 3.3X P/BV FY13E and YES at 2.5X P/BV FY13E. We recommend that investors use the uptick in YES to move into IIB since the potential for capital appreciation is higher w.r.t. IIB. Therefore, Accumulate IIB wherein we also anticipate price correction from current levels providing opportunity to enter.

Source : Equity Bulls

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