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Yes Bank's Q3FY18 results (Underperformer) - Strong growth but lower NIM and higher than expected stress loan formation.

Q3FY18 results

• YES Bank’s PAT for 3Q18 at Rs10.8bn was strong though slightly below our estimate.  Strong loan and fee growth were the key positives while lower NIMs, high capital consumption and higher than expected stress loan formation (including sale to ARC) were the key negatives. While NII was 5% lower than expected due to lower NIMs, it was offset by non-interest income being much stronger than expected. 
• As expected, slippages fell sharply qoq in 3Q after a weak 2Q when slippages rose sharply on account of divergence. Slippages of Rs4.9bn were lower than Rs19.9bn qoq. Most of the total slippage, Rs2.5bn, came from accounts that were already classified as SDR/S4A/5:25. Also, the bank sold one standard loan of net book value of Rs4.2bn to an ARC.  The gross value will be Rs5.5-6bn. While slippages were low, stress loan formation including sale to ARC at more than Rs10.5bn was higher than our expectation.  Gross NPLs rose 9.3% qoq to 1.72% and the provisioning cover at end 3Q was 46%. Total stress loans now stand at 3.23% of loans versus 3.43% in 2Q18.
• The bank has highlighted that there was no slippage in 3Q18 from the standard accounts that were on RBI’s divergence list of FY17. YES Bank has also recovered Rs4.5bn from the accounts that were on the divergence list.
• NII growth at 25% yoy (0% qoq) lagged asset growth of 36% as NIMs declined 20 bps qoq. Of the 20 bps NIM decline, 10bps was driven by the issue of perpetual and other bonds for capital adequacy. Sale of a loan to ARC also pulled down NIMs. Non-interest income grew faster at 42% yoy and 14% qoq driven by a strong 102% yoy and 52% qoq growth in corporate fees..
• Loans grew 46% yoy and 15% qoq. Consumer banking saw the strongest growth of 101% yoy and 19% qoq. Corporate loans grew 44% yoy and 16% qoq while branch banking which includes consumer banking grew 52% yoy and 14% qoq.  Capital consumption has been high with a decline of 70bps qoq in CET1 due to strong growth. Proportion of RWA/Total Assets remained stable qoq despite a strong sequential growth in retail loans.
• The CEO guided to the provisioning cover improving to 60% by June 2018.

Valuation and view

We maintain Underweight. We believe NIMs, news flow and timing of a fresh equity issuance and divergence with RBI remain key monitorables. The last two divergence reports were negative. While management remains confident about improving provisioning cover driven by higher recoveries, we believe the next divergence list (likely in 2Q19) will also have a big bearing on provisioning cover. Fresh equity issue will likely be discussed in the Board Meeting of Apr-2018.