Event update: Yes Bank (Downgrade to Underperformer) - RBI cuts CEO tenor to less than 5 months

Rana’s tenor cut to less than 5 mths: YES Bank has notified the exchanges that RBI has allowed Rana Kapoor to continue as its MD&CEO up to January 31, 2019 – a very short term of four and a half months only. RBI’s letter is dated September 17, 2019. This was communicated by the bank today evening. The Board will meet on September 25 to decide on the future course of action – which is succession planning.

Board had asked for a 3-year term but RBI granted 4.5 months: As background, the Board and shareholders had approved Rana’s re-appointment for 3 years and sought RBI’s approval for the same. But RBI decided to cut short the tenor to 4.5 months only. This term is less than what was granted to Shikha Sharma of AXIS who was given 7 months.

A very big negative for YES: We believe this is a big negative for YES. Mr Kapoor was central to the bank’s business strategy. His absence will slow down loan and fee growth for the bank which could lead to a sharp fall in valuations. It could also impact YES Bank’s ability to raise high net worth deposits. More importantly, YES needs fresh capital given its strong loan growth, which will be difficult to raise after this event.

We always saw CEO re-appointment as a key risk: While YES has been reporting higher-than-sector loan growth and lower-than-sector NPLs for several quarters; we never turned Overweight on the stock because we were worried about succession planning at the bank. Over the last one year we have repeatedly highlighted the big risk of RBI not approving Mr Rana’s re-appointment. That big risk has now materialized.

Downgrade the stock to Underperformer, cut TP to Rs230. We are cutting our TP to Rs230 from Rs350. Our revised target multiple is 1.5x down from 2.2x earlier. An increase in credit cost to 80bps and a 10bps decline in NII/assets and fees/assets can take the sustainable RoE down to below 14% from 18%.  We are downgrading the stock to Underperformer from Neutral. The stock is a top BUY for many brokerages. So it appears that this risk has not been priced in by the street which means that there could be a significant correction in the stock price due to this event.

RBI has no tolerance for divergence: While RBI’s reasons for cutting short the tenor will not be made official; we believe that RBI has zero tolerance for divergence. YES Bank’s divergence was high for FY16 and FY17. We believe this year’s divergence report for YES which will be out soon is another important risk factor to watch out for.

Not known whether Rana’s successor will be internal or external: YES will now focus on succession planning. Left to the bank, the first preference would be an internal candidate, most likely Rajat  Monga.  But the new candidate has to be approved by RBI. It is likely that RBI insists on an external candidate.

It is important to recognize the risks and not be carried away by rumours: There are many rumours about Mr Rana’s successor. There are reports that Mr Paresh Sukthankar who has resigned from HDFC Bank could be roped in. To the best of our knowledge, Mr Sukthankar is likely to take up a job for a social cause and unlikely to join a competing bank. There are also rumours that Kotak Bank can acquire YES Bank. We believe Mr Uday Kotak’s business philosophy of granular lending is very different from YES Bank’s current loan composition. As such we see such a merger as highly unlikely. We believe it is important to recognize the impact of Mr Rana’s absence on YES Bank’s earnings.  Till there is complete clarity on the successor, we would avoid getting into the stock. In our view,  one key reason for Mr Rana not getting a 3-year tenor is divergence. His successor will have to tweak the corporate lending strategy to eliminate divergences and divergent lending structures in the future, which may lead to slower growth in loans and fees for some time.