Yes Bank Ltd. (YES), the best-performing Indian bank stock last year, has lost almost half its market value in less than a month on investors’ concern that a record surge in interest rates will erode profits and boost defaults.
The stock has tumbled 43 percent, the most in the S&P BSE Bankex Index, since the Reserve Bank of India on July 15 began taking emergency steps to tighten liquidity and bolster the rupee. Mumbai-based Yes Bank, which gets 69 percent of its funding from bulk deposits and debt, is among lenders that are most vulnerable if rates remain high, according to Espirito Santo Securities India Pvt.
Chief Executive Officer Rana Kapoor responded to the unexpected cash crunch by increasing what Yes Bank pays for cheaper term deposits, putting pressure on profits. The Bankex index has also dropped 17 percent as the surge in funding costs triggered speculation that defaults may be exacerbated in an economy that expanded last year at the weakest pace in 10 years.
“The sudden reversal in the interest rate scenario caught everybody offguard,” Jisha Nair, a Mumbai-based analyst at BoB Capital Markets Ltd. who recommends clients buy Yes Bank shares, said by telephone. “Margin pressures, slowing loan growth and losses on their investment books will remove the cushion lenders have to offset rising bad loans.”
The Bankex, which had slumped 6 percent this year through July 15, has since had a steeper plunge as all its 13 stocks declined in Mumbai trading. State-run banks including Union Bank of India (UNBK) and Canara Bank (CBK), which were dropping on concern that defaults were climbing, plummeted more than 30 percent as analysts including BoB Capital’s Nair predicted that government bond holdings would also lose value.
Yes Bank posted the worst slump, declining 43 percent since July 15. The stock rose 1.4 percent to 287 rupees at 10:50 a.m in Mumbai trading. It had surged 95 percent last year, the most in the Bankex index.
The bank has been targeted by short sellers and hedge funds that are selling out, Jaideep Iyer, group president for financial management, said in an interview in Mumbai on Aug. 6. The lender, founded in 2004, has survived previous crises such as the global credit crunch of 2008-09, he said.
“The operating environment hasn’t changed so dramatically” for Yes Bank, Iyer said. Most of its loans are on a floating-rate basis, giving the bank flexibility to maintain loan margins by raising borrowing costs, while the bank’s asset quality is also better than that of the broader financial system, he said.
Still, Yes Bank may slow its expansion plans and reduce the number of branches it will open by March 2015 to 750 from an earlier target of 900, Iyer said. The lender has 475 branches nationwide, compared with 3,350 branches at ICICI Bank Ltd. (ICICIBC), the nation’s largest private-sector lender.
India’s credit crunch was precipitated by the rupee’s plunge to 61.2125 per dollar -- then a record -- on July 8.
That prompted the RBI on July 15 to unexpectedly raise two interest rates by 200 basis points to 10.25 percent, cap cash injections into the banking system and sell $2 billion of government bonds to drain funds from the economy. A week later, the central bank further limited banks’ borrowing and raised the daily balance requirement for the cash reserve ratio.
“There is no question that the banking industry has headwinds,” billionaire Uday Kotak, who controls Mumbai-based Kotak Mahindra Bank Ltd., said in an interview with Bloomberg TV on Aug. 8. “I would be very surprised if the short term interest rates drop from here at least for a while.”
The RBI’s tightening measures come even as it predicts economic growth will be slower than earlier forecast. The authority on July 30 cut its estimate to 5.5 percent from 5.7 percent for the year through March 2014. The central bank also surprised markets that day by indicating the liquidity measures would be rolled back as the currency stabilizes.
On Aug. 6, the rupee fell to a record of 61.805 per dollar.
India’s central bank responded two days later by announcing that it would drain $3.63 billion of cash from the economy each week to stem volatility in the exchange rate. The currency has declined 11 percent this year.
“If there are more measures by the central bank to tighten liquidity to defend the rupee, the banks could see a crisis,” Vishal Narnolia, Mumbai-based banking analyst at SMC Global Securities Ltd., said by telephone. Yes Bank’s “dependence on short-term rates is high.”
That’s because Yes Bank gets about 40 percent of its funding from bulk deposits, Santosh Singh and Saikiran Pulavarthi, analysts at Espirito Santo in Mumbai, wrote in a note to clients on July 29. Singh covers non-bank financing companies while Pulavarthi covers banks.
The rate on short-term wholesale deposits may have climbed by more than 100 basis points to as much as 12.5 percent following the RBI’s measures last month, he estimated. A basis point is 0.01 percentage point.
The lender also gets 20 percent of its funds from short-term debt and 9 percent from certificates of deposit, Singh estimated. The cost on three-month borrowings may have climbed by as much as 250 basis points to 10.9 percent following the first two rounds of tightening, while three-month CD rates may have climbed as much as 350 basis points to 10.8 percent, he estimated.
Yes Bank has taken steps to reduce its dependence on bulk deposits and short-term debt, Iyer said. Savings accounts now generate about 10 percent of its total funds, up from 2 percent two years ago, after the lender raised what it pays for those deposits to 7 percent, the highest in the nation, Iyer said. That compares with the 4 percent paid by ICICI.
Still, investors are demanding a higher premium to hold Yes Bank’s debt, sending yields on the company’s 10-year bonds to the highest levels since issuance. The rate on its 10.05 percent rupee-denominated bonds maturing December 2027 rose 31 basis points to 10.06 percent on Aug. 2 from a month earlier, according to the Fixed Income Money Market and Derivatives Association of India. The bonds haven’t traded since then.
At rival IndusInd Bank Ltd. (IIB), the best-performing Indian banking stock in the past 12 months, wholesale deposits and borrowing accounted for 56 percent of funds, according to Espirito’s Singh. That was the highest after Yes Bank among the 16 lenders tracked by the analyst. Those banks together averaged 31 percent. IndusInd’s stock has fallen 28 percent since July 15.
The central bank is unlikely to reverse its measures “in a hurry,” and may keep them in place for longer than one quarter, IndusInd CEO Romesh Sobti said in an e-mailed response to questions on Aug. 7.
His bank “has demonstrated resilience in its balance sheet in both rising and falling interest rate scenarios,” Sobti wrote. “We do not expect this liquidity cycle to be any different from the previous ones in terms of impact on our margins.”
Lenders including Yes Bank moved quickly to reduce their dependence on bulk deposits and short-term borrowings following the first two rounds of liquidity-tightening measures by the RBI. The bank boosted what it will pay for one-year retail term deposits by 25 basis points to 9 percent, starting Aug. 1.
Banks also began passing on the higher cost of funding to borrowers to curb erosion of their net interest margins. Yes Bank raised the base lending rate for the first time in almost two years, increasing it by 25 basis points to 10.75 percent, according to a July 31 statement.
The higher borrowing costs “will lead to them losing competitiveness in the loan market,” SMC’s Narnolia said.
The impact may be particularly punitive because loan growth has already weakened in India. Loans at Indian lenders grew by 14.2 percent in twelve months to July 12 after dropping in June to the slowest pace since December 2009, according to RBI data, which is distributed with a one-month lag.
Costlier credit could hamper a government push to revitalize investment and revive growth that had weakened last year to 5 percent, the least since 2003.
Other lenders that are vulnerable to the higher rates include the state-run Oriental Bank of Commerce, Espirito’s Singh estimated.
Current and savings accounts, or CASA, which offer the cheapest form of funding for banks, accounted for just 23 percent of New Delhi-based Oriental Bank’s financing, Singh estimated. The lender has slid 32 percent since July 15. S. L. Bansal, chairman and managing director of Oriental Bank, didn’t reply to an e-mail or a call to his office.
Falling bond prices may also hurt the value of Yes Bank’s corporate debt holdings, Anish Tawakley, an analyst at Barclays Plc, wrote in a note to clients that same day.
The central bank’s steps to shore up the rupee drove yields on five-year corporate bonds up by 131 basis points in July to 10 percent, the highest level since December 2008, before easing down to 9.72 percent on Aug. 7, according to an index compiled by Bloomberg.
“We were deeply in the money on our corporate bond investments until July 15,” Yes Bank’s Iyer said in the interview. “Even now, there are no losses. If rates go up further, there will be losses on the book.”
The convergence of stress points led Morgan Stanley to downgrade Yes Bank to neutral in a July 25 report. The rising rates have “increased challenges” at the lender, according to Sumeet Kariwala, a Mumbai-based analyst at Morgan Stanley, who cited its higher reliance on wholesale deposits, its large bond investments and a lower Tier 1 capital ratio than rivals.
SMC’s Narnolia agrees that the company’s capital adequacy ratio, which is among the lowest for the six biggest private-sector banks by assets, is a worry.
Yes Bank’s Tier 1 capital ratio, which tracks the core capital a lender holds in reserve as a percentage of assets, was 9.5 percent as of June 30, exchange filings show. While that surpasses the 6 percent minimum regulatory requirement under the so-called Basel III rules, it’s below the 12.4 percent average ratio for the top five Indian banks by market value.
The lender, which has regulatory approval to raise as much as $500 million through overseas share sales or private placements, will wait for its stock to recover before going ahead with the offering, Iyer said.
Uncertainty about interest rates and economic growth prospects will probably to be an overhang on banks stocks, said BoB Capital’s Nair. Higher rates will mean that lenders including Yes Bank will “suffer more,” she said.
“There is no short-term measure to cut dependence on wholesale funding,” Nair said. “Margins will come under pressure for banks as cost of funds rise in an environment where the ability to pass it on to borrowers are limited.”
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