Moody's upgrades YES Bank outlook to positive, affirms ratings

The positive outlook takes into account the improvement in the bank's asset quality and capitalization over the past 2-3 years, somewhat offset by the bank's weak core profitability driven by high funding costs and the strain from meeting priority sector lending (PSL) targets.

“We expect that YES Bank's core profitability, which is measured by pre-provisioning profits to total assets, will gradually improve to above 1.2% over the next 12-18 months from 0.8% in the financial year ended March 2024 (fiscal 2024),” Moody’s said.

An improvement in YES Bank's ability to meet the central bank's PSL rules through new lending from its branches will help reduce operating expenses for meeting the targets, improving its overall profitability, as per Moody’s.

Also, YES Bank's lending focus on higher yielding, albeit higher-risk retail and small and medium enterprise segments will help widen its net interest margins, the rating agency said.

A gradual increase in the bank's credit costs will be largely offset by recoveries from its legacy stressed assets, given the high loan loss provision coverage of those assets.

“Despite these improvements, YES Bank's profitability will remain weak compared with the Indian peers we rate and a key drag on further improvements to its credit profile,” it said.

“We expect the bank's funding costs to remain higher than its peers' over the next 12-18 months because of increasing competition amongst banks for deposits.”

The bank's asset quality has significantly improved. Its non-performing loan (NPL) ratio declined to 1.7% as of 31 March 2024 from 2.2% a year earlier, supported by lower slippages as well as stronger recoveries and higher write-offs.

“We expect a gradual increase in NPLs due to portfolio aging and a shift towards riskier, high-yield segments. However, the NPL ratio will remain stable because of write-offs and recoveries of legacy problem loans,” Moody’s said.

Over the next 12 to 18 months, Moody’s expects the bank's capitalization to moderately decline because credit growth will outpace internal capital generation.

Given the positive outlook, a downgrade of YES Bank's ratings is unlikely over the next 12-18 months.

Moody’s could downgrade YES Bank's ratings if its asset quality significantly deteriorates, leading to an erosion of its profitability and capitalization.