March 10, 2016

Mumbai

CRISIL downgrades eight public sector banks Changes outlook to ‘Negative’ on five others

Steep rise in NPAs, expected further surge in stressed assets and the consequent hit on profitability and capital will dent credit profile

CRISIL has downgraded its ratings on the debt instruments of eight public sector banks (the rating on one bank has been placed on “Watch negative”), and revised its outlook on five others to ‘Negative’ from ‘Stable’. This is in addition to another rating downgrade and an outlook revision to ‘Negative’ on two public sector banks (PSBs) over the past month. The ratings on instruments of ten other CRISIL-rated PSBs have been reaffirmed wherein four of them carry a “Negative” outlook.

CRISIL’s actions are driven by the expectation that the asset quality problems being faced by PSBs will remain acute and continue through most of the next fiscal. The resultant impact on profitability and capitalisation can further dent the credit profiles over the medium term.

On February 10, 2016, CRISIL had issued a Credit Alert titled ‘Heightened asset quality stress to dent PSB credit profiles’, which highlighted that CRISIL was in the process of assessing the impact of the deterioration in asset quality and profitability on the credit profiles of the rated PSBs.

Significant stress in the corporate loan book of PSBs is expected to result in their weak assets ballooning to Rs 7.1 lakh crore by March 31, 2017 (11.3 percent of total loan book) from around Rs 4.0 lakh crore as on March 31, 2015 (7.2 percent of loan book). Over the next few quarters, CRISIL expects slippages to NPAs to remain high driven by stretched cash flows of highly leveraged corporates (mainly in the vulnerable sectors such as infrastructure, metals and real estate), continued proactive recognition of stressed assets by banks, and limited ability of banks in the current environment to recover from exposures to large corporates that have slipped into NPAs.

Further, the earnings profile of most PSBs has deteriorated with many expected to report a full-year net loss this fiscal. With the banking system having to migrate to the marginal cost of funds-based lending rate, or MCLR, regime from April 1, 2016, and the proportion of zero income-generating bad assets in the loan book of PSBs rising, net interest margin will come under fresh pressure in the near-term. This, coupled with loan loss provisioning at a number of PSBs surpassing pre-provisioning profit, due to increased slippages and a rising inventory of ageing NPAs, could result in many PSBs reporting a loss even for the next fiscal.

CRISIL’s ratings on PSBs continue to factor in support from its majority shareholder, the Government of India. Given that net worth coverage for un-provided weak assets is very low at ~1.5 times, PSBs will have to raise a substantial amount of capital to maintain sufficient cushion against asset-side risks and to meet the Basel III minimum capital requirements.

Despite the recent relaxation of capital regulations by the Reserve Bank of India for computing capital ratios and expectation of lower growth upto 2019, equity capital support of Rs 70,000 crore committed by the government in the next four years under the Indradhanush plan will not be sufficient. This is because the Tier 1 capital requirement for PSBs, upto 2019 has increased from our earlier estimate largely on account of sharp decline in their profitability.

Given that capital raising through the non-government route will be a challenge for PSBs because of their weak financial performance and low valuations, and in the absence of any commitment of enhanced capital support from the government, CRISIL has lowered its floor rating for corporate credit rating (or Tier II bonds) for PSBs to ‘CRISIL A+’ from the current ‘CRISIL AA-’. Most ratings, however, for now continue to remain in the AA category or higher.

Annexure 1: List of rating actions on PSBs

Bank of Baroda

Rating outlook revised to 'Negative'

CRISIL has revised its rating outlook on Bank of Baroda’s (BoB) Tier-II bonds (under Basel III) and Lower Tier-II bonds, Tier-I perpetual bonds, and Upper Tier-II bonds (all under Basel II), to ‘Negative’ from ‘Stable’, while reaffirming the rating at ‘CRISIL AAA’ (refer CRISIL’s release titled ‘CRISIL downgrades eight public sector banks Changes outlook to ‘Negative’ on five others’, dated March 10, 2016).

The outlook revision reflects significant weakening of BoB’s asset quality during the first nine months of 2015-16 (refers to financial year, April 1 to March 31) and the resultant profitability pressures. CRISIL believes the bank’s asset quality will remain under pressure over the next few quarters because of stretched cash flows of highly leveraged corporates, limited recoveries from non-performing assets (NPAs), and continued proactive recognition of stressed assets in the near term. Deterioration in asset quality will result in increased pressure on profitability. Nevertheless, CRISIL’s rating continues to reflect the support that BoB is likely to receive from its majority owner, the Government of India (GoI), established position in the banking industry, adequate resource profile, and adequate capitalisation.

The distinguishing feature of Tier-II capital instruments under Basel III is the existence of the point of non-viability (PONV) trigger, the occurrence of which may result in loss of principal to the investor, and hence, to default on the instrument by the issuer. As per the Basel III guidelines, the PONV trigger will be determined by the Reserve Bank of India (RBI). CRISIL believes that the PONV trigger is a remote possibility in the Indian context given the robust regulatory and supervisory framework, and the systemic importance of the banking sector. The inherent risk associated with the PONV feature is adequately factored into the rating on the instrument.

BoB’s asset quality has deteriorated significantly during the second and third quarter of 2015-16 and is expected to remain under pressure over the next few quarters. Gross NPAs increased to 9.68 percent as on December 31, 2015, and 5.56 percent as on September 30, 2015, from 3.72 percent as on March 31, 2015. Slippages to NPAs increased to 7.6 percent (annualised) during the first nine months of 2015-16 from 2.1 percent in 2014-15. The slippages were primarily from vulnerable sectors such as iron and steel, infrastructure, and construction in the large corporate and mid-corporate loan book. Outstanding restructured standard advances (RSAs) declined to Rs.171.3 billion as on December 31, 2015, constituting 4.5 percent of advances (Rs.259.1 billion and 6.1 percent, respectively, as on March 31, 2015) as slippages from RSAs remained high, at Rs.75.35 billion during the first nine months of 2015-16. Given the increase in gross NPAs, weak assets increased to 11.0 percent as on December 31, 2015 (7.4 percent as on March 31, 2015). Given the challenging macroeconomic environment, asset quality remains vulnerable to slippages to NPAs over the next few quarters, despite remaining lower than peers as the bank has completed the asset quality review exercise during the quarter ended December 31, 2015. Ability to contain deterioration in asset quality, and hence in profitability, remains a key monitorable.

The bank’s earnings profile has been significantly impacted due to deterioration in asset quality. It had a net loss of Rs.21.6 billion during the first nine months of 2015-16 as against a net profit of Rs.34.0 billion in 2014-15. The decline in profitability was mainly because of a sharp increase in provisioning costs to 1.6 percent (annualised) in the first nine months of 2015-16 as against 0.7 percent in 2014-15. The bank has significantly low net interest margin (NIM) in its international operations which results in considerably low overall NIM; the bank’s NIM was 1.8 percent (annualised) in the nine months ended December 31, 2015 (1.9 percent in 2014-15). Interest income reversals on NPA slippages during the first nine months of 2015-16 also accentuated the already low NIM. Profitability remains susceptible to further increase in credit costs and decline in interest spreads. Ability to arrest asset quality deterioration, the resultant provisioning costs, and thereby the impact on profitability will remain a key rating monitorable.

In its ratings on public-sector banks (PSBs), CRISIL continues to factor in the likelihood of strong support from GoI, both on an ongoing basis and in any event of distress. This is because GoI is both the majority shareholder in PSBs and the guardian of India's financial system. The stability of the banking sector is of prime importance to GoI, given the criticality of the sector to the economy, the strong public perception of sovereign backing for PSBs, and the severe implications of any PSB failure in terms of political fallout, systemic stability, and investor confidence in public sector institutions. CRISIL believes that the majority ownership creates a moral obligation on GoI to support PSBs, including BoB. Since 2008-09, GoI has already infused or committed to infuse capital of around Rs.960 billion in the PSBs. Furthermore, under the Indradhanush plan, GoI has committed that all PSBs will maintain a safe buffer over the regulatory minimum. CRISIL believes that GoI will continue to provide distress support to all PSBs and not allow any of them to fail. It will also ensure that the PSBs meet their Basel-III capital regulations.

BoB is among India’s five largest banks by asset size, with assets of Rs.6.9 trillion as on December 31, 2015 (Rs.7.1 trillion as on March 31, 2015). The bank had a share of around 6.8 percent and around 5.6 percent in the industry’s deposits and advances, respectively, as on December 31, 2015. It has a geographically diversified domestic network, with 5271 branches as on December 31, 2015. It has a strong brand image and a wide reach in the rural and semi-urban areas, especially in West India. BoB also has the largest international presence among Indian banks, after State Bank of India, in terms of geographical coverage; around 31 percent of total business as on December 31, 2015, was from foreign operations.

BoB has a large, stable, and diversified resource profile. The bank had a large deposit base of Rs.5.9 trillion as on December 31, 2015 (Rs.6.2 trillion as on March 31, 2015). The low-cost current account and savings account (CASA) deposits were adequate, at 29.9 percent of total domestic deposits as on December 31, 2015, despite declining from 33.0 percent as on March 31, 2015. CASA deposits constituted 24.0 percent of the bank’s total global deposits as on December 31, 2015 (26.3 percent as on March 31, 2015). Interest costs decreased to 4.72 percent in 2014-15 from 4.86 percent in 2013-14, and was lower than the industry average. The decrease was mainly because of reduction in high-cost wholesale deposits. The bank’s large proportion of international deposits supports its resource profile. CRISIL believes BoB will maintain an adequate resource profile over the medium term, given its well-spread branch network, diversified investor base, and access to international deposits.

BoB is adequately capitalised with Tier-I and overall capital adequacy ratio (under Basel III) of 9.6 percent and 12.2 percent, respectively, as on December 31, 2015 (9.9 percent and 12.6 percent, respectively, as on March 31, 2015). Networth was large at Rs.355.7 billion as on December 31, 2015 (Rs.398.3 billion as on March 31, 2015). Capitalisation is supported by equity infusion of Rs.85.5 billion by GoI and Life Insurance Corporation of India over the past six years including Rs.17.9 billion in 2015-16 under the Indradhanush plan. GoI’s ownership, at 59.24 percent as on December 31, 2015, provides moderate flexibility to raise equity capital by diluting GoI’s stake over the medium term. However, net worth coverage for net NPAs declined sharply to 1.6 times as on December 31, 2015, from 4.9 times as on March 31, 2015, and is expected to remain under pressure over the medium term. CRISIL believes BoB’s capitalisation will remain adequate over this period, primarily supported by capital support from GoI.

Outlook: Negative
The ‘Negative’ outlook reflects the increased pressure on BoB’s asset quality and earnings profile. CRISIL believes the bank will continue to benefit from strong GoI support and maintain adequate capitalisation over the medium term. The rating may be downgraded in case of further deterioration in asset quality or earnings profile. Conversely, the outlook may be revised to ‘Stable’ in case of a substantial and sustained improvement in asset quality and earnings profile.

About the Bank
Incorporated in 1908 as a privately owned institution headquartered in Vadodara, BoB expanded its operations through mergers and acquisitions before being nationalised in 1969. GoI’s shareholding in BoB was at 59.24 percent as on December 31, 2015. BoB is among the five largest banks in India. It had a domestic network of 5271 branches, with around 63.5 percent of its branches in the semi-urban and rural areas, as on December 31, 2015. It has the second-largest international presence among Indian banks, with 105 overseas offices across 24 countries.

For 2014-15, profit after tax (PAT) was Rs.34.0 billion on a total income (net of interest expense) of Rs.175.9 billion, against a PAT of Rs.45.4 billion on a total income (net of interest expense) of Rs.164.3 billion for the previous year. For the nine months ended December 31, 2015, there was a net loss of Rs.21.6 billion on a total income (net of interest expense) of Rs.126.3 billion, against a PAT of Rs.28.0 billion on a total income (net of interest expense) of Rs.131.2 billion for the corresponding period of the previous year.


¹ Weak Assets is CRISIL’s measure for assessing banks’ asset quality. Weak Assets = Gross NPAs + 40 percent of outstanding restructured standard advances (excluding state power utilities) + 75 percent of security receipts + 15 percent of loans structured under 5/25 (flexible structuring of long-term project loans)