The Jammu & Kashmir Bank Ltd.

Rating downgraded to 'FAA/Negative'

Fixed Deposits FAA/Negative (Downgraded from 'FAA+/Stable') Short Term Fixed Deposits CRISIL A1+ (Reaffirmed) Certificate of Deposits CRISIL A1+ (Reaffirmed)

CRISIL has downgraded its rating on the fixed deposits of The Jammu & Kashmir Bank Ltd (J&K Bank) to 'FAA/Negative' from 'FAA+/Stable'. The rating on the bank's short-term debt instruments has been reaffirmed at 'CRISIL A1+'.
 
The rating downgrade reflects the ongoing stress in the bank's asset quality and the expected impact on its profitability. The stress is on account of two factors: weakness in  some large corporate accounts following the economic downturn, which has resulted in sizeable slippages during the quarter ended June 30, 2014; and the potential impact of the devastating floods that hit Jammu & Kashmir (J&K) in September 2014. Both developments are likely to result in J&K Bank's financial performance being below-par for the previous rating level, notwithstanding restructuring packages that are likely to be announced by the central bank.
 
There have been material slippages in J&K Bank's large corporate book in recent months. The weak asset quality in the corporate advances segment is due to exposure to high-risk sectors and borrowers. The bank's overall gross non-performing assets (NPAs) increased to 4.2 per cent as on June 30, 2014, from 1.7 per cent as on March 31, 2014, due to slippages in two large corporate accounts. Chunkiness in the corporate advances vis-a-vis the bank's net worth increases the vulnerability. The top 20 large corporate advances accounted for 2.2 times its net worth as on March 31, 2014.
 
CRISIL believes that weakness in J&K Bank's corporate loan book will be compounded by the impact of the recent floods. Several districts, including Srinagar and Anantnag, were severely affected by the unprecedented floods. The significant losses in commercial property and business assets for the small and medium enterprises (SME) and trader borrowers will affect the bank's asset quality. Around 45 per cent of the bank's advances are to J&K. Borrowers have been affected by floods both directly and indirectly. In view of the weakness in corporate accounts and the expected impact of floods, CRISIL estimates J&K Bank's weak assets¹ to be higher than the weak asset levels of peer banks. The weakness in asset quality will constrain profitability: the bank's return on assets is expected to be less than 1 per cent for the next few quarters.
 
 J&K Bank is in discussions with the state and central governments to obtain funding support and with the Reserve Bank of India (RBI) for relaxation in prudential norms for asset classification and provisioning. The extent of government funding support the bank obtains will be crucial, as it will determine the pace at which it gets back to normal health. The insurance claims for losses suffered by borrowers because of floods would be received by the bank.  Nevertheless, while restructuring of affected loans could provide temporary relief, restoration of underlying business confidence, trade, and economic activity could take some time, given the magnitude of the devastation caused by the floods. Therefore, the restructuring exercise may not be adequate to restore the quality of all the affected accounts. The bank's focus over the next few quarters will be to formulate and administer the restructuring package for borrowers. Its credit risk profile is, therefore, expected to be below-par for the previous rating level over the medium term.
 
The rating continues to reflect J&K Bank's healthy resource profile, and the systemic support it is expected to receive in the event of distress, given its dominant banking role in J&K and its unique status as banker to the Government of Jammu & Kashmir (GoJK). These rating strengths are partially offset by the bank's average asset quality, and small scale of, and high geographical concentration in, its operations. 
 
J&K Bank's resource profile is marked by a stable retail deposit base; the share of low-cost current and savings account (CASA) deposits in the bank's total deposits was 41 per cent as on June 30, 2014'significantly higher than the industry average of 32 per cent. Its overall cost of borrowing, at 6.0 per cent for 2013-14 (refers to financial year, April 1 to March 31), was, therefore, marginally lower than the industry average of around 6.4 per cent. Although J&K Bank is a small bank, it has a unique position. It is the banker to GoJK; for all other Indian states, this function is carried out by RBI. Also, it is the only scheduled commercial bank with majority ownership by a state government. CRISIL believes that J&K Bank, by virtue of its position as banker to GoJK, and its dominant share in the state's banking business, will receive systemic support for meeting its debt obligations in the event of distress.
 
However, J&K Bank's asset quality is average. Slippages in two large corporate accounts during the quarter ending June 30, 2014, have resulted in deterioration in its asset quality, with gross NPAs increasing to 4.1 per cent as on June 30, 2014, from 1.7 per cent as on March 31, 2014. The restructured advances were at 3.0 per cent of total advances and the weak assets at 5.0 per cent as on June 30, 2014. In the wake of the recent floods in J&K, the bank's asset quality is expected to further deteriorate. In addition, the asset quality also remains exposed to risks relating to large-ticket advances. In addition, J&K Bank is a relatively small player, with a share of around 0.81 per cent of the banking sector's total deposits and 0.69 per cent of its total advances as on March 31, 2014. Its operations remain geographically concentrated in J&K, with around 45 per cent of its advances being originated in the state.

CRISIL's outlook on J&K Bank's debt instruments reflects the potential stress on its asset quality on account of the recent devastating floods in J&K, where 45 per cent of the bank's advances is concentrated. The ratings may be downgraded if substantial deterioration in asset quality weakens the bank's capitalisation and earnings, or if its resource profile weakens considerably. Conversely, the outlook may be revised to 'Stable' if the impact on asset quality is lower than expected.

J&K Bank, headquartered in Srinagar, is the only state-government-owned scheduled commercial bank in India; GoJK owns 53 per cent of the bank. As on March 31, 2014, the bank's total assets were Rs.786.2 billion (Rs. 717.4 billion as on March 31, 2013).
 
For 2013-14, J&K Bank reported a profit after tax (PAT) of Rs.11.8 billion on a total income (net of interest expense) of Rs.30.8 billion (Rs.10.6 billion and Rs.28.0 billion, respectively, for 2012-13).
 
For the first quarter of 2014-15, J&K Bank reported a PAT of Rs.1.3 billion on a total income (net of interest expense) of Rs.7.7 billion.

¹ Weak assets are CRISIL's measure for assessing banks' asset quality. Weak assets = Gross NPAs + 30 per cent of outstanding restructured standard advances (excluding state power utilities) + 75 per cent of Security Receipts received against sale of assets to asset reconstruction companies. In J &K Bank's case, weak assets includes, some proportion of flood affected advances in J&K state.