Rating Rationale

Strengths:
* Strong expectation of support from government
Government is both the majority shareholder in public sector banks (PSBs) and the guardian of India's financial system. Stability of the banking sector is of prime importance to the government, given the criticality of the sector to the economy, 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. Majority ownership creates a moral obligation on the government to support PSBs, including Andhra Bank.

Government had outlined a recapitalisation package of Rs 2.11 lakh crore over fiscals 2018 and 2019, out of which Andhra Bank has received more than Rs 8,000 crore. Government has further announced capital infusion of Rs 70,000 crore in PSBs fiscal 2020.

* Adequate capitalisation
Common equity tier I (CET I), Tier-I, and overall capital adequacy ratios (Under Basel III) were 8.8%, 10.8%, and 13.7%, respectively, as on June 30, 2019 (5.6%, 7.4%, and 11.0%, respectively, as on March 31, 2018). Government shareholding, at 87.8% as on June 30, 2019, provides some flexibility to raise additional equity by diluting the government stake in future. With infusion of more than Rs 8,000 crore of equity capital over past two years, networth coverage for net NPAs improved, although it still remains low at 1.5 times as on June 30, 2019 (0.9 time as on March 31, 2018). Furthermore, government will continue to provide distress support and will ensure that the bank meets Basel III capital regulations.

Weaknesses:
* Weak asset quality
Asset quality improved from the peak of March 2018, although it still remains elevated. Gross NPA (GNPA) ratio stood to 16.4% as on June 30, 2019 (16.2% as on March 31, 2019, 17.1% as of March 2018, and 8.4% as of March 2016). Net NPA ratio stood at 5.7% as of June 19 (5.7% as of March 2019, 8.5% as of March 2018, and 4.6% as of March 2016). Deterioration in asset quality was mainly due to higher slippages in the large and medium corporate advances portfolio. Exposure to infrastructure and iron and steel sectors stood at 17.3% and 3.4%, respectively, of the total advances as on March 31, 2019 (16.1% and 4.7%, respectively, as on March 31, 2018). While corporate book contributes the most to GNPAs, the performance of the MSME (micro, small, and medium enterprises) book has also weakened over the past two fiscals, with GNPAs increasing to 15.6% as on June 30, 2019 (14.9% as on March 31, 2018, and 9.9% as of March 2017). Ability to arrest slippages and NCLT-led resolutions, mainly in the corporate and MSME loan books, will remain key rating monitorables in the near term.

* Weak earnings profile
The bank continued to post losses for the second consecutive fiscal, with losses of Rs 2,786 crore in fiscal 2019 and of Rs 3,413 crore in fiscal 2018. These were led by higher slippages and increase in provision coverage ratio. Equity infusion by the government was largely used to make incremental provisions, and resultantly, the provisioning coverage ratio increased to 68.6% as on March 31, 2019, from 55.1% as on March 31, 2018. Credit cost stood at Rs 7,434 crore (4.8% of opening net advances) for fiscal 2019 against Rs 10,822 crore (7.6%) for fiscal 2018. This led to a negative return on assets of 1.1% for fiscal 2019 (-1.5% for fiscal 2018).

The pre-provision profits to average assets ratio declined to 2.0% in fiscal 2019 (2.3% in fiscal 2018) mainly on account of lower treasury income. However, this has been better than other PSBs on account of higher yields in MSME, retail, and agriculture loan portfolios. Ability to improve asset quality, and hence profitability, remains a key monitorable.

Liquidity: Superior
Liquidity is superior supported by a healthy retail deposit base. Liquidity coverage ratio stood at 104.5% as on March 31, 2019, against the statutory minimum of 100%. Liquidity also benefits from access to systemic sources of funds, such as the liquidity adjustment facility from the Reserve Bank of India (RBI) and access to the call money market.

Outlook: Negative [Tier-II Bonds (Under Basel III), Infrastructure Bonds, Perpetual Tier-I Bonds (Under Basel II)
CRISIL believes Andhra Bank will continue to benefit from strong government support and adequate capitalisation. Asset quality and earnings are, however, expected to remain elevated and under pressure, respectively, over the medium term.

Rating Sensitivity Factors
Upward factor: (for revision in outlook to 'Stable')
* Pre-provisioning profits comfortably cover the provisioning requirement in fiscal 2020, enabling the bank to posts net profit in fiscal 2020, and/or
* Improvement in asset quality (GNPA ratio less than 15% by March 2020)

Downward factor: (rating downgrade)
* Deterioration in asset quality with GNPAs rising from current levels, and/or
* Profitability remains subdued with losses of over Rs 500 crore in fiscal 2020

Outlook: Negative [Tier-I Bonds (under Basel III)]
CRISIL believes the elevated stress in asset quality and earnings over the medium term could impact the eligible reserves position.

Rating Sensitivity Factors
Upward factor:
Improvement in asset quality, lower credit cost, and a stable pre-provisioning operating profit will likely have a positive implication on the availability of eligible reserves to service AT1 coupon payments and thereby, the rating on the instruments.

Downward factor:
The rating may be downgraded in case of deterioration in eligible reserves position. The rating may also be downgraded if there is further deterioration in asset quality or earnings profile.