Rating Rationale

Strengths

* Strong expectation of support from majority owner, the GoI:
The rating continues to factor in an expectation of strong government support, both on an ongoing basis and in the 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 the PSBs, including UCO Bank. As part of the 'Indradhanush' framework, government has pledged to infuse at least Rs 70,000 crore in PSBs during fiscals 2015-19, of which Rs 25,000 crore each was infused in fiscals 2016 and 2017. Further, in October 2017, the government had outlined recapitalization package of Rs 2.11 lakh crores over fiscals 2018 and 2019, out of which PSBs will receive Rs 88139 crore in fiscal 2018. UCO Bank has been allocated Rs 6507 crore out of this for the current fiscal. The bank received Rs 1925 crore of equity capital from GoI in fiscal 2017.

* Moderate resource profile:
CASA deposits as a proportion of domestic deposits increased to 35.2% as of September 30, 2017, from 28.6% a year before. The increase in CASA is partly attributed to the demonetisation which attracted a large volume of low-cost deposits into the banking system. UCO Bank will maintain moderate resource profile over the medium term supported by its well-established market position in eastern India, which has helped the bank maintain a stable deposit base in the east.

Weakness
* Weak asset quality:
Asset quality has deteriorated in the past few years. Gross NPAs increased to 19.74% as on September 30, 2017, from 17.12% as on March 31, 2017, and 15.43% as on March 31, 2016. The deterioration in asset quality was mainly because of slippages in the large and mid-corporate loan book, and slow recovery from delinquent accounts. Slippages remained high at 7.9% (annualized) during the first half of fiscal 2018 (7.9% in fiscal 2017 and 10.0% in fiscal 2016). CRISIL believes asset quality of the bank is peaking and incremental slippages are likely to be lower. The bank is also focusing on improving its collection and recovery mechanisms. Asset quality nevertheless remains susceptible given the bank's sizable exposure to vulnerable sectors such as infrastructure and construction and remains a key monitorable.

* Weak earnings profile:
Earnings profile of the bank has been impacted by the deterioration in asset quality. Net loss and return on assets (annualised) stood at Rs 1286 crore and a negative 1.15%, respectively, for the first half of fiscal 2018 (Rs 1851 crore and a negative 0.75%, respectively, for fiscal 2017). The losses were mainly on account of contraction in net interest margin (NIM; net interest income to average total assets) and higher provisioning costs. NIM declined to 1.34% during the first half of fiscal 2018 (1.62% for fiscal 2017) from 1.85% in the previous corresponding period (1.98% for fiscal 2016) because of interest reversals and shrinkage in performing advances. Provisioning costs as a proportion of average total assets also remained high at 1.91% in the first half of fiscal 2018 (2.0% for fiscal 2017 and 2.6% for fiscal 2016). Provisioning cost will remain high over the near term on account of ageing of NPAs and increase in provisioning requirements against accounts referred to National Company Law Tribunal. Profitability is therefore likely to remain under pressure over the medium term.