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June 3 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has today affirmed the Long-Term Issuer Default Rating (IDR) of IDBI Bank Ltd. (IDBI) and Indian Bank (IB) at 'BBB-'. Simultaneously, Fitch has also affirmed IDBI's Viability Rating (VR) at 'bb' and that of IB at 'bbb-'. IDBI's Support Rating (SR) and Support Rating Floor (SRF) have also been affirmed at '2' and 'BBB-' respectively, while those of IB have been affirmed at 'BB+' and '3' respectively. The Outlook on the IDRs is Negative. A full list of rating actions is at the end of this commentary.
KEY RATING DRIVERS
IDBI's SR and SRF are driving factors behind its IDR and primarily reflect Fitch's expectation of a continued high probability of government support to the bank. It factors in IDBI's size and systemic importance given its share in system assets and deposits (both at around 3.5% in FY12) and history of support extended during its transition from a legacy development finance institution (DFI). Regular capital injections from the government, which totalled around INR65bn (including INR3.8bn from Life Insurance Corporation of India in FY11) were also made in the last three years, as was the conversion of its Tier 1 bonds into common equity in FY12. The negative outlook on IDBI's IDR mirrors that of the sovereign.
IDBI's VR suffers from an overhang of its legacy as a DFI, which reflects in its wholesale focused business model and also performance. While Fitch acknowledges steady improvements achieved by IDBI in the last three years, it still lags behind large and some mid-sized government banks. Despite a total capitalisation of 13.1% (at FY13), Tier 1 at 7.7% is comparably lower than most peers. IDBI's low-cost deposit ratio per branch has held up well and there has been a significant reduction in its dependence on expensive bulk deposits (36% of total deposits FY13; 52% FY12). While it is still above the government's maximum prescribed ceiling of 15%, sustained lower dependence should benefit funding costs and eventually profitability in the medium term. In the interim, asset quality will remain a challenge to its profitability which has traditionally been lower (ROAA five-year average: 0.6%) owing to its wholesale focus.
In FY13, IDBI reported gross NPL ratios of 3.2% (FY12: 2.5%) though on a stressed assets basis (gross NPL plus restructured loans-to-total loans) the ratio was 10.8%. IDBI's exposure to infrastructure is partly due to its DFI legacy but stress on the sector (as a whole) is on the rise as observed through intense restructuring in the sector (particularly in power) in FY13. Fitch expects the same to maintain momentum through FY14 as structural bottlenecks push under-construction projects beyond their start dates. While IDBI has had limited success in paring down exposure, it has managed to keep it broadly stable. IDBI's non-funded book is on the higher side among government banks and while it may be a good source of fee income, the risk under this book is still largely untested. This remains a matter of concern since IDBI's ability to withstand moderate level of stress in the infrastructure sector is still lower than peers rated higher on the VR.
IB's SR and SRF are more representative of its moderate size and systemic importance despite a larger branch presence than IDBI. IB accounts for around 2% of system assets and deposits, which are concentrated in southern India. This is likely to result in a moderate probability of support from the government, if needed. IB's IDR - which is at the same level as that of IDBI - is driven by its VR. Accordingly, the negative outlook on IB's IDR is also a reflection of the potential for further weakening of its intrinsic credit profile; IB's IDR was revised to Negative ahead of the negative outlook on the sovereign.
IB's VR has come under pressure owing to asset quality issues exacerbated by high concentrations in the infrastructure sector. Consequently, the potential impact on IB's stressed asset ratio (FY13: 11.3%) has been more pronounced despite IB managing to pare down exposure to infrastructure compared with FY10.
The reported gross NPL ratio at 3.3% (FY12: 2%) has been relatively more benign and could potentially face some pressure, albeit at a moderating pace. While both IB and IDBI have been making efforts to reduce or stem their exposures, concentration risk will take time to address. IB's ability to withstand a moderate amount of stress is better than most of its peers owing to better capital position and superior profitability. However, a severe and prolonged downturn in the infrastructure sector - which is not Fitch's base case - may prove even difficult for IB to handle and could affect its credit profile.
IB's relatively solid and consistent capital position is the key underpinning its VR and is supported by a better-than-peers, albeit declining, profitability cover and an improving funding profile. While IB's total capitalisation is comparable to that of IDBI (13.1% at FY13), the quantity and quality of capital have been consistently superior with a Tier 1 ratio of around 11%. IB, thus far, has managed its capital position mainly through internal accruals supported by better profitability and stable dividends. While loan impairment charges have increased significantly for both IB and IDBI, the former's ROAA of 1.04 % (FY13) is still higher than most large and mid-sized government banks in India, albeit off its previous highs (five-year average: 1.4%).
RATING SENSITIVITIES - IDRs and VRs
IDBI's IDR is at the same level as its SRF, and will not be affected by a downgrade of its VR, unless considerations underpinning the 'BBB-' SRF also weaken. However, a downgrade of India's sovereign rating - which is currently on Negative Outlook - will also trigger a downgrade of the IDR for IDBI. Similarly, a change in the sovereign's outlook to stable will also lead to a revision of the outlook on IDBI's IDR.
In comparison, IDBI's VR at 'bb' is representative of its relative weaknesses which partly stem from its legacy as a DFI. While there have been steady, but slow, improvements in performance in the last few years, it is well behind that of better rated VR peers. The VR could, however, be downgraded if its stand-alone strength is materially affected by a sustained disruption or reversal of these improvements amid growing concentration risk, greater than expected weakening in asset quality and/or deteriorating funding mix, but this scenario is viewed unlikely.
IB's IDR and VR - which are at the same level as the sovereign - have no immediate upside. However, the IDR (and the VR) will be downgraded in the event of a sovereign downgrade or if the VR gets downgraded ahead of any sovereign downgrade. The IDR is expected to maintain its negative outlook even if the sovereign's outlook were to be revised to stable given pressures on its standalone credit profile. IB's VR, which is rated two notches above IDBI, is experiencing downward pressures and will likely be downgraded if capitalisation deteriorates more than expected. The VR also remains vulnerable to prolonged stress in the infrastructure sector which may weaken the bank's loss-absorption capacity and lead to a downgrade of the VR.
RATING SENSITIVITIES - SRs and SRFs
The SRs and SRFs are determined by the agency's assessment of the government's propensity and ability to support a bank determined by its relative size and systemic importance. A change in the government's ability to provide extraordinary support due to a change in the sovereign ratings would affect the SRs and SRFs. The SRs and SRFs will also be impacted by any change in the government's willingness to extend timely support.
The rating actions are as follows:
IDBI Bank Ltd.
Long-Term IDR affirmed at 'BBB-'; Outlook Negative
Short-Term IDR affirmed at 'F3'
Viability Rating affirmed at 'bb'
Support Rating affirmed at '2'
Support Rating Floor affirmed at 'BBB-'
Long-Term IDR affirmed at 'BBB-'; Outlook Negative
Short-Term IDR affirmed at 'F3'
Viability Rating affirmed at 'bbb-'
Support Rating affirmed at '3'
Support Rating Floor affirmed at 'BB+'