The downgrade in the Long-Term Issuer Rating reflects the consistent drop in IDBI's share of systemic assets (domestic share of advances - 1HFY16: 3.0%; FY13: 3.5%) and liabilities (domestic share of deposits - 1HFY16: 2.8%; FY13: 3.2%) as the bank struggles with its asset quality challenges. The bank continues to grapple with a weak capital profile and the Reserve bank of India's invocation of 'prompt corrective action' framework would continue to weigh on its share of systemic assets and liabilities. The Negative Outlook reflects the high possibility of IDBI reporting its common equity tier 1 (9MFY17: 7.24%) below the minimum regulatory requirement (FY17: 6.75%) and continuously struggling with its core capitalisation level, both on an immediate and sustained basis, in the absence of a significant capital infusion from the government of India
The rating downgrade of AT1 bond and upper Tier II subordinated debt reflects the structural weakening of IDBI's standalone profile, likely elevated levels of credit costs, significant erosion of capital, limited visibility on capital infusion and the bank's inability to timely garner equity capital by monetisation of its non-core assets. The downgrade of AT1 instrument also factors in weakening of IDBI's distributable reserve position which depleted to around 1.28% at end-December 2016 post accounting for nine-month losses, much lower than peers median of 4.50% for the same period.
For AT1 instruments, the agency considers discretionary component, coupon omission risk and write-down/conversion risk as key parameters to arrive at the rating. The agency recognises the unique going-concern loss absorption features that these bonds carry and differentiates them from the bank's senior debt, factoring in a higher probability of an ultimate loss for investors in these bonds. The rating on AT1 bond reflects the bank's standalone credit profile, along with its ability to service coupons and manage principal write-down risk over the Basel III transition period. Ind-Ra recognises that government support may be difficult to be relied upon by the holders of AT1 bonds considering loss absorption nature of these instruments.
In case the government's stake in IDBI drops below the majority level through a strategic divestment or otherwise, the credit profile of the bank will be reviewed on the basis of the transformation strategy and the strength of the strategic investors coming on board.
KEY RATING DRIVERS
Corporate Stress Yet to Completely Show Up: Ind-Ra expects IDBI's credit costs (9MFY17 (annualised): 369bp; FY16: 415bp) to remain significantly high over the medium term, on account of higher fresh slippages and provisioning requirements on the current stock of stressed corporates. According to Ind-Ra, the stock of stressed corporates with minimal provisioning remains high for IDBI. A substantially large portion of this exposure could slip to a substandard category over the next few quarters (including unsuccessful cases under strategic debt restructuring) which, along with the ageing impact of NPLs recognised under the asset quality review, would put significant pressure on its profit and loss statement. IDBI reported stressed assets to total loans ratio of 21.45% at end-December 2016 (FY16: 18.96%). IDBI's pre-provision profitability and capitalisation levels remain weak due to muted credit growth and the impact of interest rate reversals on its margins.
Ind-Ra expects IDBI's net interest margins to remain under pressure, as more stressed assets start slipping into the non-performing category.
Large Capital Requirement Through FY19: IDBI's capitalisation is modest at 7.24% (prior to adjusting the losses in 9MFY17; FYE16: 7.98%), driven by losses and a substantial increase in risk weighted assets adjusting for nine-month loan growth, indicating accelerated deterioration of its asset quality. The bank's risk weighted assets/net advances ratio at around 150% at end-March 2017 is the highest in the system. Ind-Ra believes IDBI's inability to grow at a decent pace would continue to put pressure on its operating buffers, limiting its ability to absorb the expected increase in credit costs and operating expenses. Considering the bank's existing capitalisation level and structural weakness, it could remain under pressure on the capital front even after an equity infusion by the government in line with past allocation. IDBI will need to raise fresh equity from capital markets by diluting some of the government's shareholding and plan for significant capital raising under Basel III. Ind-Ra estimates IDBI would need INR91 billion of Tier I capital (assuming CAGR growth of 9% over FY18-FY19) to maintain a Tier I ratio of 10% (including a capital conservation buffer of 2.5%) by FYE19. IDBI's ability to raise sufficient growth capital, along with the government's equity infusion in the short term, will be a key monitorable for its standalone credit profile and instruments linked to it, such as AT1 bonds.
Deteriorating Standalone Profile: IDBI's standalone credit profile is weaker than its peers' on account of its bleak operating and capital buffers. In 9MFY17, high credit costs and weak net interest margin continued to impact the bank's profitability, while its CET1 ratio was modest at 7.24% (prior to adjusting the losses in 9MFY17). IDBI Bank's dependence on bulk deposit remains higher than those of similar rated peers, with a 42% contribution to its total deposits as of December 2016 (December 2015: 45%). On the liquidity front, IDBI's cumulative one-year funding gap as a percentage of assets marginally improved to 22% in FY16 from 24% in FY15. At end-December 2016, IDBI's liquidity coverage ratio was 115.3%, higher than the current regulatory requirement of 80%.
Negative: IDBI's Long-Term Issuer Rating could be further downgraded to Ind-Ra's support floor for public sector banks if its share of systemic assets and liability continues to decline on a sustained basis.
The rating of AT1 instruments could be further downgraded if IDBI fails to raise sufficient equity capital or replenish distributable reserves in a timely manner. The ratings could also be downgraded in case of a significant (more than expected) decline in the asset quality is not buffered by timely support through equity infusions, leading to a consistent dilution in the bank's capability to absorb losses.
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