Moody's downgrades SBI to D+

Moody's Investors Service has downgraded State Bank of India's (SBI) bank financial strength rating based on the banking entity's capital situation and deteriorating asset quality.

According to a release, Moody's has downgraded SBI's financial strength rating (BFSR), or stand-alone rating, to D+ from C-. The revised rating maps to a baseline credit assessment (BCA) of Baa3.

"The rating action considers SBI's capital situation and deteriorating asset quality. Our expectations that non-performing assets (NPA) are likely to continue rising in the near term— due to higher interest rates and a slower economy— have caused us to adopt a negative view on SBI's creditworthiness," says Beatrice Woo, vice president and senior credit officer.

As a result of the lower BCA, the hybrid debt rating was downgraded to Ba3(hyb) from Ba2(hyb). The revised BFSR carries a stable outlook and the hybrid rating a negative outlook.

SBI reported a Tier 1 capital ratio of 7.60% as of 30 June 2011. The level pushes the bank into a lower rating band. In addition, it was below the 8% Tier 1 ratio that the government of India has committed to maintaining in public sector banks (PSB) and substantially lower than those of other C- rated Indian banks.

The latter include banks such as Axis Bank (Ba1; C-/Baa2; stable), HDFC Bank (Ba1; C-/Baa2; stable), and ICICI Bank (Ba1; C-/Baa2; stable).

Finally, such a level for its Tier 1 capital ratio provides an insufficient cushion to support growth and to absorb potentially higher credit costs from its deteriorating asset quality, said the release.

"Notwithstanding our expectations that SBI's capital ratios will soon be restored through a capital infusion by the government, SBI's efforts to secure this capital for the better part of the year demonstrates the bank's limited ability to manage its capital," says Woo.

And given that a bank's ability to freely access the capital markets is an important rating criterion globally, we therefore believe a lower BFSR for SBI is warranted, especially as these circumstances are likely to recur, added Woo.

The Rs 23,000 crore rights issue that SBI is currently seeking would raise its Tier 1 ratio to approximately 9.30%. However, Moody's estimate that capital deployed for loan growth, assuming 15% per annum for the next three fiscal years, will cause the Tier 1 ratio to fall below eight%, thereby necessitating another capital exercise.

On the asset quality front, the bank's NPA, as of 30 June 2011, reached a 3-year high of 3.52% of loans. For the system, the ratio was 2.3% as of 31 March 2011.

Against a backdrop of a slowing economy and higher interest rates, the rising trend evident in SBI's new NPA formation rate since 3QFY11 will continue. Therefore, Moody's expects SBI's potential credit costs will be relatively high in the near-term. NPA— as a percentage of the bank's Tier 1 capital ratio— is now about 43%.

Finally, the credit ratings incorporate Moody's unchanged assessment that the probability of systemic support for SBI, if needed, is very high, and results in a one-notch lift in its GLC deposit rating of Baa2 from its standalone rating of Baa3.