Nirav Modi scam: Moody's, Fitch warn fraud-hit PNB of rating downgrades

International rating agencies Moody's Investor Service and Fitch Ratings on Tuesday warned the scam-hit Punjab National Bank (PNB) of rating downgrades, citing likely networth erosion and widening losses at the second largest state-run lender.

The Rs 114 billion fraud--the biggest in the country's banking history--has raised questions on both internal and external risk controls at PNB as well as the quality of management supervision at the regulatory level considering that the fraud went undetected for several years, the agencies said.

Moody's in a note on Tuesday said the review for downgrade will focus on: (1) the timing and quantum of the financial impact of the fraudulent transactions, (2) any management actions taken to improve the capitalization profile of the bank, and (3) any punitive actions taken by the regulator on the bank.

It has also placed PNB's baseline credit assessment and adjusted BCA of Ba3 and counterparty risk assessment of Baa3(cr)/P-3(cr) under review for downgrade.

"The primary driver for today's rating action is the risk of weakening standalone credit profile of PNB, as a result of a number of fraudulent transactions" through fake letters of undertakings issued by the bank to other lenders worth $1.8 billion over the past many years, Moody's said.

On the other hand, rival agency Fitch in a separate note said it has placed the bank on rating watch negative, reflecting a possibility of downgrade following the fraud.

"Fitch Ratings has placed PNB viability rating of 'bb' on rating watch negative, following the large fraud reported by PNB," the US-based agency said.

Viability rating measures credit worthiness of a financial institution and reflects the likelihood of the entity to fail, as per Fitch's rating criteria.

The scam came out into the open on 14 February 2018, when the state-run bank informed the stock exchanges.

"These fraudulent transactions represent a contingent liability and the financial impact will be determined by the relevant laws. Nevertheless, we expect PNB will have to provide for at least a substantial portion of the exposure.

"As a result, it's profitability will likely come under pressure, although the actual impact will depend on the timing and quantum of provisions that need to be made, as well as any prospects for recovery," Moody's said, adding these fraudulent transactions represent about 230 bps of the bank's risk-weighted assets as of December 2017.

As such, its capital position would deteriorate markedly, and fall below minimum regulatory needs, if the bank is required to provide for the entire exposure, it said, adding as a result, PNB may need to raise capital externally to comply with the Basel III requirement of 8 per cent core equity by March 2019, which as of December 2017 stood at a precarious 8.05 per cent.

The agency also noted that since the scam came out into the open, PNB's share price has fallen by about 40 per cent, limiting its access to the equity capital markets.

The discovery of the fraudulent transactions also highlights the weak operational controls and corporate governance at the bank.

"We will resolve the rating watch once more clarity emerges on the extent of control failures and the impact on PNB's financial position," Fitch said, adding it will monitor the bank's full liability, potential recoveries and the extent of additional fresh capital needed to determine if its financial position is no longer consistent with the current viability rating.

Noting that PNB's asset quality and capital parameters continue to be weak but have shown some stability since Fitch's rating action in June 2017, Fitch said for the April-December 2017 period, though its NPAs eased to 12.1 per cent, profitability continued to be weak.

"Significant control failures that attract substantial management time to rectify would be likely to weaken our view of risk appetite and management, and result in a downgrade of the viability rating," it said.

The agency, however, said the fraud is unlikely to have an impact on PNB's support rating floor (BBB-) due to its systemic importance as the second-largest state-owned bank. The PNB counter was trading over 1 per cent down at Rs 115.15 on the BSE at 1400 hrs against the benchmark gaining 0.27 per cent.