OREANDA-NEWS. Fitch Ratings has affirmed the Long-Term Issuer Default Ratings on nine Indian banks as follows:

- State Bank of India (SBI), Bank of Baroda, Bank of Baroda (New Zealand) Limited (BoB NZ), Punjab National Bank (PNB), Canara Bank, IDBI Bank Ltd., ICICI Bank Ltd. and Axis Bank Ltd. have been affirmed at 'BBB-'

- Indian Bank has been affirmed at 'BB+'

The Outlook on the IDRs is Stable. A full list of rating actions is at the end of this commentary.

While the IDRs of Canara Bank and IDBI Bank were affirmed, their Viability Ratings (VRs) have been downgraded by one notch to 'bb' and 'bb-' respectively, to reflect their weaker intrinsic risk profiles compared with higher-rated peers. Both banks' capital positions are at greater risk because stressed assets have increased at faster pace than capital replenishment.

Fitch has revised the sector outlook on Indian banks to Negative from Stable implying that there are more downside risks for bank VRs unless the risks of deteriorating asset quality and weak earnings are counterbalanced by sizeable capital infusions.

Banking sector NPLs rose sharply in the financial year ended 31 March 2016 (FY16) as a result of stricter NPL recognition standards. Asset quality could deteriorate further over the next 12-18 months given the banks' exposure to stressed sectors, such as infrastructure and iron and steel, and the difficult resolution process for stressed assets in the near term. Earnings for the sector are also likely to be weak due to muted loan growth and high credit costs.

Indian banks' capital positions have historically been weak. The situation has worsened for most public-sector banks due to delayed recognition of problem assets and high loan-loss provisions, and will remain weak in the near term unless the government makes significant capital investment in the banks. The government is committed to inject USD7bn of capital in public-sector banks by FY19, out of a budgeted investment of USD11bn. However, the government or other related entities are likely to have to inject more funds because Fitch estimates the banking system needs around USD90bn of capital while many public-sector banks are likely to find it difficult to access new capital from other sources (see "APAC Banks: Chart of the Month-July 2016", which is also released today).

Resolving both the asset quality and capital questions are important conditions for some banks to regain market access. The VRs could come under more pressure if the banks' capital levels are not addressed.

The asset-quality and capital pressures on the system in the near term drive Fitch's negative sector outlook, but the Reserve Bank of India's reforms of the banking sector are likely to be positive over the long term. If fully implemented, the reforms should lead to better lending practices, earlier recognition of problem exposures, improved creditor rights, greater transparency, and a better capitalised and more competitive banking system.

KEY RATING DRIVERS

IDRS, SUPPORT RATINGS (SRs) AND SUPPORT RATING FLOORS (SRFs)

The Long-Term IDRs of SBI, Bank of Baroda, PNB, Canara Bank, IDBI Bank, and ICICI Bank are at their SRFs of 'BBB-'. The ratings are driven by their SRs of '2', which reflects Fitch's expectation that they are highly likely to receive extraordinary support from the Indian government due to their high systemic importance and the government's majority ownership in all except ICICI Bank. Indian Bank - which is also majority state-owned - has an IDR and an SRF that is a notch lower than the large state-owned banks', driven by its lower SR. Indian Bank's SR of '3' reflects the moderate probability that it would receive extraordinary timely support from the Indian government because of its lower systemic importance stemming from its smaller size and more regional character.

Axis Bank's IDR is driven by its VR of 'bbb-' while its SRF and SR are lower at 'BB+' and '3', respectively, mainly due to its moderate systemic importance and private ownership.

The VRs of SBI, ICICI Bank, Axis Bank and Indian Bank are at the same level as their IDRs and therefore, also act as drivers for their long-term ratings.

BoB NZ is a fully owned subsidiary of Bank of Baroda and its IDR is driven by expectations of high support from its parent due to the strong linkages and close integration with the latter.

The Stable Outlook on the IDRs mirrors the Outlook on India's rating (BBB-/Stable). It reflects our view that there is no material change in the sovereign's ability to support banks in a situation of extraordinary stress. For SBI, ICICI Bank, Axis Bank and Indian Bank, it also reflects a degree of stability in their standalone credit profiles, which are also drivers for their IDRs.

VIABILITY RATING (VR)

State Bank of India (SBI)

SBI is India's largest bank and the only state-owned bank to have an investment grade VR. The rating reflects its very strong deposit franchise and diversified business and earnings, partly helped by its very strong government links.

SBI's core capitalisation (CET1 ratio: 9.8% at FYE16) is better than that of other state-owned banks. This is likely to increase by 75-80bp with the inclusion of revaluation reserves, but more importantly, SBI is better able to raise capital from the markets (and not rely on government capital) than other government banks', which provides it with more flexibility.

SBI's ratio of stressed assets (NPLs plus restructured loans) to total assets was 9.1% at FYE16, better than that for other government banks. Its proportion of capital vulnerable to further erosion as a result of potential loan losses is also lower than most other public-sector peers.

Fitch expects the impending merger of SBI with its five associate banks to be neutral for its asset quality and capital, although there could be some qualitative challenges in terms of integration. Fitch believes SBI will benefit in the long term from a stronger franchise and some cost synergies.

Bank of Baroda

Bank of Baroda's VR of 'bb+' reflects its slightly better intrinsic financial profile than most other state banks' due to better core capitalisation and lower risk of further loan losses after the extensive clean-up exercise in FY16. Its VR benefits from its position as India's second-largest public-sector bank. The strong franchise supports a stable funding base. The rating also reflects the bank's relatively higher specific loan-loss cover than peers.

Although Bank of Baroda reported huge losses in FY16 due to significantly higher credit costs, its core capitalisation improved slightly, with CET1 ratio rising to 10.3% at FYE16 from 9.4% at FYE15. This was driven by contraction in its loan book, a government capital injection of INR17.8bn (4.5% of FYE15 equity), and regulatory dispensations that allowed the inclusion of revaluation, FX translation and deferred tax asset reserves in the computation of core capital.

Punjab National Bank (PNB)

PNB is the third-largest public-sector bank in India and has a strong local franchise. Its VR of 'bb' reflects pressures on asset quality and core capital due to a larger stock of stressed assets compared with other major government banks. The rating also factors in the bank's strong deposit franchise, which supports the bank's above-average pre-provision profitability. The central bank's system-wide review of asset quality led to a jump in the bank's NPL ratio at FYE16 12.9% from 6.6% a year earlier, but the 130bp rise in the overall stressed assets ratio to 17.6% was relatively moderate.

PNB's higher pre-provision profitability mitigates the pressure on its VR, which gives the bank greater flexibility to absorb further loan losses compared with many other government banks.

Canara Bank (Canara)

Canara Bank is India's fifth-largest public-sector bank with a pan-India franchise and reasonable share in system assets and deposits. Canara's VR factors in its good franchise and market position but the one-notch downgrade to 'bb' reflects the sharp deterioration in the bank's asset quality and its relatively weak core capitalisation, which is vulnerable to further erosion due to a significant increase in the bank's ratio of unprovided NPLs to equity to 66% at FYE16 from 27% at FYE15. The rating also takes into account Canara's stable funding profile with improvement in its low-cost deposit ratio. However, pre-provision profitability is lower compared with many major government banks.

IDBI Bank (IDBI)

IDBI is a large public-sector bank that ranks seventh in India in terms of assets. The one-notch downgrade of IDBI's VR to 'bb-' reflects a sharper deterioration in the bank's asset quality than Fitch expected, and its larger proportion of loans at risk of being classed as vulnerable compared with most other banks. IDBI's VR also factors in its lower pre-provision earnings and weaker core capitalisation, which is at risk of further erosion in the absence of significant capital injection. The rating takes into account progress the bank has made in improving its low-cost deposit ratio, but at 26%, it is the weakest amongst large state banks.

Indian Bank

Indian Bank is a mid-sized government bank primarily operating in the southern states of India. Its VR of 'bb+' is at the same level as its IDR and reflects its relatively better core capitalisation and moderate profitability along with its strong regional franchise. The rating factors in the deterioration in the bank's asset quality in FY16, which was in line with the trend in the system, although its stressed asset ratio of 11.5% at FYE16 was better than that for most government banks. Indian Bank's franchise is weaker compared with its larger peers' but it enjoys a stable funding profile and has a stronger market presence in south India.

ICICI Bank

ICICI Bank is India's second-largest bank by assets after SBI. Its VR of 'bbb-' reflects the bank's strong pan-India franchise as well as superior capitalisation and adequate profitability, which gives it greater flexibility to negotiate the asset-quality pressures it faces. The rating also reflects the bank's improved funding profile, which is underpinned by a large share of retail term and low-cost deposits.

ICICI Bank's NPL ratio rose to 5.8% at FYE16 from 3.8% at FYE15, and further deterioration is likely given the bank's exposure to the vulnerable, cyclical sectors (such as steel, power and mining) and hence credit costs will remain high. However, ICICI Bank's pre-provision profits at around 5.6% of loans provide significantly greater cushion to absorb higher credit costs (FYE16: 1.5%; FYE15: 0.8%) before capital impairment risks become real.

ICICI Bank's CET1 ratio of 13.1% at FYE16 is among the best in the sector and the bank may consider selling stakes in some non-bank subsidiaries to offset near-term weakness in its internal capital generation.

Axis Bank

Axis Bank's VR of 'bbb-' is underpinned by its stronger core capitalisation, superior profitability and improving liability profile, which lends stability to its rating against manageable asset-quality pressure. Axis Bank is India's third-largest private sector bank and its strong franchise and market position also underpin its VR.

The deterioration in Axis Bank's NPL ratio to 1.7% at FYE16 from 1.3% at FYE15 was much smaller compared with the government banks, while its broader stressed-asset ratio remained stable at around 4%. However, given its exposure to certain problematic sectors, and some specific accounts that may face potential stress, the bank's asset quality over the next one to two years is likely to worsen slightly.

Axis Bank's relatively strong pre-provision profitability at 4.8% of loans as at FYE16 should provide adequate buffer against a moderate increase in credit costs, which rose to around 1% in FY16 (FY15: 0.7%). Capital impairment risks in Fitch's opinion, therefore, are low and its CET1 ratio at 12.5% at FYE16 was among the highest in the system.

Axis Bank's internal capital generation has also improved, given the progress in the retail segment, both in asset mix and liabilities. The bank's net interest margin widened to 3.9% in FY16 from 3.4% in FY13, while fee income has increased over the last few years.

SENIOR DEBT, SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The senior debt ratings of SBI, Bank of Baroda, IDBI Bank, ICICI Bank, Axis Bank and Canara Bank are at the same level as their IDRs as the debts represent unsecured and unsubordinated obligations of the banks.

Legacy Upper Tier 2 bonds are rated four notches below the VR for ICICI Bank, and three notches below the VR for Bank of Baroda and Canara Bank. The notching is in accordance with Fitch's assessment of each instrument's non-performance and loss-severity risk profiles and reflects some rating compression for VRs below 'bbb-'. These subordinated debts are legacy instruments that are not Basel III-compliant.

SBI's legacy perpetual Tier 1 bonds are rated five notches below its VR in accordance with Fitch's assessment of the instrument's non-performance and relative loss-severity risk profile. This legacy hybrid debt is not Basel III-compliant.

RATING SENSITIVITIES

IDRS AND SENIOR DEBT

The VRs on Bank of Baroda, PNB, Canara Bank and IDBI Bank are lower than their SRFs and their IDRs may be downgraded if factors underpinning the SRFs weaken. For SBI, ICICI Bank and Indian Bank, where the VRs and SRFs are at the same level, their IDRs would only be downgraded if both the SRFs and the VR were to be downgraded. A downgrade of India's sovereign rating will trigger a downgrade of the banks' IDRs that are at the same level as the sovereign. Likewise, a change in the sovereign's Outlook will also lead to a revision of the Outlooks on the banks' IDRs. Axis Bank's IDR is solely driven by its VR and a downgrade to its VR, while unlikely in the near term, will lead to a downgrade to its IDR.

Any changes in the banks' IDRs would result in equivalent changes in their senior debt ratings.

VRS, SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The 'bbb-' VRs of the private banks, ICICI Bank and Axis Bank, remain sensitive to any unexpected and/or significant asset quality deterioration, particularly if that is accompanied by a reduction in capital buffers, which currently support their ratings. The VRs of ICICI Bank and Axis Bank may also move down if the sovereign is downgraded as it is not common to have bank VRs above the sovereign rating due to operating environment-related risks.

There is a negative bias on the VRs of SBI, Bank of Baroda, Canara Bank, PNB, IDBI and Indian Bank, which are sensitive to rising pressures on asset quality and capitalisation. These VRs factor in periodic government capital injections, the absence of which may weaken the banks' capital positions if asset quality continues to deteriorate. The VR of SBI will be also sensitive to downward movement in the sovereign rating or Outlook.

The banks' Upper Tier 2 and hybrid Tier 1 debt are all notched down from the VRs and will be sensitive to any change in the VRs.

SUPPORT RATINGS (SRs) AND SUPPORT RATING FLOORs (SRFs)

The SRs and SRFs are determined by the agency's assessment of the government's propensity and ability to support a bank, based on the bank's 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 propensity to extend timely support.

The rating actions are as follows:

SBI:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at F3'

- Viability Rating affirmed at 'bbb-'

- Support Rating affirmed at '2'

- Support Rating Floor affirmed at 'BBB-'

- USD10bn MTN programme affirmed at 'BBB-'

- USD3.5bn senior unsecured notes affirmed at 'BBB-'

- USD400m perpetual tier 1 bonds affirmed at 'B'

PNB:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at 'F3'

- Viability Rating affirmed at 'bb'

- Support Rating affirmed at '2'

- Support Rating Floor affirmed at 'BBB-'

Bank of Baroda:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at 'F3'

- Viability Rating affirmed at 'bb+'

- Support Rating affirmed at '2'

- Support Rating Floor affirmed at 'BBB-'

- USD3bn MTN Programme 'BBB-'

- USD1.5bn senior unsecured notes under the MTN programme affirmed at 'BBB-'

- USD300m Upper Tier 2 notes under MTN programme affirmed at 'B+'

BOBNZ:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Support Rating affirmed at '2'

Canara Bank:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at 'F3'

- Viability Rating downgraded to 'bb', from 'bb+'

- Support Rating affirmed at '2'

- Support Rating Floor affirmed at 'BBB-'

- USD2bn MTN programme affirmed at 'BBB-'

- USD850m of senior notes under MTN programme affirmed at 'BBB-'

- USD250m Upper Tier 2 notes under MTN programme downgraded to 'B', from 'B+'

IDBI Bank:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at 'F3'

- Viability Rating downgraded to 'bb-', from 'bb'

- Support Rating affirmed at '2'

- Support Rating Floor affirmed at 'BBB-'

- USD5bn medium-term note programme affirmed at 'BBB-'

- USD2bn senior unsecured notes affirmed at 'BBB-'

Indian Bank

- Long-Term IDR affirmed at 'BB+'; Outlook Stable

- Short-Term IDR affirmed at 'B'

- Viability Rating affirmed at 'bb+'

- Support Rating affirmed at '3'

- Support Rating Floor affirmed at 'BB+'

ICICI Bank:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at 'F3'

- Viability Rating affirmed at 'bbb-'

- Support Rating affirmed at '2'

- Support Rating Floor affirmed at 'BBB-'

- USD4.2bn senior notes affirmed at 'BBB-'

- USD750m Upper Tier 2 bonds affirmed at 'B+'

Axis Bank:

- Long-Term IDR affirmed at 'BBB-'; Outlook Stable

- Short-Term IDR affirmed at 'F3'

- Viability Rating affirmed at 'bbb-'

- Support Rating affirmed at '3'

- Support Rating Floor affirmed at 'BB+'

- USD5bn MTN programme affirmed at 'BBB-'

- USD1.75bn senior unsecured notes affirmed at 'BBB-'