OREANDA-NEWS. S&P Global Ratings said today that it had lowered its long-term issuer credit rating on Union Bank of India to 'BB+' from 'BBB-'. The outlook is stable. At the same time, we lowered our short-term issuer credit rating on the India-based bank to 'B' from 'A-3'. We also lowered our long-term issue ratings on Union Bank's senior unsecured notes to 'BB+' from 'BBB-'.

"We downgraded Union Bank because we expect the bank's asset quality to remain weak over the next 12 months, following a deterioration over the past few quarters," said S&P Global Ratings credit analyst Nikita Anand. Accordingly, we have lowered our assessment of the bank's stand-alone credit profile (SACP) to 'bb' from 'bb+'.

We continue to see a very high likelihood that the government of India (BBB-/Stable/A-3) will continue to provide timely and sufficient extraordinary support to the bank. Our view of the likelihood of extraordinary government support is based on our assessment of the bank's very strong link with, and very important role to, the government. The rating is therefore one notch higher than the SACP.

The pickup in corporate performance and debottlenecking of stressed sectors in India is likely to be gradual, hurting Union Bank's asset quality. The bank has a high exposure to the corporate and small and midsize enterprise segments in India. The stress in these segments has pushed up the bank's non-performing loan (NPL) ratio to 10.2% as of June 30, 2016, from 5.0% as of March 31, 2015. We have therefore revised our assessment of Union Bank's asset quality to weak from moderate.

We continue to assess Union Bank's capital and earnings as moderate because we expect the bank's pre-diversification risk-adjusted capital (RAC) ratio to remain at 5%-5.5% over the next 12 months. This ratio is 5.4% as of March 31, 2016.

"We anticipate that Union Bank's profitability will remain modest over the next 12 months, mainly due to elevated credit costs," said Ms. Anand. "The bank's profitability has reduced in recent years because of margin pressure and increasing credit costs stemming from a rise in NPLs. However, Union Bank has been able to remain profitable in recent quarters, unlike some of its peer public sector banks."

We believe that the government will continue to infuse capital into Union Bank. The government injected Indian rupee (INR) 11.1 billion equity into the bank in fiscal 2013 (year ended March 31, 2013), INR5 billion in fiscal 2014, and INR10.8 billion in fiscal 2016. We could lower our forecast RAC ratio if economic risks in India increase because we calibrate risk weights to the underlying economic risk in a country. This may negatively affect our assessment of Union Bank's capital and earnings.

The regulatory requirement for Tier 1 capital (including capital conservation buffer) in India is set to increase to 8.25% effective March 31, 2017. Union Bank's stand-alone Tier 1 ratio is 8.39% as of June 30, 2016. Our base-case expectation is that the bank will meet the minimum regulatory capital requirement by tapping the capital markets or receiving capital from the government or government-related entities. Our view is based on the government's public commitment as part of its plan to revamp public sector banks (including Union Bank) and help them to maintain a safe buffer over their Basel III requirements. Union Bank's inability to raise sufficient capital, such that it breaches the regulatory capital requirement, could lead to a multiple-notch downgrade. S&P Global Ratings caps the SACP of a bank that breaches the regulatory capital requirement (and is still allowed to continue to operate) at 'ccc+'.

We expect Union Bank to maintain its average domestic business franchise and strong funding and liquidity profile over the next 12 months.

The stable outlook on Union Bank reflects our expectation that the likelihood of government support to the bank will remain very high. The outlook also reflects our view that, although Union Bank's SACP is likely to remain under pressure over the next 12 months, it is unlikely to deteriorate to a level that will lead to a change in the rating.

We could lower the rating if Union bank's SACP weakens by two notches to 'b+'. We could lower our assessment of the SACP to 'bb-' from 'bb' if the bank's pre-diversification RAC ratio dips to below 5% on a sustained basis. The RAC ratio could deteriorate if the bank grows aggressively and is unable to support this growth with sufficient capital infusion, or if the economic risk in India rises.

We currently see no upside potential to the rating on Union Bank for the next 12 months at least.