Moody's concludes review of Punjab National Bank; downgrades ratings to Ba1 from Baa3, outlook stable

Moody's Investors Service has downgraded the local and foreign currency deposit rating of Punjab National Bank (PNB) to Ba1/NP from Baa3/P-3.

At the same time, Moody's has downgraded the bank's baseline credit assessment (BCA) and Adjusted BCA to b1 from ba3.

These actions complete Moody's review of the bank's ratings initiated on 20 February 2018, following the bank's announcement of the discovery of some fraudulent and unauthorized transactions amounting to INR144 billion ($2.2 billion) in February and March 2018.

Moody's has also downgraded PNB's foreign currency issuer rating to Ba1 from Baa3. And, Moody's has downgraded the Counterparty Risk Assessment (CRA) of the bank to Ba1(cr)/NP(cr) from Baa3(cr)/P-3(cr).

 

The ratings outlook is stable.

RATINGS RATIONALE

DETERIORATION OF STANDALONE PROFILE IS THE KEY DRIVER OF THE RATING ACTIONS

The downgrade of the bank's BCA and ratings reflects the negative impact of the discovery of a number of fraudulent transactions on the bank's standalone profile, particularly its capital position. The rating downgrade also reflects the weak internal controls and processes of the bank, given that the fraudulent transactions were undetected for a number of years.

The bank's weak earnings profile as seen by its large stock of nonperforming loans (NPLs) and the associated credit costs will limit its ability to absorb the impact of the fraudulent transactions over the next 12-18 months. Furthermore, provisions relating to the fraudulent exposures will largely offset the benefit the bank will receive from the Indian government's (Baa2 stable) capital infusion plan.

On 14 February 2018, PNB announced to the stock exchange that it had discovered some fraudulent and unauthorized transactions amounting to INR113.9 billion ($1.7 billion). Based on the bank's subsequent announcements, PNB's total exposure to these transactions amounts to INR144 billion ($2.2 billion).

Moody's expects that PNB will receive capital support from the Indian government and that the bank will be able to release some capital from the sale of its non-core assets such as its real estate holdings as well as a partial stake sale in its listed housing finance subsidiary, PNB Housing Finance Limited. Nevertheless, these sources will unlikely prove sufficient to restore the bank's capitalization to levels before the fraudulent transactions were discovered.

The fraudulent transactions represented 320 basis points of the bank's risk-weighted assets as of March 2018. In the financial year ended March 2018 (fiscal 2018), after providing for 50% of the fraudulent exposure, the bank reported a common equity tier 1 (CET1) ratio of 5.95% compared to 8.05% in the quarter ended December 2017. The bank will provide for the remaining 50% exposure in the next few quarters.

Moody's estimates that PNB will require external capital of about INR120-INR130 billion in fiscal 2019 to meet the minimum Basel III CET1 ratio of 8% by March 2019, including a capital conservation buffer. This estimate takes into account the aging basis provisions for the NPLs, the deferred provisions for the fraud, investment losses and employee benefit expenses as well as a reduction in risk weighted assets.

While the Indian government has budgeted an infusion of INR650 billion into the country's 21 public sector banks, Moody's expects that the large capital shortfall will negatively impact PNB's ability to grow its loan book over the next year.

VERY HIGH LEVEL OF GOVERNMENT SUPPORT

As the second largest public sector bank in India by total deposits, the systemic importance of PNB is very high and Moody's expects that the government will provide extraordinary support to the bank's creditors and depositors when required. The systemic importance of the bank is evidenced by the role it plays in the corporate lending market, as well as in lending to large infrastructure projects; with the latter forming a priority for the Indian government.

Government support is also evidenced by the fact that the bank's funding and liquidity profile has largely remained stable, despite the negative reports in the media in the past few months on the bank's fraudulent transactions. For example, PNB's low-cost current and savings account (CASA) ratio measured 43.8% at 31 March 2018 compared to 45.5% at 31 December 2017.

Moody's assumption of a very high level of government support for PNB in times of need results in a three-notch uplift to the bank's ratings to Ba1 from its BCA of b1.

STABLE RATING OUTLOOK

The stable ratings outlook reflects Moody's expectation that the negative impact of the fraudulent transactions is largely known and is reflected in the rating actions taken today.

WHAT COULD CHANGE THE RATING UP

PNB's BCA could be upgraded if the capital infusion received from the Indian government, and or any actions taken by the management, improves the bank's capitalization to a level which is in line with other similarly-rated Indian public sector banks.

WHAT COULD CHANGE THE RATING DOWN:

Moody's will downgrade PNB's BCA and ratings if the bank's capitalization worsens beyond what Moody's expects in this ratings action. Furthermore, any indication that government support to the bank has diminished will also lead to a ratings downgrade.

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