By Jindal Haria

India Ratings and Research (Ind-Ra) has assigned Canara Bank’s (Canara) proposed up to INR24bn Basel III compliant Tier 2 bonds an ‘IND AAA’ rating with Stable Outlook. A list of outstanding ratings is at the end of the commentary.

KEY RATING DRIVERS

The Long-Term Issuer Rating reflects Canara’s systemically important position. Canara is India’s fifth-largest public sector bank (PSB) by asset size, has the second- and third-largest branch networks in Karnataka and Kerala, respectively, in September 2015 and was 66% owned by the government at end-September 2015. Canara also had 4.6% of system advances and 5.4% of system deposits in 1HFY16. Moreover, it attracted an INR15.2bn infusion from the government and INR15.16bn from Life Insurance Corporation of India in 2015. For all these reasons, the bank’s Long-Term Issuer Rating is at the highest level despite its standalone profile being weaker than peers’, as reflected in the bank’s additional Tier 1 issuance rating.            

The bank has lost significant 1.6% of current deposit (CA) market share since FY10 (1HFY16: 4.6%) ,mainly due to the loss of the government business, and consequently has also lost current and saving deposits (CASA) market share by 0.6%.  The bank has traditionally relied on wholesale deposits to fund its loan growth, the higher costs of which has kept its net interest margins lower than even AA- peers’. Average net interest margins have improved marginally (FY15: 2.14%; 1HFY16: 2.25%) on the back of changing deposit profile. Also, the bank set up almost 2,000 branches during FY13-1HFY16 to gain traction in retail deposits. Its retail term deposits grew 33.7% yoy in 1HFY16 while certificates of deposit and preferential rate deposits declined about 60% to INR270bn. Its CASA remained steady at about 24% during FY12-1HFY16 but could increase marginally on seasoning of new branches. The bank’s average cost of deposits come down to 7.1% in 1HFY16 from 7.2% in FY15 and could see a further 10bp-15bp decline over the full year.

Although the bank’s operational costs are in line with the median of AAA rated PSBs, its cost to income has remained high due to its branch expansion. The operational cost to operating income decreased to 47% in 1HFY16 from 51% in FY15 due to slower branch expansion. Canara’s provision coverage ratio adjusted for technical write-offs was lower at 33% in 1HFY16 than 35%-56% for AA+ rated and 40%-50% for AAA rated peers, limiting the headroom for improvements in credit costs even if slippages were to trend down.

 

The total stressed sector exposure (infrastructure, metals, textiles, engineering, construction) of the bank increased to 27% in 1HFY16 from about 24% in FY14, bulk of which is to increased exposure to infrastructure and engineering. Given that Canara’s exposure to the stressed sectors is higher than most peers’, the bank could see higher additions to gross non-performing assets (GNPAs). Although the bank’s GNPAs at 4.2% in 1HFY16 were lower than peers’, its stressed assets exposure (GNPA and restructured standard advances) is in line with the median of AA+ rated peers. Also, 25% of its restructured assets in 1HFY16 were state discom utilities that may not slip, given the support from state and central governments. Canara’s operating buffers (pre-provision operating profit less credit cost to average assets) track the median of ‘IND AA+’ rated PSBs.

Canara’s operating buffers (pre-provision operating profit less credit cost to average assets) track the median of ‘IND AA+’ rated peers. It has the highest exposure to stressed sectors among large PSBs, although the concentration declined in 1HFY16.

On the liquidity front, Canara’s short-term funding gap improved to 14% of the total assets in FY15 from 22% in FY14, resulting from a replacement of bulk deposits with retail deposits. The gap was 1% in 1HFY16. The bank’s liquidity coverage ratio was 65% in 4QFY15 and 88% in October 2015 and the bank expects to maintain it above 100% by FY17.

The bank’s CET1 improved to 8% in 1HFY16 from 7.13% in 1HFY15 because of capital infusions from the government and LIC. The bank’s average internal accruals at about 7.7% are closer to those of its AA+ rated peers. In Ind-Ra’s assessment, the bank is expected to require additional INR55bn of equity infusion, INR60bn of additional Tier 1 and INR88bn of Tier 2 capital over the Basel III transition period (upto FY19). The agency believes the bank will be able to manage its capital requirements given its systemic importance and capital market presence.

The ratings of Canara’s Basel III compliant Tier 2 bonds are equated to its Long-Term Issuer Rating according to Ind-Ra’s rating criteria.


RATING SENSITIVITIES

Negative: Canara’s Basel III Tier-2 instruments are linked to its Long-Term Issuer Rating which is at its support floor and is unlikely to change unless there is a change in the government’s support stance.


COMPANY PROFILE

Canara is a Bengaluru headquartered bank with 5,734 branches at 1HFYE16. It is the third largest government bank by branch network and fifth largest by total assets in India. Its total advances and deposits were INR3,284bn and INR4,852bn, respectively, in 1HFY16. 

INSTRUMENT FEATURES

The proposed unsecured Tier 2 debt instruments have a maturity period of 10 years, and are subordinated to the claims of depositors, general creditors and senior to investors in Tier 1 or equivalent instruments. The instruments are non-convertible, and come with a point of non-viability trigger for a permanent principal write-off (to be decided by Reserve Bank of India).

Canara’s outstanding ratings (including the above):

- Long-Term Issuer Rating: ‘IND AAA’/Stable
- INR15bn Basel 
III compliant Additional Tier 1 bonds: ‘IND AA’
- Proposed INR24bn Basel III compliant Tier 2 bonds: ‘IND AAA’/Stable



SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of the issuer, and therefore, India Ratings has been compensated for the provision of the ratings.

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer. 

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Analyst Names

  • Primary Analyst

    Jindal Haria

    Director
    India Ratings and Research Pvt Ltd Wockhardt Towers, 4th floor, West Wing Plot C-2, G Block. Bandra Kurla Complex Bandra (East), Mumbai 400051
    +91 22 40001750

    Secondary Analyst

    Abhishek Bhattacharya

    Director and Co Head Corporates
    +91 22 40001786

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121