By Jindal Haria

India Ratings and Research (Ind-Ra) has assigned Canara Bank’s (Canara) additional proposed up to INR30bn 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 rating of Canara’s Basel III compliant Tier 2 bonds has been equated to its Long-Term Issuer Rating (according to Ind-Ra’s rating criteria) which reflects Canara’s systemically important position and Ind-Ra’s expectation of strong continuous support from the government of India. Canara is India’s fifth-largest public sector bank (PSB) by asset size, had the second- and third-largest branch networks in Karnataka and Kerala, respectively, in September 2015 and was 66.3% owned by the government at end-March 2016. Canara also had 4.6% of system advances and 5.4% of system deposits in 1HFY16. Moreover, it attracted an INR9.5bn infusion from the government and INR15.20bn from Life Insurance Corporation of India in FY16. 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’s common equity improved to 8.1% in 3QFY16 from 7.0% in 3QFY15 and is better than most PSBs’. It could see further improvements given that bulk of revaluation reserves (RR at 55% discount; FY15: INR24.3bn) and foreign currency translation reserves (FY15: INR1.9bn) could be treated as CET1. The bank’s average internal accruals at about 7% are closer to those of its AA+ rated peers. Ind-Ra expects the bank to require additional INR55bn of equity infusion (including revaluation reserves and foreign currency translation reserves), INR60bn of additional Tier 1 and INR55bn of Tier 2 capital (excluding current issuance) over the Basel III transition period (up to FY19). The agency believes the bank will be able to manage its capital requirements given its systemic importance and capital market presence. 

The bank has lost 1.6% of current deposit 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 market share by 0.6%. Average net interest margins have improved marginally (FY15: 2.14%; 3QFY16: 2.16%) on the back of a changing deposit profile, but the improvement has also been partially offset by interest income reversals and lower interest income due to the recognition of some corporate exposures as non-performing (attributed to asset quality review carried out by the Reserve Bank of India in 3QFY16). The bank’s average cost of deposits came down to 7.0% in 3QFY16 from 7.2% in FY15 due to a higher proportion of retail deposits and could see a further 10bp-15bp decline over FY17. 

Given that
Canara’s exposure to the stressed sectors (24% in FY14, 27% in 1HFY16) is higher than most peers’, the bank’s gross NPAs, although lower than peers’, have seen higher additions in 3QFY16. While the bank’s gross NPAs (FY15: 3.9%, 3QFY16: 5.8%) are likely to increase further given stress recognition planned in 4QFY16 based on to asset quality review by the Reserve Bank of India (about 50% is due in 4QFY16), overall impaired assets ratio (FY15: 10.6%, 9MFY16: 11.9%) might remain comparable to peers’ (10%-15% as of 3QFY16). Canara’s loan loss coverage ratio at 34.7% in 3QFY16 is comparable to peers’. 

Ind-Ra had also earlier highlighted that PSBs would remain vulnerable to risks
emanating from highly levered large corporate exposures, of which barely half have been recognised in headline impaired ratios. Consequent to the RBI’s action addressing some of these concerns, the median return on assets of PSBs would barely remain in the positive territory for FY16 with a few of them potentially clocking a loss for the full year. In this context, Ind-Ra expects Canara to report a better operating performance (27bp in RoAA for 9MFY16; FY15: 52bp), helped by its stable net interest margins (2.2% in 3QFY16; 2.4% in FY15) and declining operating costs, which remain in line with the median ratios for similarly rated peers.


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 5,794 branches at 3QFYE16. It is the third-largest government bank by branch network and fifth-largest by the total assets in India. Its total advances and deposits were INR3,319bn and INR4,906bn, respectively, in 3QFY16.  

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 3 compliant Additional Tier 1 bonds: ‘IND AA’
- INR54bn Basel 3 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

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121