Fitch places PNB on ‘Rating Watch Negative’ with possibility of downgrade

Fitch Ratings has placed Punjab National Bank's (PNB) Viability Rating of 'bb' on Rating Watch Negative (RWN), following the large fraud reported by the bank. The RWN, according to Fitch, reflects the possibility of a downgrade of PNB's Viability Rating following the detection of a $1.8-billion fraud in one of the bank's branches.

Moody’s too has placed the lender under review for downgrade. The agency has a Baa3/P-3 rating on the Delhi-based lender now while it has a Baa3 rating on its foreign currency issuer rating. The bank overall has a Baa2 rating with a stable outlook now from Moody’s.

“Moody's Investors Service has today placed under review for downgrade Punjab National Bank's (PNB) local and foreign currency deposit rating of Baa3/P-3 and foreign currency issuer rating Baa3,” it said in a statement on Tuesday, adding that the likely financial impact of the fraudulent transactions is the key driver for the review.

Fitch observed that while the exact financial impact from this event is still being ascertained, it has raised questions on both internal and external risk controls as well as the quality of management supervision, considering that the fraud went undetected for several years.

Fitch, in a statement, said it will look to resolve the Rating Watch once more clarity emerges on the extent of control failures and the impact on PNB's financial position. In addition, the agency will monitor PNB's full liability, potential recoveries and the extent of additional fresh capital from both internal and external sources (eg government) to determine if the bank's financial position is no longer consistent with the current VR.

At this stage, Fitch does not view this event to have an impact on PNB's Support Rating Floor (BBB-) due to the bank's high systemic importance as the second-largest state-owned bank. "We believe that the state's propensity to provide extraordinary support to PNB remains high, subject to the sovereign's ability, which is captured in India's sovereign rating of 'BBB-'," the credit rating agency said.

Fitch assessed that PNB's asset quality and capital parameters continue to be weak but have shown some stability since its rating action in June 2017. For the nine months of the financial year to December 2018, PNB's non-performing loan (NPL) ratio eased to 12.1 per cent (12.5 per cent FY17), while its CET1 ratio improved to 8.05  per cent (7.9 per cent). "Profitability continued to be weak, but the bank raised Rs 5,000 crore ($770 million) in fresh equity from the capital markets in 3QFY18. PNB is also likely to get an additional Rs 5,400 crore ($850 million) from the government by end-March 2018 under the government's recapitalisation agenda.

"However, this recent fraud event has been a setback for the bank in its reputation and has had a capital market impact," said the agency.

Moody's review

PTI reports: The review for downgrade will focus on: (1) the timing and quantum of the financial impact of the fraudulent transactions, (2) any management actions taken to improve the capitalization profile of the bank, and (3) any punitive actions taken by the regulator on the bank, Moody’s Investor Service said.

It has also placed the bank’s baseline credit assessment (BCA) and adjusted BCA of Ba3 and the counterparty risk assessment (CRA) rating of Baa3(cr)/P-3(cr) under review for downgrade.

“The primary driver for today’s rating action is the risk of weakening standalone credit profile of PNB, as a result of a number of fraudulent transactions” through fake letters of undertakings issued by the bank to other lenders worth USD 1.8 billion over the past many years, Moody’s said.

The scam came out into the open on 14 February 2018, when it informed the stock exchanges.

“These fraudulent transactions represent a contingent liability and the financial impact will be determined by the relevant laws. Nevertheless, we expect PNB will need to provide for at least a substantial portion of the exposure.

“As a result, the bank’s profitability will likely come under pressure, although the actual impact will depend on the timing and quantum of provisions that need to be made, as well as any prospects for recovery,” the agency said.

The fraudulent transactions represent about 230 basis points of the bank’s risk-weighted assets as of December 2017.

As such, its capital position would deteriorate markedly, and fall below minimum regulatory needs, if the bank is required to provide for the entire exposure, it said.

Consequently, PNB may need to raise capital externally, mainly from the government, to comply with the minimum Basel III capital requirement of 8 per cent common equity tier 1 (CET1) ratio by March 2019.

The bank reported a CET1 ratio of 8.05 per cent in the December 2017 quarter. Since the announcement of the fraudulent exposure, PNB’s share price has fallen by about 30 per cent, limiting its access to the equity capital markets.

The discovery of the fraudulent transactions also highlights the weak operational controls and corporate governance at the bank.

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