Oriental Bank of Commerce

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1 Summary of Rated Instruments: Oriental Bank of Commerce May 24, 2018 Instrument Rated Amount(Rs. crore) Rating Outstanding Basel II Compliant Upper Tier II Bonds A+ ; Basel II Compliant Lower Tier II Bonds 1, ; Basel III Compliant Tier II Bonds 3, ; Total 4, Material Event Oriental Bank of Commerce (OBC) announced its Q4 FY2018 and FY2018 results. Results were weak with the bank not maintaining the regulatory capital conservation buffer (CCB) of 1.875%. The results were significantly weaker than expected and ICRA is monitoring the capital raising by the bank and will take appropriate rating action in case the bank reports a capital adequacy ratio (CRAR) below the regulatory levels 1 or maintains CCB below regulatory levels on a consistent basis. ICRA has a rating of (pronounced ICRA double A minus) outstanding for the Rs. 1,200 crore Basel II compliant lower Tier II bonds. ICRA also has a rating of (pronounced ICRA double A minus hybrid) for the Rs. 3,000 crore Basel III compliant Tier II bonds. Further, ICRA has a rating of A+ (pronounced ICRA A plus) for the Rs. 500 crore Basel II compliant upper Tier II bonds. The outlook on all the ratings is Negative. Update OBC reported a loss before tax of Rs. 1,934 crore during Q4 FY2018 and Rs 6,095 crore for FY2018, which is much higher than the capital infusion of Rs. 3,571 crore from the Government of India (GoI) during the year, thereby resulting in erosion in capital ratios. While the capital ratios were above the regulatory minimum levels, i.e. Tier 1 of 7.00% and CRAR of 9.00% excluding CCB, the CCB stood lower at 61 bps as on March 31, 2018 as against the regulatory requirement of 1.875%. ICRA also notes that the bank has availed various regulatory dispensations 2, which, if adjusted, would have further adversely impacted the capital ratios. Given that capital cushions have significantly reduced, continued degrowth in risk-weighted assets (RWAs) and fresh capital raisings will be required to improve the capital position and restore the CCB to the regulatory requirement. In a scenario of a 5-10% decline in risk-weighted assets during FY2019 and the loss guidance given by management for FY2019, ICRA expects that the bank will require sizeable capital of Rs. 5,000 5,500 crore (~ % of its market capitalisation) during FY2019 to achieve a Tier 1 capital ratio (primarily CET-I) of 9.5% including CCB of 2.5%. Further, ability to maintain Tier 1 of 7.00% and, hence, CRAR of 9.0% is critical for servicing of its debt capital instruments 3, while adhering to the covenants for these instruments. The ratings factor in the majority sovereign ownership by the GoI, demonstrated support for capital infusion, the bank s established presence and branch network in North India and satisfactory deposit profile. 1 Tier 1 of 7% or CRAR of 9%, excluding CCB required of 1.875% as on March 31, 2018 and 2.5% as on March 31, The bank has deferred provisions totalling Rs. 733 crore, equivalent to 0.50% of CET 1 and Tier 1 capital (based on risk-weighted assets) as on March 31, Such as Upper Tier II instruments and Tier I instruments issued under Basel II 1

2 Outlook: Negative In ICRA s view, the bank s capital requirements are significant with dependence on capital infusion by the GoI to meet regulatory capital ratios including CCB. Accordingly, the rating may be revised downwards further, if the bank is unable to raise sufficient capital to restore capital ratios above regulatory levels (including CCB). If the bank can raise sufficient capital to offset the impact of expected losses during FY2019 and restore CCB levels to the regulatory minimum, the rating outlook will be made Stable. Key rating drivers Credit strengths Majority sovereign ownership - While OBC s sovereign ownership (GoI shareholding was 77.23% as on March 31, 2018) is a significant positive factor for the ratings, given the bank s large capital requirements in relation to its market capitalisation, the bank will be dependent on timely capital infusion from the GoI while maintaining a minimum GoI shareholding of 52%. Based on our estimates of capital requirement of Rs. 5,000 5,500 crore during FY2019, ~30% of the incremental capital will be required to be infused by the GoI, while the balance can be raised from other sources. However, in case the bank is unable to raise capital from other sources, its dependence on the GoI for capital will increase. Strong franchise in North India, with access to a wide customer base - While gross advances declined to Rs lakh crore as of March 2018 from Rs lakh crore as of March 2017 (YoY decline of ~11%), the degrowth in total advances was largely driven by a decline in interbank participatory certificates (IBPCs) to Rs. 4,428 crore in March 2018 from Rs. 17,686 crore in March Advances to the retail, agriculture and MSME (RAM) sectors increased to Rs. 72,782 crore as of March 2018 from Rs. 71,182 crore as of March Retail (15.79%), agriculture (14.40%) and MSME (18.91%) accounted for 50.62% of gross advances as of March 2018, an improvement from 47.85% as of March Accordingly, corporate credit, as a percentage of total advances, reduced to 49.38% as on March 31, 2018 from 52.15% as of March The growth in the retail sector came from the housing loan, vehicle loan and personal loan segments, which grew 8.62%, 13.51% and 69.09%, respectively, during FY2018. Satisfactory deposit profile - With degrowth in advances and a consequent need to mobilise the reduced quantum of bulk deposits, the bank continues to witness an improvement in its low-cost current account and saving account (CASA) deposits. CASA deposits increased to 31.7% of total deposits as on March 31, 2018 as against 30.5% as on March 31, Despite an improvement, the bank s CASA deposit ratio remains below the public sector banks (PSBs) average of 36-37%. The share of retail term deposits also improved to 45.8% of total deposits, as of March 2018, from 41.8% of total deposits as of March With declining interest rates, reducing bulk deposits and improving CASA, the bank s cost of interestbearing funds reduced to 5.72% during FY2018 (5.69% during Q4 FY2018) from 5.99% during FY2017. However, because of the lower CASA base, the bank s cost of interest-bearing funds remains above the PSB average of ~5.1% during Q3FY2018. Credit challenges Large capital requirements in FY2019 to meet regulatory capital requirements including CCB - OBC s reported capital ratio, i.e. CET1, Tier 1 and CRAR stood at 7.46%, 7.61%, and 10.50%, respectively, as against the minimum regulatory requirements of 7.375%, 8.875% and % (including CCB of 1.875%), respectively, as on March 31, The above ratios, as on March 31, 2018, were after the bank had redeemed its Basel III Tier 1 bonds, aggregating Rs. 3,000 crore, upon the exercise of the regulatory event call option. While the above capital ratios were higher than the minimum capital ratios of 5.5%, 7.00% and 9.00%, respectively, the bank is not maintaining a CCB of 1.875% as per the regulatory requirement for March Further, the capital cushion for breaching regulatory minimum ratios also stands low at 61 bps for Tier 1, which translates into a loss - absorption capacity of ~ Rs. 900 crore. In an event the bank breaches 7% on 2

3 Tier 1, it will not be able to meet the CRAR of 9.00% also, which is critical for servicing its debt capital instruments, while adhering to their covenants. The bank has availed various dispensations which include a) reduced provisioning of 40% (instead of minimum 50%) on accounts referred under the Insolvency and Bankruptcy Code (IBC) 2016, thereby lowering provision requirements by Rs crore though the same will have to be provided for in Q1 FY2019, b) amortisation of mark-to-market losses on the bond portfolio amounting to Rs crore, pursuant to RBI guidelines and c) deferment of gratuity liability of Rs crore after enhancement in gratuity limits. Had the bank not deferred these provisions, aggregating Rs crore, losses would have been higher, and reported CET and Tier 1 would have been lower by 0.50% (based on risk-weighted assets as on March 31, 2018). In a scenario of a 5-10% decline in risk-weighted assets during FY2019 and the loss guidance given by management for FY2019, ICRA expects that the bank will require sizeable capital of Rs. 5,000 5,500 crore (~ % of its market capitalisation) during FY2019 to achieve a Tier 1 capital ratio (primarily CET-I) of 9.5% including CCB of 2.5%. In an event of the bank being unable to raise capital and reporting a CRAR below the regulatory minimum of 9.0%, it will be a rating negative. Additionally, in case the bank does raise adequate capital and maintains the CCB below regulatory levels on a sustained basis, this will also be a rating negative. Weak asset quality and consequently weak solvency profile; fresh slippages to remain high during FY2019, recoveries upon resolution of stressed accounts to drive asset quality and further provisioning -Asset quality indicators remain weak with gross NPAs (GNPAs) at 17.63% as of March 2018 (16.95% in December 2018 and 13.73% in Q4FY2017). Net NPAs (NNPAs) also increased to 10.48% in Q4 FY2018 (9.52% in Q3 FY2018 and 8.96% in Q4 FY17). Standard restructured advances declined to 0.60% of standard advances as of March 2018 as against 4.05% as of March 2017, reflecting the majority of the slippages coming from the standard restructured book. OBC s GNPAs and NNPAs are much higher than PSBs averages, which also resulted in the bank being placed under the RBI s prompt corrective action (PCA) framework in October The provision cover against NNPAs also stands low at ~45% (64.07% including technical write offs) as of March 2018, implying elevated credit provisioning during FY2019 as well. The accounts under special mention category 4, SMA1 and SMA2 stand at Rs. 2,500 crore (2.05% of standard advances) and Rs. 4,500 crore (3.69% of standard advances), respectively, which can be a potential source of additional slippages. Management has guided towards fresh slippages of ~Rs. 7,000 crore during FY2019, which is high and will continue to result in weak asset quality. OBC has exposure to 25 accounts referred under (IBC), totalling Rs. 7,807 crore, against which the bank has provisions of ~61%. Overall exposure to cases filed under IBC stands at Rs. 12,290 crore with high provision cover of 69%. Given the quantum and provisions held by the bank against the cases being resolved under IBC, recoveries upon resolution can be a key driver for reduction in NPA levels as well as some recoveries and reduction in future provisioning requirements. Weak profitability profile with a likelihood of losses in FY2019 as well - The bank has reported losses for the last two consecutive years with a net loss of Rs. 5,872 crore in FY2018 and Rs. 1,094 crore in FY2017. With the decrease in total advances and lower earning assets, NIM, as a percentage of average total assets (ATA), declined to 1.87% in FY2018 from 2.01% during FY2017. OBC S NII decreased on a YoY basis by 8.12% to Rs. 4,511 crore during FY2018. Even though operating costs remained steady during FY2018, a decline in NII resulted in a decline in core operating profits (before treasury income and provisions) to Rs. 2,482 crore in FY2018 from Rs. 2,763 crore in FY2017. The core operating profit is much weaker than that of peers at 1.03% of ATA during FY2018 as against 1.13% during FY2018 because of lower NIMs (in turn because of higher cost of interest-bearing funds) as well as lower non-interest income. Increase in bond yields also resulted in a decline in treasury income (net of MTM provisions) on the bond portfolio to Rs. 518 crore (0.22% of ATA) during FY2018 compared to Rs. 1,281 crore (0.53% of ATA) during FY2017. Credit provisions surged to Rs. 9,112 crore (3.77% of ATA) during FY2018 from Rs. 6,019 crore (2.47% of ATA) during FY2017 because of aging of NPAs as well as elevated provisioning requirements 4 SMA1 is accounts overdue by days and SMA 2 is accounts overdue by days 3

4 on IBC accounts. With credit provisioning far exceeding operating profits and treasury income, the bank reported a loss before tax of Rs. 6,095 crore (-2.52% of ATA) during FY2018 as against Rs. 1,523 crore (-0.62% of ATA) during FY2017. Going forward, management has guided towards credit provisions of ~4-5% of advances during FY2019, which will remain above the bank s core operating profits. The rising bond yields are unlikely to add to the bank s core operating profits during FY2019 and, hence, the bank is expected to report losses during FY2019 as well. Analytical Approach: For arriving at the ratings, ICRA has applied its rating methodologies as indicated below. Links to applicable criteria: ICRA Rating Methodology for Banks The previous rating rationale is available on the following link: Click here About the company: Oriental Bank of Commerce (OBC) is owned 77.23% by the Government of India (GoI) and operates primarily in northern India. The bank had a network of 2,389 branches, as on March 31, 2018, with ~50% of the branches located in rural and semi-urban areas. OBC reported a net loss of Rs. 5,872 crore during FY2018 on an asset base of Rs. 231,939 crore vis- à - vis a net loss of Rs. 1,094 crore during FY2017 on an asset base of Rs. 251,616 crore. During Q4 FY2018, the bank reported a net loss of Rs. 1,650 crore against a net loss of Rs. 1,218 crore during Q4 FY2017. As on March 31, 2018, the bank reported gross NPA of 17.63% and net NPA of 10.48%. Its Tier 1 and CRAR, as on March 31, 2018, stood at 7.61% and 10.50%, respectively. Key financial indicators (audited) (standalone) FY 2017 FY 2018 Q4FY 2017 Q4FY 2018 Net Interest Income 4,910 4,511 1,307 1,095 Profit before tax -1,523-6,095-1,824-1,934 Profit after tax -1,094-5,872-1,218-1,650 Net advances 157, , , ,368 Total assets (excluding revaluation reserves) 251, , , ,939 % CET % 7.46% 7.59% 7.46% % Tier % 7.61% 8.88% 7.61% % CRAR 11.64% 10.50% 11.64% 10.50% % Net Interest Margin / Average total assets 2.01% 1.87% 2.13% 1.86% % Net Profit / Average total assets -0.45% -2.43% -1.98% -2.80% % Return on Net Worth -8.39% % % % % Gross NPAs 13.73% 17.63% 13.73% 17.63% % Net NPAs 8.96% 10.48% 8.96% 10.48% % Provision coverage excl. technical write offs 38.24% 45.35% 38.24% 45.35% % Net NPA/ Net worth % % % % Amounts in Rs. Crore; Figures as per ICRA Research Net worth and total assets excludes revaluation reserves Source: Oriental Bank of Commerce; ICRA research 4

5 Status of non-cooperation with previous CRA: Not applicable Any other information: None Rating history for last three years: Instru ment Basel III compli ant Tier II Bonds Basel II Lower Tier II Bonds Basel II Upper Tier II Bonds Ty pe Lo ng Ter m Lo ng Ter m Lo ng Ter m Current Rating (FY2019) Amoun Amou t nt Outsta Date & Rating Rated nding (Rs. (Rs crore) Crore) May * Out standing Out standing A+ Out standing Date & Rating in FY2018 Apr 2018 A+ Aug 2017 A+ May 2017 ti ti A+ ti Jan 2017 Date & Rating in FY2017 ti ti ti Sep 2016 Chronology of Rating History for the past 3 years ti ti ti Jun 2016 bl e) bl e) bl e) Date & Rating in FY2016 Feb (hyb ) Jan (hyb ) + *Bank raised only Rs. 1,025 crore against rated amount of Rs. 1,200 crore Complexity level of the rated instrument: ICRA has classified various instruments based on their complexity as "Simple", "Complex" and "Highly Complex". The classification of instruments according to their complexity levels is available on the website 5

6 Annexure-1: Instrument Details ISIN No INE141A08019 Instrument Name Date of Issuance / Sanction Coupon Rate Maturity Date Amount Rated (Rs. crore) Basel III Compliant Tier II Bonds Programme 27-Oct % 27-Oct , Current Rating and Outlook INE141A08035 INE141A08043 Basel III Compliant Tier II Bonds Programme 26-Oct % 26-Oct , Basel III Compliant Tier II Bonds Programme 24-Jun % 24-Jun , INE141A09132 Lower Tier II Bonds Programme 30-Nov % 30-Nov , INE141A09090 Upper Tier II Bonds Programme 12-Feb % 12-Feb A+ - Lower Tier II Bonds Programme Yet to be issued Source: OBC 6

7 ANALYST CONTACTS Karthik Srinivasan Shashank Singh Anil Gupta Niraj Jalan RELATIONSHIP CONTACT L. Shivakumar MEDIA AND PUBLIC RELATIONS CONTACT Ms. Naznin Prodhani Tel: Helpline for business queries: (open Monday to Friday, from 9:30 am to 6 pm) info@icraindia.com About ICRA Limited: ICRA Limited was set up in 1991 by leading financial/investment institutions, commercial banks and financial services companies as an independent and professional investment Information and Credit Rating Agency. Today, ICRA and its subsidiaries together form the ICRA Group of Companies (Group ICRA). ICRA is a Public Limited Company, with its shares listed on the Bombay Stock Exchange and the National Stock Exchange. The international Credit Rating Agency Moody s Investors Service is ICRA s largest shareholder. For more information, visit 7

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