Fitch Maintains Bank Of Baroda’s VR On Rating Watch Negative On Impending Merger

Fitch Maintains Bank Of Baroda’s VR On Rating Watch Negative On Impending Merger - Sakshi Post

Fitch Ratings-Mumbai: Fitch Ratings has maintained Bank of Baroda's (BOB; BBB-/Stable) Viability Rating (VR) of 'bb' on Rating Watch Negative (RWN) as its proposed merger with two mid-sized Indian state banks, Vijaya Bank and Dena Bank, has yet to be completed.

Fitch expects the proposed merger to come into effect starting April 2019, but it may take another four to six months before the full impact of the merger is visible on BOB's combined financial position.

BOB will be the surviving entity after the merger, becoming India's third-largest bank after State Bank of India (BBB-/Stable/bb+) and HDFC Bank Limited, overtaking Punjab National Bank (BBB-/Stable/b) and ICICI Bank Ltd.

(BBB-/Stable/bbb-) in terms of asset share. Fitch believes the merger will increase BOB's systemic importance and enhance the government's propensity to support the bank, in case of need.

Key Rating Drivers BOB's VR reflects pressure on its capital position from extended financial weakness in terms of non-performing loans (NPL) and earnings despite some recent positive trends.

The RWN on the VR reflects our view that the effects of the merger will be potentially negative in the near term while any benefits from scale, cost and business synergies would be visible only in the medium-to-long term, subject to smooth integration of the banks' businesses.

At the same time, the effect on the combined financials of BOB may not be visible until the first quarter of the financial year ending March 2020 (FY2020) when there may be greater clarity on the additional capital injection the state may provide to the merged entity.

We believe the merged bank will probably have higher levels of non-performing loans and provisioning in the near term, which may in turn pressure BOB's core capitalisation following a decline in 9MFY19.

The bank's common equity Tier 1 ratio fell 40bp to 8.65% in 9MFY19 from the previous quarter after it was required by regulation to allocate INR13 billion in capital to its UK subsidiary.

However, earnings were positive for 9MFY19 with return on assets of 0.26%, supported by a significant decline in credit costs to 76% of pre-provision profits (FY18: 124%).

Asset quality also improved with its gross NPL ratio moderating to 11% in 9MFY19 and loan-loss allowances/impaired loans further improving to 64%. Funding continues to be stable, underpinned by its large franchise and strong government linkage.

Rating Sensitivities Fitch will review the RWN once there is more clarity over the merger and its impact on BOB's financial profile, which will likely be available with 1QFY20 results.

The VR is most sensitive to a weakening in BOB's asset quality and earnings after the merger from the bank's pre-merger financial position. Downside risks to the VR will also increase without a sufficient fresh injection of equity to absorb the impact of the probable increase in NPLs, the higher provisioning requirements and the resultant impact on earnings.

Conversely, Fitch may remove the RWN and affirm the VR if the agency believes BOB's loss-absorption buffers will remain sufficient after the merger, notwithstanding pressures on the bank's financial performance.

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