MOODY’S Investors Service, a United States-based leading provider of credit ratings, research, and risk analysis has downgraded Mauritius Commercial Bank Ltd’s long-term and short-term deposit ratings to Baa3/Prime-3 from Baa1/Prime-2.
Concurrently, Moody’s lowered the bank’s baseline credit assessment (BCA) to ba1 from baa3 within the D+ standalone bank financial strength rating (BFSR) category.
All ratings placed on review for further downgrade.
The downgrade of Mauritius Commercial Bank’s ratings is driven by: the decline in its core capitalisation, following a group restructuring,which has reduced the bank’s loss absorption capacity and raised single-borrower concentrations; the recent weakening in asset quality, which is also pressuring the bank’s profitability through higher provisioning expenses; and a moderation of Moody’s government support assumptions incorporating the insights gained from the global financial crisis and a recognition of the still large size of the bank relative to the balance sheet of the government, despite recent regulatory measures to ring fence the bank’s non-bank and international subsidiaries.
The review will focus on a forward-looking assessment of further downward pressure on asset quality, profitability, and capital, including an assessment of risks relating to large-single borrower concentrations and cross-border operations.
A full list of affected ratings is provided at the end of this press release.
RATINGS RATIONALE –REDUCED CAPITAL BUFFERS AND INCREASED CONCENTRATION LEVELS The primary driver of the downgrade is the weakening of Mauritius Commercial Bank’s core capital buffers available to protect against losses.
Following the group’s restructuring, which involves the transfer of non-banking and foreign banking subsidiaries to a new holding company, Mauritius Commercial Bank’s consolidated Tier 1 ratio declined to 11% as at June 2014 from 13% reported as at June 2013. Furthermore, and despite the bank recently raising Tier 2 capital, Moody’s expects some additional downward pressure on capital as the bank continues to complete its restructuring, with the final post-restructuring capital level dependent on the timing of the transfer of remaining operations.
Single-borrower concentrations have also increased significantly both in absolute terms and relative to Tier 1 capital. Moody’s estimates that post-restructuring top 15 exposures (funded and unfunded) have grown to around 3.4x Tier 1 capital as of June 2014, from around 2.3x as at June 2013.
Although these exposures remain diversified across economic sectors, Moody’s expects they will continue to render the bank vulnerable to downside risks in the event of default of one of the large corporates.
–WEAKENING ASSET QUALITY LEADING TO HIGHER PROVISIONING REQUIREMENTS
The second driver of the downgrade is the deterioration in Mauritius Commercial Bank’s asset quality in the fiscal year ended June 2014 (FYE2014), with the volume of non-performing loans (NPLs) (excluding bank exposures) increasing to 7.3% of loans as at end-June 2014, compared to 5.1% in June 2013 and 3.5% in June 2011.
The weakening in asset quality is primarily driven by the default of a few large Indian corporate exposures in Mauritius Commercial Bank’s off-shore lending business, which remains within the restructured entity (i.e. cross-border business carried out by the bank from Mauritius). As a result of the increase in the volume of NPLs, Mauritius Commercial Bank’s provisioning requirements rose significantly and are also pressuring the bank’s profitability metrics, with return on average assets declining to 1.8% in FYE2014 from 2.1% reported in FYE2013.
Moody’s considers that the bank will need to continue to build its provisioning coverage, with loan loss reserves estimated at a low 55% of problem loans as at end-June 2014, which will exert further pressure on net profitability.
Despite the collateral held against the problem loans, Moody’s considers that raising the provisioning coverage is particularly important as the bank’s cross-border operations are to jurisdictions characterised by weak institutional frameworks and slow recovery procedures.
–MODERATION OF SYSTEMIC SUPPORT CONSIDERATIONS
The third driver of the downgrade reflects a moderation of Moody’s government support assumptions. Although Moody’s continues to view the probability of government support for Mauritius Commercial Bank to be high — based on the bank’s systemic importance and dominance in the domestic system — the rating agency has moderated its assumptions, resulting in one notch of uplift from the standalone rating, compared to two notches previously.
The moderation reflects the insights gained from the global financial crisis, which have illustrated how governments — in line with global regulatory trends — are increasingly employing market solutions in the provision of support to troubled banks, particularly when systemic banking crises coincide with periods of challenging macro-economic conditions.
This is particularly relevant for the Mauritian banks, given the large size of the domestic banks in relation to the balance sheet of the government and the strong correlation between the government’s finances and performance of these banks.
Although Moody’s recognises that the amendments to the Banking Act in 2013, leading to the restructuring and the ring-fencing of the large domestic banks, will limit contagion risks from non-bank operations and partially reduce risks from overseas (through subsidiaries), they also highlight the challenges authorities would face in supporting large domestic banks in a stress scenario.
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