Moody's Investors Service has downgraded State Bank of India 's (SBI) bank financial strength rating (BFSR), or stand-alone rating, to D+ from C-

[alok agarwal]

Moody's Investors Service has downgraded  State Bank of India 's (SBI) bank financial strength rating (BFSR), or  stand-alone rating, to D+ from C-. The revised rating maps to a baseline  credit assessment (BCA) of Baa3.
Immediately, SBI tanked 4% as investors panicked at the downgradation.

Ratings Rationale: Moody's report

"The rating action considers SBI's capital situation and deteriorating  asset quality. Our expectations that non-performing assets (NPA) are  likely to continue rising in the near term -- due to higher interest  rates and a slower economy -- have caused us to adopt a negative view on  SBI's creditworthiness," says Beatrice Woo, Moody's Vice President and  Senior Credit Officer.

SBI reported a Tier 1 capital ratio of 7.60% as of 30 June 2011. The
level pushes the bank into a lower rating band. In addition, it was below
the 8% Tier 1 ratio that the government of India has committed to  maintaining in public sector banks (PSB) and substantially lower than  those of other C- rated Indian banks. The latter include banks such as  Axis Bank (Ba1; C-/Baa2; stable), HDFC Bank (Ba1; C-/Baa2; stable), and  ICICI Bank (Ba1; C-/Baa2; stable).

Finally, such a level for its Tier 1 capital ratio provides an  insufficient cushion to support growth and to absorb potentially higher credit costs from its deteriorating asset quality.

"Notwithstanding our expectations that SBI's capital ratios will soon be  restored through a capital infusion by the government, SBI's efforts to secure this capital for the better part of the year demonstrates the  bank's limited ability to manage its capital," says Woo.

"And given that a bank's ability to freely access the capital markets is an important rating criterion globally, we therefore believe a lower BFSR  for SBI is warranted, especially as these circumstances are likely to  recur," says Woo.

As SBI, similar to other PSB in India, will face cyclical swings in its  Tier 1 ratio over a 3-year period, we have rated it through the cycle  assuming an average Tier 1 capital ratio of 8.5%.

The INR230 billion rights issue that SBI is currently seeking would raise  its Tier 1 ratio to approximately 9.30%. However, we estimate that  capital deployed for loan growth, assuming 15% per annum for the next  three fiscal years, will cause the Tier 1 ratio to fall below 8%, thereby  necessitating another capital exercise.

On the asset quality front, the bank's NPA, as of 30 June 2011, reached a
3-year high of 3.52% of loans and INR277,680 million on a absolute basis.

For the system, the ratio was 2.3% as of 31 March 2011.

Against a backdrop of a slowing economy and higher interest rates, the  rising trend evident in SBI's new NPA formation rate since 3QFY11 will
continue.

Therefore, Moody's expects SBI's potential credit costs will be relatively high in the near-term. NPA -- as a percentage of the bank's Tier 1 capital ratio -- is now about 43%.  In determining SBI's stand-alone BFSR, Moody's assessed the bank's  capital after incorporating expected losses in its risk assets using  scenario analysis.