Fitch places India's Federal Bank on watch negative on possible merger with Catholic Syrian Bank

24 September 2009: Fitch Ratings has today placed on Rating Watch Negative (RWN) India's The Federal Bank Limited's (FBL) 'AA-(ind)' National Long-term rating and the 'AA-(ind)' rating of its INR6bn subordinated Lower Tier 2 debt programme. At the same time, the agency has placed on Rating Watch Positive Catholic Syrian Bank Ltd's (CSB) 'BBB(ind)' National Long-term rating and the 'BBB(ind)' rating of its INR400m subordinated Lower Tier 2 debt programme. The rating actions follow FBL's announcement that it has commenced financial due diligence of CSB for a merger consideration. The merger is subject to shareholders and regulatory approval. A list of the banks' other ratings are at the end of this release.

The RWN reflects likely deterioration in FBL's credit profile consequent to the merger as CSB's financials remain considerably weaker. Fitch downgraded CSB's National Long-term ratings to 'BBB(ind)' from 'BBB+(ind)' and assigned a Negative Outlook in May (for more information please refer to "Fitch Downgrades Catholic Syrian Bank's National Long-term Rating to 'BBB(ind)', Outlook Negative" published on 26 May 2009). The merger would improve FBL's existing branch network, help it consolidate its good franchise in the state of Kerala and possibly help the banks develop cost and efficiency synergies in the long-term; in the short-term maintaining good asset quality would remain the primary concern for the merged bank. Given CSB's regional concentration, small franchise and high exposure to the vulnerable textile sector (FY09: 11% of gross loans) its asset quality could deteriorate further (FY09 gross NPLs increased to 4.6%; FY08: 3.9%) amidst the challenging operating environment. Likewise, Fitch remains concerned about FBL's asset quality given its regional concentration; in Q110 45% of loans were sourced from Kerala, an economy with higher reliance on inward remittances from the Gulf countries.

The RWN on FBL's ratings would be resolved once it completes the first phase of the integration process and will also be dependent on long-term benefits of the merger becoming more clear. Given CSB's small size (its total assets were about a fifth of FBL's total assets at FY09) and FBL's healthy Tier 1 ratio (Q110: 17.5% and among the best for Indian banks), as such, deterioration in FBL's credit profile appears to be moderate; indeed, if the asset quality outlook improves FBL's rating could be affirmed at 'AA-(ind)' and assigned a Stable Outlook.

FBL was established in Kerala in 1931 and while it is one of the larger 'old' private banks, more than half of its 622 branches and deposits are sourced from its home state. FBL was the first 'old' private bank to raise equity from the international market and the bank's global depository receipts are listed on the London Stock Exchange.

CSB is an "old private" bank set up in 1920 in Kerala by members of the local community. Over 80% of CSB's 375 branches as well as the bulk of its deposits and loans are concentrated in the two southern states of Kerala and Tamil Nadu.

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