Fitch Ratings has downgraded the Viability Rating (VR) of India-based Punjab National Bank (PNB, BBB-/Stable) to 'b' from 'bb-' and maintained it on Rating Watch Negative (RWN). At the same time, the agency has affirmed PNB's Long-Term Issuer Default Rating (IDR) at 'BBB-' and its Support Rating Floor and Support Rating at 'BBB-'and '2', respectively. The Outlook on the IDR is Stable. A full list of rating actions is at the end of this commentary.

PNB's IDR is at its Support Rating Floor of 'BBB-' and reflects our view of the state's high propensity to provide extraordinary support to PNB.

The two-notch downgrade to PNB's VR is a reflection of the significant deterioration in its standalone credit profile, mainly due to a drop in its core capital ratio that was bigger than Fitch's expectation. The deterioration in its core capitalisation was caused by a sharp increase in its non-performing loans (NPLs), including the USD2.2 billion in fraudulent transactions reported in February 2018, and the related increase in credit costs, which resulted in large losses in the financial year ended March 2018 (FY18). The decline also highlights management's weaker execution and previous underwriting and oversight gaps, which the bank has already started taking steps to address.

The RWN reflects our expectations that the pressures, mainly relating to asset quality, earnings and profitability, will persist at least over the next few quarters. This could weaken its already low core capitalisation further unless the bank is able to save or generate capital through intrinsic sources such as non-core asset sales and cost reductions although there is the prospect of the government injecting further capital into the state banks.

PNB's ability to sustain, if not improve, its buffers through sources such as retained earnings, fresh equity raising and stake sales is important for its VR. Fitch will continue to focus on the bank's ability to raise a significant portion of its capital needs-independent of the government - to counter pressures on its asset quality and earnings performance, failing which further action could be taken on the bank's standalone creditworthiness.

Shares of the bank gained Rs 0.3, or 0.36%, to settle at Rs 83.20. The total volume of shares traded was 1,373,142 at the BSE (Monday).