Standard & Poor (S&P)'s Ratings Services lowered its long-term issuer credit rating on India-based Indian Overseas Bank (IOB) to 'BB+' from 'BBB-'. The outlook is stable. "At the same time, we lowered our short-term rating on the bank to 'B' from 'A-3'. We also lowered our issue ratings on IOB's senior unsecured debt to 'BB+' from 'BBB-'."

''We downgraded IOB following a recent deterioration in the bank's asset quality and our expectation that it will remain weak over the next 12 months. We revised our assessment of the bank's risk position to 'weak' from 'moderate,' as our criteria define those terms. Accordingly, we lowered the bank's stand-alone credit profile (SACP) to 'bb' from 'bb+','' said S&P.

The rating continues to reflect IOB's 'adequate' business position, 'moderate' capital and earnings, 'above average' funding, and "strong" liquidity, as our criteria define those terms. We still see a 'very high' likelihood that the government of India will provide timely and sufficient extraordinary support if the bank comes under financial distress.

''We expect IOB's credit costs to remain high because of the bank's weak asset quality,'' said Standard & Poor's credit analyst Amit Pandey. ''We believe that it could be another two quarters before the pace of creation of stressed assets starts receding for the industry as a whole and IOB in particular. In our view, IOB's aggressive growth over the past several years has stressed its internal control system.''

Moreover, IOB's focus on the corporate segment brings in some concentration in that segment. The bank's exposure to high-risk sectors, such as iron and steel and textiles, is also greater than peers'. The bank's reported nonperforming loan ratio rose sharply to 7.3% as of Sept. 30, 2014, from 5% as of March 31, 2014, to become the highest among the Indian banks that we rate. The share of gross standard restructured loans outstanding in IOB's loan book is also high at 7.85%.

''We expect IOB's earnings to remain under pressure because of high credit costs. The bank's mediocre internal capital generation is unlikely to support its moderate loan growth. IOB relies on large capital infusion on an ongoing basis to support its growth owing to its low retained earnings. We anticipate that new capital from the government or the capital markets will keep IOB's risk-adjusted capital (RAC) ratio (pre-diversification) under Standard & Poor's framework above 5% over the next 12-18 months; the ratio was 5.6% as of March 31, 2014. However, we could lower our forecast RAC ratio if the economic risk in India increases because we calibrate risk weights to the underlying economic risk in a country. This may negatively affect our assessment of capital and earnings.''

IOB's business position reflects the bank's adequate domestic business franchise, and satisfactory business and geographic diversification. IOB's stable funding ratio of 126% underpins its funding profile.

''The stable outlook reflects our expectation that IOB will continue to benefit from a very high likelihood of government support,'' said Pandey. Therefore, a weakening in IOB's SACP may not result in a lower rating. For IOB to be downgraded because of a weaker SACP, the SACP must be lowered by two notches to 'b+', a scenario which we view as unlikely in the next 12 months.

We could lower IOB's SACP to 'bb-' from 'bb' if: (1) the bank's funding profile deteriorates; or (2) the RAC ratio declines to below 5%, which could happen if IOB can't raise sufficient capital to support its growth or the economic risk in India rises.

We could upgrade the bank if its risk management improves, and its asset quality improves sharply and is more in line with that of the industry.

Shares of the bank declined Rs 1.3, or 2.16%, to trade at Rs 58.80. The total volume of shares traded was 169,783 at the BSE (11.17 a.m., Wednesday).