Axis Bank Limited: [ICRA]AA+ (Stable) assigned to Basel III Tier I bonds; ratings reaffirmed

Axis Bank Limited’s (Axis Bank) ratings are supported by its strong position in the Indian financial system by virtue of being the third-largest private sector bank with a 6.2% share in advances and a 5.1% share in the deposits of the banking system. Further, the overall capitalisation levels remain comfortable, while internal capital generation witnessed a steady improvement with the gradual decline in pressure on the asset quality and credit costs. Additionally, Axis Bank continues to operate with large floating/prudent provisions. This, coupled with the provision coverage ratio (PCR; excluding technical write-offs) of ~77% as on June 30, 2022, provides sufficient cushion to absorb unforeseen asset quality shocks and to support the improvement seen in the internal capital generation.

Axis Bank ICRA ratings upgrade

The gross slippage rate remained relatively high in the retail segment during FY2021-FY2022, but witnessed a gradual moderation in Q1 FY2023. The headline asset quality metrics continued on an improving trajectory, supported by strong recoveries and upgrades. Incrementally, the overall standard restructured book at 0.5% and the book rated BB & below stood at 1.2% of standard advances as on June 30, 2022 could remain a source of future stress, although the same remains at a manageable level. However, the recent weakening in macroeconomic factors, including the sharp rise in input and commodity prices and its associated impact on a wider set of customers and their servicing abilities, will remain a monitorable. Nevertheless, the overall asset quality metrics are expected to remain at much better levels compared to the weaker levels seen in past years.

Axis Bank’s assigned ratings also factor in the strong liability profile, with a steady increase in granularity, which is reflected in the high share of retail term deposits (RTDs) and current account and savings account (CASA) deposits in total deposits. Going forward, the ability to sustain the improvement in the granularity of the deposit base and deposit costs will remain critical for further improvement in the operating profitability level while pursuing growth.

The Stable outlook on the ratings reflects ICRA’s view that Axis Bank will continue to maintain its strong position in the Indian banking sector while sustaining the improvement in its solvency position. Although the capitalisation profile is likely to moderate from the current levels upon the acquisition of Citibank’s Indian consumer business, the capital cushions above the regulatory levels are expected to remain well above the negative rating triggers. The improvement in internal capital generation is also expected to support the growth, which will also aid the capitalisation profile.

ICRA has withdrawn the rating assigned to the Rs. 1,925-crore Basel II Lower Tier II bonds and Rs. 7,000-crore Basel III Tier I bonds as these are fully redeemed and no amount is outstanding against the rated instrument. The rating was withdrawn in accordance with ICRA’s policy on withdrawal and suspension.

Key rating drivers and their description

Credit strengths

Strong position in financial services industry supports the share of granular assets – Axis Bank is the third-largest private bank and the seventh-largest bank in the overall Indian banking sector, with the share of advances witnessing a steady rise in banking sector credit to 6.2% as on March 31, 2022 (against 6.1% as on March 31, 2021, 5.9% as on March 31, 2020 and 5.4% as on March 31, 2019). Furthermore, Axis Bank through its subsidiaries, namely Axis Capital Limited, Axis Asset Management Company Limited, Axis Finance Limited and Axis Securities Limited, offers various financial services across investment banking, asset management, securities broking and lending. It has also expanded its foothold in the insurance distribution business following the Group’s ~13% stake acquisition in Max Life Insurance Company Limited, with the option to acquire an additional ~7% stake in the future.

Axis Bank’s net advances witnessed a strong pickup in growth over the past few quarters with a year-on-year (YoY) growth between 14% and 15%. This supported the growth in net advances to Rs. 7.01 lakh crore as on June 30, 2022. The growth momentum was largely driven by the granular retail book, which continued to grow at a comparatively higher pace of ~25% YoY as on June 30, 2022. Going forward, ICRA expects the bank to remain focused on growing its granular retail book, which will support an improvement in its profitability metrics as well.

Capital cushions expected to remain strong even on conclusion of planned purchase of Citibank’s Indian consumer business – Axis Bank’s capitalisation profile remains strong with CET I, Tier I and CRAR (as a percentage of risk-weighted assets) at 14.6%, 15.2% and 17.3%, respectively, as on June 30, 2022 against 15.4%, 16.5% and 19.1%, respectively, as on March 31, 2021. The capital position was strengthened by equity capital raises, totalling ~Rs. 33,700 crore over FY2018-FY2021. Additionally, Axis Bank raised dollar denominated additional Tier I (AT-I) bonds amounting to USD 600 million (~Rs. 4,400 crore) in FY2022, which led to an increase in its Tier I capital. The meaningfully large capital raise in recent years has helped widen the capital cushions, which helped offset the impact of weak internal capital generation due to elevated credit costs.

Furthermore, ICRA notes that the bank is likely to recognise the consideration paid for the acquisition of Citibank’s Indian consumer business as goodwill and write off the same when the acquisition is completed. This would lead to a moderation in the capitalisation levels as well as the capital charge representing the risk-adjusted value of the assets acquired by the bank. In ICRA’s view, despite the one-time impact of the acquisition, the overall capital cushions above the regulatory levels are expected to remain better than our negative rating trigger of 4%. Moreover, given the expectation of a continued improvement in the profitability, the internal capital generation will support the near-to-medium-term growth, although Axis Bank may consider raising growth capital over the medium term.

Steady growth in granular deposit base, although cost of interest-bearing funds remains higher than peer banks – The bank’s overall deposit base grew by a strong 13% YoY to Rs. 8.03 lakh crore as on June 30, 2022. This was driven by the ~14% YoY growth in the lower-cost CASA deposits, while term deposits grew by ~11% YoY during this period. Accordingly, CASA/total deposits stood at 43.7%, which remains higher than the private sector average, although it remains lower than the >50% levels seen in the past. Nevertheless, the bank continues to steadily grow its granular RTD base, which accounted for ~63% of the total term deposits as on June 30, 2022 (~71% as on March 31, 2021). Together, CASA and RTD dominate the deposit profile at ~79% of the total deposits, which, to an extent, helped narrow the asset-liability gaps for the bank over time.

However, Axis Bank’s interest rate proposition remains relatively higher than peer banks, resulting in a relatively higher cost of interest-bearing funds for the bank compared to peer private sector banks. While the cost of interest-bearing funds moderated to 3.77% in Q1 FY2023 (3.71% in FY2022 and 4.22% in FY2021), it is likely to rise as interest rates go up. Going forward, the bank’s ability to achieve stronger growth while maintaining or improving the cost differential will remain key for supporting an improvement in its operating profitability.

Earnings profile continues to improve; sizeable floating/prudent provisions provide cushion to profitability – While net interest margin (NIM)/average total assets remained steady at 3.06% in FY2022 (3.06% in FY2021 and 2.94% in FY2020), it improved to 3.23% in Q1 FY2023 largely led by the expansion in spreads. As the impact of the Covid-19 pandemic subsided and the growth momentum improved, non-interest income also witnessed an improvement, although this was offset by the sharper rise in the overall operating expense level as the bank continues to grow its franchise. As a result, the operating profitability remained between 2.1% and 2.3% over FY2021-Q1 FY2023. While elevated credit costs had weighed down the return on assets (RoA) in the past, it improved steadily to 1.2% in FY2022 (0.7% in FY2021) and further to 1.4% in Q1 FY2023 despite the mark-to-market (MTM) losses on the investment book. Furthermore, the bank continues to hold floating/prudent provisions, excluding standard asset provisions and including provision on restructured assets of ~Rs. 6,200 crore or 0.9% of standard assets as June 30, 2022. This is expected to provide cushion against unforeseen asset quality pressures while providing support for continued improvement in the RoA. Going forward, ICRA expects the bank to maintain RoA >1.0%, which shall be sufficient for the growth capital requirements over the medium term.

Credit challenges

Tail risk of Covid-19 and impact of macroeconomic factors on asset quality remain monitorable – The gross fresh nonperforming advances (NPA) generation rate moderated to 2.1% (annualised) in Q1 FY2023 from 2.9-3.3% in FY2021-FY2022, and was meaningfully lower than the levels seen prior to the onset of the pandemic. Further, slippages have largely been from the retail segment, as these segments were relatively more severely impacted by Covid-19, while lumpy slippages in the corporate book remained limited in relation to earlier levels. Led by lower slippages as well as strong recoveries and upgrades, the gross NPA% and net NPA% improved to 2.9% and 0.7%, respectively, as on June 30, 2022 (4.1% and 1.3%, respectively, as on June 30, 2021). Axis Bank’s overall restructured book remains manageable (1.2% of standard advances), while the corporate book rated BB and below (excluding restructured accounts; 1.2% of standard advances) could remain a potential source of near-to-medium-term stress although it is expected to be manageable for the bank, considering the healthy operating profitability and sizeable prudent provisions. Going forward, the impact of various macroeconomic factors, including rising input and commodity prices, which could pressurise the servicing abilities of certain vulnerable borrowers will remain a monitorable.

Liquidity position: Strong

Axis Bank’s liquidity remains strong with the daily average liquidity coverage ratio (LCR) at 117% in Q1 FY2023 against the regulatory requirement of 100%. Besides this, the bank’s reported net stable funding ratio (NSFR) stood at 134% in Q1 FY2023, above the regulatory ask of 100%. Further, it reported excess statutory liquidity ratio (SLR) holding of ~Rs. 76,000 crore, translating into 9% of net demand and time liabilities above the regulatory requirement of 18%. The excess SLR holding above the regulatory levels can be utilised to avail liquidity support from the Reserve Bank of India (RBI; through reverse repo) apart from the marginal standing facility of the RBI in case of urgent liquidity requirement.

Rating sensitivities

Positive factors –Not applicable as all the ratings are at the highest possible levels

Negative factors – ICRA could assign a Negative outlook or downgrade the ratings if there is a material weakening in the bank’s liability franchise, thereby impacting its resource profile. This apart, a deterioration in the asset quality or capital position, leading to the weakening of the solvency profile with net NPA/core capital of >15% on a sustained basis, could be a negative trigger. Further, a sustained RoA <1.0% and/or a fall in the capital cushions over the regulatory levels, to less than 4% at the CET I level, on a sustained basis will remain negative triggers. Additionally, the weakening the distributable reserves eligible for the coupon payment on the AT-I bonds will be a negative trigger for the rating for these bonds.