Fitch Ratings has affirmed the African Development Bank’s (AfDB) Long-Term Issuer Default Rating (IDR) at ‘AAA’ with a Stable Outlook and Short- Term IDR at ‘F1+’. A full list of rating actions is at the end of this rating action commentary.
Key Rating Drivers
The ‘AAA’ rating primarily reflects extraordinary support from AfDB’s shareholders, assessed by Fitch at ‘aaa’, which provides a three-notch uplift over the bank’s intrinsic rating.
AfDB enjoys strong support from its 80 member states, which include 26 non-African countries with high average ratings. Callable capital subscribed by member states rated ‘AAA’, the largest of which are the US, Germany and Canada, accounts for 21% of the total. This fully covered the
bank’s net debt at end-2016, underpinning the ‘aaa’ assessment of shareholders’ capacity to support. The strong propensity of member states to support the bank in case of need is illustrated by on- going capital increases and the bank’s important role in the region’s financing.
Fitch notes that fast growth in lending in the last two years has translated into a rapid increase in AfDB’s indebtedness. Management has indicated that if there is no clear evidence of a capital increase within the next two years, it will curb lending growth to preserve the bank’s solvency metrics. However, if no capital increase is approved by 2019, debt will not be fully covered by callable capital from ‘AAA’ rated countries. This would place substantial pressure on Fitch’s assessment of extraordinary support and, hence on AfDB’s IDR.
Fitch assesses AfDB’s solvency at ‘aa’. AfDB’s capitalisation is strong, but declining, as a result of the rapid growth in lending. Additionally, internal capital generation has been affected by the negative impact of low interest rates on the pension scheme and high relocation costs in Abidjan. The bank’s equity-to-asset ratio decreased to 23% in 2016 from 27% in 2015, and based on the current trend, is projected to decline further in the coming years, although AfDB is still receiving annual instalments from its 2010 capital increase.
We deem AfDB’s overall exposure to risks as low. Since 2015 it has benefited from the marked improvement in risk concentration, driven by the introduction of Exposure Exchange Agreements (EEAs) with the World Bank and the Inter-American Development Bank. As a result, the share of the five largest exposures has decreased to 36% of the banking portfolio in 2016, from 56% in 2014.
The relatively high risk profile of borrowers is mitigated by the preferred creditor status (PCS) that the bank enjoys on its sovereign exposures, notwithstanding some past experience of default on those exposures. However, the bank’s rapid growth in private sector financing (24.5% of total exposure in 2016) is clearly affecting its asset quality, as private sector loans are not covered by PCS and have a high and rising impairment rate (9.2% in 2016).
Asset quality is also affected by the 2014 change in credit policy which has allowed the bank to extend loans to poor countries eligible for concessional lending. In addition, AfDB has significant exposure to oil-exporting countries affected by the drop in prices, in particular Angola (B/ Negative), and to Northern African countries whose credit quality is under pressure, such as Egypt (B/Stable). In Fitch’s opinion, the pressure on borrowers’ risk profiles will translate into a decrease
in the average rating of loans, currently ‘BB’, and an increase in the impaired loans ratio over the medium term.
Fitch assesses AfDB’s liquidity at ‘aaa’. This reflects excellent coverage of short-term debt by liquid assets (2.9x). However, Fitch notes that the share of the portfolio invested in securities or bank placements rated ‘AA-‘ or above (83% in 2016) is declining, although their quality is still assessed at excellent. Fitch understands that management intends to rebalance the treasury assets portfolio in order to increase the proportion of assets rated ‘AA-‘ or above. This would help underpin Fitch’s assessment of the strength of extraordinary support, given the relevance of liquid assets’ quality to the net debt calculation.
The -1 notch adjustment to AfDB’s solvency stemming from our assessment of its business environment reflects the high risk operating environment in which the bank operates. The majority of African countries are classified as low income by the World Bank. The average income per capita and average rating of member states are the lowest of all regional MDBs, and they are subject to an overall high level of political risk. This largely offsets the high quality of the bank’s governance and management as well as operational support from member states.
Rating Sensitivities
The Outlook is Stable. The main factors that could, individually or collectively, lead to negative rating action are as follows:
– Coverage of net debt by callable capital from member states rated ‘AAA’ falling below 100% as a result of an increase in gross debt or a reduction in the proportion of liquid assets rated ‘AA-‘ or above. This could also be prompted by a downgrade of the ratings of the largest ‘AAA’ rated shareholders, ie, the US, Germany, or Canada.
– Marked deterioration in asset quality or increase in lending leading to a substantial decrease in capitalisation, bringing the intrinsic rating below ‘aa-‘. Any further decrease in the intrinsic rating would lead to negative rating action as the uplift from extraordinary support is currently at the maximum of three notches permitted under our criteria.
Key Assumptions
In its base case scenario, Fitch assumes that:
– Loan approvals will be substantially reduced after the 2016 peak of SDR6.1 billion, and will stabilise slightly below SDR4 billion in 2018 and 2019, leading to slower growth in assets.
– A general capital increase will be approved by shareholders within the next two years.
– The average quality of loans will erode in the next three years, resulting in a decline in the average rating of loans to ‘BB-‘.
– Risk concentration will continue to improve, with the share of the five largest exposures nearing 30% of the total banking portfolio by 2020.
The full list of rating actions is as follows:
Long-Term IDR affirmed at ‘AAA’; Outlook Stable Short-Term IDR affirmed at ‘F1+’
Issue ratings on long-term senior-unsecured bonds affirmed at ‘AAA’ Issue ratings on long-term market-linked notes affirmed at ‘AAAemr’ Issue ratings on long-term subordinated bonds affirmed at ‘AA+’ Issue ratings on short-term senior-unsecured bonds affirmed at ‘F1+’
In accordance with Fitch’s policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different from the original rating committee outcome.