Moody’s Investors Service (Moody’s) has affirmed the East African Development Bank’s (EADB) Baa3 long-term issuer rating and maintained a stable outlook.
The rating affirmation reflects the EADB’s strong capital position, offset by low development asset credit quality and a legacy of high non-performing assets (NPAs).
Liquidity and funding benefit from relatively robust liquidity levels but are marked by a less diverse funding structure than many rating peers.
Moody’s assessment of the strength of member support balances a large cushion of callable capital with the limited ability of shareholders to provide support given the low ratings of the EADB’s four main shareholders – Kenya (B3 negative), Rwanda (B2 stable), Tanzania (B2 positive), and Uganda (B2 negative).
The stable outlook reflects a balance of upside and downside risks. Notwithstanding the risks associated with a challenging operating environment and the elevated concentration of the EADB’s portfolio, the potential for capital erosion is mitigated by the Bank’s currently very low leverage ratio and cautious approach to new lending.
Moody’s assumes that the bank will continue to develop its risk management framework, which is not as advanced as other rated peers, while maintaining robust capital adequacy, and prudent liquidity levels.
RATING RATIONALE
A STRONG CAPITAL POSITION ACTS AS A KEY MITIGANT FOR LOW-ASSET QUALITY
EADB’s leverage ratio stood at 102% in 2022, having fallen from 126% in 2017. The Bank’s ratio is one of the lowest among the multilateral development banks (MDBs) that Moody’s rates and remains significantly below several rating peers, including the Trade and Development Bank’s (TDB, Baa3 stable) and the West African Development Bank (BOAD, Baa1 negative).
Limited growth in development assets, the continuing completion of capital subscriptions by shareholders, and a modest but consistent contribution from retained earnings to the capital base have driven the steady decline in the leverage ratio.
EADB’s strong capital position acts as a key mitigant for its low development asset credit quality. EADB has the mandate to build its portfolio within its four member states, which leads to the unavoidable geographic concentration of the loan portfolio.
Concentration risk is manifest in other ways, with the 10 largest exposures accounting for 84% of the development-related assets portfolio on a gross basis at the end of 2022. However, the concentration risk is somewhat overestimated by these indicators as some of EADB’s loans are on-lent by financial institutions to their clients.
The NPA ratio stood at 3.8% in 2022, consisting of a single loan. The stock of NPAs has remained more contained in recent years after reaching 8.7% of development-related assets in 2018, notwithstanding the twin shocks to the region caused by the pandemic and the global implications of Russia’s invasion of Ukraine.
However, given EADB’s track record of sudden spikes in NPAs and fluctuations in the nonperforming portfolio, Moody’s expects asset performance to remain a constraint on EADB’s credit profile.
LIQUIDITY IS SUPPORTED BY PRUDENT LIQUID ASSET LEVELS, ALTHOUGH FUNDING REMAINS DRAWN FROM A SMALL INVESTOR BASE
Prudent liquid asset levels and long-dated borrowings support the EADB’s liquidity. Based on end-2022 figures, the Bank’s availability of liquid resources (ALR) ratio stood around 107%, indicating that liquid resources would be sufficient to more than cover net cash outflows over 18 months.
EADB has a liquidity policy that sets a minimum liquidity coverage ratio of 1.33x total liabilities (i.e. covering liabilities for the next 16 months). At the end of 2022, the Bank’s operating level of liquidity was well above its minimum requirement at 8.1x, up from 5.8x in 2021, although a normalization is likely as loan disbursements and other designated liabilities gain pace over the coming years under a new medium-term strategic plan.
The Bank’s main sources of financing are concentrated in lines of credit from MDBs, which provide a stable and cheap source of financing, and regional financial institutions. The main lending institutions for long-term financing as of end-2022 include the OPEC Fund for International Development (OFID), Arab Bank for Economic Development in Africa (BADEA, Aa2 positive), Kreditanstalt fuer Wiederaufbau (KfW, Aaa stable), and NCBA Bank Kenya Plc.
However, Moody’s assesses EADB’s funding position as relatively weak, reflecting a difference between the Bank and some of its peers that can rely on a much larger and more diversified investor base.
SHAREHOLDERS HAVE LOW ABILITY TO PROVIDE SUPPORT, LIMITING UPLIFT FROM LARGE CALLABLE CAPITAL BUFFER
Moody considers the ability of ADB’s shareholders to support the Bank to be limited, based on their “B2” weighted average shareholder rating, among the lowest across rated MDBs. Commensurate with such a rating, Moody’s assessment of the ability of the EADB’s main shareholders to quickly transfer callable capital to the Bank in the event of an emergency is low.
A shared exposure to systemic risks between shareholders and borrowers – as EADB’s loan portfolio is located entirely within the same geographic region as its member states – also acts as a constraint.
EADB has a large cushion of callable capital, which stood at almost 1000% of total debt in 2022. However, past delays in the payment of capital contributions suggest that shareholders have limited capacity that constrains willingness to support, although progress has been made on the completion of outstanding subscriptions.
Moreover, if only taking into account the share of callable capital from investment-grade shareholders, for which Moody’s has a high level of confidence a capital call would be paid on time, the coverage ratio decreases to 1.5%.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects a balance of upside and downside risks. Notwithstanding the risks associated with a challenging operating environment and the elevated concentration of the EADB’s portfolio, the potential for capital erosion is mitigated by the Bank’s low leverage ratio and cautious approach to new lending.
Although Moody’s expects loan portfolio growth to gradually accelerate under the impulse of a new medium-term strategic plan, leverage will remain relatively low as the Bank continues to proceed prudently toward new loan disbursements.
Moody’s assumes that the Bank will continue to develop its risk management framework, which is not as advanced as other rated peers, while maintaining robust capital adequacy, and prudent liquidity levels.
