Suspension of Debt Payments to Multilateral Development Banks a Risk to Ratings

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Thursday, April 23, 2020 / 5:19 PM  / By Fitch Ratings / Header Image Credit: FDC

 

Suspension of sovereign debt payments owed to multilateral development banks (MDBs) would be negative for MDB ratings unless they were fully compensated by their shareholders, Fitch Ratings says. The G20 and Paris Club called for MDBs to 'explore the options for suspension of debt service payments' when they announced a coordinated debt relief initiative by official bilateral creditors for the poorest countries that request forbearance.

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The bilateral creditor initiative would see interest and principal payments suspended from May until at least end-2020. Delays of principal or interest payments on an MDB sovereign loan lasting more than six months would lead Fitch to classify the MDB's full exposure to this sovereign as impaired. In line with our supranationals criteria, such a delay would affect an MDB's credit profile through three key metrics.

First, the impairment of sovereign loans would constitute a breach of the MDB's preferred creditor status (PCS), which gives repayment of loans to MDBs priority in a sovereign debt crisis. PCS is a key strength in MDBs' credit profiles. If breached, we would reduce the uplift we apply to the credit quality of the loan portfolio to reflect PCS, which is based on the track record of sovereign loan performance. The size of this adjustment would reflect the size of the impaired sovereign exposure and whether the sovereign borrower continued to repay other creditors, including private sector creditors.

Secondly, the ratio of impaired loans to gross loans, a key measure of credit risk in MDB asset portfolios, would increase. We would revise our medium-term forecasts for this ratio, which has a relatively high weight in our criteria, according to the length of the suspension of payments and our expectations of the sovereign borrower's ability to resume payments to the MDB after the period of suspension of debt payment is over. Exposures to the affected sovereign would be assigned a default rating, reducing the average rating of the MDB's loan portfolio, and weakening capitalisation metrics.

Thirdly, the suspension of debt payments would also adversely affect the MDB's cash flows and liquidity. Lower-rated MDBs with relatively weak liquidity profiles, including limited access to capital markets or alternative sources of liquidity, would be particularly penalised in terms of our liquidity assessment.

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The negative credit impact of debt suspension might be mitigated or fully offset by support from an MDB's shareholders. Fitch would assess how far additional shareholder contributions could offset the risk that payment delays extend to six months or longer, and any medium-term deterioration in loan performance metrics. In Fitch's view, full compensation by shareholders or other donors in the form of contributions to cover forgone sovereign debt payments, similar to that seen at the time of Multilateral Debt Relief Initiative from 2005, would reduce credit risk to the MDB and offset the impact of debt payment suspension on its intrinsic rating. If made by shareholders, such contributions would also be a very strong signal of support.

It is unclear how MDBs will respond to the G20's request. Fitch would expect regional MDBs to be the most likely to act, as G20 member countries are also the regional MDBs' largest shareholders. If debt suspension applied to the same countries as the bilateral debt relief initiative (those eligible for International Development Association lending and United Nations Least Developed Countries), the most exposed Fitch-rated regional MDBs would be those operating in sub-Saharan Africa.


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