Fitch Affirms African Development Bank at 'AAA'; Outlook Stable


Sunday, July 25, 2021   07:10 AM / by Fitch Ratings/ Header Image Credit: African Development Bank


Fitch Ratings has affirmed African Development Bank's (AfDB) Long-Term Issuer Default Rating (IDR) at 'AAA' with a Stable Outlook.


Key Rating Drivers

AfDB's 'AAA' Long-Term IDR is driven by the extraordinary support it receives from its shareholders, which Fitch assesses at 'aaa'. The rating is also supported by the bank's Standalone Credit Profile (SCP), reflecting the lower of its ratings of 'aa-' for solvency and 'aaa' for liquidity.


Fitch assesses AfDB's support rating at 'aaa', based on its forecast that the bank's net debt will be fully covered by callable capital from 'AAA'-rated member states by 2023, the end of our forecast period. The 'Strong' propensity of shareholders to support translates into a zero-notch adjustment to the capacity to support. Fitch's projections assume annual growth of about 8% in lending operations and a capital increase in line with the bank's General Capital Increase (GCI) VII plan. In 2020 and 2021, 44 member states have completed their GCI subscriptions, representing 73% of the bank's shareholding.


In March 2021, AfDB's board of governors approved a temporary callable capital increase of XDR28.6 billion (bringing the bank's total capital to XDR180.6 billion), which follows a capital increase in 2019. The subscription of the additional callable capital would become effective and permanent should a single event lead to a reduction in the stock of the bank's 'AAA'-rated callable capital by at least 30%. In Fitch's view, this temporary capital increase is strong evidence of shareholder support and should ensure the coverage of the bank's net debt by 'AAA'-rated callable capital, the key metric underpinning the rating.


In 2020, the AfDB allocated USD6.9 billion under its Covid-19 Response Facility to ease the economic impact of the pandemic. However, this came at the expense of other operations and overall loan approval almost halved in 2020. This decline in loan approval is in sharp contrast with the trend in other regional multilateral development banks and reflects the constraint from the AfDB's own capitalisation framework, with a capital utilisation rate at 86% as of end-2019, close to its 100% maximum limit. After peaking in mid-2020 (100%), the rate had fallen to 88% as of 1Q21, supported by the receipt of paid-in capital payments under the GCI.


AfDB's 'aa-' solvency assessment is underpinned by its 'Strong' capitalisation. The equity/assets ratio slightly increased to 22% at end-2020, from 21% a year earlier, owing to receipt of capital payments under the GCI VI and the commencement of payments under the subsequent GCI. Fitch's usable capital/risk-weighted assets ratio also improved to 37%, from 34% at end-2019. The improvement was primarily driven by the payments under the capital increase, which offset the asset-quality deterioration. Fitch expects the capital increase to improve both metrics, with equity/assets and risk-weighted asset ratios picking up closer to 25% and 40%, respectively, by 2023.


Fitch assesses AfDB's overall exposure to risks as 'Low', balancing 'Moderate' credit risk with 'Excellent' risk management policies, 'Low' concentration, and 'Very Low' equity and market risks.


The average rating of loans and guarantees deteriorated to 'B+' as of end-2020, from 'BB-' at end-2019. This was driven by a downgrade of several large borrowers, namely Morocco (BB+/Stable; accounting for 14% of total banking exposure), Tunisia (B-/Negative; 10%) and South Africa (BB-/Negative; 6%). About 30% of loans are extended to entities based in countries where the Outlook on the sovereign is Negative (also including Kenya (B+), Namibia (BB), Uganda (B+) and Ghana (B)). A single-notch downgrade of those exposures would not affect our estimate of the weighted average rating of the bank's portfolio. Fitch does not therefore expect further weakening in the credit quality of loans and guarantees, which would remain at 'BB-' after a one-notch uplift for the bank's preferred creditor status.


Non-performing loans (NPLs) decreased to 2.8% of gross loans in 2020 and 2.9% as of end-1Q21 from 3% at end-2019. This was driven by clearance of Somalia's arrears, a write-off of a non-sovereign loan and an increase in the size of loan portfolio. In May 2021, Sudan paid off its XDR144 million arrears as a result of renewed access to external financing following its removal from the US government's sanctions list. Fitch forecasts the NPL ratio to exceed 3% in the medium term, driven by higher impairment of non-sovereign loans, including those that benefit from payment deferrals. We expect the lingering impact of the pandemic to result in an increase in non-sovereign NPLs.


Fitch views AfDB's risk-management policies as conservative and assesses them as 'excellent', in line with 'AAA'-rated peers. Concentration risk is 'low', with the bank's five largest exposures accounting for 32% of total banking portfolio at end-2020. AfDB continues to benefit from the Exposures Exchange Agreement with the Inter-American Development Bank (AAA/Stable) and the International Bank for Reconstruction & Development (IBRD) (AAA/Stable) since 2015. Fitch expects equity participations to remain below 5% of the banking portfolio by 2023, in line with the bank's internal limit of 15% of risk capital. Foreign-exchange and interest rate risks are very limited and conservatively managed.


AfDB's 'aaa' liquidity assessment reflects an 'Excellent' liquidity buffer and quality of liquid assets. At end-2020, liquid assets were 1.9x short-term debt and Fitch expects the liquidity ratio to remain well above the 1.5x threshold for an 'Excellent' assessment by 2023. The share of 'AAA'-'AA' rated assets in the bank's treasury portfolio was 79% in 2020. Other assets are government debt securities from China (A+/Stable; 6% of treasury assets) and Japan (A/Negative; 3%), and cash in the Bank of Japan (11%), which are considered eligible for the net debt calculation in our support assessment.


Fitch assesses AfDB's business environment as 'Medium Risk', balancing 'Low' business profile risk with 'High' operating environment risk. The former primarily reflects the large size of the bank's portfolio, high quality of its governance and the importance of its public mandate. AfDB's 'High' operating environment risk is consistent with the low ratings, low income per capita and high political risk in its countries of operations.


Rating Sensitivities

Factors that could, individually or collectively, lead to positive rating action/upgrade:


The ratings are 'AAA', which is the highest level on Fitch's scale and cannot be upgraded.


Factors that could, individually or collectively, lead to negative rating action/downgrade:


Support: Coverage of net debt by callable capital from members states rated 'AAA' falling below 100% due to a lower-than-expected increase in callable capital or delays in capital payments from 'AAA'-rated member states or faster-than-expected growth in lending and debt.


Solvency (Risk): A weakening in asset quality from a fall in the weighted average rating of loans and guarantees to below 'B+' or the NPL ratio exceeding 6%. A weakening in the bank's solvency assessment leading to a downward revision of the SCP assessment below 'aa-' would result in negative rating action as the uplift above the SCP for extraordinary support is at the maximum of three notches permitted under our criteria.


Solvency (Capitalisation): Weaker-than-expected capitalisation ratios due to delays in capital payments or significant losses on assets that affect the bank's own funds.

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Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.


Key Assumptions

We assume that the global economy develops in line with our latest Global Economic Outlook, published on 15 June 2021.


Fitch assumes that most member countries, including key shareholders, will subscribe to GCI VII and continue to honour their commitments in existing and new capital increases.

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ESG Considerations

AfDB has an ESG Relevance Score (ESG.RS) of '4[+]' for 'Human Rights, Community Relations, Access & Affordability'. The AfDB is part of the African Development Bank Group, which extends concessional loans and grants to low-income countries through the African Development Fund. This supports AfDB's policy importance and shareholders' propensity to support the bank. This has a positive impact on the credit profile and is relevant to the ratings in conjunction with other factors


AfDB has an ESG.RS of '4' for 'Governance Structure'. The high share of capital ownership by borrowing countries with weak credit fundamentals and limited access to external funding has led to pressure to increase the pace of operations, potentially at the expense of prudent lending growth. This has a negative impact on the credit profile and is relevant to the ratings in conjunction with other factors.


AfDB has an ESG.RS of '4' for 'Rule of Law, Institutional & Regulatory Quality'. All supranationals attract a score of '4'. Supranationals are neither subject to bank regulation nor supervised by an external authority. Instead, supranationals comply with their own set of rules. Fitch pays particular attention to internal prudential policies, including compliance with these policies. This has a negative impact on the credit profile and is relevant to the ratings in conjunction with other factors.


AfDB has an ESG.RS of '4' for 'Policy Status & Mandate Effectiveness'. AfDB's record of Preferred Creditor Status on its sovereign exposure over the long term has been weaker than peers. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.


Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity.

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