Moody’s Investors Service (Moody’s) has today affirmed the East African Development Bank’s (EADB) Baa3 long-term issuer rating and maintained the 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 benefits from relatively robust liquidity levels but is marked by a less diverse funding structure than many rating peers. Moody’s assessment of 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.
RATINGS RATIONALE
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 a mandate to build its portfolio within its four member states, which leads to 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 normalisation 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’s considers the ability of EADB’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 delay 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 expect 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.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
EADB’s CIS-3 credit impact score reflects moderate exposure to environmental risks and a governance profile marked by a comparatively weaker but developing risk-management framework.
EADB’s environmental issuer profile score at E-3 reflects its area of operations, characterised by borrowers across East Africa particularly exposed to physical climate risks, mostly because of their reliance on large agricultural sectors and thus exposure to extreme weather conditions and natural disasters.
EADB’s social issuer profile score is neutral-to-low (S-2). Customer relations are strong given the Bank’s role and importance as a promoter of socio-economic development and regional integration, in fields including agriculture and increasing access to finance for small and medium enterprises. The Bank works in close cooperation with its shareholders, deriving support from its mandate.
EADB’s governance issuer profile score of G-3 reflects comparatively weaker risk management standards that have resulted in asset quality deterioration in past periods of stress. EADB has been continuously developing its risk management framework as part of the Bank’s strategic plan. The gradual strengthening of risk-management practices will be key in helping to manage the challenges presented by a weak operating environment across borrower countries.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING
Moody’s would consider upgrading EADB’s rating should it become clear that the Bank, supported by improvements in risk management, is able to expand its balance sheet and reduce concentration risks, while at the same time preserving a high capital buffer and a moderate level of nonperforming assets. A diversification of EADB’s investor base, accompanied by sustained improvements in the liquidity position, could also exert upward pressure on the rating.
The rating would likely come under downward pressure if the size of the Bank’s loan portfolio were to continue to decline in the coming years, despite its strategic ambitions to grow its lending. Such a contraction could point to difficulties in fulfilling the Bank’s mandate and could over time lead to reduced shareholder support. A renewed and sustained deterioration in asset quality would also exert negative pressure on the rating. This could happen if the growth in EADB’s assets leads to a marked increase in credit risk, without a commensurate strengthening in governance and risk management.
The principal methodology used in this rating was Multilateral Development Banks and Other Supranational Entities Methodology published in October 2020 and available at https://ratings.moodys.com/rmc-documents/69182. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.
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Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1355824.
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