Fitch Ratings has affirmed the Islamic Development Bank’s (IsDB) Long-Term Issuer Default Rating (IDR) at ‘AAA’ with a Stable Outlook. The Short-Term IDR has been affirmed at ‘F1+’. The trust certificates issued by IDB Trust Services Ltd with the benefit of a guarantee provided by IsDB have also been affirmed at ‘AAA’.
The ratings reflect the intrinsic strengths of IsDB, in particular its strong capitalisation. Its liquidity and fairly low concentration risk compare favourably with other regional multilateral development banks (MDBs).
KEY RATING DRIVERS
The ratings and Stable Outlook reflect the following key rating drivers:
The IsDB is one of the best-capitalised MDBs rated by Fitch, with an equity-to-asset ratio of 48.9% at end-1436H (October 2015 in the Gregorian calendar). Sustained growth in its financing operations (portfolio grew 9.7% in 1436H and 8.6% in 1435H) has led to a continued increase in leverage, which nonetheless remains lower than peers, with a debt-to-equity ratio of 101.8% at end-1436H (49% at end-1432H).
According to the bank’s 10-year strategic plan, financing operations are expected to grow at a slow pace; financing approvals will increase only 1% per year over the next three-to-four years. The last capital increase in 2014 (fifth general capital increase), which entirely consisted of callable capital (Islamic dinars, equivalent to IMF’s special drawing rights 32bn), provides scope to substantially extend the financing capacity of the bank, which is statutorily capped by subscribed capital and reserves, and will allow the bank to raise more debt. The disbursement of the paid-in portion of the fourth general capital increase of ID4.4bn started in 1437H and will be spread over 20 years.
The IsDB extends financing predominantly to sovereign entities (89% of total loan portfolio at end-1436H), and the bank benefits from preferred-creditor status. Due to its focus on developing countries, its credit risk is significant: the average rating of the portfolio is estimated at ‘B+’ at end-1436H.
IsDB’s portfolio is more diversified than many other regional MDBs, with the five-largest exposures representing 35.1% of total financing operations at end-1436H. However, some of IsDB borrowers have experienced deep political troubles (Syria, Yemen). Impaired financing amounted to 2.9% of portfolio at end-1436H; financing to Syria (2.3% of the bank’s portfolio at end-1436H) accounted for the largest share of impaired assets.
The IsDB’s risk framework is stringent; further measures such as the Risk Management Roadmap are under implementation to progressively align itself with industry best practice. However, compared with other ‘AAA’-rated MDBs, the level of provisioning is low given the bank’s exposure to the aforementioned countries experiencing deep political troubles. The ratio of total provisions to impaired assets stood at 55.6% at end-1436H. The leverage limit was further relaxed in 1435H to 125% from 100%.
Liquidity ratios are high, with treasury assets covering 255% of short-term liabilities at end-1436H, in line with ‘AAA’-rated MDBs. However, the credit quality of treasury investments is lower than peers, with only 14.8% of treasury assets invested in instruments (mostly bank deposits) rated ‘AA-‘ and above at end-1436H; this risk is mitigated by the significant use of short-term assets at a diversified range of banks. Foreign-exchange risk is hedged.
Shareholders’ support is not a rating driver but acts as a backstop in the event of a material weakening of the bank’s intrinsic financial condition. IsDB’s capital is owned by the 57 member countries of the Organisation of the Islamic Cooperation. Credit quality of member states has been affected by the impact of lower oil prices; the rating of Saudi Arabia, IsDB’s largest shareholder, was downgraded to ‘AA-‘ from ‘AA’ in April 2016 and remains on Negative Outlook. The average rating of key shareholders (BB+) has overall remained constant from last year. Shareholders have consistently demonstrated their propensity to support the bank through regular inflows of fresh capital.
Pressure on the rating would arise from material deterioration in capital and leverage as a result of either a pronounced weakening in asset quality or an unexpected surge in credit growth. However, any negative rating action would be limited to three notches in the absence of a change to the rating of IsDB’s main source of external support – Saudi Arabia.
Fitch assumes that the asset quality of the largest borrowing countries will stabilise at current levels. It also assumes that member countries will continue to participate in the ongoing capital increase and lending growth will remain moderate over the coming years.