Rating action

Scope Ratings GmbH has today assigned the European Bank for Reconstruction and Development first-time AAA long-term issuer and senior unsecured foreign-currency ratings, along with a short-term issuer rating of S-1+ in foreign currency. All Outlooks are Stable.

For the supranational scorecard, click here.

Summary and outlook

The AAA rating assigned to the European Bank for Reconstruction and Development (EBRD) reflects the supranational’s highly rated key shareholders, high capital endowment, very strong liquidity position and excellent capital markets access. The EBRD’s mandate to provide lending to transition economies results in relatively weak asset quality, including substantial exposures in Turkey (B+/Stable). The Stable Outlook reflects Scope’s assessment of the EBRD’s significant financial buffers to withstand external and balance-sheet-driven shocks.

Rating rationale

The EBRD’s AAA rating is supported by the institution’s highly rated shareholders, including the United States (AA/Stable), Japan (A+/Negative), the UK (AA/Negative) and all EU-27 member states. The key shareholder rating of AA-, representing 75% of the share capital when starting with the largest shareholders, reflects i) the ability of its shareholders to provide the EBRD with a very strong framework ensuring preferential treatment for and investor acceptance of its debt instruments and ii) the strong commitment of shareholders with a high willingness and ability to provide the Bank with additional financial support if ever needed. In addition, compared to its AAA-rated peers, the Bank benefits from a unique global distribution of shares, with the G-7 countries accounting for more than 50% of the institution’s share capital. The remainder of shares is distributed evenly across highly rated shareholders (AA- or higher), resulting overall in a low shareholder concentration. In addition to the indirect support provided by the sovereigns’ political and economic strengths, the EBRD’s shareholders have paid in about 21% of their share capital, the highest such ratio among AAA-rated development banks. The high capitalisation provides a comfortable basis for the EBRD to fulfil its mandate in fostering the transition of mainly Central and Eastern European countries towards open market-oriented countries¹.

Scope estimates the EBRD’s available and credible capital resources at around EUR 18bn. These include paid-in capital (EUR 6.2bn), accumulated reserves and retained earnings (EUR 11.6bn) and the callable capital of the shareholders rated AA- or above who can directly benefit from the Bank’s activities (EUR 0.2bn). Dividing these resources by the institution’s total capital subscriptions plus reserves and surpluses, i.e. the maximum lending capacity (EUR 41.4bn), results in a ratio of around 43%. This implies that if the EBRD were to operate at full capacity as allowed under its treaty, its institutional set-up can ensure available and credible resources would cover almost half of its potential liabilities².

In addition, in line with most multilateral development banks, the EBRD’s outstanding loan portfolio benefits from preferred creditor status as evidenced during the 1998 Russian crisis when the Bank was formally excluded from the then prevailing capital controls. This is despite the institution’s mostly private-sector oriented lending, which Scope assigns a higher probability of loan impairment compared to sovereign exposures in its assessment. The mandate to provide financing to emerging market regions exposes the EBRD to conduct its activities in countries with a comparatively lower credit quality. The top 10 countries in which the EBRD operates have a weighted average borrower quality of B+. Offsetting some of these risks however, Scope notes that compared to peers, the EBRD’s borrowing members account for only 14% of the share capital, which strongly limits pro-cyclical risks of creditworthiness between the key capital providers and beneficiaries of the institution. Overall, the strong commitment of highly rated and diversified shareholders, a high capitalisation, and preferred creditor status provide the EBRD with a very strong institutional set-up.

The EBRD’s AAA rating also reflects its conservative capital and liquidity management. The bank’s investment guidelines stipulate i) a minimum 100% coverage of one-year debt service plus 50 percent of undrawn commitments by liquid treasury assets; ii) a minimum 75% coverage of the next two years’ net cash requirements by net treasury liquid assets; and iii) the ability to meet its obligations for at least 12 months under a scenario of extreme stress. In addition, the EBRD hedges foreign exchange and interest rate risks stemming from its lending portfolio. It is Scope’s view that the EBRD’s liquidity policies provide a substantial cushion in the current market environment and allow the bank to fulfil its mandate also during more uncertain environments.

Specifically, considering the EBRD’s cash and deposits as well as its financial assets rated AA- or above, Scope estimates the EBRD’s liquid assets at around EUR 29.6bn for end-2019. Conversely, EBRD liabilities due within one year amounted to around EUR 20.5bn while disbursements of loans and equities totalled EUR 7.2bn. This brings total liabilities and disbursements due within one year to around 27.7bn at end-2019. On this basis, Scope calculates a weighted average liquid assets ratio for the three years during 2017-19 of around 105.7% (107% in 2019), which implies available liquid assets can cover all outstanding liabilities and all disbursements due within one year without a need to access capital markets. This is one of the strongest liquidity cushions among supranational institutions. 

Scope also notes that this liquidity assessment uses past disbursements as a proxy for future disbursements, reflecting the EBRD’s mandate to continue activities precisely when economic and financial circumstances deteriorate, as could be the case over the coming months via enhanced requests for funding during the pandemic. The EBRD has already announced a coronavirus solidarity package, which raises the bank’s funding to EUR 21bn until the end of 2021³. With current disbursements at EUR 7.2bn, this would raise annual lending to a maximum of EUR 10.5bn, including equity investments. Scope considers the bank’s available resources and conservative risk management policies as prudent to maintain its strong creditworthiness despite higher expected investment activities in an increasingly uncertain economic environment.

Another factor supporting the EBRD’s AAA rating is its strong capital market access. The EBRD’s bond issuances are designated as Level 1 HQLA assets, granted a 0% risk weight under the Basel framework and are eligible for the European Central Bank’s asset purchase programmes. This preferential regulatory treatment, an established track record of capital market presence and its strong shareholder and capital base underpin the EBRD’s status as a benchmark issuer with annual issuance volumes of around EUR 8.5bn over the years 2017-19. Furthermore, the bank’s prudent funding strategy is reflected by the roughly five-year average maturity of its 2019 issuances, limiting refinancing and maturity mismatch risks, and its diversification in terms of instruments and currencies⁴. The EBRD also benefits from a diverse investor base with about half of its 2019 issuances bought by institutional investors, 40% by financial institutions, 12% by central banks and 3% by retail investors. In terms of regional diversification, the bank has a strong track record of attracting investors from outside the EMEA region, with meaningful shares from the Americas (8%) and Asia (13%) in 2019. In 2019, the EBRD expanded its presence on the green bond market, by inaugurating two new benchmark bonds that align with the Green Bonds Principles, namely the Climate Resilience Bonds and the Green Transition Bonds, which allowed the bank to increase green bond issuance to EUR 2.7bn in 2019 (27% of total issuance) from EUR 329m in 2018.

Finally, the EBRD’s high capitalisation levels and prudent capital adequacy policies ensure continued operationality given the bank’s relatively riskier loan and equity exposures. The EBRD’s capital buffers are ensured via conservative internal capital adequacy policies⁵. First, a 1:1 gearing ratio stipulates that the bank’s operating assets (i.e. disbursed banking assets) cannot exceed its unimpaired subscribed capital and accumulated reserves. At end-2019, the ratio stood at 76%, up from 73% in 2018, with ample headroom to the internal policy maximum of 92%. Second, to minimise risks of recourse to callable capital, the bank maintains an internal policy limit of 90% of required capital (imputed capital losses in line with the Bank’s AAA-rating) to available capital (paid-in capital and reserves), which stood at 66% in 2019. Consequently, at end-2019, the bank’s leverage ratio stood at 266%, which compares favourably to other highly rated supranationals. The bank’s high, albeit volatile, retained earnings with a weighted average share of retained earnings to equity between 2017-19 of 5.8%, evidence the bank’s ability to generate internal capital, strengthening accumulated reserves to EUR 11.6bn at end-2019 from EUR 10bn in 2017.

Despite these credit strengths, the EBRD also faces the following credit challenges:

First, the EBRD’s loan portfolio is characterised by a weak borrower quality environment with a weighted average sovereign borrower rating of B+ for the top 10 country exposures (accounting for 51% of the investment portfolio) in the years 2017-19. Together with the majority of activities in the private sector, the EBRD faces substantial asset quality risks, which require ample risk buffers and conservative provisioning putting constraints on its operating flexibility. Exposures in Turkey (B+/Stable) constitute a key risk as they account for 17.8% of total loans of the EBRD’s portfolio, the highest such country-specific exposure. Political instability in the middle east region, including a slowdown of economic reform progress could negatively impact the outstanding loan portfolio. A further deterioration of the business environment, especially in the context of the Covid-19 crisis, is likely to result in forced restructurings and corporate defaults, and thereby impact the bank’s profitability and NPL ratio, which at around 4.5% is already one of the highest among supranationals. Furthermore, the concentrated activities in emerging market economies raises risks related to sudden capital outflows and sudden stops, which put borrowers at risk of losing capital market access. At the same time, the sectoral allocation of the EBRD’s loan portfolio with a limited concentration to most hit sectors such as tourism and services as well overall high diversification across regions and sectors partly mitigate credit risks.

Second, the EBRD is engaged in equity participations with outstanding investments amounting to EUR 5.18bn (29% of members equity), resulting in a heightened volatility of returns given revaluations of equity investments. In contrast to its hedged banking portfolio, the bank is exposed to equity price and foreign exchange risks through equity investments, especially to the Russian rouble with an outstanding fair value amount of EUR 1.1bn invested in Russian equity and EUR 609mn share investments in Turkey. The repercussions from the Covid-19 crisis are thus likely to substantially impact the bank’s returns this year and beyond by fair value corrections and higher provisioning. At the same time, Scope notes that the EBRD’s very strong capitalisation and conservative liquidity policies form adequate risk buffers to withstand the expected shortfalls.

Rating-change drivers

The rating could be downgraded if: i) highly rated key shareholders are downgraded; ii) liquidity buffers significantly reduced; and/or iii) the EBRD recorded sustained losses via missed repayments from borrowers, resulting in a lower capital base and its preferred creditor status being effectively repealed.

Factoring of Environment, Social and Governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in its supranational methodology. Governance-related factors are implicitly captured in Scope’s assessment of the ‘fundamental rating’, which Scope assesses for the European Bank for Reconstruction and Development with a ‘AA’. Additional negative adjustments to governance issues are addressed under the additional considerations in the methodology. In line with peers, the EBRD’s governance is strong and transparent.

Environmental and social factors are considered during the rating process, including the risk to ‘stranded assets’ and the benefits from issuing green and/or social bonds, but these had no impact on this rating action. At the same time, Scope acknowledges the strong increase of sustainability-linked bonds and the standard-setting transparent impact reporting for the use of proceeds across issuance instruments. Scope also notes the EBRD’s increasing issuance of social and environmental bonds and meeting a target of 40 per cent financing of Green Economy Transition (“GET”) eligible projects as a share of annual business investments, a strong commitment compared to any peer institution.

Scope’s supranational scorecard

Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative ‘AAA’ rating for the European Bank for Reconstruction and Development. Additional considerations allow Scope to incorporate idiosyncratic characteristics that cannot be assessed in a consistent and comprehensive manner across all supranationals, but which may still affect the creditworthiness of the issuer.

For the EBRD, no additional consideration has been identified.

A rating committee has discussed and confirmed these results.

For further details, please see the Appendix.

Rating committee
The main points discussed were: i) key shareholders and institutional setup; ii) liquidity management and buffers; iii) asset quality; iv) capitalisation; v) risk management; vi) resilience to stress; vii) ESG issuance; and viii) peer comparison.

Rating driver references
1. EBRD Basic documents
2. EBRD Financial statements, 2019
3. EBRD Press statement, April 03 2020
4. EBRD Investor presentation, May 2020
5. EBRD Strategic and capital framework 2016-2020

Methodology
The methodology used for this rating and rating outlook, ‘Supranational entities’ published on 4 November 2019, is available on https://www.scoperatings.com/#!methodology/list/5.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rating process was conducted:
With Rated Entity or Related Third Party Participation  NO
With Access to Internal Documents                               NO
With Access to Management                                         NO
The following substantially material sources of information were used to prepare the credit rating: public domain.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst: Bernhard Bartels, Director
Person responsible for approval of the rating: Giacomo Barisone, Managing Director

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.