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Rating action

Scope Ratings GmbH (Scope) has today assigned BBB+ long-term issuer and senior unsecured ratings on MFB Hungarian Development Bank Private Limited Company (MFB) in both local and foreign currency. Scope has also assigned an S-2 short-term issuer rating in both local and foreign currency. All Outlooks are Stable.

Summary and Outlook

Scope’s assignment of MFB’s BBB+ rating reflects: i) the explicit, direct and irrevocable statutory funding guarantee of Hungary (BBB+/Stable) for MFB’s financial obligations arising from bonds issued, credits and loans taken, deposits from the interbank market and replacement costs of currency or interest rate swaps entered into by MFB for fundraising purposes; ii) a record of financial support from the Hungarian state, which has strengthened MFB’s capitalisation and liquidity; iii) the supportive legal set-up, making changes in MFB’s business model or guarantee structure unlikely; and iv) the bank’s high strategic importance as a key government-related entity (GRE) implementing economic and social policies for the Hungarian state. In addition, Scope acknowledges the bank’s robust balance sheet with high capital buffers and sound asset quality. MFB’s modest but stable profitability alongside limited loan portfolio diversification reflects the development bank’s public policy mandate.

The ratings could be upgraded in the event of an upgrade of Hungary. The ratings could be downgraded in the event of: i) a downgrade of Hungary; and/or ii) changes in the legal framework or guarantee structure that notably weaken government support for MFB.

Rating rationale

MFB’s BBB+ rating reflects the guarantee framework for its liabilities provided by Hungary, which is the key factor for equalising MFB’s ratings with the ratings of the sovereign. The explicit, direct and irrevocable guarantees cover the bonds issued, credit and loans taken, deposits from the interbank market, and replacement costs of currency or interest rate swaps entered into by MFB for fundraising purposes. Only a parliamentary act can amend, revoke or restrict these guarantees. Scope deems any such development unlikely.

The bank manages its foreign exchange risk through a foreign exchange arrangement scheme with the Hungarian state. In principle, the bank’s exchange rate risks are assumed by the central government’s budget up to a threshold, via hedging agreements with the Ministry of Finance for the forint equivalent of the euro funds. The state budget reimburses losses incurred by MFB in converting the loans or funds into euro, while foreign exchange gains are passed on to the state budget. The main objective of this scheme is to ensure interest rates remain low for the ultimate beneficiaries of MFB’s loans. At the same time, the scheme shields the bank from losses arising from forint volatility.

The Hungarian state sets annual limits on the guarantee scheme to MFB via budgetary acts. Scope considers the limits for 2021 sufficient to address the planned expansion of the bank’s lending.

To support MFB’s financial position and lending, Hungary has strengthened MFB’s capital position on several occasions. The latest involved a capital increase of HUF 151.4bn at the end of 2020 in the context of a rapidly growing balance sheet and increasing risk-weighted assets. Hungary has also provided financial support in periods of intense capital market volatility. For example, in 2009 it provided a multi-currency loan from moneys borrowed from the IMF. The state also provides short-term bridge financing to optimise the timing of capital market transactions by MFB and other Hungarian GREs, the reason being that sovereign bonds serve as the benchmark for MFB issuances.

The rating is underpinned by MFB’s high strategic importance to Hungary. As the only development bank in Hungary focusing on the domestic market, MFB plays a key role in meeting key economic and political objectives on a national level. This was recently highlighted during the pandemic with MFB’s central role to disseminate state financial support to Hungarian companies. In 2020, MFB’s provision of financing hit a record high, contributing a larger share than planned to the overall volume including various loan, capital and guarantee programmes. MFB’s activities are split into four areas: i) lending via disbursements under loan programmes or of individual loans and provision of guarantees mostly for large corporates, SMEs and municipalities; ii) fundraising activities; iii) equity participations; and iv) intermediation of EU funds, which is off balance sheet as funds are distributed on behalf of managing authorities.

MFB’s asset quality is high, helped by a steadily decreasing share of non-performing loans relative to gross customer loans, which reached 3.39% in 2020. However, Scope expects the share of non-performing loans to reverse by the end of this year due to: i) the delayed economic impacts of the pandemic and the phasing-out of payment moratoriums; ii) rising loans associated with increased risk (Stage 2 loans); and iii) the increase of the risk-weighted exposure, reflecting the bank’s supportive role in the crisis. The sizeable loan programmes launched in 2020 against the pandemic’s effects should continue to support MFB’s balance sheet growth with limited risk in 2021 given that state guarantees cover up to 90% of new loans.

MFB’s Tier 1 capital ratio of 22.4% in 2020 (versus the 8% minimum) is sound, allowing the bank to retain earnings to support further growth as well as providing a sufficient buffer in view of a sharply increasing balance sheet. In addition, MFB’s key strategic purpose, low substitution risk and contribution to macro-economic stability support Scope’s view of a high likelihood of exceptional support from the Hungarian state if required.

The guarantee structure allows the bank to tap capital markets at favourable rates and provides resilient access to capital markets when needed. The bank’s funding access is further supported by preferential treatment of the bank’s bonds under Solvency II and the zero risk-weighting under Basel.

Despite these credit strengths, challenges to the BBB+ rating include the limited loan portfolio diversification and modest though stable profitability, both a reflection of MFB’s public policy mandate.

First, MFB’s loan portfolio is characterised by sectoral concentration. The limit to domestic exposures makes the bank’s asset quality somewhat susceptible to developments in the Hungarian economy. Any significant worsening in Hungary’s export-oriented economy has the potential to impact the bank’s asset quality and profitability. Unfavourable demographic trends also pose long-term challenges for Hungary’s export-oriented engineering and car manufacturing industry. However, in the context of the Covid-19 crisis, Hungary’s competitive manufacturing sector has remained resilient, and the bank is prudently managing single name concentration risks via single obligor limits.

Second and finally, MFB’s profitability is modest though stable, reflecting its non-profit character and public policy mandate according to the MFB Act. The bank’s performance is largely dependent on its primary source of revenue, interest income. While the bank has been unable to withstand the challenges of the low interest rate environment, most of its lending exhibits low but stable margins in its mandate-driven businesses. MFB recorded negative earnings of HUF 8.8bn in 2020, mostly reflecting increased impairments and provisions. This is in the context of the rapidly growing balance sheet, driven by an expanding loan and investment portfolio and in part by the payment moratorium to support liquidity in the economy during the pandemic. Scope expects profitability to remain subdued in view of the low interest rate. In past years, net profits were retained.

Qualitative Scorecard (QS1 and QS2)

Provided that the GRE benefits from an ‘integral/strong’ level of integration with the government, Scope may apply the ‘top-down’ approach, which takes the government’s rating as the starting point and negatively adjust it by up to three notches (although exceptions can apply). Equalisation of a GRE’s rating with that of its government is possible if an explicit guarantee exists.

Scope assigns a ‘strong’ level of integration between MFB and the Hungarian state (QS1), reflecting the bank’s i) single public ownership by the Hungarian state; and ii) fulfillment of operating activities exclusively on behalf of the government, with the main purpose of providing a key service in the public interest. Scope applies the rating equalisation factor due to the explicit, direct and irrevocable statutory guarantee for MFB’s debt obligations provided by Hungary (BBB+/Stable).

Scope assigns a ‘high’ assessment to the ‘control and regular government support’ for MFB (QS2) as a result of: i) the ‘high’ ability of the government to control MFB, given that the scope and content of its activities are defined and regulated by law; and ii) the history of financial support for MFB, which has strengthened its liquidity and capital, enabling it to fulfill its promotional duties.

Scope assigns a ‘high’ assessment to the ‘likelihood of exceptional government support’ if MFB were to experience difficulties in making payments (QS2). This reflects the bank’s ‘high’ strategic importance to the government, ‘high’ substitution difficulty and ‘medium’ default implications for Hungary.
For further details, please see Appendix I of the rating report.

Factoring of Environment, Social and Governance (ESG)

Governance and social considerations are material to MFB's rating and included in Scope’s assessment of integration with the sponsoring government. This highlights the supportive legal framework that requires MFB to comply with its statutes and fulfil its role as a competition-neutral public-law institution. One task under this role includes the general provision of key services in the public interest to support national economic and social objectives, more recently shown in measures to deal with implications of the coronavirus outbreak. Long-term environmental developments were also considered alongside the assessment of rating-relevant credit risks but these did not play a direct role in this rating action.

Rating committee
The main points discussed during the rating committee were: i) level of integration with government; ii) liability support mechanism; iii) control and regular government support; iv) likelihood of exceptional support; and v) supplementary analysis of MFB’s fundamentals.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Government Related Entities, 5 May 2021), is available on www.scoperatings.com.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other 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 Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit 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 factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Jakob Suwalski, Director
Person responsible for approval of the Credit Rating: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 16 July 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures 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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