Scope affirms Black Sea Trade and Development Bank’s A rating with Stable Outlook
Scope Ratings GmbH (Scope) has today affirmed the Black Sea Trade and Development Bank’s A 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 associated Appendix, click here.
Summary and Outlook
The Black Sea Trade and Development Bank’s (BSTDB) A rating is driven by its ‘strong’ intrinsic strength. The BSTDB’s institutional profile benefits from strong governance and high importance for its shareholder governments. This is supported by its dual mandate for economic development and regional cooperation in the Black Sea region, the successful implementation of medium-term strategic goals and strong growth in loan disbursements since 2018.
The BSTDB’s financial profile benefits from very high capitalisation levels with paid-in capital of 30% of subscribed capital, further supported by adequate profitability and earnings retention. The bank’s loan book is well diversified and benefits from credit protections. Asset performance is strong with limited non-performing loans. The BSTDB’s liquidity and funding profiles are adequate. Challenges include a difficult operating environment and expanding operations as foreseen in the bank’s strategy.
Finally, the BSTDB’s rating does not benefit from an uplift from Scope’s assessment of the bank’s shareholder support as measured via the key shareholders’ sovereign credit ratings and available callable capital from highly rated shareholders (AA- or higher). The key shareholders are the largest economies surrounding the Black Sea, i.e. – Russia (BBB/Stable), Turkey (B/Negative), Greece (BB+/Stable), Romania (BBB-/Stable), Bulgaria (BBB+/Stable) and Ukraine. This group’s weighted average rating is BB+, below investment grade. Furthermore, there is significant overlap between the bank’s key shareholders and countries of operation.
The Stable Outlook reflects Scope’s assessment that the BSTDB’s institutional and financial profiles are resilient to the challenging operating environment as well as lingering risks on asset quality and profitability from the Covid-19 shock. The ratings/Outlooks could be upgraded if, individually or collectively: i) liquidity buffers increased; ii) profitability improved, raising capitalisation; and/or iii) key shareholders’ ratings improved. Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) liquidity buffers decline; ii) asset quality deteriorated, resulting in sustained losses; iii) capitalisation levels decreased; and/or iv) the bank’s implementation of its strategy diverged from self-imposed targets and shareholder demands.
The first driver of the BSTDB’s A rating is its strong institutional profile.
This reflects the BSTDB’s high strategic importance to its shareholder governments. The BSTDB started operations in 1999 after being established by 11 sovereigns and members of the Black Sea Economic Cooperation. It aims to support economic development and regional cooperation in the Black Sea region, predominantly through extending loans to private enterprises, and the public sector. A recent expansion of activities in response to shareholder demands supports the bank’s strategic role. This also included a shift of activities in 2020 to support businesses in the Covid-19 crisis. In accordance with its strategy the bank’s focus is on maintaining high disbursement levels and a share of public sector projects at around 30% of the loan book, which are key to economic development in member states1.
However, prudential limits on capitalisation levels constrain the bank’s scope for expanding its activities, given that the balance sheet is expected to be near its maximum allowable size at the end of the year. The bank thus envisages a capital increase out of available authorised capital of EUR 816.5m2. A timely and sufficiently large capital increase would bolster the BSTDB’s strategic importance. Given capitalisation constraints, the BSTDB also considers expanding on co-financing and off-balance sheet activities, such as risk sharing and asset transfers, which would be a significant shift of its traditional hold-to-maturity business model, and thus come with the need to first build expertise in the bank.
In response to shareholder demand, the bank is increasingly taking climate change resilience and adaptation into account in its operations, which it formalised in the climate change strategy3. Here, the challenge for the BSTDB lies in navigating the needs of its shareholders, with economies still heavily dependent on fossil fuels for primary energy production, including coal, while at the same time supporting their environmental transition under the Paris Agreement, which all members have now ratified. Scope has assessed the BSTDB’s potential environmental risk exposure and its environmental policies in this context. This includes the risk of stranded assets and the reputational risk of pursuing activities, either directly or through counterparties, that are contradictory to its mandate and environmental objectives. Scope assesses these risks as ‘medium’ compared to peers, mostly driven by Scope’s internal assessment of transition risks faced by member states. Scope sees the BSTDB’s evolving climate policies, together with a relatively shorter lending maturity, as adequately addressing these risks and enhancing climate change resilience and mitigation in member states. Policies include introducing carbon tracking for projects, aiming for a 30% share of annual climate financing by 2030, up from 20% from 2011-20, and including climate risks in risk management practices and project selection.
The second pillar underpinning the BSTDB’s A rating is its strong financial profile.
The BSTDB’s capitalisation levels are very high compared to peers. Equity and reserves stood at around EUR 844m at YE 2020. The bank’s operational gearing ratio determines the limit for outstanding loans, financial guarantees and equity investments at 100% of own funds (subscribed capital, reserves and surpluses), around EUR 2.5bn in 20204. Assuming maximum operations under the gearing ratio limit and current capitalisation, Scope calculates the capitalisation ratio of about 34%, which is one of the highest capitalisation levels among peers. This is a result of both conservative capital adequacy policies and the 30% share of paid-in capital of subscribed capital, which is higher than the 10% share observed for several peer institutions. The bank’s actual capitalisation ratio of 41% in 2020 was also very high, based on disbursed gross loans and equity investments, however lower than the 59% observed in 2018, highlighting rapid growth in loan disbursements in recent years.
The bank’s capital position is supported by stable, but relatively modest, profitability and continuous earnings retention. Scope notes that the BSTDB has been profitable every year since 2004, with average annual returns on equity of 1.2% since 2015. The BSTDB’s net income in 2020 of EUR 14m, or 1.7% of equity, was negatively impacted by the Covid-19 crisis via an increase in the cost of risk due to a worsening macroeconomic environment. This was compensated by higher net interest income on derivatives, resulting in a broadly unchanged level relative to 2019. While the bank’s profitability outlook could be challenged by its shift towards public sector borrowers with lower lending rates, compressed net interest margins and increases in the cost of risk due to lingering effects of the Covid-19 pandemic, Scope expects the bank to remain profitable over the medium-term.
The BSTDB’s A rating is further underpinned by strong asset performance and its adequate portfolio quality. The bank has a track record of recording only limited non-performing loans in recent years, despite the challenging operating environment. Scope considers this a core credit strength, despite an uptick of non-performing loans to EUR 27.7m in 2020, or 1.4% of gross loans. This was higher than the roughly 0% level seen in 2018 and 2019 but still well below the 5.5% seen in 2015. Further, the bank had six Stage 3 exposures at YE 2020, amounting to EUR 78m, or 3.9% of gross loans, up from EUR 51m, or 2.8% of gross loans in 2019. Stage 3 provisions stood at 48% of Stage 3 loans, down from 68% in 2019. While Scope expects asset performance to remain broadly in line with its pre-pandemic trend and that financial losses in relation to write-downs will remain very limited, a persistently higher non-performing loan ratio would be credit negative.
As a reflection of its mandate, the bank’s average borrower quality is relatively weak, with Scope estimating the average quality in the ‘b’ category before credit enhancements. This is based on Scope’s estimate of the geographical and sectoral distribution of aggregate loans outstanding and on Scope’s sovereign ratings. The majority of the bank’s borrowers are in Turkey (B/Negative), Greece (BB+/Stable) and Russia (BBB/Stable), with aggregate exposure in these countries amounting to around 57% of the overall portfolio at YE 2020. Public sector exposures amounted to around 29% of the BSTDB’s total loan book, including around 17% to sovereigns directly, up from around 10% in 2017, reflecting the bank’s strategic shift towards public sector projects. Finally, only EUR 26m or 3.1% of the bank’s own funds was invested in equities, mostly via regional equity funds rather than direct investments.
The BSTDB’s loan book benefits from a high degree of credit protection overall, lifting Scope’s assessment of the bank’s portfolio quality to ‘adequate’. When it comes to sovereign exposures, Scope considers the BSTDB to benefit from preferred creditor status because of the bank’s track record of i) being exempt from the risk of non-payment by private sector borrowers due to the imposition of capital controls implemented in Greece in 2015, and ii) not having experienced a loss from its loan operations with sovereigns. Looking at the private sector exposure, counterparties provided collateral or guarantees amounting to around 54% of the total loan book in 2020, and for its lending activities to small- and medium-sized enterprises, the bank on-lends its funds to commercial banks who take on the ultimate credit risk of the borrower. In sum, Scope estimates conservatively that 40-60% of the total loan book benefits from preferred creditor status or strong credit enhancements.
The bank’s strong asset quality is also reinforced by the diversification of its loan portfolio. The portfolio is diversified by geographies, with country exposure limited at 30% of planned commitments, and by sectors, particularly across financial institutions (which represented 27% of gross loans in 2020, down from 40% in 2018), transportation (18%) and the industrial sector (18%). In addition, the bank has set a single-obligor limit of 10% of own funds for private-sector entities, 20% of own funds for sovereign-guaranteed and sovereign exposures, and 3% of paid-in capital for equity investments5.
Finally, the BSTDB’s A rating is further supported by its conservative liquidity management, proven capital market access and diversified funding mix. Internal liquidity guidelines stipulate that the bank’s available liquid assets must cover 50% of net cash outflows, including committed disbursements, over the next 12 months. While this is lower than the 100% limit usually applied by other multilateral development banks, the BSTDB’s coverage is significantly higher in practice. To cover liquidity needs, the bank holds cash and bank balances, short-term deposits, a treasury portfolio of commercial papers and investment grade bonds and committed credit facilities with highly rated national and international financial institutions.
The BSTDB’s liquid assets coverage is sound in Scope’s view. Specifically, Scope estimates the BSTDB’s available liquid assets to be EUR 605m at end-2020. These include cash and cash equivalents, short-term treasury assets and committed, undrawn and unconditional credit lines from supranational counterparties or national development banks rated AA- or higher. Conversely, the BSTDB’s liabilities due within one year amounted to around EUR 646m in 2020 and loan disbursements in 2021 are estimated at EUR 882m. Thus, total liabilities and disbursements due within one year amounted to around EUR 1.5bn at end-2020. On this basis, Scope calculates a liquid assets ratio of 40% in 2020, in line with 2019. This implies that available liquid assets, as defined under Scope’s methodology, can cover more than one-third of outstanding liabilities and loan disbursements within 12 months without the need for the BSTDB to access capital markets.
In addition, Scope notes positively the BSTDB’s proven capital market access, which also benefits from a reduction of risk weights (to 30% from 50%) to be applied for exposures to A rated multilateral development banks in the Basel framework. Still, compared to levels of larger supranationals and given the modest size of its balance sheet, funding volumes are lower, and issuance is less frequent. The bank’s prudent funding strategy is reflected by the roughly five-year weighted average maturity of its issuances, which broadly mirrors the bank’s loan maturities and minimises risks of maturity mismatches. While the bank mostly issues bonds and private placements denominated in US dollars or euros, smaller issuances are denominated in the local currencies of its member states. The bank also diversifies its funding sources via credit lines from national and international development banks, such as Kreditanstalt für Wiederaufbau (AAA/Stable) and the European Investment Bank (AAA/Stable)6.
Despite these credit strengths, the BSTDB also faces the following credit constraints:
First, the BSTDB’s mandate to operate exclusively in its member states limits its scope to diversify its portfolio towards countries with a more stable operating environment and thus improve its average borrower quality. The bank’s exposures to Turkey (B/Negative) with a 23% share represent the largest and riskiest portion of its loan portfolio, given the country’s recent history of economic and balance-of-payments crises. The risk of loan losses in Turkey is mitigated to a degree as most loans are extended to the public sector, which increases the likelihood of the bank benefitting from preferred creditor status in case of severe sovereign distress. Exposures to Russia (16% of total loans) and Ukraine (12%) are also subject to risks, given weakening growth outlooks and/or ongoing international sanctions.
Second, the bank’s leverage is increasing, in line with its medium- and long-term strategy, which is focused on enhancing the bank’s strategic importance for shareholders by expanding operations. This will also lead to lower capitalisation levels as the bank’s balance sheet size grows closer to internal capital adequacy limits. The bank projects its loan and equity exposure will increase from EUR 2.1bn in 2020 to EUR 2.5bn at YE 2022, which would be the maximum allowable size given current capitalisation. This would lead the ratio of capital relative to mandated assets to decrease over the medium-term, from 41% in 2020 to around 35%, putting pressure on Scope’s assessment of actual capitalisation.
Scope notes that in its long-term strategic framework, the BSTDB envisages a capital increase of between EUR 0.8bn and EUR 1.15bn of remaining unallocated authorised capital, of which 30% would be fully paid-in by 2030. The strategy also aims for continued growth of activities, mostly in the loan portfolio of around 5-7% on average per year, leading to an associated expansion of the balance sheet while maintaining the bank’s internal capitalisation ratio of over 30% (total assets over own funds). In Scope’s view, implementation of the long-term strategy would be credit neutral overall. While the capitalisation levels over the long-term compared to 2018-20 would be somewhat lower, the capital increase and the continued high levels of disbursements would signal a greater strategic importance for its shareholders.
Finally, the BSTDB’s rating does not benefit from an uplift from Scope’s assessment of the bank’s shareholder support as measured via the key shareholders’ sovereign credit ratings. The six largest economies in the region – Russia (BBB/Stable), Turkey (B/Negative), Greece (BB+/Stable), Romania (BBB-/Stable), Bulgaria (BBB+/Stable) and Ukraine – form the key shareholder group with a capital-weighted average rating of BB+. Scope has adjusted this downwards by one notch to account for the significant overlap between countries of operation and key shareholders (82% of loans were in key shareholder countries in 2020), highlighting the risk of worsening macroeconomic conditions impacting both the shareholder and aggregate borrower side. In addition, the bank’s credit profile does not benefit from callable capital provided by highly rated shareholders, as none of them are rated AA- or above.
Scope’s shareholder support assessment could change if the BSTDB were to attract a AAA-rated international financial institution as a meaningful shareholder per its strategic plans, depending on the size of the capital subscription. Despite these constraints, Scope notes positively that 30% of the bank’s capital is paid-in, one of the highest such ratios among supranationals, which is expected to be maintained with the forthcoming capital increase, demonstrating shareholders’ political and financial commitment to supporting the BSTDB.
Factoring of environment, social and governance (ESG)
Scope considers ESG sustainability issues during the rating process as reflected in its supranational methodology. ESG factors are explicitly captured in Scope’s assessment of the institutional profile, which Scope assesses as ‘strong’ for the BSTDB.
Scope’s supranational scorecard
Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative ‘A / BBB+’ rating for the BSTDB. 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 BSTDB, the following additional consideration has been identified: i) in Scope’s view the increase in the non-performing loan ratio in 2020 to 1.4% of gross loans from around 0% in 2019 and 2018 does not signal a systematic trend of asset performance worsening vis-à-vis the previous trend. This is despite the change of the asset performance assessment in the supranational scorecard. Scope has acknowledged this factor with a one-notch positive adjustment.
A rating committee has discussed and confirmed these results.
For further details, please see the Appendix.
The main points discussed were: i) institutional profile; ii) financial profile, including capitalisation, asset quality, liquidity and funding; iii) shareholder support; iv) additional considerations; and viii) consideration of peers.
Rating driver references
1. Review and Update of Medium Term Strategy and Business Plan 2019-2022
2. BSTDB Long-Term Strategic Framework 2021-2030
3. BSTDB Climate Change Strategy
4. Financial Statements for 2020
5. Portfolio Risk Management and Investment Policies
6. Investor Presentation June 2021
The methodology used for these Credit Ratings and/or Outlooks, (Supranational Rating Methodology, 7 September 2021), is available on https://www.scoperatings.com/#!methodology/list.
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 Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit 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 Ratings: public domain.
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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.
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: Alvise Lennkh, Executive Director
Person responsible for approval of the Credit Ratings: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 6 November 2020.
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