Scope Ratings GmbH (Scope) has today downgraded the Black Sea Trade and Development Bank’s long-term issuer and senior unsecured foreign-currency ratings to A- from A and affirmed its short-term issuer rating of S-1 in foreign currency. All Outlooks are Negative.

For the associated appendix, click here.

Rating drivers

The downgrade of the Black Sea Trade and Development Bank (BSTDB) reflects:

1. The adverse impact of the war between Russia and Ukraine on the bank’s operating environment and asset quality, particularly due to heightened transactional risks in Russia and severe credit quality risks in Ukraine. Together, both countries account for 32% of the bank’s outstanding loans.
    
2. The expected increase in provision requirements over the coming years, which Scope expects will lead to revisions of the bank’s future earnings growth and absorb a high share of the bank’s reserves, weighing on its capitalisation.

The downgrade reflects changes in Scope’s assessment of the bank under the ‘financial profile’ category of its supranational methodology.

The Negative Outlook reflects the elevated uncertainty surrounding the final impact of the Russia-Ukraine war on the bank’s balance sheet, strategy and shareholder relations.

The ratings could be downgraded if, individually or collectively: i) asset quality deteriorated beyond Scope’s baseline, lowering the bank’s profitability and capitalisation; ii) the bank’s preferred creditor status were to be questioned or even repealed due to events prompted by the crisis; iii) liquidity buffers declined significantly; iv) the bank’s implementation of its strategy diverged significantly from self-imposed targets, for instance, via a delay in the planned capital increase; and/or v) shareholders’ commitment towards the bank’s mandate and willingness to provide associated support deteriorated, weakening the bank’s governance and efforts to establish itself as a financially and developmentally relevant international institution in the Black Sea region.

Conversely, the Outlooks could be reversed to Stable if, individually or collectively: i) asset quality improved beyond Scope’s baseline; ii) liquidity buffers increased; and/or iii) shareholders provided additional support, for example, via accelerating and increasing their payments of the already agreed capital increase.

Rating rationale

The first driver of the downgrade of the BSTDB’s rating to A- is the adverse impact of the war between Russia and Ukraine on the bank’s operating environment and asset quality. Specifically, based on the latest available information, the bank has an exposure of EUR 470m to Russia (or 21% of total) and EUR 279m to Ukraine (11% of total). This means both countries combined account for EUR 748m of the bank’s exposure, or about 32% of its outstanding mandated assets (mostly loans).

Since the outbreak of the war, Scope downgraded Russia three times to C from BBB+/Stable before withdrawing the ratings for business reasons in line with EU sanctions and regulations, and has downgraded Ukraine to CCC from B/Negative. Admittedly, there remains significant uncertainty regarding the duration and broader consequences of the war on both countries. Still, it is Scope’s baseline that Russia and Ukraine will face a much deeper recession in 2022 than during the Covid-19 pandemic, which will have adverse consequences on the bank’s asset quality.

In addition to the war in Ukraine, Scope also notes with concern the ongoing deterioration of Turkey’s credit profile. This has been mostly the result of governance risks reflected by the country’s structurally loose monetary policy, high inflation and negative net foreign-currency reserves, increasing the likelihood of deeper balance-of-payments, financial and/or political crises in the country. Scope has thus downgraded Turkey by one notch to B-/Negative. As activities in these three countries constitute about 50% of the bank’s total operations, Scope assesses the BSTDB’s operating environment to have materially deteriorated since the last rating review six months ago, to the extent that its asset quality can be reasonably expected to be materially and adversely impacted in 2022-23.

The second and related driver of the downgrade of the BSTDB’s rating to A- is Scope’s expectation of a material weakening of the bank’s asset performance, which will weigh on its capitalisation over the medium term. Scope expects the BSTDB to face heightened transactional risks in Russia driven by capital controls and sanction policies as well as severe credit quality risks in Ukraine. The bank’s exposures in both countries are entirely and directly linked to the private sector. Specifically, the bank’s main exposures in Russia refer to systemically important financial institutions and state-owned corporations active in export-driven sectors including transport and energy. To date, only one of the bank’s clients in Russia is a sanctioned entity: Sovcombank, which owes about USD 60m in loans to the BSTDB, of which USD 20m is due by Q4 this year. Despite the expected recession in Russia, the credit quality of these entities is unlikely to be materially affected this year given their systemic importance and presumed ability to re-orient at least part of their goods to China.

Still, at the minimum, Scope expects the capital controls and sanction policies to result in delays and a possible re-profiling of some of the bank’s outstanding loans in Russia, even given the BSTDB’s preferred creditor status and the associated expectation that it will receive payments in foreign currency from Russian counterparties despite restrictions on cross-border transactions imposed by the Russian central bank. This will adversely affect the bank’s provisions and profitability in 2022-23.

In addition, Scope expects the bank to set aside significant provisions for its Ukrainian exposures this year despite the fluid and opaque situation of the war preventing any accurate assessment at this stage. However, given that about 50% of the bank’s loans relate to the nation’s leaders in iron ore and home renovation, Scope does not expect the entire Ukrainian portfolio to become non-performing. This view is also underpinned by Scope’s expectation of significant international financial assistance to Ukraine once the situation stabilises.

Nonetheless, while Scope understands that Ukrainian counterparties have continued to pay on time since the war started and given that the extent of the damage on Ukraine is still highly uncertain, the shock of the war in Ukraine, the bank’s fourth largest geographical exposure, is already of such a magnitude that it will necessarily impact the bank’s profitability and consume much of its reserves (EUR 185m as of H1 2021), thus adversely affecting its capitalisation in 2022-23. These factors underline Scope’s decision to downgrade the BSTDB by one notch to A-.

Despite these significant rating pressures, the BSTDB retains several credit strengths supporting the A- level, including its conservative risk management practices, strong capitalisation, preferred creditor status, prudent liquidity position and Scope’s expectation that the bank will retain its strategic importance to all its shareholders over the coming years.

First, the BSTDB’s capitalisation levels are very high compared to peers. Equity and reserves stood at around EUR 871m at H1 2021. 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 as of H1 2021¹. Assuming maximum operations under the gearing ratio limit and current capitalisation, Scope calculates the capitalisation ratio at about 35%, which is among the highest of its peers. This reflects the bank’s conservative capital adequacy policies and the 30% share of paid-in capital. The bank’s capital position is further supported by stable, but relatively modest, profitability and continuous earnings retention. The BSTDB has been profitable every year since 2004, with average annual returns on equity of 1.2% for the 2015-20 period. For 2021, Scope estimates record net profits of about EUR 40m-50m (EUR 34m as of H1 2021), which will help absorb the financial impact of the Russia-Ukraine war in 2022.

Second, the BSTDB’s loan book benefits from high overall credit protection, supporting Scope’s assessment of manageable non-performing loans from the Russia-Ukraine war. Critically, Scope considers the BSTDB to benefit from preferred creditor status. This view is based on the bank’s record: i) it was exempt from the risk of non-payment by private sector borrowers in Greece after capital controls were imposed there in 2015; and ii) its loan operations with sovereigns have never seen losses. On this basis, Scope expects the bank to also be exempt from the capital controls and sanctions relating to Russia, which would allow its Russian counterparties to repay the bank in foreign currency, thereby eliminating the bank’s transfer and convertibility risks in the country. This assumption critically underpins Scope’s expectation of a manageable credit quality impact of the crisis on the bank’s operations in Russia.

Third, the BSTDB’s A- rating is further supported by its conservative liquidity management 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 practice¹.

Currently, using the bank’s estimates of its liquid assets, including EUR 83m in cash and EUR 510m securities, of which 92% are rated A1 or above, its liquidity coverage is 407% over 30 days, 153% over 90 days, and 120% over 12 months, including planned disbursements of about EUR 600m. Assuming the bank honours its contractual obligations only, disbursements would be around EUR 282m. On this basis, the 12-month liquidity ratio would be around 282% and would still be 178% assuming no repayments from its counterparties in Russia and Ukraine this year. Liquidity is further supported via undrawn credit lines of EUR 130m from highly rated international development banks. Scope also notes positively that the bank’s debt maturity profile does not foresee major debt repayments in 2022 (EUR 134m) and 2023 (EUR 331m), with the five-year USD 500m bond coming due in 2024 only. The BSTDB’s strong liquidity position, disbursement flexibility and favourable maturity profile support the A- rating.

Finally, the BSTDB’s A- rating is further supported by its high strategic importance to its shareholder governments, including Russia, Turkey and Greece (all with a 16.6% capital share), Romania (14.1%), Bulgaria and Ukraine (both 13.6%). The BSTDB aims to support economic development and regional cooperation in the Black Sea region. Its recent expansion of activities and the agreed capital increase to support additional loan growth, with EUR 245m to be paid in during 2023-30, demonstrate this². Scope therefore expects that shareholders will provide at least EUR 60m in additional capital during 2023-24, which will help offset the financial impact of the Russia-Ukraine crisis. Any delay to the planned capital increase or signs of weakening shareholder commitment to the bank from either Russia, the EU and/or NATO member states would be credit-negative. Conversely, additional financial and political support to the BSTDB enhancing its role in a post-conflict reconstruction phase would be credit-positive.

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, no additional considerations have 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) 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. Investor Presentation November 2021 
2. Capital increase, October 2021

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Supranational Rating Methodology, 7 September 2021), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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      YES
With Access to Internal Documents                                   YES
With Access to Management                                             YES
The following substantially material sources of information were used to prepare the Credit Ratings: the Rated Entity and public domain.
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: 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. The Credit Ratings/Outlooks were last updated on 8 October 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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