Rating action

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 BBB+ from A- as well as its short-term issuer rating to S-2 from S-1 in foreign currency and revised all Outlooks to Stable.

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 Russia-Ukraine war on the bank’s asset quality, resulting in record-high provisions and losses in 2022, elevated stage 3 loans and NPLs over coming years.
    
2. The expected involuntary 20-25% contraction of the bank’s loan portfolio over 2022-24, which will significantly curtail its ability to generate earnings over coming years. The deleveraging is driven by the need to preserve internally generated liquidity to repay two maturing bond obligations until June 2024 for a total EUR 750m without external borrowing given sustained elevated external funding costs.

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

The Stable Outlook reflects Scope’s view that the bank’s high capitalisation, reinforced via the capital increase approved on 8 March 2023, its preferred creditor status ensuring the eventual repayment of its exposures from Russian counterparties, and the prudent liquidity management mitigate the remaining uncertainty surrounding the final impact of the Russia-Ukraine war on the bank’s balance sheet.

The ratings/Outlooks could be downgraded if, individually or collectively: i) asset quality deteriorated beyond Scope’s baseline; ii) the bank’s preferred creditor status were to be questioned or even repealed due to events prompted by the crisis, particularly related to exposures in Russia; iii) liquidity buffers declined significantly; iv) the bank’s implementation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 receiving payments of the agreed capital increase or failure to return to growth from 2025 onwards; and/or v) shareholders’ commitment towards the bank 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 ratings/Outlooks could be upgraded if, individually or collectively: i) asset quality improved beyond Scope’s baseline; and/or ii) liquidity buffers increased permanently.

Rating rationale

The first driver of the downgrade of the BSTDB’s rating to BBB+ is the adverse impact of the Russia-Ukraine war on the bank’s asset quality and performance. Scope expects record-high provisions and losses in 2022 as well as elevated stage 3 loans and an NPL ratio of around 6-10% over coming years, significantly above the five-year average of around 1% before the war. The bank’s combined exposure of about EUR 380m to Russia (or 19% of total) and EUR 262m to Ukraine (13% of total) account for about 33% of its outstanding mandated assets (mostly loans) as of end-2022. The bank’s revised medium-term strategy, which accounts for the developments since the outbreak of the war in February 2022, forecasts under the baseline scenario that provisions in 2022 will amount to EUR 120m resulting in a record loss of EUR 92.6m, about twice the net profit from 2021 of EUR 43.9m. As a result, the 2022 loss almost halves the bank’s reserves to around EUR 106m from EUR 199m in 2021, weighing on its capitalisation¹.

Given the prevailing geopolitical risks and the ongoing war there remain uncertainties as regards the timely repayment of the large due payments in 2023-24 of around EUR 270m from Russian and Ukrainian counterparties, which may result in additional provisions and losses. To date the bank’s provisions relate mostly to exposures in Ukraine as the bank classifies most of its Russian exposures as stage 2 loans on account of its preferred creditor status and the expectation that repayment risks from its counterparties in Russia are transactional only. Scope notes that despite the war Ukrainian counterparties repaid 60% while the bank managed to obtain 77% of its due payments from its Russian counterparties despite sanctions in 2022, underpinning its preferred creditor status.

While Scope therefore expects additional provisions to remain limited for Russian counterparties, uncertainties remain on the timely repayment ability from Ukrainian counterparties given the ongoing war. It would be credit negative should additional provisions in 2023-24 be needed beyond the bank’s expectation of around EUR 12m, which appears optimistic the longer the war prevails, as this would raise total provisions beyond EUR 130m by 2024 and possibly result in additional losses. Still, even if additional provisions are needed to cover losses in Ukraine, Scope expects significant international financial assistance to Ukraine once the situation stabilises, which should also improve the creditworthiness of the bank’s counterparties. These stand to benefit from eventual reconstruction efforts as about 50% of the BSTDB’s loans in Ukraine relate to the nation’s leaders in iron ore and home renovation.

The second driver of the downgrade of the BSTDB’s rating to BBB+ is the expected involuntary 20-25% contraction of the bank’s loan portfolio over 2022-24, which will significantly curtail its ability to generate earnings over coming years. The expected deleveraging is driven by the bank’s need to preserve internally generated resources to repay two maturing bond obligations until June 2024 of around EUR 750m without external borrowing given sustained elevated external funding costs. Market conditions remain prohibitive for the bank one year after the outbreak of the war, with the 5Y USD bond maturing in June 2024 still trading at levels close to 10%. This environment is forcing the bank to significantly reduce its planned disbursements to preserve liquidity, driving the marked decline of disbursements to EUR 393m in 2022, EUR 117m in 2023 and EUR 251m in 2024 compared with EUR 1bn in 2021 alone.

This significant deleveraging will reduce the bank’s loan portfolio to around EUR 1.8bn by 2024, broadly in line with its outstanding loans back in 2019, and markedly below the EUR 2.1bn in 2022 and EUR 2.3bn in 2021. Even under the bank’s more optimistic scenario, its portfolio is still expected to decline to around EUR 1.9bn by 2024, or about 20% below its 2021 level. Overall, these developments highlight the severity of the impact of the war in Ukraine on the bank’s balance sheet, funding conditions and liquidity constraints driving Scope’s decision to downgrade the BSTDB’s rating to BBB+.

Despite these significant rating pressures, the BSTDB retains several credit strengths that anchor the BBB+ rating level, including its high capitalisation and shareholder support, preferred creditor status, and prudent crisis and liquidity management.

First, the BSTDB’s capitalisation levels are very high compared to peers and have been reinforced by the capital increase approved on 8 March 2023. This first step of the capital increase, which showed strong shareholder support with 10 of 11 member states participating and two over-subscribing, will increase the bank’s capital on a pro-rata basis, starting with an additional EUR 30.6m paid-in capital in 2023, which will help offset the financial impact of the Russia-Ukraine crisis. In July the board of governors is expected to approve the second step of the capital increase, which will decide on the final allocation of shares, payment and transfer of voting rights, paving the way for the bank’s paid-in capital to increase by EUR 245m during 2023-30 to EUR 931.5m^{2 3}. This is a very important step as it not only strengthens the bank’s capital position but also affirms its shareholders’ commitment to the bank and its mandate despite the war and persistent tensions among some of its shareholders. Any payment delays related to the capital increase would thus be credit negative.

Equity and reserves remain elevated and are forecast at EUR 793.1m for end-2022, down from EUR 885.7m at end-2021 given the financial impact of the war in Ukraine. 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 2.4bn as of 2022. Assuming maximum operations under the gearing ratio limit and current capitalisation, Scope calculates the capitalisation ratio at about 33%, 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 prior to the war. The BSTDB has been profitable every year since 2004, with average annual returns on equity of 2.0% for the 2017-21 period. Scope expects the bank to return to very modest profits in 2023-24.

Second, Scope considers the BSTDB to benefit from preferred creditor status, supporting the expectation that additional stage 3 loans and provisions will remain limited, and that the bank’s non-performing loans ratio should not exceed its self-imposed 10% tolerance and target. 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.

Thus, while the bank still faces transactional risks in Russia driven by capital controls and sanction policies resulting in delays of repayments of the bank’s outstanding loans in Russia, Scope expects the bank to ultimately receive payments in foreign currency from Russian counterparties. This reflects Scope’s expectation that the Russian central bank will lift restrictions imposed on cross-border transactions related to the bank’s future repayments as it has already done for most repayments due in 2022. In addition, it also reflects Scope’s expectation that the bank’s main exposures in Russia, which include systemically important financial institutions and state-owned corporations active in export-driven sectors including transport and energy, are able and willing to honour their obligations to the BSTDB.

This is because the credit quality of these entities is unlikely to be materially affected by the Russian recession given their systemic importance and ability to re-orient at least part of their goods to China. In addition, given the absence of local capital markets, the Russian counterparties depend on foreign capital for funding, driving their willingness to honour their repayments. These assumptions critically underpin Scope’s expectation of a manageable impact of the crisis on the bank’s operations in Russia.

Third, the BSTDB’s BBB+ 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 higher in practice⁴. The bank’s liquidity management also requires a 100% coverage of cash outflows over 90 days and a 75% coverage of maturing obligations over the next 12 months.

Currently, using the bank’s estimates of its liquid assets, including EUR 153m in cash and EUR 608m securities, its liquidity coverage is 183% over 12 months, including planned disbursements of about EUR 117m in 2023. Extending the horizon to June 2024, thus including the maturing 5Y USD 550m bond, the coverage is 102%.

To ensure this coverage, the expected disbursements of EUR 368m over 2023-24 are about half the bank’s expected repayments of around EUR 667m over the same period. Of these expected EUR 667m repayments, about EUR 90m are due from Russian and Ukrainian counterparties, which is a conservative 1/3 estimate of their total due payments until 2024 and compares to around EUR 100m received in 2022. It is also lower than the bank’s remaining reserves of EUR 106m providing additional buffers if needed.

In Scope’s opinion, the bank’s prudent liquidity management, which also benefits from a favourable asset-liability maturity structure, will thus ensure that the bank honours its two upcoming bond obligations of EUR 750m, specifically CHF 200m by June 2023 and USD 550m by June 2024. This is also because the bank is likely to refinance at least part of its exposure via private placements in 2023-24.

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. Medium-term strategy 
2. Capital increase, March 2023 
3. Capital increase, October 2021 
4. Investor presentation, H1 2022 

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Supranational Rating Methodology, 11 August 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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: public domain, 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 rating 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-Yunus, 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 1 April 2022.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings of the Black Sea Trade and Development Bank are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Publication Calendar 2023: Sovereign, Sub-Sovereign and Supranational Ratings" published on 1.12.2022 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the BSTDB’s Board of Governors decisions on March 7, which agreed on the first step of the capital increase (published on March 8) and the medium-term strategy (published on March 13), providing further clarity on the bank’s baseline projections, prompting the publication of the credit rating action on a date that deviates from the previously scheduled release dates per Scope’s release calendar, published at www.scoperatings.com.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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