Asian Development Bank Ratings Affirmed At #AAA# With Stable Outlook

Stocks and Financial Services Press Releases Friday June 22, 2018 15:08
SINGAPORE--22 Jun--S&P Global Ratings

SINGAPORE (S&P Global Ratings) June 22, 2018--S&P Global Ratings said today that it has affirmed its 'AAA' long-term and 'A-1+' short-term foreign currency issuer credit ratings on the Asian Development Bank (AsDB). The outlook remains stable.

We affirmed the ratings on AsDB to reflect our assessment of the bank's extremely strong business profile and financial profile. The bank enjoyed a transfer of Asian Development Fund (ADF) loans and certain other assets to AsDB's OCR, boosting total lending capacity substantially due to the addition of nonleveraged ADF equity to the OCR. The combined account's equity has nearly tripled to approximately US$50.3 billion as of end-2017. This has provided for an extremely strong capital position, which underpins our assessment of AsDB's stand-alone credit profile (SACP) at 'aaa'.

We believe the merger was undertaken to provide ADB with more lending capacity, particularly to less-developed countries. In addition, the merger will assist with private-sector economic development by gradually increasing leverage on the fully equity financed concessional lending. We believe it will assist the bank in achieving its targets toward the immense developmental needs in the Asia-Pacific region. The merger was considered achievable since, compared to when the ADF was established four decades ago, there are now smaller economic gaps between OCR and ADF countries. The improvement of many countries from lower to middle income status has also blurred the scope between the two lending windows.

We consider the main benefit of the merger is the additional lending headroom capacity. This allows the bank to catalyze further sovereign and private sector developmental lending in the region. Some of the potential risks we anticipate could be the lowering of preferred treatment given the increase in private sector lending, and competition from burgeoning regional multilateral lending institutions (MLIs).

Lending activity has accelerated prudently following AsDB's increase in lending capacity. The OCR's loan commitments for sovereign and nonsovereign lending in 2017 amounted to US$18,641 million (of which US$2,272 million was provided on concessional terms), an increase of 51% compared to prior to the merger.

We believe that the increasing disbursements following the augmented capacity is positive and underpins AsDB's role in the region. In addition, AsDB's loan commitments for nonsovereign sector operations increased to US$1.9 billion from US$1.3 billion, its highest level to date. Private sector operations also attracted US$5.9 billion in cofinancing, driven by the robust growth in AsDB's Trade Finance Program, a key strategic initiative of the bank going forward.

In fact, the increased private sector focus is more on the mobilization aspect than increasing the bank's own lending extensively. As a key focus area for the overall sector, private sector mobilization will become an integral part of the strategy of many MLIs, including AsDB, and we expect shareholders to closely monitor the progress in this area.

We consider AsDB will continue to receive preferred creditor treatment, even with the higher credit risk exposure from loans transferred from the ADF, given the payment record of its borrowing members. In our view, the payment record of ADF clients has been strong. Despite instances of arrears by Myanmar, Nauru, and the Marshall Islands, the amounts were small and were eventually repaid, with interest. As of Dec. 31, 2016, AsDB had one nonsovereign loan of US$20 million in default, which was completely written off in 2017. It has no sovereign defaults to date.

In our view, the addition of significant capital resources outweighs the increase in risk, as indicated by AsDB's extremely strong risk-adjusted capital (RAC) ratio of 45% before adjustments as of Dec. 31, 2017 (compared with 27% as of Dec 31, 2016 before the merger). Compared with a RAC before adjustments of 48.7% as of Jan. 1, 2017, the RAC slightly declined because it includes the additional lending completed during the year without a commensurate increase in capital.

We note the average risk weights for sovereign exposures have increased to 62% from 46%, due to the addition of the ADF portfolio's increase in lower credit rated sovereigns. AsDB's RAC after adjustments comes out to 33% as of Dec. 31, 2017 (Jan. 1, 2017: 36%, Dec. 31, 2016: 16%), with the major multilateral specific adjustment being the single-name concentration charge for the sovereign and corporate portfolio.

Our assessment of AsDB's funding and liquidity have been less affected than that of the capital position. AsDB significantly ramped up its funding and raised around US$29 billion in 2017. AsDB is a frequent issuer across global markets with a diversified investor base, and raised new borrowing in 15 currencies in 2017. While we consider market access to be strong and the investor base well diversified, we note that our static funding gap analysis for the next 12 months results in a ratio of 1.01x, which compares unfavorably with 'AAA' rated peers.

AsDB maintains a strong liquidity buffer, increasing its prudent investment portfolio to US$36 billion in 2017, from US$27 billion in 2016. We expect AsDB to be able to meet its obligations under stressed market conditions and without access to the capital markets for at least one year. For year-end 2017 data, the liquidity ratios including collateral held against derivative exposures were 1.5x at the one-year horizon without any loan disbursements and 1.1x with scheduled loan disbursements. However, when taking into account undisbursed loans in a stress scenario (beyond those currently planned in the next 12 months), we estimate ADB may need to spread out potential disbursements.

Although the Chinese government's initiative to spur infrastructure investment in Asia via the Asian Infrastructure Investment Bank (AIIB) could see its lending volume eventually eclipsing that of the AsDB, we do not expect that to hamper AsDB's policy importance. This is because the region's infrastructure needs are immense, and will be larger than what one MLI can handle. While we are expecting some overlaps, we believe AIIB will cooperate, more so than compete, with AsDB and other MLIs to boost the level of infrastructure and developmental growth in Asia.

We believe AsDB will continue to promote the economic and social development of its members in the Asia-Pacific, through loans, policy dialogue, technical assistance, equity investments, grants, and guarantees. In terms of its size of purpose-related exposures, the bank is the third-largest MLI that we rate globally, after the European Investment Bank, and the International Bank for Reconstruction and Development. In our view, AsDB's role, unwavering public policy mandate, and membership support anchor our assessment of its extremely strong business profile. We believe the recent merger of the concessional window underpins our assessment of the business profile.

AsDB benefits from the support of its members and a diverse shareholder base. Forty-eight members from Asia-Pacific own 63.5% of the bank and 19 nonregional members own the remainder. While Japan and the U.S. have always been the AsDB's largest shareholders (both own 15.6%), the bank's shareholder base is diversified with eight governments owning more than 5% of the capital each. These include China (6.4%), India (6.3%), Australia (5.8%), Indonesia (5.4%), Canada (5.2 %), and Korea (5.0%). Nonborrowing members have about 62% of the voting rights of AsDB. We believe this helps the bank adopt prudent lending and investment policies.

Given the 'aaa' SACP on AsDB, the ratings on the bank do not rely on callable capital. However, should AsDB's cash capital position weaken, we believe the bank could call on 10 'AAA' rated shareholders to provide up to US$27 billion of callable capital to support its debt servicing requirements.

The stable outlook on AsDB reflects our expectation that the bank will maintain its extremely strong business profile with borrowers treating the bank as a preferred creditor. In addition, we view the significant capital increase as anchoring the extremely strong financial profile. We also expect AsDB will address its funding gaps over the next year. Our base case indicates a relatively low probability that we would lower our issuer credit rating over the next 24 months.

We may lower the ratings on AsDB if either the bank's business or financial profile substantially deteriorates. For example, the rating will come under pressure if, contrary to our expectations, the AsDB management adopts more aggressive financial policies, if poor-quality loan growth increases, or if the bank's derivative activities generate persistent operating losses. Should AsDB's other strengths deteriorate, such as its preferential creditor treatment weakening on the diversified portfolio, the rating could also come under pressure.

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