Moody’s affirms EADBs Baa3 long-term issuer rating; outlook stable

NAIROBI (Capital Markets in Africa) – Moody’s Investors Service has today affirmed the East African Development Bank’s (EADB or the bank) Baa3 long-term issuer rating and maintained the stable outlook. EADB is a regional multilateral bank that serves the East African Community (EAC) with the aim of promoting sustainable socio-economic development as well as the regional integration of its shareholder member states: Uganda (B2 stable), Kenya (B1 stable), Tanzania (unrated) and Rwanda (B2 stable). It supports both public and private sector projects within the EAC with short to long-term loans and other products.

Moody’s decision to affirm the rating reflects EADB’s high capital position and strong liquidity, balanced against a challenging operating environment, low asset quality and concentration risks that has led to a recent rise in non-performing loans. While shareholders remain firmly committed to the bank, the low credit quality of shareholders provides no uplift to the bank’s creditworthiness.

The maintenance of a stable outlook reflects the expectation that the balance of credit strengths and challenges is unlikely to shift over the outlook horizon.

EADB has one of the highest asset coverage ratio (Usable Equity / (Gross Loans + Equity + Expected Loss on Liquid Assets) in Moody’s MDB rating universe at 120.2 per cent in 2016. This ratio has been declining since 2015 due to the bank’s balance sheet expansion. This decline is likely to continue, in line with the bank’s 2016-2020 strategic plan, but is going to be slow, in part due to the ongoing increase of the bank’s capital base. In particular, the bank has benefitted from both the $90 million general capital increase agreed in 2007 (of which $68.9 million is already paid in) and the bank’s profitability increasingly contributing to the capital base since 2012 (adding $36.5 million). At the end of 2016, EADB’s subscribed capital amounted to $1,033 million and paid-in capital to $190 million.

Furthermore, the EADB maintains a strong liquidity position, reinforced by a high level of liquid assets which act as a strong buffer in case of shocks. The debt service coverage ratio (short-term debt and currently maturing long-term debt to discounted liquid assets) is one of the strongest ratios among our MDB rated universe, improving to 18.9 per cent in 2016 from 20.2 per cent in 2014. This is the result of EADB’s strong liquidity policy that sets a minimum liquidity coverage ratio of 1.33 times total liabilities (i.e., covering its liabilities for the next 16 months). In addition, the bank has access to a number of funding sources, although the majority of its funding is drawn from other development financial institutions (DFIs) offering concessional rates. However, unlike other MDBs, the bank has not yet issued Eurobonds to further diversify its investor base. In addition, the bank presents a relatively long-dated debt maturity structure and moderate funding costs that have steadily increased due to local currency borrowing.

The EADB’s operating environment is challenging, as evidenced by the recent increase in non-performing loans (NPLs) which increased to 7.0 per cent of gross loans in 2016. The surge in NPLs was related to a loan in the tourism sector in Kenya, which continues to suffer from regional tensions exacerbated by several terrorist attacks over the last few years. This represents an abrupt reversal in trend after the significant decline in the NPL ratio to a low of 0.6 per cent in 2015, following a restructuring of the bank between 2008 and 2012. One of the main rating constraints to EADB is the low average quality of its loan portfolio, which is potentially under further pressure given the challenging environment (both economic and political) in East Africa. However, Moody’s expects the macroeconomic outlook of this region to remain supportive to some extent, with real GDP growth around five per cent-6 per cent over the next two years.

In addition, EADB’s loan portfolio is concentrated geographically in an unusually small number of countries for an MDB, namely Kenya, Uganda, Tanzania and Rwanda, which are increasingly integrated. Also, the bank shows high exposures to some sectors, such as development finance institutions (22.5 per cent of total loans), electricity companies (17.2 per cent) and tourism (13.2 per cent), even though they remain below the bank’s internal sector limits.

While shareholders remain firmly committed to the bank, Moody’s assessment of EADB’s strength of member support is constrained by the low average credit quality of its shareholders countries. In 2016, the weighted median shareholder rating for the EADB was B2 which is among the lowest of all Moody’s MDB rated universe. This is shared only by Eastern and Southern African Trade and Development Bank (Ba1 positive), African Export-Import Bank (Baa1 stable) and Africa Finance Corporation (A3 stable). Therefore, the rating agency views the ability of these governments to quickly transfer callable capital or provide extraordinary support to the EADB as low, in the hypothetical event of an emergency. Moody’s only considers the investment-grade rated African Development Bank (Aaa stable) — which represents 8.8 per cent of paid-in capital and 1.7 per cent of callable capital as of end 2016 — to be able to support the bank in a timely manner in the event of stress.

In addition, the high correlation between assets and the small number of increasingly integrated economies of the East African Community further constrain the strength of member support assessment. Nevertheless, shareholders’ willingness to support EADB is very high, as illustrated by a track record of consecutive capital increases since its inception.

The stable outlook reflects Moody’s expectation that the balance of credit strengths and challenges is unlikely to shift over the outlook horizon. Asset quality is unlikely to deteriorate further despite the challenging environment. The bank will continue to develop its operations while maintaining strong capital positions and a high level of liquidity.

A further deterioration in asset quality will exert negative pressure on the rating. Additionally, if the bank’s rapid asset growth leads to a disproportionate increase in credit risk, undermining recent improvements in governance and risk management, the rating could be affected. Finally, increased use of leverage over retained earnings or shareholder capital to fund expansion of the loan book could also negatively pressure the rating.

A return to a low NPL ratio while the bank continues to expand its balance sheet in the coming years would be credit positive. Additional shareholder support from higher-rated shareholders could also lead to a positive reassessment of EADB’s credit rating.