Tuesday, December 18, 2012
Tuesday, December 18, 2012
Following a review of the Caribbean Development Bank (CDB) under Standard and Poor’s revised criteria for multilateral lending institutions (MLIs), the rating agency has lowered its long-term foreign currency issuer credit rating on CDB to ‘AA’ from ‘AA+’ and affirmed its ‘A-1+’ short-term foreign currency rating. The following statement was released by the rating agency.
— Following a review of the Caribbean Development Bank (CDB) under our revised criteria for multilateral lending institutions (MLIs), we have lowered our long-term foreign currency issuer credit rating on CDB to ‘AA’ from ‘AA+’ and affirmed our ‘A-1+’ short-term foreign currency rating.
— The issuer rating on CDB combines its ‘aa-‘ stand-alone credit profile and one notch of potential extraordinary shareholder support, owing to callable capital from CDB’s higher-rated sovereign shareholders.
— The stand-alone credit profile, in turn, derives from CDB’s “strong” business profile and “very strong” financial profile.
— The negative outlook reflects rising embedded risks in CDB’s public-sector loan portfolio.
On Dec. 12, 2012, Standard & Poor’s Ratings Services lowered its long-term foreign currency issuer credit rating on Caribbean Development Bank (CDB) to ‘AA’ from ‘AA+’. The outlook is negative. We also affirmed our ‘A-1+’ short-term foreign currency rating on CDB.
The ratings on CDB reflect its “strong” business profile and its “very strong” financial profile, as our criteria define the terms, in addition to our
expectation for extraordinary shareholder support through callable capital from higher-rated sovereign shareholders.
CDB, established by treaty in 1969, today has 26 member countries, and it contributes to the economic growth and development of its 18 borrowing member countries in the Caribbean. The bank provides loans and guarantees principally to sovereign governments, to public-sector companies, and to a small portfolio of private enterprises. CDB had $1 billion of development-related exposure at the end of 2011.
The development bank’s “strong” business profile is anchored by its role as a prominent lender to Caribbean governments and its historical capacity to lend countercyclically through the credit cycle in support of its public policy mandate. Periodic capital increases–the most recent of which is planned to increase CDB’s paid-in capital by 138% over six years (2010-2016)–have demonstrated shareholder support. Most major and extraregional shareholders have begun to pay in their subscriptions on time, although 28% of anticipated subscription payments for the first two years are pending because of administrative and parliamentary delays.
CDB’s “strong” business profile has elements that are weaker than those of higher-rated peers. Although most borrowing members traditionally have treated CDB as a preferred creditor, one government borrower is more than 180 days in arrears to CDB on interest and principal, while the government has paid its commercial debt. By its policy, the bank has halted disbursements to this borrower in arrears, and a late interest penalty is accruing on the arrears.
Preferred creditor treatment is an important element in our assessment because it speaks to CDB’s membership support, capital adequacy, and our expectation of loss given default. CDB’s exposure to the government borrower more than 180 days past due is 3% of loans and 5% of adjusted common equity (net of receivables from members).
The bank instituted a risk management review in 2012. After an evaluation by an external advisor, the bank has established a risk management unit and formalized a risk committee that will include senior management and the chief risk officer. Management has undertaken efforts to better align the bank’s policies of funding, liquidity, and capital adequacy with the board’s stated risk appetite. Management has also proposed establishing a longer-term capital planning framework to manage the bank’s capital, funding, and liquidity needs over a longer time horizon than the bank’s current four-year cycle.
CDB’s capitalization is the cornerstone of its “very strong” financial profile. Standard & Poor’s has adopted a risk-adjusted capital framework to
analyze MLIs’ capital adequacy. CDB’s basic risk-adjusted capital (RAC) ratio was 34% as of year-end 2011. After taking into account concentration exposure to sovereign governments and other MLI-specific adjustments, the RAC ratio declines to 21%, which is higher than that of many other MLIs but
appropriate given CDB’s operational risks. Our concentration adjustment to the RAC ratio reflects CDB’s largest loan exposures to Jamaica (24% of loans), Barbados (12%), St. Vincent and the Grenadines (10%), St. Lucia (9%), and Belize (7%).
These top-five borrowers remain current on their obligations to the bank.
CDB’s near-term funding and liquidity outlook has strengthened since our last review. To address its liquidity gap and $226 million in funding needs for 2012, the bank issued a $300 million bond in November that has improved its liquidity position and smoothed its near-term maturity schedule. CDB expects it will need up to $30 million of funding in 2013 to support approximately $100 million of disbursements (although actual disbursements could be lower if borrower demand declines under fiscal pressures in many borrowing member countries). CDB’s liquidity now is sufficient to cover 12 months of debt service and scheduled loan disbursements, on par with peers.
Nonetheless, the bank continues to face structural financing risks. As a small MLI, the issuance cost and the size of its financing needs limit the frequency of CDB’s international capital market issues, similar to other small MLIs, and can make its debt maturity schedule uneven. To mitigate this rollover risk, CDB structured its $300 million bond due in 2027 with a feature that amortizes the principal evenly over the last five years to maturity instead of using a traditional bullet payment.
We incorporate one notch of uplift above the stand-alone credit profile, raising the long-term issuer credit rating to ‘AA’. We expect that CDB’s
higher-rated sovereign shareholders–Canada, Germany, and the U.K.–would provide extraordinary shareholder support in the form of callable capital in the event of a capital call.
The negative outlook reflects embedded credit risks in CDB’s loan portfolio. Our view of the treatment of CDB as a preferred creditor by its borrowing member shareholders, which is established by practice, is a pivotal component of this analysis. We could lower our ratings on CDB if the government borrower more than 180 days in arrears does not clear its arrears with CDB, if other member governments fall more than 180 days past due, or if (contrary to our expectation) the bank’s funding conditions or liquidity weaken. The ratings could stabilize at current levels if the public-sector loan performance improves and if member capital contributions comply with scheduled payments.
Related Criteria And Research
— Multilateral Lending Institutions And Other Supranational Institutions
Ratings Methodology, Nov. 26, 2012
— Caribbean Development Bank, Sept. 13, 2012
— Supranationals Special Edition 2011, Sept. 23, 2011
— Standard & Poor’s Risk-Adjusted Capital Framework Provides Insight
Into Basel III, June 9, 2011
— Principles Of Credit Ratings, Feb. 16, 2011
— Bank Capital Methodology And Assumptions, Dec. 6, 2010
— For Development Banks, Callable Capital Is No Substitute For Paid-In
Capital, Dec. 31, 2009
— How Preferred Creditor Support Enhances Ratings, June 15, 1999
(Caryn Trokie, New York Ratings Unit)