This commentary amends the version published on 19 June 2014 to include a rating action on the trust certificates issued IDB Trust Services Ltd.
Fitch Ratings has affirmed the Islamic Development Bank’s (IsDB) Long-term Issuer Default Rating (IDR) at ‘AAA’ with a Stable Outlook and its Short-term IDR at ‘F1+’. The trust certificates issued by IDB Trust Services Ltd with the benefit of a guarantee provided by IsDB were also affirmed at ‘AAA’.
KEY RATING DRIVERS
The affirmation and Stable Outlook reflect the following key rating factors:
IsDB is one of the strongest-capitalised multilateral development banks (MDBs) rated by Fitch, with an equity-to-assets ratio of 54% and a debt-to-equity ratio of 79.5% at end-1434H (3 November 2013 in the Gregorian calendar). Although capitalisation has been steadily declining due to a scale-up in operations since the global financial crisis, Fitch believes that capital buffers are large enough to ensure continued strong capitalisation in line with targeted growth of operations.
Credit risk remains moderate but higher than peers, arguing for stronger capital buffers than peers. The estimated average rating of non-equity operations was ‘B+’ at end-1434H, at the lower range of peers, but 85.5% of them were extended to or guaranteed by sovereigns, on which the bank benefits from preferred creditor status. Private sector operations are higher than in some peers (21.7% of total operations, including equity stakes), but impairments based on IsDB’s definition have historically remained low, at 1% of non-equity operations at end-1434H, and are adequately provisioned for. The moderate level of country and obligor concentration also mitigates credit risk arising from non-equity operations.
IsDB has higher equity participations (accounting for 8.4% of total operations at end-1434H) than commonly seen among peers, which represents a rating weakness. However, concentration in this portfolio is moderate and risks are mitigated by IsDB’s long-term outlook on these equity participations and disposals have usually been made at a profit with favourable timing.
Other risks are manageable. Liquidity is adequate, with treasury assets covering 153.3% of short-term liabilities at end-1434H, in line with peers. Only 24.2% of treasury assets were invested in instruments (mostly bank deposits) rated ‘AA-’ and above at end-1434H, but the risk is mitigated by heavy recourse to short-term maturities in a diversified range of banks. Interest-rate and foreign-exchange risks are tightly hedged.
Risk management is conservative and the bank consistently abides by its self-imposed risk management framework. Even though some limits have recently been relaxed (the leverage limit was raised to 100% from 50%), the risk framework remains stringent, and IsDB is progressively aligning it (eg, on the liquidity policy and new capital adequacy framework) with that of other highly-rated peers.
As is typical of most MDBs, IsDB is not profit-oriented and does not distribute dividends. Profits are moderate compared with commercial banks, but are steady and in line with peers (with a return on equity of 2.5% in 1434H), ensuring regular equity strengthening.
Shareholder support, a secondary rating driver, remains strong. The credit quality of member countries is lower than usually observed among peers, with an estimated average rating of ‘BBB-’ at end-1434H; however, they have consistently demonstrated their propensity to support the bank through regular inflows of fresh capital. The latest general capital increases will increase callable capital threefold while adding another 3.6bn Islamic dinars (equivalent to the SDR) in paid-in capital over 20 years, which will support expected growth in activity.
The Stable Outlook reflects Fitch’s assessment that downside risks to the ‘AAA’ rating are currently not material. Given that IsDB’s ratings are not driven by support, a moderate weakening in the credit quality of the shareholders would not jeopardise the ratings.
Downward pressure on IsDB’s ratings would result from pronounced deterioration of asset quality or unexpected deterioration in capitalisation and leverage.
Fitch assumes that shareholders’ willingness to support the bank will remain strong.
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