Supranationals. Islamic Development Bank. Saudi Arabia. Full Rating Report. Key Rating Drivers. Rating Sensitivities. Ratings

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1 Saudi Arabia Full Rating Report Ratings Long-Term IDR AAA Short-Term IDR F1+ Outlook Long-Term IDR Financial Data Stable Oct 15 Oct 14 Total assets (IDNm) 16, ,075.3 Equity (IDNm) 7,849 7,721 Net income (IDNm) ROA (%) ROE (%) Equity/adjusted assets (%) Debt/equity (%) NPLs/gross loans (%) Key Rating Drivers Excellent, Eroding Capitalisation: The capitalisation of the (IsDB) is the strongest among multilateral development banks (MDBs) rated by Fitch, with an equity/assets ratio of 48.9% as of end-1436h (October 2015 in the Gregorian calendar). The sustained growth in operations has led to an increase in leverage, which remains lower than peers, with a debt/equity ratio of 101.8% at end-1436h, up from 49% at end-1432h. Growth will be moderate in the next three to four years, according to the bank s business plan. Capital Increase: The last capital increase launched in 2014 (5 th General Capital Increase), which consisted entirely of callable capital (Islamic dinars, equivalent to the IMF s Special Drawing Rights 32bn), provides scope to substantially extend the financing capacity of the IsDB, which is statutorily capped by subscribed capital and reserves, and will allow the bank to raise more debt. The receipt of the paid-in portion of the 4 th General Capital Increase, IDN4.4bn, has started in 1437H and will be spread over 20 years. Sovereign Exposure: The IsDB is extending financing predominantly to sovereign entities (89% of the portfolio at end-1436h), on which the bank benefits from preferred creditor status. Its credit exposure is significant: the average rating of the portfolio is estimated at B+ at end-1436h. Exposure to Troubled Countries: The IsDB s portfolio is well diversified compared to other regional MDBs, with the five largest exposures representing 31.5% of total financing operations at end-1436h. However, some of the IsDB s borrowers have experienced deep political troubles (Syria, Yemen). Impaired financing amounted to 2.8% of the bank s portfolio at end- 1436H, compared to 0.98% at end-1433h. Financing to Syria (2.3% of the end-1436h portfolio) accounted for the largest share of impaired assets. Risk Management: The IsDB s risk framework is stringent. However, compared with other AAA rated MDBs overall, the level of provisioning is relatively low given the bank s exposure to the aforementioned countries experiencing deep political troubles. The loan loss reserves/ non-accrual loans ratio stood at 55.0% at end-1436h. The leverage limit has been further relaxed from 100% to 125% in 1435H; however, it is still significantly lower than at other MDBs. Strong Liquidity: Liquidity ratios appear high, with treasury assets covering 255% of shortterm liabilities at end-1436h, in line with AAA rated MDBs. However, the credit quality of treasury investments is lower than at peers, with only 14.8% of treasury assets invested in instruments (mostly bank deposits) rated AA and above at end-1436h; this risk is mitigated by the significant use of short-term maturities at a diversified range of banks. Analysts Nicholas Perry nicholas.perry@fitchratings.com Eric Paget-Blanc eric.pagetblanc@fitchratings.com High Shareholder Support Propensity: Shareholders support is not a rating driver. The IsDB s capital is owned by the 57 member countries of the Organisation of Islamic Cooperation (OIC). Though the rating of Saudi Arabia, the IsDB s largest shareholder, was downgraded to AA from AA in April 2016 and remains on Negative Outlook, the average rating of key shareholders (BB+) has remained constant from last year. Shareholders have consistently demonstrated their propensity to support the bank through regular inflows of fresh capital. Rating Sensitivities Deteriorating Balance-Sheet Quality: Pressure on the rating would arise if there were pronounced asset quality worsening or unexpected deterioration of capitalisation and leverage, as the IsDB s ratings are driven by intrinsic factors. 26

2 Profile and Support Profile The IsDB is an MDB established in 1975 that provides financial assistance to member countries and Muslim communities in non-member countries based on the principles of sharia, including the prohibition of interest payments and the obligation of asset-based financing. Headquartered in Jeddah, Saudi Arabia, the IsDB operates through four regional offices in Morocco, Malaysia, Kazakhstan and Senegal. Moreover, two country gateway offices were opened in 2014 in Indonesia and Turkey. In line with other MDBs, the IsDB s supreme governing body is the Board of Governors, which meets annually to set policy and follow up on developments in capital. It delegates day-to-day management of the business to the Board of Executive Directors, headed by the President. The IsDB s fiscal year is the lunar Hijra year, which is 11 days shorter than the Gregorian year. This report is based on financial statements at 30 Dhul Hijah 1436H (13 October 2015). This will, however, change next year as the Board of Governors has approved use of the solar Hijri calendar to determine the start and end dates of the financial year. This decision results in all future financial statements being equivalent to the Gregorian year and the 1437/38H transitional financial year will be from 14 October 2015 to 31 December The IsDB group comprises both the bank and affiliated entities in which the bank has stakes. Fitch s IDR applies to the bank only; the terms the IsDB or the bank refer to the bank alone. Operations The IsDB s operations mainly take the form of project finance extended to or guaranteed by sovereigns, and to a lesser extent trade finance. At end-1436h, the portfolio was reasonably diversified (Middle East and North Africa 47%, sub-saharan Africa 22%, Asia 18%, and Countries in Transition 13%). Financing mostly takes the shape of lending but based on principles of Islamic finance: Operations (%) Under Istisna a (1436H: 35.5% of total operations), the IsDB sells the customer an asset (eg specific equipment) according to predefined specifications at an agreed price. Equity 7% Instalment 12% Loans 16% Murabaha 3% Source: IsDB, Fitch Other 5% Ijarah 22% Istisna'a 35% Ijarah Muntahia Bittamleek (21.8%) is very similar to a lease agreement. Loans (16.4%) provide long-term financing for development projects in basic infrastructure and agriculture. They are interest free but carry service fees to cover costs. Instalment sales (12.1%) consist of purchases by the bank of equipment and machinery for resale to the beneficiary at a mark-up, repayable over six to 20 years. The asset s ownership is transferred to the beneficiary on delivery. Murabaha (2.7%) consists of trade financing through the purchase by the IsDB of goods for resale to the beneficiary at a mark-up. The activity is being progressively wound down. Equity stakes (7%) are limited to the acquisition of a maximum of a third of the company s equity, in both corporates and banks, and also not to exceed 5% of the portfolio. Most of them are listed; additionally, the bank has stakes in affiliates, which are excluded from the operational activity portfolio. Related Criteria Supranationals Rating Criteria (July 2016) 2

3 Largest IsDB Shareholders & Sovereign Ratings Share of callable capital Rating Saudi Arabia 24.1 AA Libya 9.7 N.R. Iran 8.4 N.R. Nigeria 7.8 BB Largest shareholders 50.0 Source: Fitch Shareholders Support Peer Comparison: Shareholder Support IsDB (AAA) AfDB (AAA) AsDB (AAA) IADB (AAA) End-1436H Projectionª End-2015 End-2015 Jun-2015 Coverage of net debt by AA AA AAA AA+ AAA callable capital Average rating of key BB+ BB+ BBB+ A+ A- shareholders Propensity to support a Medium-term projections AfDB African Development Bank; AsDB Asian Development Bank; IBRD International Bank for Reconstruction and Development Source: MDBs, Fitch calculations, estimates and methodology The IsDB s 57 member states belong to the OIC. It was announced at the IsDB s 41st Annual General Meeting that the Co-operative Republic of Guyana has now officially become a member state. As usual among MDBs, member states have provided both paid-in and callable capital, which is an irrevocable commitment to provide additional funds in case of need by the bank to honour its liabilities. Capital Breakdown (IDbn) 50 Callable capital Paid-in capital Support, though strong, is not the primary driver of the rating. The bank still has no shareholder rated AAA, and some of the larger member states are either not rated (Libya, Iran) or rated sub-investment grade (Nigeria). Shareholders support is not a rating driver but acts as a backstop in the event of a material weakening of the bank s intrinsic financial condition H 1433H 1434H 1435H 1436H Credit quality of member states has been affected by the impact of lower oil prices on the credit quality of Gulf countries overall; the rating of Saudi Arabia, the IsDB s largest shareholder, was downgraded to AA from AA in April 2016 and remains on Negative Outlook. That said, the average rating of key shareholders (BB+) has remained constant from last year. Shareholders have consistently demonstrated their propensity to support the bank through regular inflows of fresh capital. Source: IsDB, Fitch Stabilisation in Lending Approvals (IDNbn) H 1432H 1436H Source: IsDB, Fitch Propensity to support the bank is strong. Despite the moderate size of its balance sheet, the IsDB is an important tool to channel sharia-compliant financing to member states, and Islamic finance has gained momentum in recent years. Support has been constantly illustrated by a steady inflow of fresh capital into the bank, either by individual member states willing to increase their share in capital or through general capital increases. Given this repeated propensity to provide support illustrated in the past, Fitch considers that the arrears by some member states on their capital investment are not revealing of a decline in support. Organisation and Performance Management and Strategy The bank s operations are focused on the public sector. A total of 80% of operations, including equity participations, were extended to or guaranteed by sovereigns at end-1436h, and Fitch expects the IsDB to remain heavily sovereign-focused in the coming years. The IsDB expects approvals to grow 1% per annum for the next three years, reaching IDN3,764m in Financing operations are growing at a slower pace. According to the bank s business plan, growth in operations will be moderate in the coming years. Approvals are expected to grow by only 1% per year in the next three to four years. 3

4 Profitability Peer Comparison: Profitability IsDB AfDB AsDB IADB (%) End-1436H Projectionª End-2015 End-2015 Jun-15 Net income/average equity a Medium-term projections Source: MDBs, Fitch calculations, estimates and methodology Financial statements are prepared in accordance with the Financial Accounting Standards issued by the Accounting and Auditing Organisation for Islamic Financial Institutions; for issues not covered by this institution, the bank uses IASB standards. As a supranational body, it is immune from taxation and does not distribute dividends; profit-making is not a main priority for MDBs and is a secondary rating driver. Profitability has historically been low but regular as the bank passes on its borrowing and administrative costs to customers. RoE was 2.0% in 1436H (1435H: 2.2%). Profitability is less volatile than at most peers due to accounting standards by which fair value variations of equity investments and transfers to other funds of the group are not recorded in net income but directly in equity. The IsDB s cost/income ratio, at 37.5% in 1436H, is in the range of peers. Capitalisation, Leverage & Liquidity Capital and Leverage Peer Comparison: Capitalisation, Leverage and Liquidity IsDB AfDB AsDB IADB End-1436H Projectionª End-2015 End-2015 Jun-2015 Equity/adjusted assets (%) Paid-in/subs. capital (%) Usable/required capital (x) Debt/equity (%) Liquid assets/st debt (%) b ª Medium-term projections b At end-2014 Source: MDBs, Fitch calculations, estimates and methodology Capitalisation is a clear rating strength. The IsDB is one of the best capitalised and least leveraged MDBs rated by Fitch, with an equity/assets ratio of 48.9% and a debt/equity ratio of 101.8%. The IsDB s capital adequacy ratio, the principles of calculation of which are close to the Basel II standard approach, was 41.0% at end-1436h (40.0% at end-1435h) against a minimum threshold of 35% set by the bank s internal policies. Going forward, it is forecast that the capital adequacy ratio will slightly erode, but will remain above the required minimum. Capitalisation has eroded in recent years (48.9% at end-1436h from 70.7% at end-1431h) and leverage risen (101.8% at end-1436h from 37.2% at end-1431h) in line with steady growth in financing operations. Fitch anticipates a continuing but slow decline in capital ratios. The bank s statutory limit, which caps outstanding financing activities by subscribed capital and equity, was significantly enlarged with the 2014 capital increase and will allow the bank to issue more debt. Additionally, the bank has loosened its leverage policy (the maximum debt/equity ratio has been increased to 125% from 100%); this will allow it to raise more debt in the future. The bank has diversified its funding in recent years, becoming a more frequent issuer of Sukuk since 1430H (2009) as the market for Islamic instruments has grown. Liquidity Liquidity is in line with peers, with liquid assets structurally exceeding 100% of short-term liabilities (end-1436h: 255.2%). In addition, the IsDB can rely on the Special Account 4

5 Resources Waqf Fund (Waqf Fund). The Waqf Fund originated out of the bank s accumulated reserves, but it is a separate fund whose resources are under management by the bank. Subject to availability of liquid funds and in an extreme stress scenario, there are no external or internal barriers to prevent the bank from executing commercial investments from the Waqf Fund. Total assets of the Waqf Fund at end-1436h amounted to IDN890m with net assets amounting to IDN792m, of which liquid assets represented IDN465m (IDN324m placements and IDN141m Sukuk/other) in addition to investment assets amounting to IDN223m. Risks Peer Comparison: Risks IsDB AfDB AsDB IADB End-1436H Projectionª End-2015 End-2015 Jun-15 Estimated average rating of loans & B+ B+ BB BBB BB guarantees Impaired loans/gross loans (%) Share of non-sovereign exposure (%) Equity stakes/(loans + equity stakes) (%) Five largest exposures/total loans (%) Share of AAA - AA treasury assets (%) ª Medium-term projections Source: MDBs, Fitch calculations, estimates and methodology Credit Risks on the Loan Portfolio Credit risk is the main risk faced by the IsDB due to the large share of loans in its balance sheet and to the risk of its countries of operations. Taking into account the benefit of sovereign guarantees, the average rating of loans was lower than at peers, at B+ at end-1436h (end- 1435H: B+ ). 65% of loans were extended to below-investment-grade or unrated obligors, such as Pakistan (7.8% of loans at end-1436h), Iran (6.5%), Sudan (3.4%) and Syria (2.6%). Non-sovereign financing is mostly extended to public-private partnership projects, and to a lesser extent to banks (for SME financing) and through trade finance loans. Non-sovereign exposure (20.4% of portfolio at end-1436h) is riskier than sovereign-guaranteed financing, as the bank does not benefit from preferred creditor status on such private borrowers. The amount of impaired loans has been restated by Fitch to take into account the loans overdue from a number of sovereigns, most notably Syria. Fitch considers as impaired any financing with overdues of more than six months (three months for the private sector). The following sovereign exposures have been fully included in impaired loans: Algeria, Guinea- Bissau, Libya, Oman, Somalia and Syria. Therefore, according to Fitch s calculations, the total impaired loans ratio for the IsDB (including sovereign and non-sovereign) is 2.8%. The loan loss reserves/non-accrual loans ratio stood at 55.0% at end-1436h, based on Fitch s calculations. This level of provisioning is weak compared to AAA peers. Concentration Risk Concentration risk remains a rating strength. The IsDB s eligible borrowers are more numerous than seen in comparable regional MDBs, and the bank follows strict concentration limits. The largest and five largest obligors accounted for 8.0% and 31.5% of total loans respectively. Concentration limits are 15% of total exposure on a single country, 40% on the top five exposures and 60% on the top 10 exposures. Country concentration to the Middle East has declined in recent years, to the benefit of Asia and Africa. 5

6 Credit Risks on Treasury Assets and Derivatives More than 51% of the IsDB s treasury assets are invested in bank deposits, with the remainder invested in Sukuk, which has changed considerably over the past two years. In 1434H, over 80% of the IsDB s treasury assets were invested in bank deposits, but there has been a considerable increase in Sukuk issuance in recent years. The overall asset quality is somewhat lower than usually observed in MDBs, with 14.8% of treasury assets being rated AA or above at end-1436h. Fitch also views positively the moderate risk of treasury assets from the shortterm maturity of most bank deposits, as 74% were due in less than six months at end-1436h. Equity Risks Exposure to equity risk is higher than for peers (except the EBRD). This is a rating weakness due to the greater riskiness of equity investments. However, Fitch considers this risk manageable for the IsDB, as it remains a contained activity that has declined in recent years. Risk management of equity participations is also adequate: the bank internally defines impairments of equity stakes as when the fair value falls 20% below the cost of acquisition, and fully provisions them. Concentration levels remain moderate: even if country concentration is significant, single equity concentration remains moderate. Market Risks The bank is exposed to interest rate risk due to its large, equity-funded, variable-rate liquid assets. This risk has materialised since 1429H in a low interest rate environment. However, the bank does not depend on the yield on placements to generate profits (administrative and borrowing costs are covered by lending margins). Exposure to exchange rate risk is limited. The bank aligns the currency composition of its operations with the currency composition of the Islamic Dinar through recourse to currency swaps. Foreign exchange variations recorded in the P&L account remain moderate compared to total net income and equity. The IsDB continues to hedge most debt raised in currencies other than the US dollar, through sharia-compliant profit rates and cross-currency swaps. Selected counterparties have to be rated at least A, but the bank does not require any collateral on positive mark-to-market valuations. Operational and Governance Risks The bank operates in a difficult region in terms of operational and governance risk, but its management and procedures have proved efficient in monitoring such risks. In line with the IsDB s 10-Year Strategy, efforts are under way to undertake a comprehensive review of the Board of Executive Directors governance and effectiveness. During 1437H, the Board Committee on Development Effectiveness has been established to enhance the bank s focus on development results and in the implementation of the 10-Year Strategy. Risk Management Policies The IsDB s risk management is conservative overall, with prudential rules limiting the exposure to a single country, a single sector and a single investee as a proportion of the portfolio. However, provisioning policy is less conservative than in AAA peers overall (see provisioning rate above). The Board of Executive Directors has approved a Risk Management Roadmap to be implemented over three years, comprehensively covering all policies, guidelines, tools and systems needed to ensure: i) long-term resilience of the institution through effective capital management; ii) efficient management of lending headroom; iii) adequate liquidity; and iv) a risk profile commensurate with the requirements for a AAA standalone rating. 6

7 Income Statement 13 Oct Oct Nov Nov 2012 Year End Year End As % of Year End As % of Year End As % of Year End As % of USDm IDNm Earning IDNm Earning IDNm Earning IDNm Earning Original Original Assets Restated Assets Restated Assets Restated Assets 1. Interest Received Interest Paid NET INTEREST REVENUE Other Operating Income Other Income (19.9) (14.1) (0.09) (0.9) (0.01) Personnel Expenses Other Non-Interest Expenses Impairment charge Other Provisions n.a. n.a. - n.a. - n.a. - n.a PRE-DERIVATIVE OPERATING PROFIT Net gains / (losses) on non-trading derivative instruments n.a. n.a. - n.a. - n.a. - n.a POST-DERIVATIVE OPERATING PROFIT Other income and expenses n.a. n.a. - n.a. - n.a. - n.a NET INCOME Fair value revaluations recognised in equity n.a. n.a. - n.a. - (43.2) (0.31) FITCH'S COMPREHENSIVE NET INCOME

8 Balance Sheet A. LOANS 13 Oct Oct Nov Nov 2012 Year End Year End As % of Year End As % of Year End As % of Year End As % of USDm IDNm Assets IDNm Assets IDNm Assets IDNm Assets Original Original Original Restated Restated Restated Restated Restated Restated 1. To / Guaranteed by Sovereigns 14, , , , , To / Guaranteed by public institutions n.a. n.a. - n.a. - n.a. - n.a To / Guaranteed by Private Sector 1, , , , , Of which Trade Financing Loans (memo) n.a. n.a. - n.a. - n.a. - n.a Other Loans n.a. n.a. - n.a. - n.a. - n.a Loan Loss Reserves (deducted) TOTAL A 15, , , , , B. OTHER EARNING ASSETS 1. Deposits with Banks 2, , , , , Securities held for Sale & Trading n.a. n.a. - n.a. - n.a. - n.a Investment Debt Securities - (incl. other invest.) 2, , , Equity Investments 2, , , , , Derivatives (incl. Fair-value of guarantees) n.a. - TOTAL B 7, , , , , C. TOTAL EARNING ASSETS (A+B) 23, , , , , D. FIXED ASSETS E. NON-EARNING ASSETS 1. Cash and Due from Banks Other (542.3) (384.2) (2.39) (453.3) (3.01) (558.6) (4.16) F. TOTAL ASSETS 22, , , , , G. SHORT-TERM FUNDING 1. Bank Borrowings (< 1 Year) , Securities Issues (< 1 Year) 1, Other (incl. Deposits) n.a. n.a. - n.a. - n.a. - n.a. - TOTAL G 2, , , H. OTHER FUNDING 1. Bank Borrowings (> 1 Year) n.a. - 1, n.a Other Borrowings (incl. Securities Issues) 8, , , , , Subordinated Debt n.a. n.a. - n.a. - n.a. - n.a Hybrid Capital n.a. n.a. - n.a. - n.a. - n.a. - TOTAL H 9, , , , , I. OTHER (Non-Int Bearing) 1.Derivatives (incl. Fair value of guarantees) n.a Fair value portion of debt n.a. n.a. - n.a. - n.a. - n.a Other (Non-Int Bearing) TOTAL I J. GENERAL PROVISIONS & RESERVES n.a. n.a. - n.a. - n.a. - n.a. - L. EQUITY 1. Preference Shares n.a. n.a. - n.a. - n.a. - n.a Subscribed Capital 70, , , , , Callable Capital (57,261.2) (40,563.8) (251.99) (40,511.1) (268.73) (8,852.5) (65.92) (12,470.4) (108.94) 4. Arrears/Advances on Capital (6,231.8) (4,414.6) (27.42) (4,500.8) (29.86) (4,151.4) (30.91) (722.0) (6.31) 5. Paid in Capital (memo) 6, , , , , Reserves (incl. Net Income for the year) 3, , , , , Fair-value revaluation reserve TOTAL L 11, , , , , M. TOTAL LIABILITIES & EQUITY 22, , , , , Exchange rate USD1 = IDN USD1 = IDN USD1 = IDN USD1 = IDN

9 Ratio Analysis I. PROFITABILITY LEVEL 13 Oct Oct Nov Nov 2012 Year End Year End Year End Year End % % % % Original Restated Restated Restated 1. Net Income/Equity (av.) Net Income/Total Assets (av.) Net Interest Revenue + Commitment Fees / Gross Loans + Treasury Assets + Guarantees (av.) Cost-Income Ratio Income from Equity Investment / Equity Investment (av.) Provisions / Average Total Banking Exposure (excl LCs) II. CAPITAL ADEQUACY 1. Net Total Banking Exposure (excl LCs) / Subscribed Capital + Reserves Equity/Adjusted Total Assets Equity /Adjusted Total Assets + Guarantees Paid-in capital / Subscribed capital Usable Capital/Required Capital III. LIQUIDITY 1. Treasury Assets / Debt < 1 Year Treasury Assets / Total Assets Treasury Assets / Undisbursed Loans & Equity IV. ASSET QUALITY 1. Impaired Loans /Gross Loans Loan Loss Reserves / Gross Loans Equity Loss Reserves /Equity Investment Total reserves / Gross Loans, Equity Investment & Guarantees Loan Loss Reserves/Non Accrual Loans V. LEVERAGE 1. Debt/Equity Debt/Subscribed Capital + Reserves Debt/Callable Capital Net Income + Interest Paid/Interest Paid

10 Spread Sheet Annex 13 Oct Oct Nov Nov 2012 IDNm IDNm IDNm IDNm Original Restated Restated Restated 1. LENDING OPERATIONS 1. Loans outstanding 11, , , , Undisbursed Loans 9, , , , Approved Loans 3, , , , Disbursed Loans 1, , , , Loan Repayments Net disbursments OTHER BANKING OPERATIONS 1. Equity participations 1, , , , Guarantees LCs and other off BS credit commitments n.a. n.a. n.a. n.a. 4. Total banking exposure (BS & off BS) 12, , , , Growth in total banking exposure (BS and off BS) SUPPORT 1. Share of AAA / AA shareholders in callable capital Share of A / BBB shareholders in callable capital Share of Speculative Grade shareholders in callable capital Callable capital from shareholders rated AAA - AA / outstanding debt Weighted Average Rating of Key Shareholders BB+ BB+ BBB- BBB 6. Rating of callable capital ensuring full coverage of net debt AA- AA BBB- BBB 4. BREAKDOWN OF BANKING PORTFOLIO 1. Loans to Sovereigns / Total Loans & Equity participations Loans to Non Sovereigns / Total Loans & Equity Participations Equity participation / Total Loans & Equity Participations Non Sovereign Exposure (incl. guarantees)/total Banking Exposure CONCENTRATION MEASURES 1. Largest exposure Five largest exposures 3, , , , Largest exposure / Equity (%) Five largest exposures/ Equity (%) Five largest exposures / Total Loans (%) CREDIT RISK 1. Average Rating of Loans B+ B+ B+ B+ 2. Loans to Investment Grade Borrowers / Gross Loans Share of Treasury Assets rated AAA-AA n.a

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