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Caribbean Development Bank credit rating cut

by: - June 14, 2012
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NEW YORK, USA — On Tuesday, Standard & Poor’s Ratings Services lowered its long-term issuer credit rating on the Caribbean Development Bank (CDB) to ‘AA+’ from ‘AAA’ and affirmed the short-term ‘A-1+’ rating. The outlook is stable.

According to S&P, the downgrade reflects the agency’s view that CDB’s risk management is not commensurate with other ‘AAA’ rated multilateral lending institutions, particularly given its size and regional economic weakness. CDB has failed to comply with one of its internal liquidity policy guidelines, and borrower concentration remains high. The bank’s liquidity was tighter in 2011 than in previous years.

At the end of 2011, CDB had a negative funding gap of 3-12 months due to $226 million of debt maturing in 2012. Liquid assets represented 70% of undisbursed loans and projected one year of debt service at the end of 2011. Despite covering 143% of debt maturing in one year or less, CDB’s liquid assets were less than the minimum of 200% it maintained during the prior five years. CDB expects to raise sufficient debt this year to roll over its 2012 maturities and finance a planned $100 million of lending.

Related to liquidity, funding management is of concern and compares less favorably with the diversified funding strategies of other small multilateral institutions. CDB’s reliance on capital markets has resulted in a concentration of maturities in 2012-14.

Borrower concentration has historically been high for CDB, and stresses have emerged because of the prolonged economic weakness in the Caribbean. The top five borrowers account for 63% of loans and 103% of narrow risk-bearing capacity. Given rising credit vulnerabilities in the region, this high concentration is an increasing credit weakness for CDB.

The ongoing economic and financial stress in the region contributed to public-sector past-due-but-not-impaired loans of 2.4% of public-sector loans in 2011. (Under an accounting presentation change in 2011, CDB recognized the full amount of past-due-but-not-impaired loans in lieu of the balance of billed-but-uncollected amounts.) CDB determined no public-sector loans were impaired in 2011, and it has not taken provisions for its public-sector portfolio.

Two private-sector impaired loans represented 21% of the private-sector loan portfolio at the end of 2011; the bank has taken a 47% provision against these loans. CDB’s loan portfolio growth slowed to 2% in 2011 from 21% in 2010.

CDB recognized comprehensive income of $41 million in 2011 and $42 million in the restated 2010 period. However, the bank’s net interest margin (net interest and similar income-to-average loans outstanding) and its investment income-to-average investments outstanding have decreased since 2009, a trend of lower profitability that, if continued, could put pressure on the bank’s generated cash flows in the medium term.

A change in the accounting treatment for derivatives relating to CDB’s two Yen issues caused a small negative adjustment (cumulative from over 10 years) to its retained earnings (0.04% of adjusted shareholders’ equity).

CDB has experienced recently a change of senior management and a number of senior positions are in the process of being filled. The bank is also reviewing its risk management and capital adequacy frameworks, which are expected to be completed by the end of 2012.

“Despite the aforementioned qualitative weaknesses, we believe that CDB’s financial profile, especially its very strong capitalization, supports the rating. CDB traditionally has been well-capitalized and continued to be so as of the end of 2011, with narrow risk-bearing capacity to development-related exposure (DRE) of 60%,” S&P said.

Standard & Poor’s measure of capitalization is narrow risk-bearing capacity — comprised of paid-in capital adjusted for receivables, retained earnings, and provisions for loan losses-relative to DRE, which includes gross loans outstanding, guarantees, equity investments, and securities of borrowing members. This ratio is higher than many of CDB’s larger ‘AAA’ rated peers with more diversified membership and funding sources. Broad risk-bearing capacity (which includes ‘AAA’ callable capital) represented 91% of DRE at the end of 2011, its highest level during the past six years.

The capital position is improving further through the incoming capital installment payments, following the general capital increase approved in 2010. As part of this increase, the bank should raise its paid-in capital by 138% by 2016. In 2011, the members paid in just over 10% of the capital increase, although a handful of smaller borrowing members had arrears as of June 2012.

“The stable outlook reflects our expectation that the financial profile will remain stable, with new capital subscriptions offsetting lower profitability seen this past year and that it will remain so in the near future. We expect the continuation of preferred creditor treatment and the bank’s prominent position as a lender in its borrowing member countries. Strengthening of risk management policies could contribute to an upgrade. The deterioration of the financial profile would lead to a downgrade. Additionally, the ratings could be affected — up or down — by our new criteria for multilateral lending institutions, which we expect to adopt later this year,” S&P concluded.

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