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Rating Action:

Moody's upgrades IIB's rating to A3 from Baa1; outlook changed to stable from positive

30 Apr 2018

New York, April 30, 2018 -- Moody's Investors Service (Moody's) has today upgraded the issuer and senior unsecured debt ratings of International Investment Bank (IIB) to A3 from Baa1. The outlook was changed to stable from positive.

The main drivers for the rating upgrade are IIB's improvement in asset quality, more robust risk management systems, an increasingly diversified loan book and funding strategy and the strengthened credit quality of its treasury portfolio. Moody's believes that IIB's new medium-term strategy will likely maintain these improved credit features.

RATINGS RATIONALE

RATIONALE FOR THE UPGRADE TO A3 FROM Baa1

IMPROVED ASSET QUALITY ON THE BACK OF ENHANCED RISK MANAGEMENT

Moody's rating upgrade of IIB to A3 from Baa1 reflects the improved performance of its loan book and the expectation that the bank will be able to contain the level of its non-performing loans (NPLs) as it continues to expand its activities under its new five-year plan. The improved performance stems from a combination of the new management's explicit focus on credit quality, an associated reduction in loan concentration (both by borrower and location) and more recently, a cyclical economic upturn across the bank's diverse membership. Moody's notes, however, that some of the improvement in the level of NPLs relative to gross loan (NPL ratio) reflects the gearing up of the bank's lending activities in the last few years.

Changes in risk management procedures have both contributed to improved asset quality and are likely to sustain it. The bank's almost entirely new management significantly changed IIB's business approach since its re-launch in 2012, now lending via intermediaries and jointly within syndicates (often including larger MDBs) together with a steady tightening of its risk management procedures. Moody's sees these new strategies and closer monitoring of the portfolio as mitigants against the risks associated with lending to borrowers of generally low credit quality and the still-concentrated nature of its loan book and small number of loans.

IIB's average NPL ratio over the last five years was 3.2%, which represents a structural change in comparison to the situation the bank faced in the decade to 2012, after two-thirds of the loans extended before the re-launch of IIB became impaired. Two additional NPLs developed from the old loan portfolio after the bank's re-launch; those were written down in 2017 after being fully provisioned over 2015-16. Beyond that, only two loans from the 'new' portfolio were in default as of the end of 2017, accounting for 4.5% of gross loans.

IIB's capital and leverage ratios also remain relatively strong, which together with the improvements in asset quality drives Moody's decision to raise its assessment of the bank's capital adequacy to "medium" from "low". That said, Moody's anticipates that these aspects of the bank's credit profile will weaken somewhat in the next two-three years as both lending and funding continue to expand.

GREATER DIVERSIFICATION OF EQUITY, LENDING AND FUNDING MITIGATES WEAK BORROWER QUALITY AND LOAN BOOK CONCENTRATION

Moody's says that the changes undertaken by the new IIB management in the past three years have largely addressed the credit weaknesses the rating agency cited when it downgraded the bank to Baa1 from A3 in March 2015. Those weaknesses related in large part to the bank's heavy concentration in Russia at a time when Russia was confronting a major crisis: Russian loans constituted 38% of its lending, Russia's share of IIB equity was 50% and 80% of IIB's funding came from the Russian market. Russia's economy is now growing again, albeit slowly. In the meantime, however, loans outstanding to Russia were reduced to 27% of the loan portfolio at the end of 2017 (and 18% as of Q1-2018), Russia's equity share had dropped to about 48% (IIB's five EU member countries make up nearly 49%) and Russian market funding accounts for just 30% of IIB's total funding (whereas just over half of the bank's total funding comes from EU local markets).

IIB has diversified its lending to the extent that it now lends to at least one project in each of its nine member countries. At year-end 2017, IIB's top 10 loan exposures accounted for a significantly smaller share of its loan portfolio than in early 2015. Its loan concentration at the country level also fell to 12.7% in 2017 from 14% in 2016 (2013: 32%). The concentration at sectoral levels continued to improve as well, having declined to 16% in 2017 from just above 17% in 2016 and 39% in 2015. Finally, the concentration at the regional level increased slightly to 27.4% in 2017 from 22.3% in 2016, largely driven by growing operations in the CEE market which is in line with the 2018-2020 business plan.

IIB's ability to raise stable financing improved significantly over the last few years, especially with respect to the diversity of its investor base. IIB has expanded its funding to 11 countries from two in March 2015, with 52% of funding stemming from EU countries as of end-2017. Diversification by products increased to seventeen (up from four as of end 2014). The bank plans to continue to increase the size of its investor base and the range of financing products every year, after initially having raised most of its funding in Russia. IIB is also targeting to issue in more member states over time, as a sign of its commitment to the development of those countries' capital markets.

HIGHER CREDIT QUALITY OF TREASURY PORTFOLIO ENHANCES LIQUIDITY

The credit quality of IIB's treasury portfolio was poor three years ago, with only 23% of its holdings in Aaa-A rated assets at the end of 2014 and an even lower 14% by the end of 2015. That share has since risen to 44% by the end of 2017 (and to 49% in the first quarter of 2018 according to unaudited statistics). The medium-term plan calls for high-quality Aaa-A assets to rise to a 65% share of treasury assets by 2020. A key emphasis has been to shift more holdings to assets in non-member states to de-correlate the two sides of its balance sheet, such that assets of non-member countries rose to 58% in 2017 from 15% in 2014. Meanwhile, Russian assets are down to just 5% of total treasury assets, compared to 53% at the end of 2014.

Last year, IIB also decided to double its liquidity buffer -- made up of cash and cash equivalents, liquid deposits and securities -- to cover 12 months of estimated cash flow needs on a forward-looking basis. The buffer is meant to allow the bank to operate normally even in a stressed market environment when its access to market borrowing would presumably be difficult. At the end of 2017, the liquidity buffer amounted to €71 million compared to the estimated cash flow needs of around €25 million, which suggests that IIB would still be able to extend a relatively large share of planned loan disbursements on top of its operating expenses.

Other measures of liquidity, such as the debt-service coverage ratio or liquidity ratio, are relatively strong. The former measures the three-year average of the stock of short-term and currently maturing long-term debt against the stock of liquid assets. The liquidity ratio is currently strong as well, but it is likely to weaken with the further expansion of the balance sheet in the next several years. That said, IIB's liquidity ratio improved last year to 28% from 41% in 2016, due to a lengthening of the maturity of IIB's debt that more than offset the expansion of the loan portfolio and the reduction in treasury assets. This is a similar position to the bank's more established MDB peers in the A rating range.

RATIONALE FOR A STABLE OUTLOOK ON THE A3 RATING

Moody's says that the change to a stable from a positive outlook on IIB's rating balances the positive developments noted above against a number of remaining challenges, which relate both to the relative newness of the institution as well as its small size and still relatively concentrated loan mix. IIB is still building its reputation among investors, a process that has gone well at a time of low global interest rates but that could prove more challenging as interest rates normalize. A higher cost of funds could also negatively affect the bank's ability to be a competitive lender, which could be problematic in view of its already low return on assets. The relatively young vintage of its loan book also presents elements of risk as the bank has yet to establish a long track-record of limited asset quality pressure under its new strategy. Finally, Moody's believes that IIB will still need time to solidify its new business model and its market position as a go-to source of infrastructure funding or trade finance among its member countries.

WHAT COULD CHANGE THE RATING UP/DOWN

The rating would likely be upgraded if the bank's expansion were to be supported through additions to paid-in capital, further progress in containing asset quality pressure and diversifying its loan portfolio were made, in addition to achieving its medium term objective of continuing to strengthen the quality of its treasury assets.

Conversely, IIB's rating would come under negative pressure if asset quality pressures were to rise materially and expected to remain elevated, particularly if these adverse developments were to occur at a time of weakening capital buffers and/or an erosion in its favorable liquidity position. Although not anticipated, a significant deterioration in the strength of member support would also lead the rating agency to consider a rating downgrade.

The principal methodology used in these ratings was Multilateral Development Banks and Other Supranational Entities published in March 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Kristin Lindow
Senior Vice President
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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