OREANDA-NEWS. Standard & Poor's Ratings Services affirmed its 'BBB/A-2' long- and short-term foreign currency issuer credit ratings on Eurasian Development Bank (EDB). The outlook remains negative.

We also affirmed our Kazakhstan national scale rating on the bank at 'kzAA+' and the Russia national scale rating on the bank at 'ruAAA'.

The ratings on EDB are based on its strong financial profile and its weak business profile, as our criteria define these terms. Together these assessments lead us to assess EDB's stand-alone credit profile (SACP) at 'bbb.' Our ratings on EDB do not incorporate any explicit uplift for extraordinary shareholder support in the form of callable capital.

EDB was founded in 2006 by the governments of Russia and Kazakhstan. It is a subregional multilateral lending institution (MLI) comprising six member states. The other members are Armenia, Belarus, Kyrgyzstan, and Tajikistan. EDB has a clearly defined public policy role of supporting regional integration, economic growth, external trade, and economic ties within the countries of the Eurasian Economic Community.

Russia and Kazakhstan continue to dominate EDB in terms of the decision- making process, given that voting rights are proportional to capital contributions: As of the end of 2014, Russia held a 65.97% stake, Kazakhstan 32.99%, Belarus 0.99%, Tajikistan 0.03%, Armenia 0.01%, and Kyrgyzstan 0.01%. EDB's operations are primarily located in the member states, mainly Russia and Kazakhstan, which leaves EDB exposed to the economic and financial markets of those countries.

In our view, EDB serves an important regional role that could only be partly played by other domestic public institutions, such as local development banks. However, EDB has a relatively short track record of fulfilling its public policy mandate, compared with MLI peers. While we do not expect any current members to withdraw, we note that in the current economic and geopolitical environment, it is unlikely that EDB will attract new member states, which remains one of the bank's priorities.

We view EDB's financial profile as strong. Historically, EDB has maintained a high level of capitalization, although this gradually declined over 2012-2013 due to portfolio growth. Its risk-adjusted capital (RAC) ratio was 25% at year-end 2014, increasing from 23% at year-end 2013 due to declined loans to customers (negative 7.5%) and fewer total assets (negative 14.7%). However, if we adjust the 2014 year-end RAC ratio to reflect the current ratings of EDB's two largest shareholders, Russia and Kazakhstan, the RAC drops to 23%--flat compared with last year's result. Our downgrade of Russia at the beginning of 2015 led us to revise down the economic score of our Banking Industry Country Risk Assessment (BICRA) on Russia to '8' from '7'; while our downgrade of Kazakhstan in February 2015 did not result in a revision of the economic risk score of our BICRA of Kazakhstan.

EDB's balance sheet is highly concentrated: most of its loans to customers are in Russia and Kazakhstan (79.4%), and the top-10 loans account for 52.8% of the purpose-related loans. After factoring in these concentrations, the RAC as of year-end 2014 decreased to 15%. Amid a worsening macroeconomic environment we observed several loan defaults during 2013 that were fully provisioned and subsequently written off. EDB wrote off one of its largest loans for US\$125.3 million (including principal amount, interest, fees, and penalties accrued) to Nitol Project, a polysilicon producer in Russia's Irkutsk Region. The project failed at year-end 2013 owing to technological problems and significant implementation delays, coupled with deteriorating market conditions and a substantial decline in product price. We foresee some further deterioration in loan portfolio quality as the Russian and Kazakhstan economies slow. As of year-end 2014 nonperforming loans (NPLs; loans overdue more than 90 days) accounted for 4.5% of the loan portfolio. In our base-case scenario, and taking into account a decreased average loan size over the last two years and improving underwriting procedures, we do not expect credit losses to exceed 6% of the loan portfolio in 2015.

EDB has a good track record of successful bond issuance, and we assess its funding and liquidity position as strong. EDB has issued annually several instruments in different currencies (U.S. dollars, Russian rubles, and Kazakhstani tenge). In 2013 it raised the equivalent of US\$1.3 billion. However, over 2014, EDB managed to issue a total of US\$0.3 billion in bonds. Such a drop in fund raising was caused by several reasons: slow portfolio growth, no need for U.S. dollar-denominated funding, and deteriorating conditions in local markets with higher costs of funding and narrowed liquidity. However, we expect EDB to be able to raise sufficient financing denominated in ruble and tenge if needed.

EDB's liquidity is ample, with US\$1.5 billion or 37% of the balance sheet held in liquid assets. Similar to other MLIs, EDB depends heavily on wholesale market funding (representing 90% of its liabilities). In our view, this is mitigated by its conservative liquidity policy, slowing loan portfolio growth, and ability to attract bilateral loans--including from its two largest shareholders--if market access were to worsen.

In July 2014, EDB's council increased the bank's charter capital to US\$7 billion, from the current paid-in capital of US\$1.5 billion, in the form of callable capital. There is no payment of capital linked to this capital increase; all the newly subscribed capital is callable. The council's decision was aligned with the bank's strategy for 2013-2017, which it revised at its July 2014 meeting to reflect a more moderate loan portfolio increase due to the weaker economic growth prospects in member states, particularly Russia and Kazakhstan. The additional stock issued is worth US\$5.48 billion. Russia, which receives 65.97% of the additional shares, subscribed to an additional US\$3.6 billion, while Kazakhstan (receiving 32.99% of the additional shares), subscribed to an additional US\$1.8 billion.

While callable capital can in principle enhance an MLI's SACP and result in a higher issuer credit rating, we factor in no explicit uplift in the case of EDB, mainly because of its highly idiosyncratic ownership structure. No other rated MLI has a single shareholder owning more than half of the shares, or two shareholders holding almost all of them. Also, EDB's SACP is now higher than or equal to the rating on its two main shareholders.

The negative outlook reflects our view that there is at least a one-in-three likelihood that we could lower the ratings on EDB within this year or the next if its financial profile weakens, due to deterioration in the loan portfolio or a more meaningful weakening of the region's economy than we currently anticipate. Such a downgrade could occur if we revised down our BICRA economic scores for Russia or Kazakhstan, which would signal our view of elevate risks on exposures in these countries and increased strain on EDB's RAC ratios.

A downgrade could, but would not necessarily, follow a similar action on Russia or Kazakhstan, for both of which we have a negative outlook. The ratings on EDB could also be affected positively or negatively by changes in the operating environment in the region. If the environment became more difficult--for example, if the level of EDB's NPLs increased, shareholder support weakened, or relations between shareholders deteriorated--we could lower the ratings. Conversely, the ratings would be supported by a strengthening in the institutional and governance framework in Russia and Kazakhstan.