S&P Global Ratings is publishing its yearly report on MLIs and other nonbank supranational institutions, a publication that first started in 1986.

MLIs Ramped Up Lending Support During Pandemic, But Resources Will Be More Constrained Given Demand

Eighteen months into the pandemic, the actual role MLIs have played is clearer, in terms of their lending support and conversely, the impact on financial ratios. Undoubtedly, 2020 was marked by increased flows, particularly as MLIs sped up disbursing loans compared to prior years.

In terms of new loans disbursed--a relevant measure of the sector's impact--MLIs paid out $210 billion in 2020, up from $156 billion in 2019.

Disbursements during 2020 by region were: Europe (40%), Asia-Pacific (28%), Latin America and the Caribbean (17%), and Africa (15%). The European Investment Bank accounted for about 30% of all new disbursements, the same as in 2019.

The many MLI relief packages to address the health and economic consequences of COVID-19 contributed to the increase in funding. For most institutions, this represented a front-loading and repurposing of operations that created additional lending space. While approval levels were generally consistent with pre-COVID-19 lending trajectories, the shift toward faster-disbursing loans, such as policy-based lending, translated into larger flows overall. A handful of institutions, such as the International Bank for Reconstruction and Development, used designated crisis buffers designed for these types of extraordinary circumstances. Generally, these capital buffers would need to be recapitalized to be subsequently used again.

Since MLIs are generally conservative and manage lending levels over a longer-term planning horizon, we expect that front-lending--and the faster utilization of resources and use of buffers during 2020--will likely constrain balance sheets in subsequent years. Actual disbursement volumes over the next two years may look like pre-pandemic levels, which were relatively stable, growing by an average of 2% since 2016 compared with 35% in 2020 (total exposure at default increased by 3%, reflecting repurposing of undisbursed loans).

Chart 1

This comes at a time when countries continue to experience the economic effects of the pandemic, let alone the risk of further COVID-19 waves. Demand for multilateral resources before the pandemic was already high, and it remains high, particularly for low-income countries, with an emphasis on liquidity support. On the other hand, MLIs' balance sheets have been somewhat constrained, accentuated now by the pandemic. In response, this year the G20 urged MLIs to continue exploring ways to optimize capital. About five years ago, the G20 made similar calls to explore capital optimizations, which prompted many MLIs to take a series of actions that led to an overall capital strengthening process.

Capital optimizations have thus become a consistent theme for the sector, with many MLIs merging concessional balance sheets and launching various credit risk transfer mechanisms. This has allowed MLIs to sustain larger lending volumes and freed up capital. However, there is a constant need for additional resources, and MLIs in company with the global community have fallen short of the lofty goals to support the UN's Sustainable Development Goals (SDG) required annual investments of $5-$7 trillion (see "It's Time For A Change: MLIs And Mobilization Of The Private Sector," published Sept. 21, 2018).

We believe capital optimizations will continue to be a useful tool from a capital and risk management perspective but will not translate into substantial lending capacity unless accompanied by high levels of mobilization, capital increases, or an increase in overall risk tolerance from MLI shareholders. We recently published an article requesting comments on our proposed criteria outlining how we could incorporate hybrid capital in our MLI rating process (see "Request For Comment: Hybrid Capital Methodology For Multilateral Lending And Multilateral Insurance Institutions," published Sept. 20, 2021). We think this could create a broader capital raising mechanism for the sector, although we believe it will be relatively contained as a source of capital.

Capital Ratios Were Moderately Impacted In 2020

Removing certain MLI outliers (the European Stability Mechanism, New Development Bank, IDB Invest, the International Development Association, International Fund For Agricultural Development, Credit Guarantee and Investment Facility, Asian Infrastructure Investment Bank, and Fondo Latinoamericano de Reservas), and looking at 20 MLIs, risk-adjusted capital (RAC) ratios on average declined by 100 basis points (bps) when comparing ratios before the pandemic (data based on the 2019 October suprabook) to the latest financial information and rating parameters as of September 2021. The combination of higher balance sheet exposure and rating downgrades during the year were the main factors.

Some institutions saw their RAC ratios decline by 400-800 bps, although these were driven by unique idiosyncratic considerations. For instance, the Eurasian Development Bank's (EDB) RAC declined by 800 bps to 20% due to an aggressive growth strategy. The Asian Development Bank's RAC had increased to 40% before the pandemic due to the merging of their concessional window, and therefore it was an active management decision to draw on further resources during the pandemic.

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That said, these declines for the most part were carefully managed within each MLI's capital adequacy approach. Most institutions also directly or indirectly anchor lending decisions to their RAC ratio. Therefore, most MLIs maintained their capital assessments. There were a few exceptions, with EDB and the Nordic Investment Bank seeing a one-category deterioration in the capital assessment, and the Islamic Corp. for the Development of the Private Sector's capital assessment improving by one category over the past 18 months.

MLIs Left Callable Capital Buffers Untouched

Close to 60% of MLIs maintain the strongest capital adequacy assessment of extremely strong, and 92% manage their RAC ratios in the two highest categories. That said, about half of MLIs we rate have callable capital buffers that, if the RAC ratio declined by a category or more, would provide uplift and could mitigate the impact to the issuer credit rating. A key consideration for this capital mitigant is that ratings on highly creditworthy sovereigns, which provide the callable capital, remain the same or do not fall by more than one notch.

Some institutions do have callable capital but don't qualify from eligible callable capital under our criteria, given the rating distribution of shareholders below the stand-alone credit profile of the MLI. Currently, only two institutions use callable capital in support of their rating levels, namely the African Development Bank and Eurofima Rolling Stock Financing. We believe callable capital continues to be a useful countercyclical buffer that provides rating stability in the event of larger declines in the RAC.

Table 1

While Private Sector Lending Performed Well, MLIs Have Prioritized Sovereign Lending

With the onset of COVID-19 last year, there was higher risk of pressure on asset quality materializing for private sector portfolios. Nonetheless, we saw that MLIs with private sector exposure in fact performed quite well, with nonperforming loans relatively in line with previous years. Many MLIs lend to financial institutions, and overall, this sector held up well considering robust response measures from governments, and banks in emerging markets were overall more capitalized during this shock compared to previous shocks. Also, MLIs had relatively less exposure to hard-hit sectors such as tourism and entertainment.

One outcome from the pandemic was that the overall share of private sector lending in fact declined as many MLIs with mixed balance sheets prioritized sovereign lending. Lending to corporates, such as infrastructure, took the largest hit, with a 7% reduction in 2020. This reflects some detour from the private sector-led development model linked to the 2030 SDG agenda that had been gaining momentum over many years, with many MLIs expecting to increase the share of private sector lending and mobilization efforts. We do expect this will gradually normalize, and private sector lending will pick up and continue to be an important theme.

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Environmental, Social, And Governance (ESG) Are Core Strategic Mandates

The MLI sector has over the years been strengthening its ESG focus by developing or revamping ESG policies, processes, and frameworks applied to its lending portfolio. It has also been incorporating minimum ESG requirements and targets, the latter largely focused on climate finance.

The pandemic did create some detours from the more traditional ESG-focused sectors such as climate change and green finance, as MLIs shifted to faster-disbursing budgetary support loans and liquidity support for private sector borrowers. There was however a larger focus on social sectors such as supporting vaccine deployment and hospital constructions. During 2020, many MLIs issued social and sustainable bonds, which were tied to the response efforts for COVID-19.

We expect the sector to continue refining its ESG approach and extending its climate change commitments to an increasingly larger share of its lending portfolio. Most MLIs have climate finance targets between 20%-50% of the lending portfolio over the next five years, addressing both transition risk and climate shocks. At the same time, MLIs are exploring new ways of supporting members through new types of instruments, some which relate to natural disasters and catastrophes through parametric features.

Financial Data For The 34 Supranational Institutions We Rate

The 34 rated supranationals had a total combined balance sheet of $2.60 trillion as of year-end 2020 compared with $2.35 trillion in the prior year. Credit quality among the 34 supranationals remains high. We rate 41% of them 'AAA' and most at 'AA-' or higher (see chart 4).

Chart 4

The average rating on supranational debt is 'AA' but ranges from 'BBB' to 'AAA'. On a debt-weighted basis, the average creditworthiness of this asset class has been stable since 2011, and 'AAA' rated MLI debt represented 95% of all supranational debt, based on year-end 2020 data (see chart 5).

Chart 5

As of Oct. 26, 2021, 85% of our supranational ratings have stable outlooks, 12% (Black Sea Trade and Development Bank, the European Atomic Energy Community, European Union, and Corporacion Andina de Fomento carry positive outlooks, and one negative outlook (Arab Investment and Export Credit Guarantee Corp.; see chart 6). The main triggers of rating or outlook changes since October 2018 were related to strengthening or weakening mandates (see table 2). The MLI asset class is perhaps one of the most resilient as no negative rating actions were taken because of COVID-19. Instead, we made idiosyncratic considerations related to the particular institutions.

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Table 2

Supranational Debt Totaled $1.5 Trillion At The End Of 2020

Supranationals' outstanding debt at year-end 2020 increased to $1.5 trillion compared with $1.43 trillion in the previous year. Total outstanding debt as of year-end 2008 was less than $800 billion. The $1.5 trillion represented close to 1.77% of the world's GDP at year-end 2020 (see chart 7).

Chart 7

The pace of rated supranationals' debt growth has peaked twice: in 2009 by 16% and in 2012 by 24%. This reflects their countercyclical role. Most increased their lending operations after the 2008 crisis to support investments in their countries of operation. The 2012 debt increase stemmed mainly from the European Financial Stability Facility commencing operations, when its outstanding debt surged to $208 billion from $23 billion in 2011. Many also benefited from a capital increase during the crisis and could then increase their borrowings accordingly. Debt increased during 2020, in line with larger disbursement volumes, though by a lesser degree given that there was a repurposing of lending and there were not large increases in new financing commitments.

Table 3