Fitch Rates International Fund for Agricultural Development 'AA+'; Outlook Stable

Fitch Ratings - Paris - 02 Oct 2020: Fitch Ratings has assigned International Fund for Agricultural Development (IFAD) a Long-Term Issuer Default Rating (LT IDR) of 'AA+' with a Stable Outlook and Short-Term IDR of 'F1+'.

Key Rating Drivers

IFAD's 'AA+' LT IDR is based on the institution's intrinsic features. IFAD's intrinsic assessment is driven by its solvency ('aa+') and liquidity ('aa+') profiles. The medium-risk business environment does not translate into any notch adjustment to the rating. Our assessment of IFAD's shareholders' capacity and propensity to support does not provide any uplift above the fund's intrinsic assessment.

IFAD is a United Nations (UN) agency focusing on supporting rural economies and food security. The bulk of its lending portfolio (84%) consists of concessional loans to low and lower-middle income countries, and it also extends grants to some of its members. IFAD's main financial resources are contributions from its member states, paid though three-year replenishment cycles, with the most significant contributors the G8 countries, including the US (AAA/Negative, 11% of contributions), Japan (A/Negative, 7%) and Germany (AAA/Stable 7%).

Fitch considers IFAD's "excellent" capitalisation as a key rating strength, primarily driven by our view that IFAD's equity/assets ratio will continue to far exceed the 25% 'excellent' threshold over the medium term. As of end-2019 this ratio was around 85%. Our assessment is also supported by the fund's usable capital/risk-weighted assets (FRA) ratio, which also far exceeds the 35% 'excellent' threshold (end-2019: 75%). IFAD is inherently loss-making, owing to its business model, but this is offset by the paid-in contributions it receives from its member states.

The agency expects IFAD's capitalisation ratios to remain well above the "excellent" thresholds in the medium term, as the bank gradually increases its leverage. To date IFAD's borrowing has been limited to bilateral sovereign and quasi-sovereign loans (USD741 million as of end 2019, ratio of debt to equity of 9.1% as of end 2019). Fitch understands that the fund is aiming to diversify borrowing towards the private sector in the medium term. IFAD's borrowing would primarily serve to fund "ordinary" loans (rather than concessional ones) at market rates to middle-income countries.

Our assessment of IFAD's solvency combines the institution's "excellent" capitalisation and its 'low-risk' profile. IFAD's loan portfolio comprises solely of sovereign borrowers, about two-thirds of which are low and lower-middle income countries and one-third upper-middle-income countries. A considerable portion of borrowers are not rated by Fitch, and their credit quality is assessed as very low. Consequently, the agency estimates IFAD's loan portfolio average rating at 'B+' at end-2019. Fitch expects the average rating of the fund's lending portfolio to deteriorate by one notch to 'B' over the medium term, owing to the ongoing economic and rating uncertainty caused by the COVID-19 crisis. Fitch currently has Negative Outlooks on a significant number of IFAD's sovereign borrowers.

Fitch assesses IFAD's strength of preferred-creditor status (PCS) as "excellent", which translates into a +three notch adjustment above the average rating of loans. The average rating of IFAD's lending portfolio after PCS adjustment, for year-end 2019, is therefore 'BB+'. Our assessment of IFAD's 'excellent' PCS is anchored on the fact that over the past 10 years, there have only been nine out of 109 sovereign borrowers that have reached non-accrual status with IFAD (i.e. beyond 180 days in arrears) and the fund's lending portfolio is exclusively to sovereign borrowers. In addition, a number of sovereigns have remained current with IFAD while defaulting to other creditors, including multilateral ones.

Non-performing loans (NPLs) represented 2.7% of total loans at end-2019. As of September 2020, the four sovereigns in arrears to IFAD (North Korea, Somalia, Venezuela, Yemen) were the only borrowers that were non-performing in the portfolio. In line with IFAD's own expectations, Fitch forecasts that the level of NPLs will increase from a 'low' level (below 3%) to a 'moderate' level (3%-6%) over the medium term, reflecting the impact of the COVID-19 crisis on loan performance. Fitch forecasts the NPL rate to be closer to 4.0%-4.5% by the end of the forecast period (2022).

We assess IFAD's concentration risk as "low", reflecting the fund's well-diversified lending book, with over 100 sovereign borrowers in its portfolio. Fitch expects that IFAD's top five exposures will continue to amount to between 25%-30% of the institution's total banking exposure by 2022, in line with our estimate of 28% at end-2019.

Fitch assesses IFAD's equity participation risks as "very low", as the fund does not expect to make equity investments in the medium term.

Market risks are assessed as "very low" for IFAD owing to both limited interest rate risk and FX risks. The introduction of borrowing activities has generated some modest interest rate risk, albeit very limited. This is mitigated by ensuring that the borrowing terms of IFAD's financial liabilities are matched against the terms of on-lent funds. As IFAD develops operations funded by market borrowing, its own borrowing costs will be fully passed on to its borrowers. In terms of FX risk, IFAD conducts its operations in various currencies. The retranslation of assets between USD/SDR creates unrealised gains/losses in IFAD's income statement but Fitch notes that these are unrealised gains and losses and do not have cash flow or financial stability implications.

Risk management policies are assessed as "strong" by Fitch. IFAD has a broad range of internal policies that govern its risk management framework and the fund is fully compliant with these limits. Consistent with the ongoing transition towards a more levered balance sheet, IFAD is in the process of adjusting some of its internal policies, including its capital adequacy framework based on deployable capital. A track record of operations under the revised framework could lead to an upward revision of our assessment of risk management. The assessment is further supported by the very high level of expertise of the fund's management.

Liquidity is a rating strength for IFAD, with the institution's liquidity profile assessed at 'aa+', reflecting its "excellent" liquidity buffer, "strong" asset quality and "weak" access to capital markets. To date, IFAD has not tapped international capital markets. Its main funding source is replenishment contributions from member states. However, IFAD is taking steps to further diversify its funding profile and borrowing instruments and the fund expects to issue private placements over the medium to long term as an additional borrowing instrument to complement bilateral loans. To complement the diversification of its funding, IFAD's liquidity management policy is also expected to be adjusted in 2020, with the liquidity coverage of gross disbursements over 12 months set to significantly increase from 60% currently.

In terms of IFAD's liquidity buffer, as of end-2019, IFAD's coverage of short-term debt by eligible liquid assets stood at well above 1000%, far above the 150% "excellent" threshold outlined in the criteria. We expect this ratio to remain comfortably above this 150% threshold over the forecast period, reflecting IFAD's very limited debt burden. IFAD's treasury asset quality is 'strong' and at end-2019, the portion of 'AAA'-‌'AA' rated assets represented 68% of treasury assets.

IFAD's business environment is deemed "medium risk", which translates into a zero-notch adjustment to the solvency and liquidity assessments of 'aa+', leading to an intrinsic rating of 'aa+'. Our assessment of IFAD's "low risk" business profile is driven by the "low" risk quality of governance, supported by the large share of non-borrowing member states (with List A contributors representing 49.5% of voting rights) and the absence of one overly dominant contributor. The fund's exclusive focus on sovereign lending and the importance of the its public mandate further support the "low" risk assessment. Our "high risk" assessment of IFAD's operating environment reflects the relatively high share of low-income countries within the distribution of IFAD's countries of operations, along with the "high risk" credit quality of the fund's countries of operation.

IFAD's rating is fully driven by its intrinsic merits, and support is not currently a rating driver. IFAD's support rating is assessed at 'aa-‌'‌. This assessment is anchored on the weighted average rating of IFAD's key contributors, which Fitch defines as those member states that contribute over 50% of the fund's total replenishments. IFAD has no callable capital. An assessment of a "strong" propensity to support the institution, based on the regularity of contributions from member states that have totalled USD9 billion since inception, leads to a zero notch adjustment on the average rating of key shareholders, resulting in an overall support rating of 'aa-‌'‌.

IFAD's Short-Term IDR of 'F1+' is in line with the rating correspondence table outlined in Fitch's criteria and, given the LT IDR is 'AA+', is the only available ST rating that Fitch can assign.

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RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

--Solvency (Risk): Resilience of the loan portfolio to the COVID-19 crisis that results in a stronger credit risk profile than currently anticipated, particularly an improvement in the fund's loan impairment ratio relative to Fitch's current expectations, to a level commensurate with a "low" assessment and/or improvement in the average rating of the lending portfolio.

- Business Environment (Business Profile): Improvement in our assessment of IFAD's business profile driven by a successful transition towards gradual increase in leverage, diversification in funding sources and exposure to middle-income borrowers, while adhering to the revised risk management framework.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Solvency (Risk): Worse-than-expected impact of the COVID 19 crisis on the bank's loan portfolio that leads to a higher loan impairment ratio and/or weaker credit quality of the loan portfolio than currently expected.

- Business Environment (Business Profile): A deterioration in the fund's business profile, which could lead to a deterioration of our current "low" risk assessment. For example this could stem from any potential weakening in the fund's strategy risk in the context of the ongoing transition towards a more levered balance sheet. Our assessment of IFAD's policy importance could be affected if the replenishment under IFAD12 was significantly weaker than our expectation.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].

Key Assumptions

The global economy will develop in line with Fitch's Global Economic Outlook published on 7 September 2020, including a deep but short-lived recession in 2020 due to the pandemic. There is an unusually high level of uncertainty around these forecasts and risks are firmly to the downside.

Fitch assumes continued strong support to be demonstrated from IFAD's member states, in the form of multi-year replenishment cycles that will remain IFAD's main financial resource.

IFAD will gradually increase its leverage in the medium term. Its debt to equity ratio will remain limited to 50%.

Date of Relevant Committee

22 September 2020

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Additional information is available on www.fitchratings.com

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