credit analysis arab petroleum investments corp orations...to its five-year plan, equity investments...

CREDIT ANALYSIS

SOVEREIGN & SUPRANATIONAL SEPTEMBER 6, 2013

Table of Contents:

RATIONALE AND OUTLOOK 1 ORGANISATIONAL STRUCTURE AND STRATEGY 2 GOVERNANCE AND RISK MANAGEMENT 4 CAPITAL ADEQUACY 5 LIQUIDITY 9 STRENGTH OF MEMBER SUPPORT 11 RATING HISTORY 13 ANNUAL STATISTICS 14 MOODY’S RELATED RESEARCH 19 RELATED WEBSITE 19

Analyst Contacts:

NEW YORK +1.212.553.1653

Annette Swahla +1.212.553.4037 Analyst [email protected]

Steven A. Hess +1.212.553.4741 Senior Vice President [email protected]

Bart Oosterveld +1.212.553.7914 Managing Director - Sovereign Risk [email protected]

DUBAI +971.4.237.9536

Aurelien Mali +971.4.237.9537 Vice President - Senior Analyst [email protected]

This Credit Analysis provides an in-depth discussion of credit rating(s) for Arab Petroleum Investments Corp. (APICORP) and should be read in conjunction with Moody’s most recent Credit Opinion and rating information available on Moody's website.

Arab Petroleum Investments Corporation Supranational

Rationale and Outlook

The Arab Petroleum Investments Corporation’s (APICORP) Aa3 and Prime-1 long and short-term debt ratings with stable outlook reflect the corporation’s strong capital adequacy position, high-quality asset portfolio (which benefits from de facto preferred creditor status) and its strong shareholder support. However, the rating also takes into account APICORP’s weaker liquidity position relative to peers and the high degree of asset concentration.

APICORP’s risk asset coverage ratio (based on Moody’s calculation) was 353.9% at year-end 2012, which is a very strong position relative to its peers, and even compares favourably with Aaa-rated multilateral development banks (MDBs). Given that APICORP has a wholesale banking branch in Bahrain, it calculates a qualifying capital adequacy ratio consistent with the Central Bank of Bahrain/Basel II. At year-end 2012 that ratio was 27.2%, well above the central bank’s 12% requirement and APICORP’s own 15% policy minimum.

The performance of APICORP’s assets is comparatively strong, with a weighted average credit quality of its assets that is equivalent to a Aa rating (according to the corporation’s own calculations). Around 29% of the corporation’s loan assets are covered by completion guarantees from project sponsors, most of whom are governments (9% of guarantees) or government-owned oil companies (58% of guarantees).

APICORP benefits from strong member support, including a pledge to support the organisation on a “joint and several” basis (although the wording of this pledge is not regarded as a full financial guarantee for creditors). Its highest-rated members are Kuwait, Qatar, and the United Arab Emirates (UAE), all rated Aa2 and owning a significant portion of the corporation (44% combined). In addition, Saudi Arabia owns 17% and is also highly rated at Aa3. This significant ownership by highly rated sovereigns indicates a strong ability of members to support APICORP financially, if necessary.

http://www.moodys.com/credit-ratings/Arab-Petroleum-Investments-Corp-APICORP-credit-rating-822112017

SOVEREIGN & SUPRANATIONAL

2 SEPTEMBER 6, 2013

CREDIT ANALYSIS: ARAB PETROLEUM INVESTMENTS CORP. (APICORP)

The main rating constraint is APICORP’s weaker liquidity position which is the result of reliance on less stable short-term wholesale deposits for funding and the unbalanced maturity profile of its balance sheet. The bulk of the corporation’s liabilities are short term (maturing within one year), whereas the bulk of its assets are long term (with a maturity greater than one year). This uneven maturity profile derives from the corporation’s use of short-term wholesale deposits to fund its sizeable treasury operations for the purposes of profit generation and liquidity. In addition, it uses short-term deposits to fund a small portion of its longer-term investment operations.

APICORP has slightly changed the composition of its funding since 2005; however, it is unlikely to change sufficiently in order to compare equally or favourably with its peers. APICORP’s business model (in terms of its use of deposits to fund treasury and some investment operations) is fundamentally different from MDBs, and is unlikely to change. Indeed, in its five-year business plan, it projects deposits to account for 38% of total liabilities, lower than its current level of 49% but still uniquely high for the MDB sector.

Another credit weakness is the high geographic and sector concentration of APICORP’s development portfolio when compared to those of most other MDBs. Around 70% of APICORP’s loans are granted to entities in Saudi Arabia and Qatar, and over half of total loans are to petroleum-related endeavours.

Organisational Structure and Strategy

APICORP is an OAPEC company APICORP was established as an MDB in September 1974 in accordance with an international agreement (Establishing Agreement of APICORP) signed and ratified by the 10 member states of the Organisation of Arab Petroleum Exporting Countries (OAPEC)1. The largest shareholders are the governments of Saudi Arabia (Aa3 stable), the UAE (Aa2 stable) and Kuwait (Aa2 stable). Its headquarters is in Dammam, Saudi Arabia, and it has a wholesale banking branch in Manama, Bahrain.

APICORP is independent in its administration and in the performance of its activities. Unlike other MDBs, it carries out its operations on a commercial basis and with the intention of generating a profit, in accordance with its statutes. APICORP usually pays a dividend to shareholders after allocating 10% of annual net income to its legal reserve fund.

The Establishing Agreement of APICORP explicitly grants APICORP privileges throughout OAPEC. These privileges include (1) the pledge and undertaking to support APICORP, jointly and severally; (2) the granting of rights and privileges of nationality within any member country of OAPEC; (3) support for APICORP’s personnel in entry and residency throughout OAPEC; (4) exemption from payment of duties and all public and financial costs within OAPEC; (5) protection of assets against appropriation; (6) immunity from political risks; and (7) exemption from currency controls, including from convertibility and transfer restrictions. Membership in APICORP is explicitly limited to member countries of OAPEC, and any country that withdraws its membership from OAPEC is obliged to withdraw from APICORP.

1 The principal objective of the OAPEC Agreement is the development of regional cooperation in the petroleum industry. In pursuit of this objective, OAPEC sponsored

the creation of four companies: APICORP, the Arab Maritime Petroleum Transport Company, the Arab Shipbuilding and Repair Yard Company, and the Arab Petroleum Services Company.


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Fulfils mandate through lending and equity investment operations APICORP’s mandate is to assist in financing petroleum projects and industries, and associated fields of activity of OAPEC members in order to strengthen member states’ economic and financial potential. In order to achieve its purpose, APICORP makes direct equity investments in (“Project Direct Equity”, 8% of assets) and extends debt financing to (“Project & Trade Finance” loans, 70% of assets) local, regional, and international sponsors in the energy and petrochemical sectors as well as the trading activities of first-tier Arab exporters and global traders with creditworthy importing countries. If investments are located outside the Arab region, there is an additional condition that they must rely on “feedstock” originating from the Arab world. The rest of the assets are invested in treasury assets. APICORP also provides advisory and treasury services related to oil and gas finance and project development, and publishes macro-economic research on oil and gas.

In the context of heightened country risk in the Middle East, the corporation’s strategy for its Project & Trade Finance loans is to maintain the current volume and contain the average maturity of its loan portfolio, while shifting focus to advisory services and trade/commodity finance. APICORP will focus trade/commodity finance activity on the Gulf Cooperation Council (GCC) countries. According to its five-year business plan, loan growth will be moderate with net loans reaching around $3.3 billion in 2017, an increase of 14% from the 2012 level of $2.9 billion. Some of this growth will be done in partnership with other large MDBs. APICORP has well-established co-financing relationships with the European Investment Bank, International Finance Corporation, and the Islamic Development Bank and is working towards broadening its relationships with the European Bank for Reconstruction and Development and the African Development Bank (we rate all Aaa).

Regarding its equity operations, APICORP’s strategy is to grow and diversify investments. According to its five-year plan, equity investments will at least double from its 2012 level of $318 million. Despite this significant growth, equity will still represent a relatively low portion of its total operations at 18% of total loan and equity operations in 2017 compared to 10% in 2012; the increased proportion does not stand out historically. Nonetheless, the corporation is adding to its personnel to handle the increased volume. Earlier this year, as a part of APICORP’s efforts to diversify investments, it created the APICORP Petroleum Shipping Fund.2

Wholesale deposit operations position APICORP as a unique MDB APICORP, unlike most MDBs, takes wholesale deposits. The few others that take deposits – Corporacion Andina de Fomento, Central American Bank for Economic Integration, Fondo Latinoamericano de Reservas – primarily take them from shareholders and do not use the deposits as a source of funding for their banking operations.

APICORP’s business model shares some characteristics with commercial banks in that it uses wholesale deposits to fund: i) primarily, treasury operations for profit and liquidity purposes and ii) a small portion of investment operations (around 10%). From the period 1998-2005, deposits from banks were the corporation’s primary funding source – accounting for 65% of borrowings on average, with term financing loans comprising the remainder. In 2006, APICORP started diversifying its deposit client base with the opening of its branch in Bahrain (a wholesale bank operating under an Investment Banking License granted by the Central Bank of Bahrain). APICORP is governed by the regulations of the central bank, but, like other offshore banks operating in Bahrain, it does not have access to central bank liquidity facilities. The purpose of the branch is to complement the treasury and capital market activities of the corporation and provide banking facilities to clients. As a result,

2 See APICORP Diversifies its Investment Activities, a Credit Positive, February 2013.

http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_150528


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deposits from corporates grew to 31.7% of APICORP’s borrowings at year-end 2012 from 12.9% at year-end 2007, while deposits from banks amounted to 20.8% at year-end 2012.

We view wholesale deposits to be a less stable source of funding that is vulnerable to market confidence. APICORP’s deposits exhibit some stability based on the corporation’s own definition of three consecutive months of renewal. While we do not consider three months to be a material sign of stability, we do consider it in our analysis as discussed in the Liquidity section below. We view retail deposits or debt to be a more stable funding source. The MDB sector is characterized by the use of debt for funding, and therefore APICORP’s overall funding profile compares negatively to its peers.

Governance and Risk Management

Relatively young risk culture APICORP’s risk management department was formed only five years ago, despite the corporation’s almost 40 years of operation. The corporation continues to devote resources to building up the department’s capacity and continues to add staff. Despite this improvement, we note some relative weaknesses compared to other MDBs. The head of risk management – a senior vice president – is somewhat more junior than the operational department heads, who are titled as executive vice presidents. The risk management department examines all new credit and investment proposals, but does not have direct veto power over them. The head of risk management is a member of the management credit committee, which holds project veto power and presents credit applications with comments on risk to the audit and risk committee.3

Moreover, APICORP only introduced thresholds for key risk metrics in the past two years in contrast to many MDBs having thresholds set at inception, some even stipulated in the establishing agreement. APICORP’s thresholds include a 15% minimum capital adequacy ratio4 and a maximum debt-to-equity ratio of 311%. As of year-end 2012, the corporation was in compliance with these metrics.

In order to manage country risk, APICORP focuses on appropriate loan structures as well as sharing the risk with government-related or other international financial institutions – a strategy it also adopts in its equity investments portfolio. In addition, equity investments are only chosen if they are economically feasible, technically sound, and commercially driven. APICORP structures its equity investments so that the size of the stake ensures at least one seat for the corporation on the board of the investee company.

One reason for the young risk culture is that APICORP’s asset portfolio is particularly strong given the high (average) creditworthiness of the energy companies towards which most of its lending is oriented. Hence, there has been less focus on risk management. APICORP has not experienced significant defaults or under-performing assets that would have provided any urgent incentive to develop a risk management apparatus. At year-end 2012, gross non-performing loans (NPLs) represented 2.3% of gross Project & Trade Finance loans, for which significant collateral and provisioning exists, bringing the net figure to nil. Much of these impaired loans are legacy NPLs that result from the default of Iraq’s state-owned companies after the 1990-91 Gulf War. In 2003, the corporation started to offset the unpaid dividends against the Iraqi defaulted loans.

3 Audit and Risk Committee comprises a select group of board members and is responsible for overseeing corporate governance and risk issues. 4 Based on Basel II risk weighted assets methodology.


5 SEPTEMBER 6, 2013


Strong track record of managing a challenging operating environment APICORP has successfully operated through a number of regional crises without difficulty. These include the Iranian revolution (1979), the Iran-Iraq War (1980 to 1988), the Iraqi occupation of Kuwait (1990-91), the US-led invasion of Iraq in 2003, and a direct terrorist attack on APICORP’s Khobar compound in 2004. The corporation has also successfully managed times of low oil prices, such as 1986 and 1999.

The wave of regional unrest that started in February 2011 in Bahrain did not affect its operations. All new lending/placements to Bahrain financial institutions were temporarily suspended, and subsequently resumed. Exposure to politically risky countries represents 6.3%5 of APICORP’s total loan portfolio at end-2012, a very manageable level.

According to APICORP, the wave of domestic political turmoil in Bahrain and Egypt (together accounting for 3.2% of Project & Trade Finance exposure) has not led to borrowers defaulting on their obligations. In both countries, the energy sector has been relatively unscathed by the domestic turmoil. However, the aftermath of the Libyan civil war (0.9% of exposure in 2012) did increase the level of NPLs. APICORP has not funded energy projects in Syria.

Capital Adequacy

Strong capitalisation balances the weaker liquidity position in APICORP’s overall credit profile Most MDBs (including APICORP) do not have access to central bank liquidity facilities, given their supranational status. Hence, MDBs typically have significantly higher levels of capital adequacy than similarly rated commercial banks.

APICORP calculates its capital adequacy ratio (Tier 1 + Tier 2 Capital/Total Risk-Weighted Exposure) at 27.2% at year-end 2012, down slightly from 28.5% at year-end 2011. This ratio exceeds the Basel II and Central Bank of Bahrain guidelines of 8% and 12%, respectively. According to APICORP’s minimum capital adequacy guideline, the ratio should not fall below 15%.

The capital adequacy ratio we use in our analysis of MDBs is the risk asset coverage ratio, which is the ratio of usable equity6 plus the callable capital pledged by those shareholders rated Aa3 or higher relative to risk assets.7 APICORP is the strongest in its peer group8, as shown in Figure 1.

5 Bahrain, Egypt, Iraq, Libya, and Sudan. 6 Paid-in capital + reserves + retained earnings. 7 Loans granted to non-investment-grade rated entities + all direct equity investments. 8 Caribbean Development Bank (CDB, Aa1); Corporacion Andina de Fomento (CAF, Aa3); Inter-American Investment Corporation (IIC, Aa2).


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EXHIBIT 1

APICORP’s capital adequacy is significantly stronger than peers Usable equity as % risk assets (year-end 2012, log scale)

Source: Respective financial statements and Moody’s.

In addition, APICORP’s shareholders have pledged to support the corporation on a joint and several basis (discussed in more detail in the “Strength of Member Support” section). This support could indicate that the most creditworthy APICORP shareholder may provide the entire amount of callable capital called by the corporation instead of just its own portion of pledged callable capital. The UAE, Kuwait, and Qatar are its highest rated members at Aa2, which qualifies for inclusion in our capital adequacy measure; however, on a joint a several basis, all callable capital pledged to APICORP could be included in the ratio. Doing so would increase the ratio to 412.6% from its already high level of 353.9%. However, the language of the joint and several clause is open to interpretation and therefore we use the ratio with only the callable capital pledged by Aaa/Aa-rated members, consistent with our standard practice.

Asset Quality

Asset quality is a credit strength The high quality of APICORP’s asset portfolio represents one of its credit strengths. Based on its internal calculations, the weighted average credit rating of its total asset portfolio is estimated to be Aa. This breaks down into project & trade finance loans averaging Aa, project direct equity averaging A, and treasury assets9 averaging A10. In addition, around 28% of APICORP’s gross loans are guaranteed. The majority of the guarantees are provided by government-owned entities (58%), while 33% are provided by private sector third-party entities, and 9% by governments.

At year-end 2012, gross NPLs represented 2.3% of gross project & trade finance loans, for which collateral and provisioning exists. This ratio fell11 from 3.3% in 2011 as a result of no loans entering non-performing status during 2012 and the restructuring of a Libyan-based loan during 2012. Current NPLs include loans granted to companies in Iraq and Sudan. Figure 2 shows a comparison of APICORP’s problem loans with its peers.

9 Loans account for 70% of APICORP’s assets, direct equity 8%, and Treasury 22%. 10 Treasury investment policy does not allow for investments in securities rated below Baa3. Current treasury exposure to member governments are to GCC countries only. 11 The corporation’s practice is to remove a loan from NPL status once all late payments have been paid.

1.0

10.0

100.0

1000.0

APICORP CDB IIC CAF

Base Ratio Incl Aaa/Aa Callable Capital in Numerator


7 SEPTEMBER 6, 2013


EXHIBIT 2

APICORP’s NPLs larger than peers, but absolute level is low Non-performing loans as % gross loans

[1] Average for 2007-11 was 0.0%. Source: Respective financial statements and Moody’s.

Despite having an asset base generally regarded as less creditworthy than that of APICORP, CAF has a strong track-record of maintaining low levels of NPLs. The CDB lends to the public sector and therefore preferred creditor status can have significant positive impact on asset performance. The IIC, on the other hand, lends only to the private sector and therefore receives very limited benefit from preferred creditor status. APICORP’s relatively weaker asset performance reflects, in part, the challenging geopolitical environment in which it operates. However, while APICORP’s relative position is weak, we do not consider the absolute position to be a credit concern.

De facto preferred creditor status supports low NPLS APICORP’s de facto preferred creditor status supports low NPLs, although it does not eliminate poor asset performance. Given that 76% of loans12 are to governments or government-related entities, preferred creditor status has the potential to boost the performance of a significant portion of its exposures. However, preferred creditor status is not incorporated into any loan documentation. Indeed, the current stock of NPLs in Sudan and Iraq are loans to government-related entities.

According to Articles 6 & 12 of the Establishing Agreement, the corporation must “preserve and protect APICORP’s assets, rights and privileges of nationality, as well as its interests [held] internationally by its members.” Article 15 grants APICORP preferential access to foreign exchange in the event of a country’s foreign-exchange crisis.

Consistent with these preferences, APICORP’s loans are exempt from country risk provisioning when applicable, and its loans have never been included in general country debt rescheduling. APICORP has only once been involved in a Paris Club rescheduling13 (Algeria in 1995) and it subsequently recovered 100% of its outstanding loan balance. Similarly, APICORP has never been subject to mandatory new money obligations under any country debt rescheduling. Examples of this include Paris Club rescheduling and debt-forgiveness of Iraqi sovereign obligations in 2003: APICORP’s outstanding loans to government-related entities were not included in any of its provisions.

12 As at end-2012. 13 Debt rescheduling by official/bilateral creditors.

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5

APICORP

IIC

CDB

CAF [1]

Avg 2007-11 2012


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Concentration of assets indicates potential for sizeable impact on capital adequacy Given its mandate (to finance energy-related projects in OAPEC member states), APICORP’s asset portfolio is inevitably concentrated – in energy and in the Middle East region. This concentration is not atypical for regional MDBs. In Figure 3, APICORP’s concentration (based on the top five country exposures) is high, but not inconsistent with its peers, with the exception of the IIC which has a larger regional scope than the others. However, APICORP’s assets are concentrated even within the country and sectoral buckets, with a particularly high geographic concentration in Saudi Arabia and Qatar (70.7% of loans) and in petroleum-related projects (over half of loans).

EXHIBIT 3

APICORP’s asset concentration exceeds peers Top 5 country exposures as % total (year-end 2012)

Inter-American Investment Corporation (IIC) 54.7

Caribbean Development Bank (CDB) 63.3

Corporacion Andina de Fomento (CAF) 73.8

Arab Petroleum Investments Corporation (APICORP) 84.9 Source: Respective financial statements and Moody’s.

We also note that APICORP’s portfolio of treasury investments at end-2012 had significant exposure to members, either directly through government bonds or indirectly through state-owned entities. While these instruments tend to be highly rated, investing treasury assets in members further compounds the geographic concentration of assets.

Profitability

Track record of profitability is supportive of APICORP’s capital base Despite having a development mandate, APICORP, unlike other MDBs, carries out its operations with the intention of generating a profit and typically pays dividends to shareholders (the Nordic Investment Bank also pays dividends). We typically assess the profitability of an MDB in terms of the contribution that it makes to building or depleting the institution’s capital base. This analysis is still appropriate in the case of APICORP as we do not believe member support is largely contingent upon the receipt of dividends, as demonstrated by the board’s decision in 2008-2010, and again in 2012, to forego the distribution of dividends in order to strengthen the corporation’s balance sheet and liquidity position.

At year-end 2012, APICORP reported a third successive year of record earnings, with net income reaching $108.9 million – compared to $105.3 million in 2011, and an average $62.4 million over the period 2006-10. The key contributor to the positive 2012 result was strong net interest income, which grew by 47.8% partly as a result of trade and commodity finance operations.14 In addition, the corporation posted an $8.5 million impairment reversal whereas in 2011 it experienced a large $21.7 million impairment loss. These gains were able to offset the lower dividend income of $74.5 million, the first time since 2002 that income from dividends fell from one year to the next, as a result of a number of struggling investments.

Return on assets for 2012 was 2.1%, compared to the average of 1.8% over the previous five years. Return on equity has been very strong, with an average of 6.7% over the past five years and year-end

14 Favorable pricing despite being shorter-term loans compared to project finance.


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2012 results of 8.3%. APICORP has a proven track record of positive results that are contributing to the build-up of capital.

Liquidity

Use of short-term wholesale deposit funding leads to balance sheet maturity mismatch… APICORP’s reliance on wholesale deposits for funding is unusual for an MDB. At year-end 2012, 49.2% of its total liabilities were short-term deposits (from banks, corporates and members), rendering the corporation the most reliant on short-term funding15 (see Figure 4). We view wholesale deposits to be a less stable source of funding compared to retail deposits, because of vulnerability to market confidence. Moreover, deposit funding is inferior to debt funding in the MDB sector because it is a sector that tends to engage in medium- to long-term lending activity.

APICORP uses short-term wholesale deposits to fund its sizeable treasury operations for the purposes of profit generation and liquidity. In addition, it uses them as a source of funding for a small portion of its investment operations (around 10%).

Including short-term liabilities such as repo securities, 58.6% of APICORP’s total liabilities were short term (remaining maturity of up to one year). By contrast, 76.0% of APICORP’s assets were long term (remaining maturity over one year), with 36.2% of assets having a remaining maturity of five years or more. This balance sheet maturity mismatch is a credit challenge for the corporation and constrains its rating. Balance sheet maturity mismatches of this magnitude are uncommon in the MDB sector.

EXHIBIT 4

APICORP has the greatest reliance on short-term funding in its peer group (%, as of year-end 2012)

Deposits/Total Liabilities Deposits + Short-Term Debt/

Total Liabilities

Caribbean Development Bank (CDB) 0.0 2.1

Inter-American Investment Corporation (IIC) 0.0 2.1

Corporacion Andina de Fomento (CAF) 17.6 40.4

Arab Petroleum Investments Corporation (APICORP) 49.2 58.6


…which is only slightly mitigated by stability of deposits There are some mitigating factors to this mismatch: deposits from members, which amounted to $104.5 million and accounted for 5.6% of the deposit base at year-end 2012, are considered stable. These deposits represent the drawn portion of the $1.0 billion line of credit which the shareholders extended to APICORP in 2008. The stability of these deposits is underscored by the requirement that the board must approve all withdrawal requests by shareholders. Indeed, despite significant transition and stress starting in 2011, Egypt, Libya and Syria have not withdrawn their deposits. The aforementioned line of credit was established in 2008 to offset the effects of the global financial crisis, one of which was a limited withdrawal of bank deposits (in 2009, financial institutions withdrew $460 million, followed by a more moderate $160 million withdrawal in 2010). The remaining $895.5

15 MDBs with a similar rating to that of APICORP: Caribbean Development Bank (CDB, Aa1 negative), Corporacion Andina de Fomento (CAF, Aa3 stable), and Inter-

American Investment Corporation (IIC, Aa2 stable).


10 SEPTEMBER 6, 2013


million of the shareholder’s line of credit is larger than the amount of wholesale bank deposits of $692.8 million at year-end 2012.

Another mitigant is that deposits from corporates (which accounted for 57.0% of the deposit base in 2012) are also relatively stable because they are mainly deposited by companies owned by member states through their state-owned oil companies. In addition, a significant portion of these companies also have a loan or direct equity investment client relationship with APICORP. Around 40% of deposits from corporations are somewhat more stable than typical wholesale deposits, based on existing loan or equity relationships in place or a history of regular renewal. Deposits from corporates have increased since the opening of the Bahrain branch when they comprised only 18% of total deposits.

Active 2012 term financing program helps lengthen liability maturity In 2012, APICORP took further balancing steps when it closed three Islamic term financings with maturities of three to five years. The total amount raised was approximately $917 million with the largest amount ($667 million) raised from a club of Saudi Arabian banks. The remainder was raised in two roughly equal-sized bilateral facilities with banks from the syndicate transaction. In addition to contributing to a maturity lengthening, the three facilities also helped diversify APICORP’s creditor base as the first Islamic financings.

Given the corporation’s modest growth plans, it has flexibility regarding the timing of its next financing efforts. It has not borrowed in 2013 to date and if it does, the funds raised will likely be about one-third the size of the 2012 program.

Liquidity management consistent with business model, different from most MDBs APICORP manages liquidity by grouping maturing assets and liabilities into four time buckets (i.e., up to three months, three months to one year, one to five years, and over five years) and matching the cash inflows and outflows; the cumulative gap between the cash flows as a percentage of liabilities is the relevant ratio that is managed by APICORP. At year-end 2012, the cash flow gap up to one year was 45.9%, therefore 45.9% of liabilities were mismatched due to their short maturities. Adjusting this calculation to account for stable corporate and shareholder deposits improves the mismatch, albeit not significantly. However, the non-adjusted ratio has improved since 2009 (when it had reached 72.1%), as a result of the corporation’s willingness to reduce the short-term maturity mismatch. APICORP has set thresholds for the ratio in each time bucket16 and at year-end 2012 was within the threshold only for the ‘one to five years’ and ‘over five years’ buckets.

Most MDBs do not have a maturity mismatch, and manage liquidity primarily through a policy dictating the holding of a minimum level of liquid assets, such that a certain number of forthcoming months’ net cash outflow demands are covered. While APICORP management does have such a policy, the methodology used for the calculations differs from other MDBs and as a result it is not meaningful to make comparisons with its peers.

As shown in Figure 5, APICORP’s liquidity position is the weakest in its direct peer group when its deposits are incorporated into the analysis.

16 Thresholds are as follows: -30%,-40%, -40%, and -75% in the ‘up to three months’, ‘three months to one year’, ‘one to five years’, and ‘over five years’ buckets,

respectively.




EXHIBIT 5

APICORP has the weakest liquid assets coverage of debt service in peer group Short-term debt + current maturities of long-term debt % liquid assets (year-end 2012)


Looking at APICORP’s portfolio of treasury investments, which are entirely funded by short-term deposits, we do not consider the quality of them to offset the wholesale and short-term nature of the funding. While the treasury investments tend to be highly rated investments we do not consider them to be the most liquid. We would consider investments in G717 sovereign debt, which are highly liquid even during times of financial market turmoil, to compensate for the less stable nature of the wholesale short-term deposit funding. As of 2011 APICORP has no investments in US Treasuries. In addition, at end 2012 it had no G7 sovereign investments. A good portion of the treasury investments are long term (54%) and there is a small portion invested in sukuk or structured notes, which are significantly less liquid due to the highly tailored and documented nature of them.

Strength of Member Support

Highly rated members able to support Of APICORP’s 10 member countries, six are publicly rated by Moody’s (Saudi Arabia – Aa3 stable, United Arab Emirates – Aa2 stable, Kuwait – Aa2 stable, Qatar – Aa2 stable, Bahrain – Baa1 on review for downgrade, Egypt – Caa1 negative). The capital base is held primarily by investment-grade countries (64%) – although none is Aaa-rated – with the remainder held by non-investment-grade (3%) or non-rated countries (33%).

According to our calculations, the weighted median rating of APICORP’s shareholders was approximately Aa3 at end-2012. This is the strongest among its peers, with CAF at Baa3 and CDB and the IIC both at Baa1.

Introduction of callable capital demonstrates willingness to support In May 2011, APICORP’s shareholders agreed to change the capital structure by introducing callable capital ($750 million). At the same time, the amount of capital paid in was increased by $200 million, all of which was funded by the capitalisation of dividends and reallocation from reserves. Similarly, the capital increases implemented in 1981, 1996, and 2003 were funded by reallocation from reserves and capitalisation of dividends rather than by new funds from shareholders. As a result, the change in

17 United States, United Kingdom, France, Germany, Italy, Canada, and Japan.

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

IIC CDB CAF APICORP

Base Ratio Incl ST Deposits in Numerator




capital structure in 2011 is the most relevant indication of member support used in our analysis because it demonstrates a willingness to provide additional funds if needed. This demonstration of financial support implies a general support of APICORP’s mandate and satisfaction with the effectiveness of APICORP in fulfilling that mandate.

Very liberal terms in relation to callable capital, which is pledged on a joint and several basis APICORP’s shareholders are unusual because they are committed to supporting the organisation on a “joint and several” basis. Although the wording of this pledge, in our opinion, is not regarded as a full financial guarantee for creditors, it does indicate a stronger willingness to support than the pro rata wording of support pledges of other MDBs. Callable capital is an unconditional and full-faith obligation of each member country to provide additional capital when called. Typically each member’s fulfilment of the callable capital obligation is independent of the action of the other shareholders.

However, APICORP’s shareholders have explicitly committed to support the institution on a “joint and several” basis. Article 6 of the Articles of Agreement states: “The Member States undertake, jointly and severally, to support the corporation, protect it and embrace its causes in every way that ensures the protection of its rights and interests internationally and otherwise and undertake to facilitate all the activities related to its objectives and to adopt all possible measures to that end.” It is rare for an MDB to have shareholder support in this more collective form. However, the language is open to interpretation and is not explicitly linked to callable capital. Hence, while we will examine the capital adequacy ratios amended for consideration of joint and several callable capital (i.e., include all callable capital because the highest-rated shareholder is rated Aa2), the key ratio we use in our analysis of APICORP relates to the traditional inclusion of only the callable capital provided by those members rated Aa3 or higher.

Another unique feature of APICORP’s callable capital is that the conditions under which APICORP can request callable capital is not restricted to debt service. Management can request callable capital in order to service debt, to expand development operations (while maintaining capital adequacy ratios), or to absorb losses from treasury or development-related assets. This represents very liberal callable capital guidelines and differs from other MDBs which can only request callable capital to service debt. Once requested, APICORP’s callable capital is expected to be paid in by members within two months.

APICORP’s deposit-taking structure enables it to receive member support outside of the usual capital increases. In 2008, shareholders pledged a $1 billion line of credit in the form of deposits, which can only be withdrawn following a board resolution. At end-2012, $104.5 million had been drawn on/deposited, and the balance of $895.5 million is currently available as contingent liquidity support.

Minimal risks from competitors As one of the companies created by OAPEC to help achieve its objective, APICORP’s prospects for long-term continued member support are strong. However, APICORP faces commercial competition given its operation in profitable energy markets.

Between 2005 and 2007, competition increased significantly from financial institutions that were attracted to the region’s high economic prosperity. As a result, APICORP faced pressure on its margins and advisory fees. Although competition has decreased following the global financial crisis, this is likely to be only a cyclical event and once the global economy and European banks recover, competition will likely increase. We also note the possibility of a slight risk that member support could potentially weaken over time if APICORP’s role were perceived to be fulfilled by market entities or other




institutions. However, the May 2011 capital increase demonstrates shareholders’ confidence in the corporation’s business model.

Rating History

Issuer Rating Outlook Date

Long-term Short-term

Rating Upgraded Aa3 Sept-12

Rating Assigned A1 P-1 Stable June-10




Annual Statistics

Arab Petroleum Investments Corporation

2005 2006 2007 2008 2009 2010 2011 2012

Balance Sheet (US$ Thousands)

ASSETS

Cash and cash equivalents 18,288 10,264 15,510 9,391 28,860 15,392 18,104 17,326

Deposits with banks 264,920 345,000 391,575 227,618 464,918 439,873 643,613 792,147

Trading securities 68,718 63,698 50,822 98 63 61 53 41

Available-for-sale securities 558,328 582,087 817,648 616,940 622,383 903,292 794,438 952,129

Available-for-sale direct equity investments 234,318 256,731 343,266 282,848 338,854 365,634 324,284 318,002

Syndicated and direct loans (net) 1,141,372 1,304,554 1,892,499 2,371,196 2,621,330 2,541,968 2,803,489 2,897,046

Property and equipment 40,473 38,300 36,518 34,174 32,070 29,263 26,832 71,470

Other assets 15,433 34,090 25,519 27,963 10,622 16,140 18,691 29,414

TOTAL ASSETS 2,341,850 2,634,724 3,573,357 3,570,228 4,119,100 4,311,623 4,629,504 5,077,575

LIABILITIES

Deposits from banks 982,440 1,155,668 1,342,906 1,388,641 930,749 770,385 663,515 692,819

Deposits from corporates 0 5,000 294,730 432,334 757,091 804,261 1,214,068 1,057,429

Deposits from shareholders 0 0 0 15,000 370,438 222,276 103,426 104,476

Securities sold under agreement to repurchase 0 0 225,557 159,558 385,368 408,289 437,777 354,603

Term financing 498,478 549,045 648,033 648,590 649,148 399,547 399,867 946,274

Bonds 0 0 0 0 0 531,018 531,498 532,010

Other liabilities 12,473 28,496 41,728 31,355 24,671 34,869 60,568 80,732

Non-controlling interest 0 0 0 0 0 0 0 1,193

Total Liabilities 1,493,391 1,738,209 2,552,954 2,675,478 3,117,465 3,170,645 3,410,719 3,769,536

EQUITY

Share capital 550,000 550,000 550,000 550,000 550,000 550,000 750,000 750,000

Legal reserve 98,000 103,100 111,300 114,100 120,000 129,600 140,100 151,100

General reserve 15,000 15,000 66,539 66,539 108,425 161,061 46,641 96,495

Available-for-sale fair value reserve 97,516 134,594 255,488 122,225 170,574 214,737 187,190 212,513

Retained earnings 87,943 93,821 37,076 41,886 52,636 85,580 94,854 97,931

Total Equity 848,459 896,515 1,020,403 894,750 1,001,635 1,140,978 1,218,785 1,308,039

TOTAL LIABILITIES AND EQUITY 2,341,850 2,634,724 3,573,357 3,570,228 4,119,100 4,311,623 4,629,504 5,077,575

Off-Balance Sheet Exposures 563,873 807,722 1,051,857 1,008,317 356,818 371,366 409,966 536,089





2005 2006 2007 2008 2009 2010 2011 2012

Income Statement (US$ Thousands)

Interest income 71,500 116,684 153,703 134,763 69,667 60,580 77,500 104,729

Interest expense -49,484 -87,195 -112,935 -104,488 -55,771 -43,731 -50,298 -64,523

Net interest income 22,016 29,489 40,768 30,275 13,896 16,849 27,202 40,206

Fee income 2,461 2,318 3,625 6,659 1,540 2,002 1,421 1,409

Fee expense -122 -159 -180 -114 -128 -200 -197 -333

Net fee income 2,339 2,159 3,445 6,545 1,412 1,802 1,224 1,076

Dividend income 16,382 30,103 31,649 57,988 59,501 67,048 100,453 74,474

(Loss) gain on trading securities 9,941 5,640 6,686 -3,893 -35 -2 -8 -12

Gain on available-for-sale securities 3,802 1,331 6,039 2,982 104 32,743 26,886 11,372

Gain on available-for-sale direct equity investments 58,755 0 5,433 0 0 0 0 0

Impairments losses/reversals -3,692 1,914 7,982 -45,368 -1,542 1,746 -21,737 8,512

General administrative expenses -16,731 -20,326 -22,296 -23,553 -21,958 -25,849 -31,514 -30,857

Other income 2,119 698 33 2,634 7,158 843 2,848 4,120

Other operating expenses -345 -30 0 0 0 0 0 0

NET INCOME 94,586 50,978 79,739 27,610 58,536 95,180 105,354 108,891





2005 2006 2007 2008 2009 2010 2011 2012

Financial Ratios

Capital Adequacy (%)

Usable Equity/Total Assets [1] 36.2 34.0 28.6 25.1 24.3 26.5 26.3 25.8

Qualifying Capital Adequacy [2] -- -- 26.0 22.0 25.7 29.2 28.5 27.2

Coverage of all Development-Related Assets:

Usable Equity/Gross Loans + Direct Equity Investments [1] 58.1 54.4 43.9 32.6 32.9 38.1 37.6 39.1

Usable Equity + CC of Aaa/Aa Members/Gross Loans + Direct Equity Investments [1][3]

58.1 54.4 43.9 32.6 32.9 38.1 51.7 52.8

Coverage of Risk Assets (a subset of Development-Related Assets):

Usable Equity/Risk Assets [1] [4] -- -- -- -- -- 210.5 266.9 262.2

Usable Equity + CC of Aaa/Aa Members/Risk Assets [1][3][4] -- -- -- -- -- 210.5 367.2 353.9

Coverage of Funding:

Usable Equity/Borrowings [1] 170.2 163.3 116.8 110.7 96.8 85.2 89.0 71.4

Usable Equity/Borrowings + Deposits [1] 57.3 52.4 40.6 33.8 32.4 36.4 36.4 35.5

Usable Equity/Borrowings + Deposits (excl Shareholder’s) [1] 57.3 52.4 40.6 34.0 36.8 39.2 37.5 36.5

Asset Quality

Gross NPL/Gross Loans (%) 5.8 7.1 4.9 2.8 3.1 2.6 3.3 2.3

Total Reserves/Gross NPL (X) 1.6 1.2 1.8 2.6 2.7 4.2 1.9 3.6

Total Reserves/Gross Loans (%) 9.2 8.5 9.0 7.3 8.4 11.1 6.4 8.2

Profitability (%)

Return on Assets (ROA) 4.0 1.9 2.2 0.8 1.4 2.2 2.3 2.1

Return on Equity (ROE) 11.1 5.7 7.8 3.1 5.8 8.3 8.6 8.3

Interest Coverage Ratio (Bonds) (X) 5.9 2.7 3.2 2.2 8.3 19.1 9.2 4.9

Interest Coverage Ratio (Bonds and Deposits) (X) 3.4 1.7 1.7 1.3 2.1 3.2 3.1 2.7

Liquidity (%)

Liquid Assets/Total Assets 38.9 38.0 35.7 23.9 27.1 31.5 31.5 34.7

Liquid Assets/Total Liabilities 61.0 57.6 50.0 31.9 35.8 42.8 42.7 46.7

Liquid Assets/Total Liabilities + Off Balance Sheet Exposure 44.2 39.3 35.4 23.2 32.1 38.4 38.1 40.9

Liquid Assets/Borrowings 182.6 182.3 146.0 105.7 107.9 101.5 106.4 96.1

Liquid Assets/Borrowings + Deposits 61.5 58.6 50.8 32.3 36.1 43.3 43.5 47.8

Loans/Deposits 124.8 119.9 121.1 134.0 131.5 146.2 147.4 163.2

[1] Usable equity = Share Capital + Reserve Funds + Retained Earnings

[2] APICORP’s calculation in line with Basel II/Central Bank of Bahrain guidelines. Tier 1 + Tier 2 Capital/Total Risk Weighted Exposure.

[3] CC = Callable capital

[4] Risk Assets = Loans to non-investment grade entities + total direct equity investments




Capital Subscriptions and Voting Power as of Year-End 2012

(US$ Thousands) Paid In Callable Subscribed Authorized

Capital Fully Paid

Percentage

United Arab Emirates 127,500 127,500 255,000 408,000 17.0

Saudi Arabia 127,500 127,500 255,000 408,000 17.0

Kuwait 127,500 127,500 255,000 408,000 17.0

Libya 112,500 112,500 225,000 360,000 15.0

Iraq 75,000 75,000 150,000 240,000 10.0

Qatar 75,000 75,000 150,000 240,000 10.0

Algeria 37,500 37,500 75,000 120,000 5.0

Bahrain 22,500 22,500 45,000 72,000 3.0

Syria 22,500 22,500 45,000 72,000 3.0

Egypt 22,500 22,500 45,000 72,000 3.0

750,000 750,000 1,500,000 2,400,000 100.0

Project & Trade Finance Gross Loans by Country as of Year-End 2012

(US$ Thousands) Outstanding Balance % of Total

Saudi Arabia 1,264,821 41.8

Qatar 876,430 29.0

Kuwait 216,082 7.1

United Arab Emirates 112,087 3.7

Morocco 101381 3.3

Oman 80,415 2.7

Egypt 74,475 2.5

Netherlands 52,563 1.7

Iraq 51,849 1.7

Libya 26,186 0.9

Algeria 25,400 0.8

Bangladesh 24,993 0.8

Bermuda 22,094 0.7

Bahrain 21,323 0.7

Sudan 16,560 0.5

Switzerland 15,709 0.5

Singapore 14,984 0.5

Turkey 10,000 0.3

United Kingdom 10,000 0.3

Marshall Islands 9,259 0.3

3,026,611 100.0




Project & Trade Finance Gross Loans by Sector as of Year-End 2012

( US$ thousands) Outstanding Balance % of Total

Petrochemicals 960,852 31.7

Liquefied Natural Gas Plants 454,593 15.0

Refineries 293,878 9.7

Marine Transportation 293,139 9.7

Power & Water 262,913 8.7

Fertilizers 166,538 5.5

Energy Intensive Sector 164,496 5.4

Trade Finance 133,170 4.4

Specialty Chemicals 107,751 3.6

Oil Field Services 72,657 2.4

Upstream Oil & Gas 70,813 2.3

Petroleum Storage 29,145 1.0

Gas Processing 16,666 0.6

3,026,611 100.0




Moody’s Related Research

Credit Opinions:

» African Development Bank

» Arab Petroleum Investments Corporation

» Caribbean Development Bank

» Central American Bank for Economic Integration

» Corporacion Andina de Fomento

» European Bank for Reconstruction and Development

» European Investment Bank

» Fondo Latinoamericano de Reservas

» Inter-American Investment Corporation

» International Finance Corporation

» Nordic Investment Bank

Issuer Comments:

» APICORP Makes Progress Toward Reducing Asset/Liability Maturity Mismatch, February 2012 (140194)

» APICORP Diversifies Its Investment Activities, a Credit Positive, February 2013 (150528)

Rating Action:

» APICORP, September 2012

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

Related Website

» APICORP

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Report Number: 157489

Author Annette Swahla

Production Specialist Wing Chan

Editor Matthew Bridle

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