Afrinvest raises red flag on bank’s capitalization

By FELIX OLOYEDE

Pressure is mounting on local deposit money banks (DMB’s) to raise fresh capital as growing non-performing loan losses melt their operating profits. With the industry’s average loan loss provision to loans outstanding in excess of 12 per cent (more than twice the regulatory guideline of 5 per cent) the authorities concern about the safety of the banks has become palpable , even if not officially expressed. Indeed at a recent private discussion between Business Hallmark and an official of the Asset Management Company of Nigeria (AMCON)the newspaper was told that, ‘we have got to take a firmer handle on the non-performing loan situation of banks otherwise the gathering storm could result into a tornado’. The official who did not want to be officially quoted as he was not authorized to speak with the press on the matter noted that, ‘bank bad debts have become tigers; once you climb on the beast you get swallowed’.

This observation underscores a point raised by investment management firm, Afrinvest (West Africa) while presenting its 2017 Banking Sector Report on the floor of the London Stock Exchange last Friday. Among other observations the report pointed out that an increasing number of banks may have to approach the capital markets in 2018 to shore up their capital base to meet both the local capital adequacy requirements (CARs) of the Central Bank of Nigeria (CBN) and the international capital adequacy standards of Basle III.  Afrinvest report authors note that, ‘the depreciation in the domestic currency resulted in higher Risk Weighted Assets on the books of the banks. Hence, capital adequacy ratios of some of the banks fell towards threateningly low levels. Consequently, we expect such banks to approach the market in order to raise capital to shore up capital buffers.’ In other words the poor quality of banks loans and advances in 2017 would compel a number of them to approach the capital market to raise fresh equity or to take on a combination of fresh equity and convertible debt.

The report which was titled: “Nigeria Reopens for Business” further noted that though the majority of Nigerian banks have been able to weather the recessionary storm that dogged the economy between 2015 and 2017, hampering credit expansion, asset quality and capital adequacy, their exposure to “high risk sectors” such as the power sector and the oil and gas sector will continue to mount pressure on banks’ capital adequacy ratios. The report mentions that commercial lenders may seek refuge in Eurobond issuance to strengthen both capital adequacy and bank liquidity.

Perhaps responding to a growing consensus amongst finance analysts of the need for local banks to resort to the foreign bond markets for improving their long term liabilities, Ecobank Trans International (ETI) on Friday announced the successful launch of its Eurobond. Zenith and UBA Plc raised US$500.0m each with both issuances oversubscribed by 3 times and 2.4 times respectively. Fidelity Bank and GT Bank have Eurobonds that will be maturing in 2018 with expectation of possible refinancing through new issuances. Furthermore, Fidelity Bank on October 13th 2017, successfully issued $400.0m through a Eurobond Offer at a coupon of 10.5 per cent, the report revealed. And Union Bank Plc has just wound up it N50 billion Right Issues, with Wema Bank Plc concluding plans to approach the market in the first quarter of 2018.

The Afrinvest report noted that the fall in oil prices since mid 2014 triggered foreign exchange dearth in the country, forced the Central Bank to devalue the naira in June, and worsened the non-performing loans of banks thereby dealing a big blow to their capital adequacy. Banks’ NPL soared past the 5 per cent regulatory benchmark and topped to a staggering 13 per cent. The central bank responded by relaxing its prudential threshold to give banks breathing space to rebuild their books. To be sure, even the International Monetary Fund (IMF) recently raised concerns over the swelling NPLs of Nigerian banks. Afrinvest notes that the Nigerian economy is gradually showing signs of recovery after coming out of a 16 month recession and growing at 0.55 per cent in Q2 2017.

Professor Leo Ukpong, a financial economist and dean of the School of Business Studies, University of Uyo notes that it is not strange that banks are struggling with their capital adequacy ratios according to Ukpong, ‘we did not prepare adequately for the sudden drop in oil prices. Although oil prices are beginning to rise and our production output has begun to stabilize, there is still a lot of corruption in the sector, which makes business difficult for the companies banks finance. Several banks are still captives of an infamously opaque industry”, he remarked.

The Afrinvest Banking Sector Report also highlights the effect of currency depreciation reflected in the size of the loan book of banks, which grew nominally by 23 per cent year-on-year given that 39.5 per cent of industry loans were foreign currency denominated. Total Deposits on the other hand  grew 19.3 per cent in 2016, following a decline of 1.8 per cent in 2015 while Total Assets and Total Liabilities grew 20.7 per and 21.8 per cent respectively.  The report noted that the banking industry would witness nominal expansion in loans in 2017, because of the large proportion of foreign currency-denominated loans granted over the period.

Afrinvest’s financial analysts assert that local banks will continue to show preference for investment in fixed income securities as already seen in their financial statements for the first three quarters of 2017. According to the report, “as already noticed in 2016, banks are more willing to direct funds towards investment securities as opposed to credit extension given the risk environment and we believe this will continue till the end of the year and possibly H1:2018’.

With government’s unbridled appetite for borrowing and the high benchmark policy interest rate of 14 per cent, lenders would always want to focus on trading in the debt market, which is risk-free rather than extend credit to the volatile real sector, argues Dr. Vincent Nwani, an economist and director, Research and Advocacy, Lagos Chamber of Commerce and Industry (LCCI), ‘unfortunately, it is almost impossible for these banks to invest in the real sector. Over 70 per cent of Nigerian bank investments are in government securities. And less than 30 per cent of credit goes to the real sector’ he explains. Nwani notes that, ‘the knowledge gap in the banking industry in terms of understanding the risks in the extractive industry is disappointing’.

Nwani has urged government to make it unattractive to banks to just put customers’ deposits in fixed income securities by lowering interest rates, so that they can extend credit to the real sector and spur growth while creating new jobs.

Meanwhile a growing number of analysts have expressed concern that banks’ capital adequacy ratios could worsen if the government carries out its resolve to confiscate about N3 trillion trapped in 40 million bank accounts which have not been linked to the bank verification number (BVN). The federal government had recently obtained a court order allowing it to take over money in accounts that have no BVN identification.

Banks can expect gross revenues to grow in both 2017 and 2018, according to the Afrinvest report, as revenues ride on the shoulders of higher interest income, on account of the high interest rate environment as well as improved non-interest income from trading inflows as well as fees & commission.’, the report notes.

With the year gradually grinding to an end banks in Nigeria may see 2017 yearend earnings results show modest growth as the economy takes its toll on manufacturing sector output and real disposable incomes. The slower growth may, however, pick up a notch in 2018 as the government refinances its public sector debt portfolio with lower amounts of domestic debt and higher amounts of external borrowings, this should bring down the average cost of debt servicing, especially when it is noted that analysts foresee an average crude oil price for 2018 at around United States of America $58 per barrel up from an average estimated USD$54 in 2017.

Does Nigerian incorporated matter? Maybe it does, with a population that is likely to rise from 180 million to 242 million over the next ten years, if the managers of the economy allow it to grow by between 10 and 12 per cent per annum over the next five years and about 8 per cent thereafter; the country may still have a fighting chance in staving off economic disaster.