Moody’s: Profitability of Nigerian Banks under threat

Moody’s Investor Service expects the profitability of Nigerian banks to decline due to reduction in yields of government securities and likely reduction in income from derivatives. The ratings agency also expect capital buffers to decline and asset quality to remain weak over the next 12 to 18 months. It also assessed whether Nigerian banks can withstand highly stressed conditions, but its stress test showed the impact of such would be severe. However, Moody’s said its outlooks on individual Nigerian bank ratings are largely stable.

“We expect return on assets of around 2 percent in 2018 (2.4 percent at 3Q17, IMF) due to declining yields on government securities,” said Moody’s in its latest Nigeria Banking System Outlook.

Local reports earlier in the year named nine banks that might be affected by the decision of the federal government to restructure its debt portfolio, leading to a reduction in yields on treasury bills. According to the report, Stanbic IBTC Bank had 36.6 percent of its interest-bearing assets in government securities. Guaranty Trust Bank (GTBank) had 18.3 percent, FBN Holdings 16.7 percent and United Bank for Africa (UBA) 14.5 percent. Other banks named were Zenith Bank, Diamond Bank, First City Monument Bank (FCMB), Access Bank and Fidelity Bank.

Moody’s, however, said that declining yields will be partially offset by increased non-interest income and lending growth.

Loan Books

Following the 2016 recession, Nigerian banks’ loan books contracted 15.4 percent in 2017 (adjusted for the devaluation of the naira. Moody’s said it expects banks to expand their lending by 10 percent this year, which will support interest income and lending fee income, in line with an August announcement by one of Nigeria’s largest banks GTBank, which disclosed plans to increase its loan book by 10 percent before the end of 2018.

GTBank reported a 13.6 percent increase in profit after tax for the first half of 2018. However, its interest income dropped from N165 billion in H1 2017 to N161 billion in H1 2018. According to Moody’s combined, interest income and lending fee income contributed about 50 percent of banks’ revenues in 2017.

The ratings agency stressed that a rebound in loan growth will partially mitigate the negative effect of lower interest income from Treasury bill yields, which have declined by an average of 660 basis points from their peak in 2017.

“Lower Treasury yields will strain interest income on new securities investment,” Moody’s said, but noted that overall interest margins will remain high because banks have some room to reduce their cost of funding.

Moody’s also expects banks to keep costs under control over the next 12 to 18 months. This, the agency said, would be driven by technology.

Even smaller banks in Nigeria are increasingly investing in technology. Wema Bank, a mid-tier bank in Nigeria launched the country’s first fully digital bank ALAT in 2017. It is also strongly pushing its agency banking services throughout the country, seeing that it becomes difficult to compete with bigger banks with more branches. Wema Bank has less than 150 branches throughout Nigeria.

Apart from technology, Moody’s noted that a stable naira and falling inflation will also mitigate risk of rising operating costs. “We expect rated banks’ cost-to-income ratio to remain around 55 percent over 2018,” the ratings agency said.

NPLs will rise
Moody’s expect the non-performing loan rations (NPLs) of Nigerian banks to rise. Already, the country’s banks have some of the highest NPLs in sub-Saharan Africa. Moody’s expects problem loans to rise modestly over the next 12 to 18 months.

“NPLs are a lagging indicator and we expect the historically low oil prices, currency depreciation and sluggish economic growth experienced in 2017 to continue to generate new NPLs during 2018. We expect the NPL ratio to range between 15.5 percent and 18 percent over the outlook period (15.1% as of 3Q 2017, IMF),” Moody’s said, adding, however, that higher GDP growth projections for 2018 and 2019 and improved foreign currency liquidity will moderate problem loan formation going forward.

Banks that highly exposed to the vulnerable oil and gas sector, as well as those exposed to foreign-currency borrowers more generally prone to loan risks, Moody’s noted. Foreign currency loans accounted for 40.7 percent of the loan book of Nigerian banks at the end of the third quarter of 2017, some 10 percent to 20 percent of which has been dispersed to borrowers with little or no foreign currency income.

“These borrowers are vulnerable to fluctuations in the naira/dollar exchange rate as a depreciation of the naira reduces their repayment capacity,” Moody’s noted.

Regardless of risks of lower profitability and higher NPLs, however, Moody’s said Nigerian banks will continue to benefit from stable deposit funding with minimal reliance on confidence-sensitive and costly market funding. When GTBank announced plans to grow its loan book, it said it would use some of its cash deposits.

Customer deposits make up about 67 percent of total liabilities, and foreign currency deposits, primarily dollars, make up 23 percent of deposits as of year-end 2017. Moody’s expects local currency deposit growth to remain positive, supported by high nominal GDP growth and rising financial inclusion.

“The banking system’s loan-to-deposit ratio was moderate at 72 percent at the end of December 2017 down from 77 percent in 2016. We therefore expect banks to be able to fund local currency loans with deposits, limiting their reliance on market funds,” Moody’s said.

“Banks will also continue to hold large amounts of liquid assets in local currency (mostly government securities), which will continue to provide a solid cushion in a funding squeeze. As of June 2017, Nigerian banks’ average liquidity ratio (liquid assets as proportion of current liabilities) was 49 percent, providing a substantial buffer to the 30 percent required by the regulator. We expect local currency liquidity to remain robust over the next 12 to 18 months.”

Can Nigerian banks withstand highly stressed conditions?

Moody’s considered a stress scenario aimed at gauging the the solvency of banks in Nigeria, which informs its opinion on the creditworthiness of the system as a whole.

“The results of our stress scenario on the Nigerian banking system show that the impact would be severe, leaving the system with capital equivalent to about 3.4 percent of its risk-weighted assets at the end of 2019, compared to 17.3 percent as of the end of 2017.”

“These results are worse than regional peers and the median of all systems and are driven by system NPLs rising to about 27.0 percent of gross loans, and loan-loss provisions totalling close to 10.3 percent of risk weighted assets.”

However, Moody’s expect the Nigerian government to keep supporting its systemically important banks, as the government has shown willingness, in recent times, to continue to do this, given the significant negative
consequences of a bank collapse to both the payments system and the wider economy.

Moody’s publicly rate seven banks, representing 68 percent of total assets in the Nigerian banking system, including Zenith Bank Plc, First Bank of Nigeria Limited, United Bank for Africa Plc, Access Bank Plc, Guaranty Trust Bank plc, Union Bank of Nigeria plc and Sterling Bank Plc.