Nigerian Banks’ Stage 3 Loans Ratio Projected to Print at 11%

Nigerian Banks’ Stage 3 Loans Ratio Projected to Print at 11%

Nigerian banks stage 3 loans or credit impaired assets is projected to rise to 11% in 2021 from 6.4% in 2019 as lenders books show steep rise in impairment charges in the third quarter earnings season.

Uncertainties surrounding the banking sector earnings outlook is yet to abate and Fitch Ratings projected an increase in stage 3 loans as proportion of gross loans at 7% in 2020.

Looking at the industry’s book, the pattern observed in the third quarter earnings results of listed banks indicates pressures on loan book.

Some of the industry’s strongest banks had tough time with profit growth as impairment charges booked in the period rise.

Fitch Ratings forecast data on Nigerian banks projected a strong growth in stage 3 loans as proportion of gross loan to close the year at 7% from 6.4% in 2019.

Read Also: Nigerian Banks Prudential Ratios to Be Severely Impacted in 2020

Based on average weighted Fitch rated Nigerian banks, loan impairment charges as a proportion of average gross loans is expected to double from 0.6% to 1.3% in 2020.

In 2021, loan impairment charge as percentage of the banking sector gross loans is estimated to rise to 2.5%

Despite economic reopening, business performances have remained slow with inflation rising to 14.23% on account of government policy somersault.

Banks are healing gradually, but the impacts of foreign exchange scarcity and high regulatory risks remain an industry issue.

Though, with the special bills, the Central Bank of Nigeria has begun process of releasing excess cash reserve requirement to Nigerian banks.

This is expected to spur liquidity, then credit growth into the real sector.

In their separate financial statements for the 9-months period in 2020, banks earrings from interest yielding asset were low due to the CBN dovish interest rate environment.

Big corporates are refinancing with low yield fixed income market instruments while oil companies are cutting back on capital expenditure.

Foreign exchange scarcity and resultant currency control have limit lenders earnings advantage, just as there is pressure with loan to deposit ratio.

In a recent report, Fitch Ratings said Bank balance sheets are highly dollarised and exposed to Nigeria’s persistent foreign exchange issues.

Fitch estimates a devaluation of the Naira in the Investors & Exporters (I&E) window of 7% in 2020 followed by 4% in 2021.

Additionally, it explained that Nigerian banks (and their customers) continue to face severe shortages of hard currency, mainly in US dollar, which arise at times of economic stress.

Naira devaluation affects banks indirectly through asset quality deterioration as some sectors, particularly the trading and manufacturing sectors (which are import-reliant), are hit hard when the currency depreciates, Fitch added.

The Ratings firm said this also leads to rising inflation (currently around 14.23% at end-October), adding to pressure on customers.

Naira devaluation translates into foreign currency revaluation gains that boost profitability for banks with long US dollar positions (which is the case for all banks).

At the same time, Fitch said devaluation inflates banks’ foreign currency risk weighted assets (RWAs) and places pressure on capitalisation.

Based on previous devaluations, Fitch said the net impact of Naira devaluation on banks’ capital ratios is likely to be contained.

In the report, Fitch explained that Banks will continue to see tight foreign currency liquidity in 2021 due to low inflows of US dollars into Nigeria and from the CBN’s measures to preserve FX reserves.

Experts explained that the banks’ limited ability to source foreign currency liquidity constrains their ability to meet obligations.

However, borrowers face the same challenges, which heightens asset quality risks for banks, especially with unhedged borrowers.

During the year banks have been able to meet their foreign currency obligations through internal resources (liquid assets and cash flows from US dollar loan repayments), but a more severe tightening in liquidity would be negative for ratings.

FX issues also have broader consequences:

The US dollar shortages have hit foreign portfolio investors (FPIs) hard as they have been unable to repatriate substantial proceeds from their investments in local currency government securities.

For now, these funds have been re-invested in treasury bills and other government securities, which has partly contributed to the sharp fall in yields in recent months (which, in turn, affects a key source of revenue for banks).

While capital flight is a risk to the country (as it further depletes FX reserves), our view is that sudden FPI outflows would have a limited impact on banks’ FC liquidity as these funds are deposited in local currency at banks.

The risk to the sovereign (and the Naira) is currently low as the CBN is restricting the supply of FC and has therefore prevented FPIs from exiting the country.

Fitch estimates that FPIs investments in government securities amounted to USD27.7 billion at end-2019, equivalent to 72% of Nigeria’s FX reserves at that time, more than half of which were in open market operations (OMOs) bills.

On banking regulatory risk, Fitch said banking sector intervention is seldom positive, often produces mixed results and usually has unintended consequences.

“We see no easing in the CBN’s interventionist stance in 2021 and it could even increase.

“The LDR and CRR policies are contradictory. The LDR aims to stimulate economic growth by encouraging banks to lend to priority sectors.

“At the same time, the CBN hits banks by applying ‘out of cycle’ CRR which drains their LC liquidity”, Fitch said.

The primary aim of the CRR measure is to mop up excess liquidity to stem the demand for foreign currency and ensure exchange rate stability.

As a result, banks hold CRR substantially in excess of the required threshold. The CRRs of banks range between 40%-60%, or even higher at some.

The CBN has debited banks with about NGN3.1 trillion (about USD8 billion) since April as additional CRR, with large banks particularly hit hard.

However, in a bid to free up excess cash reserves, the apex bank in December introduced a new class of government securities called ‘Special Bills’ as part of its liquidity management strategy.

These bills can be exchanged for excess CRR and, according to the circular, have the following features: tenor 90 days; zero coupon and yield to be determined by the CBN.

However, they can be traded among market participants but are not eligible for repurchase agreement with the CBN; and the bills will count towards banks liquidity ratios (currently set at 30% of total current liabilities).

CBN rules also allow banks to access part of their excess CRR if they use the proceeds for intervention loans (lending to priority sectors on favourable rates and terms).

These loans are 150% weighted in the LDR computation, according to the CBN circular.

Given the risks associated with intervention loans, Fitch said banks have little appetite to significantly expand in this segment.

Nevertheless, the minimum LDR requirement led to 17.7% growth in loans to the private sector in the first half of 2020.

These loans were mostly in the manufacturing, construction and consumer segments in spite of lockdown measures.

The Central Bank of Nigeria’s (CBN’s) policy measures prevented a material rise in impaired loans to date and masked the underlying performance of loan portfolios.

Banks were allowed to restructure loans by providing their customers with principal and interest payment holidays of up to one year – until March 2021.

Eligible borrowers were households and businesses operating in the most stressed sectors, including oil and gas, agriculture and manufacturing.

Banks were also mandated by the CBN to grant payment holidays for loans to state governments and SME borrowers under its ‘intervention loan programmes’.

The latter also received a reduction in loan rates.

As part of the monetary policy response since March, the CBN has cut the policy rates by a combined 200bp (currently at 11.5%).

As allowed by the CBN, loans restructured under COVID-19 measures were not considered a ‘significant increase in credit risk’ under IFRS9, preventing such loans from migrating to Stage 2, and therefore not requiring lifetime expected credit loss (ECL) provisions.

According to CBN data, about 40% of banking sector loans had been restructured under the COVID-19 measures at end-1H20, which highlights the extent of the crisis on borrowers.

These loans remain largely in the Stage 1 category and require lower provisions (12- month ECL) than loans classified as Stage 2 or Stage 3/impaired.