FX: 'There's Need to Recapitalise Nigerian Banks'

FX: ‘There’s Need to Recapitalise Nigerian Banks’

A stronger banking industry will emerge following the apex bank’s decision to relax its fist on managed foreign exchange management policy, according to Ada Ufomadu, GCR Ratings sector, financial institutions.

Ufomadu explained that with the large devaluation of the naira, said there is a need to recapitalise banks, saying the industry has been hit on many sides by various challenges that have moderated capital in recent times.

Following a pro-market speech delivered by President Bola Tinubu, the Central Bank of Nigeria (CBN) decided to bite the bullet by floating the local currency. Africa’s largest economy by size of gross domestic product has been battling foreign currency shortage for a long time.

The scarcity of foreign currency in a growth starve most populous nation in Africa has plunged the naira to a historical low. In their respective economic outlook reports for 2023, investment firms projected that the overvalued local currency would be devalued.  

MarketForces Africa reported that foreign investors maintain distance from participating in the Nigerian economy through direct investors, and there has been a large record of exits in the capital market due to the inability to upstream dollars offshore.

Though, the decision to finally float the naira came as a rude shock across Broadstreet. Unfazed by foreign currency scarcity in the economy, Godwin Emefiele, the suspended monetary authority chief had maintained a ‘no evaluation’ stance while the naira continues to lose its allure.

In less than seven years, Nigerian local currency lost 233% of its purchasing power at the investors’ and exporters’ FX window as demand exceeds forex supply.

Deposit money banks have also been at receiving end of the acute dollar shortage, lenders have been unable to trade forex freely to boost earnings. “We believe that the regulator has forced banks to put in place stricter risk management practices to tame currency risks”, GCR Ratings told MarketForces Africa.

The emerging market ratings agency said a major example is the regulatory requirement that banks are no longer allowed to lend foreign currency (FCY) to obligors that do not have FCY receivables. The CBN has also introduced some derivative type instruments that are used to hedge currency risks, although this is still evolving, GCR Ratings sector head, financial institution, said. 

“A major positive we see from this development is that when the naira finally settles at the right price, foreign currency inflows could improve from export repatriation and foreign portfolio investments, further strengthening the domestic currency”.

Speaking to ballooning oil and gas lending by Nigerian banks, GCR Ratings Ufomadu said the oil and gas in the upstream segment and manufacturing loan book where most FCY loans sit will bloat in naira terms because of the devaluation.

In its recent ratings note, Fitch expressed concern over loan concentration in the volatile oil and gas segment. It sees exposures by some banks in the tier-1 category as pressure cookers amidst fluctuating in the global market.

United Bank for Africa’s oil and gas exposure was 16% of gross loans at the end of the financial year 2022, though Fitch said the record was lower than peers.

Fitch Ratings noted that GTBank’s oil and gas exposure settled at 37% of its loans and foreign-currency lending was 57% of net loans.

Its stage 2 loans inched to 15% of gross loans in 2022, and its restructured loans were mainly concentrated within oil and gas and largely US dollar-denominated. “This remains high and represents a key risk to asset quality”, the rating note added.

With a similar trend, Zenith Bank’s oil and gas exposure registered at 23% of gross loans in 2022. Though it’s considered material, however, the asset was lower than other domestic systemically important banks.

Zenith Bank stage 2 loans were 22% of gross loans at the end of the first quarter in 2023. These near-bad loans were concentrated within oil and gas and largely US dollar-denominated.

Again, Fitch said the rate of near delinquent loans was high and represented a key risk to asset quality, forecasted the impaired loans ratio for the bank to increase moderately in the near term.

In its view, GCR Ratings said the loan portfolio of many banks that have FCY exposures generally- whether oil & gas, manufacturing, or agriculture (for exporters)- will increase; not necessarily because they have extended additional loans to these obligors, but because of the naira devaluation.

This will increase the volume of risk-weighted assets and ultimately capital adequacy ratios will decline, the emerging market ratings agency with a large footprint in African markets said.

Responding to whether there is any effect of naira devaluation on banks with Eurobond exposure and those with large foreign loans, Ufomadu said repayment obligations on FCY liabilities such as the Eurobonds will increase in naira terms.

“But if you consider that proceeds of these Eurobonds were used to create FCY assets that have FCY receivables, then the currency risk is somewhat mitigated to a large extent”, GCR Ratings added.

He explained that over the years, the banking industry in Nigeria has reduced its appetite for Eurobonds and on the asset side moderated foreign lending; especially as these loans are now largely matched to only companies that have foreign currency receivables or parent companies that can support FCY inflows.

Ufomadu emphatically stated that the adverse impact of the naira devaluation on banks with Eurobond obligations should not be as much as the sector experienced in 2016/2017. MarketForces Africa observed that some companies in the fast-moving consumer goods sector posted significant foreign exchange losses, according to audited reports reviewed.

For manufacturers, negative exchange rate fluctuation has been margin dilutive development that continues to drag their respective profitability size downward. The decision to float the naira is expected to impact companies with foreign currency denominated loans.

GCR ratings said given the translation impact, corporates with FCY loans will witness a considerable increase in debt balances and higher interest costs could shrink profitability margins. Leverage metrics and interest cover could worsen, according to the firm.

“The impact could be less severe for companies that have also priced their goods and services at parallel market rates, prior to the new exchange rate policy”, GCR Ratings chief added.

He also said some of the companies in that class may face challenges in obtaining more debt/increasing their credit limits with banks that have reached their sectoral lending limits.

Ufomadu said CBN’s revised prudential guidelines expect banks that have sectoral concentration above 30 percent of total loans to risk-weighted assets for that sector at 150%.

Looking at the impact of fx float on banks’ capital, GCR Ratings Chief noted naira devaluation will increase the size of the overall balance sheet of banks through the FCY portion which will now be converted to naira at a higher exchange rate.

“With a bigger balance sheet (in naira terms), banks will have to hold more capital as buffers. A few banks had already raised additional equity capital in preparation for the full implementation of the Basel 3 standards.

“This will be a front burner discussion now for most banks with the naira devaluation. Another impact of the naira devaluation we see for banks that hold net FCY asset positions is that revaluation gains will be recorded (depending on the quantum of naira devaluation) which will support earnings and in turn capital”.

On the possibility of bank recapitalisation, GCR Ratings said the banking industry in Nigeria has been hit on many sides by various challenges that have moderated capital in recent times.

The emerging market ratings agency said the Covid-19 pandemic and the aggressive cash reserve requirements by CBN have negatively impacted earnings growth, huge impairments were taken on exposures to Ghana sovereign Eurobonds, and now the naira devaluation.

“There is a need to recapitalise, and banks know that they need additional capital, and some of them are proactively seeking to raise capital.

“In addition, the transition of some banks to the holding company structure will require more capital to support the newly incorporated or acquired subsidiaries”.

Amidst uncertainties in the economy, GCR Ratings expects a stronger banking industry to emerge. Ufomadu said a lot of the issues banks have faced are macroeconomic-driven. 

“Banks are diversifying into other financial services offerings through the holding company structure to improve and diversify earnings and are upgrading their services to get more share of customers’ wallets”, the ratings agency told MarketForces Africa. #FX: ‘There’s Need to Recapitalise Nigerian Banks’ Reclaims Value as Nigeria Mulls Eurobond Raise