Net FX Position, Hedge Contracts to Help Banks Survive Pressure

Net FX Position, Hedge Contracts to Help Banks Survive Pressure

The Nigerian banks abilities to survive regulatory and ‘virus’ triggered economic challenges would depend on their structure, net dollar position and perhaps their short term hedges for a large percentage of oil and gas assets, United Capital Plc has hinted.

The investment firm stated this in its second half of 2020 outlook report, explained that its initial outlook for the banking sector was that interest and non-interest income would be further pressured.

“We imagined that loan growth will be modest amid concerns about asset quality”, analysts at the United Capital explained.

The investment had anticipated that margins will be strained, and profitability will be slightly impaired.

“Beyond regulatory pressure which continue to eat-up asset yields, the banking sector was served a cocktail of woes in the first half of 2020”, analysts stated.

The outbreak of COVID 19 triggered currency devaluation, oil market crash, halted business activities and worsened asset quality.Net FX Position, Hedge Contracts to Help Banks Survive Pressure

Sector Outlook Loan Growth, Asset Quality, and Impairment losses

Analysts appraised that the impact of the COVID-19 and the control measures put in place were felt across all sectors of the economy, some more than others.

Explaining further, United Capital stated that this economic slowdown across various sectors does do not provide a favourable landscape for more loan disbursement.

Therefore, loan growth is expected to be muted as banks are conscious in their risk management.

On this, the Central Bank has failed to relax its loan to deposits rate target of 65% for lenders, despite unfavourable economic condition.

In the first half, the apex bank sterilised more than ₦2 trillion, a serial CRR debit for failure to meet LDR target.

The debited sum which came three times in the period were all preceded the CBN foreign exchange auction.

Analysts said the debits were informed to reduce banks’ ability to make demand in FX auction, thus protect the local currency from losing further value.

In its note, United Capital stated that in terms of asset quality, the firm expects NPLs to increase significantly due to substantial exposure to some the hardest hit sectors.

Especially, the firm mentioned oil & gas, manufacturing, and trade & general commerce.

Also, in the consumer lending space, the firm said it expects a significant level of defaults as unemployment levels rise and salary cuts have become the order of the day.

By implication, impairment losses are also anticipated to surge on the back of guidelines prescribed by IFRS 9, United Capital stated.

“The key import of IFRS 9 is the introduction of a forward-looking “expected loss” impairment standard that requires banks to provide more timely recognition of expected credit losses (ECL), based on future expectations, in place of the “incurred loss” model.

“As such, we expect banks to take higher impairment losses as a reflection of weaker macroeconomic realities in 2020 as we know it”, analysts stated.

United Capital explained that on interest income side, lower yield, challenging macro environment and default rate would impact results.

“In terms of revenue, we expect that the interest income component of banks’ revenue will be the most pressured”, it stated.

Analysts highlighted that banks have been forced to lower interest rates earlier in a bid to meet the LDR requirement.

Also, as part of the CBN’s expansionary measures to support the economy in the COVID-19 era, MPR was reduced by 100 bps to 12.5%.

Lenders have announced various types of relief programmes and made provisions for restructuring of loans that involve payment holidays.

“The summary of the factors highlighted above means that the interest income on loans is expected to reduce.

“Furthermore, the low interest rate environment and declining rates on fixed income securities (T-bills, OMO and bonds);

“…as well as the increase in the regulatory cash reserve ratio from 22.5% to 27.5% means that overall asset yield will reduce”, analysts stated.

That said, United Capital stated that the cost of funds is also expected to reduce across board due to a drastic reduction in the fixed deposit rates amid the low interest rate environment.

It estimated that this will support net interest margin significantly and moderate pressure on earnings yield.

As per non-interest income line, a mixed performance is expected:

On a brighter note, United Capital said the lockdown and other social distancing measures might have supported growth in volumes of online and mobile transactions.

However, the 30-70% multi-tiered cut on banking fees by the CBN towards the end of 2019 may counterbalance the growth in non-interest income in 2020.

Notably, the E-business income component which has been the fastest growing revenue component before now, might remain flat this time around.

This is as fees have been slashed, and some businesses like Airline, Sport betting, Restaurants, Hotels and Cinemas which generate high volumes have not been so active.

“However, we expect an increase in trading income given the level of market volatility that was experienced and is most likely to continue till the end of the year”, analysts said.

It is not all negative

Analysts at the firm explained that the capacity of the banks to weather the storm is peculiar for each of the banks.

The leading investment firm stated that overall, the firm thinks that 2020 will once again test the resilience of the Nigerian banking sector.

Analyst said banks that have the holding company structure such as Stanbic IBTC, FCMB and FBNH are better positioned due to the multiplicity of their revenue streams.

In the same vain, analysts said banks that have a net dollar long position such as Zenith Bank and Guaranty Trust bank are at an advantage.

This is on the back of the devaluation and possible further devaluation of the naira which would result to FX gains.

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In terms of asset quality, analysts stated that some banks have short term hedges for a large percentage of their oil and gas loans.

Thus, shielding lenders from huge blow of the oil price crashed witnessed in the first half of 2020.

Nigerian banks remain strong despite multiple woes against earnings capabilities of lenders, from less ducky regulation to rampaging virus in the streets.

Banks have been debited more than ₦2 trillion for failing to meet the Central Bank of Nigeria’s loan to deposit ratio target.

This is contrary to development by central bankers around the world that have been injecting funds to stimulate economic growth.

Net FX Position, Hedge Contracts to Help Banks Survive Pressure