Nigeria’s Big Banks Withstand 40% Oil Exposure Stress Test
Godwin Emefiele, CBN Governor

Nigeria’s Big Banks Withstand 40% Oil Exposure Stress Test

Having subjected Nigerian banks oil and gas exposures to severe stress test, Fitch Ratings indicates that most large lenders are able to withstand even a 40% write-down of their oil exposures with a contained impact on capitalisation.

Under the same stress test, Fitch said in the report that smaller banks indicate a higher vulnerability given their limited loss absorption capacity.

According to the report, the Ratings said the oil sector has performed better than expected at the start of the crisis with borrowers benefiting from debt relief and the stabilisation of oil prices in 2Q20.

Expert believed that Exposures have also held up due to financial hedging and the widespread restructuring of loans following the 2015 crisis.

The oil sector is the single largest sectorial concentration, representing around 30% of total loans at end of first half of 2020.

It stated that many oil related loans have been classified as Stage 2 since the 2014/2015 oil price shock.

“Our concerns in 2020 are in the ‘upstream’ and ‘midstream’ segments (i.e. around 7% of gross loans) which have been affected by low oil prices and production cuts”, Fitch said.

Fitch quoted Nigerian lenders as saying that the majority of these projects are viable at an oil price of around USD50 a barrel.

The report reads that Oil-related loans have largely dictated banks’ creditworthiness in recent crises and remain a key risk to asset quality, profitability and, ultimately, capital.

A prolonged period of depressed oil prices and production cuts would inevitably cause distress in the sector and lead to further asset quality deterioration.

Our stress tests highlight the differing sensitivity to a deterioration in oil-related exposure between banks, Fitch explained.

The outcome of the moderate stress case of 20% write-down of their oil exposure shows a limited impact for all banks.

GTB, Stanbic IBTC Holdings (SIBTCH), Zenith and UBA were noted to have demonstrated a greater loss absorption capacity given their existing buffers, including healthy pre-impairment profitability and Fitch Core Capital (FCC) ratios.

Nigerian lenders asset quality has historically suffered when oil prices fall.

This time round, Fitch recognised that there are some important mitigating factors, believing that lessons have been learned.

It said since the 2015 crisis, banks have been prudent in underwriting oil-related loans, including stress testing exposures to very low oil price scenarios and by scaling back in foreign-currency (FC) lending to the sector.

Furthermore, the firm explained that most loans to the ‘upstream’ sector are backed by financial hedges that support cash flow generation when prices drop.

However, it is worth noting that most of these hedges will mature in the near term, which will expose banks to higher pricing (if available).

However, risks in the ‘downstream’ segment which the Ratings considers as a source of past problem loans, have decreased due to government-led reforms.

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With greater visibility of the economic shock on the banks, Fitch resolved the Rating Watch Negative (RWNs) on placed in March.

“Our view is that near-term risks have abated and that operating environment risks will feed through into banks’ credit fundamentals over a longer period than previously anticipated.

“Significant headwinds still exist, including the risk of a delayed asset quality impact on banks (especially when debt relief measures expire)”, Fitch stated in the report.

Nevertheless, on balance the Ratings believes banks are likely to benefit from a normalisation of business and revenue in 2021 compared to 2020.

Banks’ financial profiles did not weaken materially in the first half of 2020.

As expected, it was observed that lenders earnings came under pressure and credit losses started to rise.

However, Fitch recognised that banks asset quality risks have been limited and capitalisation has held firm.

“We expect these trends to continue into 2020 with a slight expected decline in the sector’s operating profit/average total assets ratio to 2.3% from 2.7% in 2019”, the report indicated.

GTB, Zenith, UBA, Fidelity, Sterling and FCMB are on stable outlook.

Fitch Ratings expressed that these banks have sufficient headroom at their current rating levels to absorb moderate shocks to our baseline scenario.

It said FBNH’s negative outlook reflects its continuing high level of problem loans (Stage 2 + Stage 3), low reserve coverage and weak capitalisation.

Meanwhile, Fitch hinted that the largest lender, Access’ negative outlook captures its weaker asset quality arising from the book acquired from Diamond Bank.

Also, Union’s high proportion of unreserved Stage 3 loans (19% of FCC at the end of first half 2020) drives the negative outlook.

Fitch has maintained the ‘Rating Watch Negative’ on Wema’s ratings to reflect its weak core capitalisation which is pressured by fast growth and by the impact of the economic downturn.

These challenges have started feeding through into deteriorating asset quality and profitability.

The bank plans a significant capital increase over the next 12-18 months, but the RWN also captures a degree of uncertainty in the plan given difficult market conditions.