Regulatory Risks Cloud Outlook of Nigerian Banks – Meristem
Following the decision of the Monetary Policy Committee (MPC) to hold key macroeconomic parameters, including the cash reserve ratio, analysts have remarked that regulatory risks continue to cloud the outlook of the Nigerian banking sector in 2020.
Meristem Securities analysts remarked that the burden of high cash reserve ratio on banks remains, with estimated effective CRR at 50%.
The firm explained in a note stated that burden of high CRR is compounded by COVID-19 pandemic which is expected to bear on gross earnings, loan loss provisioning and asset quality.
According to Meristem, the decision of the CBN to permit loan forbearance in the banking sector, is expected to result in the restructuring of up to a third of industry loans.
“While this will help mitigate asset quality deterioration, revenue and profits in the short-to-medium term will expectedly bear the brunt”, Meristem explained.
Meristem Securities expects the Committee’s decision to hold MPR at 12.50% to further support the general downtrend in industry cost of funds.
However, the firm maintains that the impact on lending rates and loan book expansion will be minimal given the relative insensitivity of lending rates to the MPR.
“We also maintain our earlier concern about the restrictive impact of a 27.50% CRR , effective CRR estimated to be as high as 50%, on banks’ capacity to create assets or fund other revenue generating activities”, analysts stated.
Meristem explained that this is expected to drive funding costs upward particularly for banks with relatively fewer funding options.
“We maintain our expectations for tight margins in 2020”, analysts at Meristem Securities stated.
Although the Committee noted the improvement in asset quality from 9.40% in June 2019 to 6.40% on the back of recoveries, write-offs and disposals, analysts said they expect asset quality and capital adequacy to remain pressured in 2020 given COVID-19- induced threats.
FG Approves Establishment of Infrastructure Development Company:
As concerns mount regarding a possible recession in 2020, the CBN has increased its focus on promoting growth in the real economy.
Manufacturing purchasing manager index (PMI) readings for June 2020 fell to 41.1 index points, from 42.4 points in May.
Commenting, analysts said this is indicative of further weakness in the manufacturing sector as the effects of the pandemic continues to bite.
However, non-manufacturing PMI rose to 35.7 index points in June 2020 from 25.3 index points in May 2020, indicating a gradual expansion the non-manufacturing sector of the economy.
“These figures point to the slow and sticky progress of the economy”, analysts explained.
However, in addition to its various stimulus packages, the CBN commended the government on recent approval of the establishment an infrastructure development company (IDC).
By design, IDC would be led by the CBN but in partnership with the African Finance Corporation and the Nigerian Sovereign Investment Authority.
The company would serve as special purpose vehicle (SPV) to finance the development of critical infrastructure across the country.
Analysts however said the MPR cut at the last meeting has not been fully transmitted into the real economy and would require additional time for the effects to be evident.
“Though, we expect the impact to be minimal”, analysts reckoned.
Meristem said establishment of the infrastructure development company and an effective administration of the company will go a long way towards addressing the infrastructure deficit in the country.
Yields Remain Pressured:
As regards activities in the fixed income market, analysts stated that buying pressure has permeated the segment since the last rate cut, sending yields to record lows.
The weak investor sentiment in the equities market, as well as the dearth of other alternative investment has aided the bullish momentum in the fixed income.
Since the last MPC, average T-bills and Bond yields have declined to 2.24% and 7.79% as against 2.64% and 10.28% as at 28th of May 2020 respectively over the period.
Likewise, at the primary market auctions, NTB rates have dropped further to 1.30%-3.35% band.
“Following the Committee’s decision to hold rates, we expect investor participation to remain unchanged in the fixed income market”, analysts said.
In addition, the impending inflows from OMO maturities is expected to increase liquidity levels, thus, spurring demand and dragging yields further.
Sell-offs Persist in a build up to Earnings Season
The domestic equities market has witnessed an extended period of bearish run since the last MPC meeting, dropped by 3.77%, as investors book profit on counters that have seen some price appreciation, while approaching the earnings season carefully.
Year to date, all sectoral indices stand firmly in the negative zone, with the consumer goods index recording the most loss of 31.60%.
Meristem’s analysts anticipate a continued wave of bearish sentiment as the impact of the COVID-19 pandemic duly reflects in companies first half 2020 earnings amid the subdued participation of foreign investors.
While improvements in the commodities market bode well for emerging economies, selloffs have been prevalent across equities markets in the region.
This is evidenced in the negative year to date return posted by frontier (-22.10%) and emerging market (- 5.30%) indices.
Although the bourgeoning macroeconomic concerns are similar in most emerging economies, from a valuation perspective, the Nigerian equities market stands out, currently trading at an attractive discount of 8.10x compared to its peers.
Going forward, analysts said they expect the CBN’s decision to hold all parameters constant to have negligible effect on the direction of the equities market.
To a large extent, the exchange rate unification effort of the CBN is likely to abate a mass exodus of offshore investors, when interventions resume at the Investors and Exporters FX window.
“However, we anticipate share price movements to be reflective of earnings performance in the first half of 2020 as investors err on the side of caution”, analysts explained.
Regulatory Risks Cloud Outlook of Nigerian Banks – Meristem