Rising Credit Losses Threaten Nigerian Banks' Profitability
Godwin Emefiele -CBN Governor

Rising Credit Losses Threaten Nigerian Banks’ Profitability

Rising credit losses threaten Nigerian deposit money banks earnings and profits performance in 2021 following the expiration of the apex bank forbearance on loans restructuring, analysts said.

This is coming following the outbreak of coronavirus and other internal disruptions that happened just last year, as analysts think recovery has been slow.

Amidst low interest rate environment, regulatory pressures on margin, some ratings agencies – Fitch, Agusto and Co- have maintained that credit losses record will dictate Nigerian banks profitability in 2021.

Following a flurry of reports on the banking sector, consensus review indicates that lenders are more likely to underperform last year earnings profile due to rising risk of credit default.

It is noted that banks earnings profile is changing so fast that lenders are making quick adjustment by way of diversifying their revenue sources.

Low interest rate has translated to reduced interest income from interest yielding assets, thus driving strong push toward building stronger non-interest revenue sources.

But, their separate financial statements show that lenders are very much in good position with funding rate coming down as yield on fixed income market plunged.

Interest payments to providers of funds have declined strongly in recent time, thanks to the apex bank dovish stance.

Analysts at WSTC Financial Limited said in a report that they expect the net interest margin pressure to persist into 2021 should CBN sustain the low-interest-rate environment.

WSTC however added that industry margins may improve relatively due to the Securitisation of cash reserve ratio (CRR) debits.

“Banks are now to enjoy some returns on the debits”, analysts at WSTC stated.

Also, the firm expects the normalisation of non-interest income in 2021 as analysts believe that the yield curve bottomed-out in 2020.

In their separate financial statements, non-interest income has become major driver of lenders’ profit performances.

Some analysts have projected that earnings from non-banking related activities would drive banking sector performance as adoption of online and other banking channels become more acceptable.

Increasing acceptance of alternative channels which was driven by the outbreak of coronavirus pandemic has been a plus on Tier-1 Banks books.

Suffice to say that COVID-19 has impacted negative credit assets books, despite the apex bank forbearance for loan restructure, impairment charge still surged in 2020. 

“We expect impairment credit losses to surge in 2021 as the pandemic’s full impact on businesses becomes more evident”, WSTC said in its report.

“Banks were able to postpone the doom day via loan restructuring in 2020. We expect the effect to become visible in 2021”, it added.

The firm expressed that banks may struggle to maintain their 2020 earnings profile due to rising cost profile amid a dwindling revenue base.

“We believe performance in 2021 will be anchored around cheaper funding, low-cost structure, a well-diversified loan book and competitive pricing for risk asset”, WSTC said.

It was observed that tight net interest margin resulting from CBN loan-to-deposit (LDR) directive and accommodative monetary policy – which ushered a low-interest-rate environment.

In their observations, Analysts stated that LDR policy triggered an intense lending competition among banks at competitive pricing.

In 2020, lenders recorded significant boost in non-interest revenue on the back of robust trading gains, and foreign exchange (FX) revaluation surpluses despite the regulatory reduction in banking fees in 2019.

However, WSTC Financial stated that lenders however booked benign impairment losses on loans despite COVID-19 disruptions.

“CBN forbearance on loan restructuring kept the industry’s non-performing loans at a reasonable level”.

Consensus remains that banking sector impairment charges on credit losses will rise as the apex bank forbearance ends.

In related development, Fitch Ratings said a report that Nigerian Banks balance sheets are highly dollarised and exposed to Nigeria’s persistent foreign exchange (FX) issues.

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

On February 12, 2021 Naira depreciated to N404 to United States dollar at the investors and exporters window.

Pressure on Naira has persisted as Fitch noted that 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”.

Experts explained that this also leads to rising inflation, adding to pressure on customers.

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

At the same time, it added that devaluation inflates banks’ FC risk weighted assets (RWAs) and places pressure on capitalisation.

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

“Banks will continue to see tight FC liquidity in 2021 due to low inflows of US dollars into Nigeria and from the CBN’s measures to preserve FX reserves”, the Ratings added.

It also said lenders’ limited ability to source FC liquidity constrains their ability to meet obligations.

Explaining further, the report stated that borrowers face the same challenges, which heightens asset quality risks for banks, especially with unhedged borrowers.

In 2020, Nigerian banks have been able to meet their FC obligations through internal resources but a more severe tightening in liquidity would be negative for ratings.

The Ratings agency explained that 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”, Fitch noted.

Fitch noted specifically that 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.

It estimates 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.

The Ratings said on the funding side, banks benefit from sizeable, stable and low cost local currency customer deposits.

There is a low reliance on FC wholesale funding, apart from Stanbic IBTC Holdings as Fitch said most of FC funding is sourced from customer deposits.

In 2020 review, banking sector LDRs came low, averaging 60% for the Fitch-rated banks.

It however added that banks customer deposits could grow in double digits annually given the underbanked population and inflows of FC deposits from export-oriented industries.

The report noted that since 2015, Nigerian banks had rebalanced their loan books towards local currency and FC LDRs have declined.

Interpreting this, the Ratings said this has reduced Nigerian banks vulnerabilities to FC refinancing risk and is credit positive.

“There have been no material FC customer deposits outflows from banks since March.

“We expect outflows to remain limited, especially with the CBN’s capital controls”, it added.

Positively, banks are less reliant on FC government deposits than in 2015-2016 when banks had to transfer these deposits to a Treasury Single Account, which had caused some FC liquidity stress in the system.

“We expect FC deposits to remain an important component of banks’ funding profiles despite the CBN’s new rules announced in December that require exporters to sell excess FC (held in banks accounts) in the I&E window”.

Additionally, experts noted that the new rules included a requirement for remittances into Nigeria to be made through the banking system.

“Given the significant size of these volumes, banks will benefit from FC liquidity, although they will likely be short-term in nature.

“At the same time, we believe some customers will prefer to hold FC deposits due to high inflation – eroding real returns in LC – and potentially benefit from a further devaluation of the naira”, the report added.

In the recent time, it was noted that lenders have become less reliant on USD borrowing, given still healthy USD customer deposit levels and the lower appetite for USD lending.

This was demonstrated by the early redemption of USD1.8 billion Eurobonds in 2018-2019 amid weak demand and appetite for FC lending.

Total outstanding Eurobonds amounted to USD1.3 billion at end-October 2020 (excluding USD393 million of Zenith’s 2022 USD500 million Eurobond repurchased by the bank), with USD1 billion maturing in 2022.

Profitability in 2021 will be dictated by credit losses, Fitch said.

“The credit loss ratio for the banks under our coverage rose by 50bp to 110bp in 1H20 but remained well below the 380bp peak in 2016 – following the 2015 crisis.

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“The lower credit loss ratio reflects regulatory forbearance on COVID-19-relate d restructured loans and associated provisioning policy being less than proactive.

“With the expiry of relief measures in 2021 and considering persistently weak macroeconomic conditions, we expect the sector average credit loss ratio to lean towards the levels seen in 2016- 2017, at around 250bp”, Fitch explained.

Rising Credit Losses Threaten Nigerian Banks’ Profitability