27 June 2018 ( Lagos )

Slow start to the year, 2018 outlook mixed across coverage 

Although earnings came in largely in line with estimates across most of their coverage names in Q1’18, performance from tier II banks remained largely weak – save for a few names. Pressured by weaker yield on assets as well as contained credit growth, analysts have seen Interest Income come in relatively flat – a trend they expect to persist for the rest of the year. Their expectation for the Non-Interest Income is however more positive. 

Analysts expect stronger transaction velocity amidst improving business environment to support Non-Interest Income despite moderating derivative income. Consequently, they anticipate a flat Gross Earnings growth on average across analyst’s coverage banks for FY’18 – with growth capped by a notably moderation from ZENITHBANK and FBNH (following high base from prior year) and flat performances from DIAMONDBNK and FCMB. 

Also, with funding cost moderating since the start of the year and expected to remain much lower than the levels seen in FY’17, analysts expect interest expense to come in softer in FY’18 and forecast a modest 5% y/y rise. Furthermore, their Operating Expense expectation across most of their coverage is positive. 

Analysts also highlight that the expense line has remained largely contained recently with growth averaging single digit across their coverage in the last few years. Hence, estimate an average 2% rise across their coverage names with STANBIC and ACCESS expected to post the top two y/y growth of 14% and 13% respectively. 

With the implementation of IFRS 9 - a more forward looking provisioning measurement, analysts believe loan loss provision will come in more volatile and subjective going forward. However, given their positive macro outlook and stable FX and oil price expectation, analysts estimate relatively more contained loan loss provision for FY’18 – translating to an average cost of risk of 2.4% for FY’18 (FY’17: 4.2%). 

Furthermore, whilst analysts expect PAT growth across the top tier banks to be mild given the high base from FY’17, they also expect earnings growth from the lower tier banks to be more pronounced given the weak performance in recent years. Overall, analysts forecast an average 18% y/y PAT growth, with the bottom line translating to an average 21% profit margin across their coverage banks for FY’18. 

Yield curve shift to constrain YoA, NIM to moderate marginally 

Amidst the heightened risk environment, banks have maintained an increased risk aversion – overweighting high-yield, risk-free, tax-free government securities and cutting back on credit growth. Whilst this generated strong investment income for banks during the golden yield era of 2016/2017, the trend appears to have reversed with yield on government securities moderating over 139bps across the curve, even with more obvious moderation in the T-bills space over the last 6-months. 

With yields on government securities expected to be sticky for the rest of the year and investment in treasury securities accounting for over 25% of interest bearing assets across analyst’s coverage names, they anticipate y/y moderation in Yield on Assets across their coverage banks. They however highlight that yield on other interest-bearing assets have remained relatively sticky despite the sharp drop in government yield. 

Having said that, given the analyst’s expectation of an uptick in inflation rate in the later part of the year as election spending intensifies, their expectation of monetary easing has been placed on hold until after 2019 general elections, providing some succor to yield on assets. 

However, analyst estimate an average 100bps moderation in YoA across their coverage banks. With cost of funds also trending lower from the start of the year, analysts estimate an average 75bps moderation in margin across their coverage.

IFRS 9 kicks off, coverage banks take a cumulative ?446 billion equity hit 

The impact of the implementation of IFRS 9 has been largely mixed across analyst’s coverage banks. With a few banks taking significantly higher than expected charges against their shareholders’ fund, the impact on some other banks has been much lower than analysts had anticipated. 

Given that the implementation has led to a one-time charge on equity without passing through the income statement, the effect on banks has gone largely unnoticed. However, analysts note that the common factor across the sector has been an erosion of shareholders’ value at varied magnitude – leading to weaker capital adequacy ratio. 

Particularly, post the IFRS 9 implementation at the beginning of Q1’18, their coverage banks recorded a total of ?446 billion write off against equity with ZENITHBANK and GUARANTY taking the highest hits. Consequently, Capital Adequacy Ratio (CAR) moderated 90bps on average within their coverage names to take average CAR to 19% - still a healthy headroom from the regulatory benchmark of 15%. 

Whilst analysts see this as a loss of shareholders’ value, they expect to see reduced provisioning in the near term – particularly for the banks that recorded huge write offs following the implementation. Overall, they estimate a cost of risk of 2.4% for FY’18 vs. the average 4.2% recorded in FY’17. 

Implementation of IFRS 9 to mask real loan growth 

On the back of improving operating and risk environment as well as the expected moderation in yield of government securities, analysts had expected banks to be more deliberate about risk asset creation and anticipated a modest 8% loan growth across their coverage banks in 2018.

Trend observed in Q1’18 suggests that credit growth has strengthened within the year with loan origination observed across some key sectors including manufacturing, general commerce, agriculture, and oil & gas. 

The impact has however been less obvious on loan book across the sector (down by an average 6% in Q1’18) as banks had to write off a significant portion of their credit portfolio following the one-time equity charge post the IFRS 9 implementation. 

Whilst analysts expect the improving macroeconomic environment to further support growth in risk assets, they expect the earlier write-offs in Q1’18 to offset some of the real growth expected for the year and estimate a flat loan growth on average across their banking coverage for FY’18. 

NPL spikes as IFRS 9 kicks in 

Despite improving operating environment within the last one year evidenced by strong oil prices, improving crude production volumes, as well as stable exchange rate, asset quality within the banking space has remained weak with NPL ratios deteriorating across analyst’s coverage names.

Particularly, following the implementation of IFRS 9 analysts have seen NPL ratio spike from an average of 70bps across analyst’s banking coverage in FY’17 to 10.6% at the end of Q1’18. More surprising is the sharp rise in NPL ratio across the perceived less risky tier I names. 

Although they expect asset quality pressure to linger for a while as the restructuring of some of the large non-performing credit obligors get prolonged, they believe the improving macroeconomic variables will continue to support recoveries across the banking space in the medium term and estimate an average 120bps moderation in NPL ratio across analyst’s coverage between Q1’18 and FY’18. 

Closure approaching, 9Mobile loan could provide some relief 

In 2013, 9Mobile (formerly Etisalat) obtained a 7-year $1.2 billion loan facility from a consortium of Nigerian banks for the purpose of financing a major rehabilitation of its network infrastructure as well as refinancing an existing $650 million loan. Post the 2014 currency crisis and the resulting currency devaluation that bedeviled the Nigerian economy in 2016, the telecom company struggled to meet up with its debt repayment plan. 

As the debt crisis deepened and following a series of failed negotiation attempts, Etisalat Nigeria’s largest shareholder, Mudabala Development Company pulled out of the company. Consequently, the consortium of lenders took control of the shares of Etisalat Nigeria and opted for a sale to new equity partners. 

Analysts note that the banks have had to take a hit of varying degrees with the average bank within their coverage already making 30% provision on the obligor. Teleology emerged as the preferred bidder for 9Mobile and has paid a non-refundable deposit of $50 million as required in the bidding process.

 The company is believed to have executed a loan purchase agreement and has assumed the debt of 9Mobile. Analysts understand that a debt restructuring is currently ongoing which might involve a haircut from the initial $1.2 billion loan amount. They expect the sale of the telecoms company to close shortly and the restructuring of the debt to gain momentum in the second half of the year. 

With analyst’s coverage banks already taking significant provision on the obligor, they do not expect to see significantly higher provisioning on this debt going forward. Consequently, they expect the loan performance to lead to improved asset quality across the sector in the near term. 

Tier 1 to top on dividend payout 

Banking stocks have historically outperformed the Nigerian market in dividend payout with analyst’s coverage banks distributing an average of 30% of earnings over the last 3-years - translating to an average dividend yield of 6%. 

Although analysts expect the recent spike in NPL ratio to constrain dividend payment across a number of banks – particularly the lower tier names, they believe payout from the top tier banks will remain strong. Across their coverage, they estimate a 42% payout ratio for the tier I (save for FBNH – 15% payout from other non-banking subsidiaries). 

Whilst analysts do not expect DIAMONDBNK to pay dividend in FY’18 given that the bank’s NPL ratio breaches the regulatory dividend paying benchmark of 10%, they estimate 25% and 40% dividend payouts from STANBIC and FCMB respectively. They expect these to be supported by earnings from non-banking subsidiaries. 

Fundamentals is a warrior – it might lose the battle but never the war 

The message across the banking sector remains the same – stocks have been over flogged and banking names appear cheap, hence, correction is imminent. With an average P/E ratio of 10.83x vs. the average P/E across frontier & emerging markets of 12.50x, the entire market appears undervalued when compared to other emerging and frontier markets. 

The banking sector appears even much more underpriced. The sector trades at a P/B ratio of 0.97x – a ratio largely skewed by the bigger banks – with average tier II names trading at weaker average multiples of 5.54x and 0.90x for P/E and P/B respectively. Analysts believe that the sector is being punished for its weak asset quality post the oil price crash of 2014 and the consequent currency crisis. 

Analysts came into 2018 with an expectation of recovery from the banking names. Whilst earlier signs had shown modest recovery across most banks, prices have slipped lower following political jitters ahead of the impending elections. However, analysts note that their fundamental valuation suggests that the banks have been over beaten, trading at an average 53% upside across their coverage names. 

Analysts believe that whilst market valuations might deviate from fundamentals in the short run, convergence will happen in the medium to long term. Hence, they maintain their BUY recommendation on most of their coverage names. 

Go long on lower tier names if you have the guts 

It is not surprising that the challenging operating and macroeconomic environment have come in much harder on the lower tier names. Their weaker asset quality, higher funding cost, lower margins, less liquidity and even relatively weaker capital adequacy have made them less appealing to investors. 

Consequently, amidst the heightened risk environment, there has been a switch to less risky banking names with more diversified earnings and stronger capital buffer. Whilst analysts expect earnings to remain pressured across the lower tier names and believe that the high NPL ratio across these banks will continue to impede their ability to pay dividend, they highlight that valuation of the lower tier banks remains weak. 

Although, as earlier highlighted,analysts believe the banking sector is largely undervalued, they believe that the tier II space has more potential upside. Analysts recall that the market rally earlier in the year saw prices across these names double in weeks – indicating a strong positive sensitivity to the broader market. 

Although they expect the anxiety surrounding the forthcoming elections to keep market sentiment cautious in the near term, analysts are much more optimistic post elections even as the broader macroeconomic environment gets brighter. 

Whilst analysts note the above average risk of the lower tier names, they maintain their medium to long term BUY recommendation on the stocks. 

Source: Analysts at Vetiva Capital Management

Reporting for EasyKobo on Wednesday, 27 June 2018, in Lagos, Nigeria.