Analysis of one of the most bullish sector’s- The Banking Sector   


Tier I Banks remain the dominant force... 


24 April 2019 : Tier I banks under analyst's coverage continue to outperform their Tier II counterparts in terms of profitability as measured by ROAE (Tier 1: 19.6% vs Tier 2: 11.3%) with notable outliers being FBNH (Tier I - FY’18: 10.5%) and STANBIC (Tier II - FY’18: 34.5%). In FY’19, analysts expect average ROAE to improve to 23.0% for Tier I banks and 12.8% for Tier II’s, driven by operational efficiencies and improved asset quality. Analyst's outlook for FY’19 ROAA (2.6%) is however subdued for Tier I banks, dragged by the sudden increase in ACCESS’ balance sheet post-merger vs 1.9% for Tier II, supported by expected improvements in STANBIC and FIDELITY. 


Analysts have taken a look at key profitability metrics to ascertain the sources of disparity in the profitability of the two groups. Analysts observed that better cost management by Tier I banks, typified by average cost-to-income ratio of 55.8% vs 73.8% for Tier II banks. Analysts also note that Tier I banks recorded an average expense ratio (operating expense less interest expense over total assets) of 4.9% in FY’18, significantly lower than 6.7% for Tier II banks. It is noteworthy to mention that STANBIC’s FY’18 ROAE of 34.5% (FY’17 28.9%) is the highest in analyst's universe of coverage, surpassing GUARANTY’s FY’18 ROAE of 30.9%; this was however achieved by the company’s non-banking subsidiaries (contribution to FY’18 ROAE-Investment Banking: 50.2%, Asset Management: 49.8%, Commercial Banking: 0.9%). Analysts also discovered a similar trend in asset utilization, with Tier I banks posting ROAAs of 2.8% (3.2% ex FBNH) vs a Tier II average of 1.6% (1.1% ex STANBIC). 


In FY’19, analysts expect average ROAE to improve to 23.0% for Tier I banks and 12.8% for Tier II’s, driven by operational efficiencies and improved asset quality. Analyst's outlook for FY’19 ROAA (2.6%) is however subdued for Tier I banks, dragged by the sudden increase in ACCESS’ balance sheet post-merger vs 1.9% for Tier II, supported by expected improvements in STANBIC and FIDELITY. 


Non-interest income to drive earnings in 2019 


Growth in alternative financial technology solutions (FinTech) has prompted banks to deliver essential financial services through cost-effective digital avenues, with mobile applications becoming genuine alternatives to traditional banking operations. Analysts believe that Fees and Commission from banking transactions, especially digital banking, will account for a larger part of banks’ Revenues in FY’19, with relatively low implementation costs involved in delivering services on a larger scale. 


In FY’18, most banks across the industry recorded notable declines in Interest Income, due to lower y/y yields on fixed income securities and contractions in loan book. This consequently led to a decline in Net interest income during the fiscal year. In 2019, banks are likely to record stronger loan growth, while yields on assets are forecasted to fall, largely a reflection of the reduction in the Monetary Policy Rate (MPR) and declining fixed income yields. On the other hand, banks have reported substantial growth in transaction volumes from digital and mobile banking channels, with the total number of Unstructured Supplementary Service Data (USSD) transactions reaching 261.7 million in FY’18, a significant jump from 92.4 million in FY’17. Growth in alternative financial technology solutions (FinTech) has prompted banks to deliver essential financial services through cost-effective digital avenues, with mobile applications becoming genuine alternatives to traditional banking operations.


Modest loan growth with focus on improving asset quality 


Analyst's projection for average loan growth of 4% across analyst's coverage banks in FY’19 is due in part to an expected contraction in loan book following the ACCESS - DIAMONDBNK business combination, with the erstwhile Diamond bank expectated to have taken provisions on loan book of between N200 billion – N250 billion, in line with the new IFRS 9 regulations. Systemically, asset quality improved significantly in FY’18 with an average NPL ratio of 11.7% vs 14.8% as at FY’17. Analysts note that credit to the real sector contracted in FY’18, as banks’ loan-books shrunk 4% y/y. 


Analysts highlight that NPLs of N1.8 trillion as at Q4’18 is the lowest in the banking space post the economic recession of 2016 (when NPLs surged by 253% y/y to N2.2 trillion in Q3’16). Analysts observe that the implementation of IFRS 9 by the CBN in 2018 was the key contributing factor to NPL reduction during the year, as the regulator alongside the commercial banks moved from a reactive to a proactive strategy in mitigating potential loan losses. As such, the apex bank effectively moved from an Incurred Loss model to an Expected Credit Loss (ECL) accounting model, resulting in larger provisions for credit losses with implications for retained earnings and capital adequacy. 


Analysts note that the improvement in asset quality due to IFRS 9 adoption can have negative effects on risk assets, earnings and capital (particularly Tier I). Under the ECL model, any provisions on NPLs will reduce loan book in direct proportion with reductions in Interest Income and Retained Earnings, which in turn leads to a reduction in Net Asset growth. However, in Q4’18, the CBN introduced a four-year transitional arrangement to cushion the effect of the ECL implementation on banks’ core capital (equity). 


CAR requirements to push banks to raise capital 


Average banking sector CAR for FY’18 was 17.05%, supported by a Tier I Banks’ average of 20.6% vs 16.6% for Tier II. Analysts see scope for additional capital injections in FY’19 and FY’20 to help absorb effects from the implementation of IFRS 9. That said, the need to raise additional Tier I capital is becoming increasingly crucial given the limitations of Tier II capital in CBN’s ratio of total qualifying capital (max 25% for SIBs) and possible adverse impact on Tier I capital from ECLs. 


Banks in the Tier II space have sought capital (predominantly Tier II Capital) from the capital market to boost CAR ratios through the issuance of subordinated bonds and SPV structured bonds to meet ratings criteria for pricing and also qualify as regulatory capital. More recently, Access Bank sealed a subordinated syndicated loan agreement totaling $162.5 million (qualifying as Tier II) from Dutch Development Bank “FMO”. This follows a capital injection of $64 million by ETI into its wholly owned subsidiary “Ecobank Nigeria” in December 2018. Analysts see scope for additional capital injections in FY’19 and FY’20 to help absorb effects from the implementation of IFRS 9, with FCMB already signaling its intent to raise additional tier-II. That said, the need to raise additional Tier I capital is becoming increasingly crucial given the limitations of Tier II capital in CBN’s ratio of total qualifying capital (max 25% for SIBs) and possible adverse impact on Tier I capital from ECLs. 


Analysts believe the current macro picture and market sentiment (NSE ASI YTD loss -4.27% as at 18 April 2019) is responsible for the low turnout of equity capital raises within the sector compared with debt capital access. Alternatively, banks could approach the CBN to apply for National as opposed 


Mild optimism thanks to growth recovery 


The fragile macroeconomic environment, general risk aversion (to maintain asset quality) and still attractive government bonds yields all combine to explain analyst's modest outlook to loan growth y/y, as banks tend to ride on the macro picture. On a relative basis, Nigerian banks quoted on the Nigerian stock exchange have seen a gradual improvement in P/B multiples, coming from an average of 0.5x in FY’16 and 0.6x in FY’17 to 0.8x in FY’18. However, the sector is currently trading at a 57% discount to MSCI EM banks (1.9x).


Analyst's forecast for Gross Earnings growth across analyst's coverage banks in FY’19 is 12.3% on average, better than the 2.2% posted in 2018. Analysts expect non-interest income to grow faster (20% y/y) relative to interest income (10.8%). Analysts expect improved income from Fees & Commissions (digital banking) and derivative transactions (FX swaps) to drive analyst's non-interest income growth forecasts. 


Amongst analyst's coverage, only STANBIC (2.0x) and GUARANTY (1.8x) are trading above book value with respective premiums of 150% and 138% to the sector average. Analysts think that current valuations suggest that the market has priced in the tepid macro outlook to domestic growth and possible fears on foreign exchange rate stability. While analysts acknowledge the fears of weak growth, analysts do not harbor similar concerns for FX stability in FY’19 given analyst's current reserve buffers ($44.7 billion) and analyst's outlook for crude oil prices. That said, analysts believe investors have been less than impressed with FY’18 dividend payouts due to regulatory constraints. Recall - the CBN in January 2018 updated its policy on internal capital generation and dividend payout ratio for Nigerian banks. This policy places restrictions on banks eligibility to pay dividends depending on their CAR, CRR and NPL ratios. 



Sector/Policy reforms to unlock credit growth in 2019 


Analysts note that credit to the real sector contracted in FY’18, as banks’ loan-books shrunk 4% y/y. Loans to key sub-sectors like Oil & Gas, Information & Communication Technology (ICT) and Real Estate declined 5.9% y/y, 42.0% y/y and 21.0% y/y respectively in FY’18, with the ICT subsector recording the largest decline of N228.9 billion during the period. Analysts attribute this to the EMTS loan restructuring of N144 billion ($301 million) following the concluded sale of 9mobile to Teleology Nigeria Limited in November 2018 with the outstanding balance spread over a 9 year period inclusive of a 2-year moratarium. 


Meanwhile, loans to the Agriculture, Trade/General Commerce and Manufacturing sub-sectors grew by 15.5% y/y, 4.9% y/y and 2.6% y/y respectively. This, in analyst's view, is reflective of the Federal Government’s fiscal thrust to priority sectors listed in the Economic Recovery Growth Plan (ERGP). Analysts expect the Federal Government to intensify efforts to fully implement the initiatives in the ERGP, further boosting the performance of these sectors in FY’19. That said, additional reforms are required to unlock credit and investments in the Oil & Gas, Power & Energy and Real Estate subsectors. In analyst's view, these sectors are critical for broad economic growth and a review of the following issues can help in realizing their potential. 


The Power & Energy sector classified by the NBS as electricity, gas, steam & air conditioning supply contributed a paltry 0.7% to GDP in 2018, albeit with an impressive y/y growth rate of 30%. According to the Managing Director of the Transmission Company of Nigeria (TCN), the 11 Discos require N1.5 trillion in funding for new transformers and injection sub-stations to resolve the power deficit situation in the country. Analysts attribute the stifled investments in the sector to the non-implementation of the pricing template adopted in the Multi-year tariff order (MYTO) by the NERC. The current MYTO has, however, not been reviewed since June 2016 despite changes in pricing variables like Inflation rate, Foreign exchange rates, Cost of fuel (gas price) and Actual available generating capacity. 


As such, Distribution Companies (Discos) and Generating Companies (Gencos) have found it difficult to attract investments due to the current liquidity constraint biting the Power value chain, as poor tarrif collection has led to persistent liquidity constraints. That said, with the implementation of the Minimum wage bill imminent, analysts would expect the Executive arm of government to use the opportunity window to approve the NERC’s review of the tariff order to mirror current economic realities and thus attract significant investment to the sector. 

For FY’19, analysts believe there is an improved possibility that the Power sector will see some reform in H2 given the time interval since the last pricing review. 


In the same vein, an anticipated full deregulation of the petroleum downstream sector in FY’20, could see banks provide credit to oil marketers. This reform, combined with a partial or complete passage of the Petroleum Industry Bill will attract investments and credit to the sector. 

Additionally, reforms around land registry and formal ownership are critical in order to enable banks extend credit to firms in the Real Estate sector. Nigeria’s housing deficit, was last estimated at 17 million units by the World Bank (2016). 


If analysts assume that the World bank estimate still stands, and a minimum housing cost of N2.7 million/unit, then a total investment of N45.9 trillion will be required to fund this gap. In analyst's view, intervention funds established by the CBN to tackle housing and other deficits can barely scratch the surface in plugging this gap. Instead, analysts think the Government should take actions in de-risking the investment process for private developers by focusing on the provision of enabling infrastructure (road networks), increasing the supply of mortgages and signing into law the NHF Act of 2018 to spur private sector investment and credit to the sector. 


Reporting for EasyKobo on Wednesday , 24 April 2019 in Lagos, Nigeria


Source: Usoro Essien and Joshua Odebisi  from Vetiva Capital Management Limited


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