THUR 30 DEC, 2021-theGBJournal- Although the investment case for the Nigerian banking sector has remained compelling over the years, this year posed more significant challenges for most sector players following the lingering impact of the pandemic on the business environment, weak macroeconomic fundamentals, and headwinds from the regulatory environment. Nonetheless, like with global economies, there has been an increased reliance on digital innovation to advance core banking operations.
Successful banking further requires agile banking platforms and maximising virtual working trends to improve cost and operational efficiencies. In addition, Nigerian banks with an existing digital presence increased the e-business platform usage, especially through their retail banking drive, which helped propel non-funded income and support gross earnings when funded income was largely pressured. These and other factors are changing the landscape, and we highlight the factors we expect will affect the sector over the short to medium-term. These include;
Central Bank Digital Currency (e-Naira) – For banks, e-Naira’s widespread adoption could moderate non-interest revenue from fees and commission income as a significant portion of the transaction conducted on the platform is free.
Although, this downside risk should be offset if adoption deepens to the extent that it improves overall banking awareness. We also foresee a more significant risk for the industry; the increasing volatility of liquidity positions resulting from bulk and undeterminable amounts moving in real-time.
Business model diversification – Considering the pressured growth prospects of traditional revenue sources, banks are finding new sustainable long-term growth. Recently, big players in the banking industry like GTCO have been granted approval in principal while Access Bank has communicated plans to transition into the HoldCo structure. This is to tap into new opportunities including asset management, pensions, insurance and payment solutions, among others. Although, we highlight that the actual impact would be seen in the medium to long term after operations are in full swing and further disclosures are made on how individual businesses will operate.
Basel III Implementation – According to the regulator’s directive, from November 2021, in addition to the existing tier-1 and 2 capital requirements, an additional conservation buffer (2.5% of total risk-weighted assets) must be held by Nigerian banks for utilisation during periods of business stress. Secondly, a countercyclical buffer ranging from 0.0 – 2.5% (based on the discretion of the CBN) will be set aside in periods of economic boom. Consequently, we look to see higher capital and debt (convertible contingent subordinated bonds) raised from 2022 to assist banks in meeting the incoming requirements which implies more stringent capital, leverage and liquidity thresholds but ultimately a boost in capital adequacy ratios across the sector.
Companies Income Tax (CITA) Exemption Order on Treasury Instruments –Currently, it remains uncertain whether or not the exemption order would be extended. In the event it is not extended, effective January 2022, funded income accruing to banks from investments in bonds and short-term government securities will be liable to a CIT and Tertiary Education Tax Levy of 30.0% and 2.0%, respectively.
Therefore, banks holding such instruments will decide whether to maintain their positions or dispose of them to minimise tax expenses and defend profitability margins. Considering the substantial tax implications, we believe banks would trade off their investment portfolios for more risk asset creation which returns better net interest margins.
For 2022FY, we believe impediments to asset quality could resurface if the CBN ends its regulatory forbearance programmes. Although, the further recovery expected in line with continued vaccine rollouts should moderate provisioning expenses in the period.
Also, system liquidity strains have persisted as the apex authority has maintained its tight liquidity management posture through the discretionary use of the cash reserve ratio tool. Furthermore, given the tepid loan creation environment, which is expected to persist in the near term, and the inability to achieve the stipulated 65.0% LDR target, banks are likely to continue experiencing high regulatory debits. This implies that a higher portion of total assets would be sterilised, thereby pressuring profitability margins for 2022FY.
Sector Valuation
We adopted a blended approach of absolute valuation (Dividend discount model and Gordon’s growth NAV) and relative valuations (justified P/B and P/E multiples) in valuing the sector’s companies, which led us to the following TPs for our coverage companies – ACCESS (BUY; TP: NGN13.80), GTCO (BUY; TP: NGN38.05), UBA (BUY; TP: NGN11.24), ZENITHBNK (BUY; TP: NGN34.46) and FBNH (SELL; TP: NGN9.08).
Overall, we remain ‘Overweight’ the Banking sector (Banking-10 index: +0.9% YTD), although it has underperformed relative to the broader market (NGX-ASI: +5.1% YTD as of 14th December)
In 2021, despite pressures across most business fronts, the earnings performance of the banking sector remained resilient as aggregate gross revenue expanded by 3.6% y/y growth to NGN3.85 trillion as of 9M-21. (References to sector performance refer to the 12 banks listed on the Nigerian Stock Exchange unless otherwise stated.)
The performance was driven by the 6.3% year-on-year growth (to NGN3.21 trillion) for Tier-1 banks that more than offset the decline in Tier-2 banks (-8.1% y/y to NGN639.57 billion).-Analysis courtesy Cordros Research
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