FEATURED ANALYSIS-Nigerian banks: Fantastic four

By Olamipo Ogunsanya

As at 9M16, FBN Holdings (FBNH), Zenith, GTBank, UBA and Access controlled c. 66% of total market assets, up from c. 55% in FY15.

THUR, MARCH 2 2017-We think the four Nigerian banks in our coverage universe that are best placed to pull through the challenges are Guaranty Trust Bank (GTBank), Access Bank, Zenith Bank and United Bank for Africa (UBA). We recently met with management teams for an update on the operating environment. We update our forecasts, pushing up our TPs across the sector, and maintain our OUTPERFORM ratings on all four banks.

NPLs yet to bottom out, capital at risk

We think sector NPLs are yet to bottom out, and we expect some deterioration in the sector over the next few months. We estimate that in the event of a further 50% devaluation in the naira, of the tier 1 banks only Access and Zenith would have CARs above the regulatory minimum. However, if we factor in revaluation gains from a devaluation, this should also provide GTBank and UBA with sufficient capital buffers. If we see a more marked devaluation in FY17, the CBN could explore the option of allowing the banks to use pre-devaluation FX rates in calculating prudential ratios – similar to what happened in Russia in 2014.

No safety net this time round

We think a second Asset Management Corporation of Nigeria (AMCON) scenario is unlikely because: 1) the country lacks the financial resources to fund such a programme; and 2) the banking sector is in a much stronger position today than seven years ago, despite current headwinds. When AMCON was set up, nine out of 24 banks failed to meet any of the CBN’s prudential requirements on liquidity, capital and corporate governance; currently, however, only a couple of banks are in breach of CBN guidelines. At the time AMCON was set up, sector NPLs peaked at 38%, vs 13.4% currently. There had previously been extended periods of poor credit writing practices, and a build-up of asset quality and margin lending crises in the sector. We think increased forbearance by regulators is a more realistic alternative to the introduction of AMCON 2.

Buy cheap, buy twice

We think given poor implementation of the June 2016 liberalisation framework, we are likely to see another devaluation. Our economist Yvonne Mhango thinks the most probable outcome of an FX policy adjustment is a managed float, with possibly a new peg. For the smaller banks, this implies further asset quality and capital stress. The smaller banks do not have sizeable net long FX positions, so we think another devaluation will be net negative for the tier 2 banks in our opinion. On our estimates, tier 2 banks in our coverage are trading on an average FY17E P/B multiple of 0.3x, but we think this is justified given the much lower RoE (FY17E average RoE of 8%) and the significant downside risks to performance.

Battle of the giants – stick to quality

The current operating environment presents an opportunity for the tier 1 banks to further consolidate the market, in our view. As at 9M16, FBN Holdings (FBNH), Zenith, GTBank, UBA and Access controlled c. 66% of total market assets, up from c. 55% in FY15. We think it is important to stick to quality in this environment, and have a relative preference for GTBank, Access, Zenith and UBA having assessed their performance on key metrics. Zenith (looking at the Nigerian operations only) has now passed FBNH’s First Bank of Nigeria as the biggest bank by total assets. For FBNH, we think fixing its capital issues is key to regaining market share.

Currency and macro

The key themes for the Nigerian banking sector continue to revolve around:

1. The currency;
2. Asset quality trends; and
3. Pressured capital levels.

The outlook, in our view, is mostly dependent on decisions made around the currency. On 20 February, the CBN put out a press release announcing some FX policy actions. We think these measures are a move in the right direction, but as we expected they fell short of a full liberalisation. The CBN plans to use the $5bn in FX reserves it has built up (via a deliberate policy of building up reserves since November) to increase liquidity in the interbank market and make FX available for retail transactions (including travel allowances and school and medical fees). This will affect c. 20% of FX transactions, according to our economist, Yvonne Mhango. The CBN has introduced FX flexibility with respect to retail transactions by allowing them to take place at an FX rate not exceeding 20% above the interbank FX rate. We take this to mean that retail transactions can be settled at any rate in the NGN315-380/$ range.

While we think this will provide much-needed short-term FX liquidity relief for the banks, it does not necessarily address all the current issues. FX policy remains interventionist, with the CBN still providing guidance on the FX rate. Furthermore, the CBN will remain the biggest supplier of liquidity on the interbank market. There was no mention of restoring an FX market where banks trade on a two-way quoting basis, whereby banks are free to buy from all FX sellers and sell to their customers at market rates for price discovery. There could also be some potential upside from commission income from the sale of FX to retail clients, as the banks are allowed by the CBN to charge a spread. However, we think the CBN is likely to sell to the banks at a rate closer to the 20% band, consequently limiting how much the banks can make on such transactions.

For the bigger banks, we think a full liberalisation of the currency is the best-case scenario, provided that the current backlog of dollar demand is cleared. From our meetings with the banks, demand backlog is estimated at $2-5bn. According to media reports, on the first day of sale to the banks (in line with the press release discussed above), the CBN offered $500mn (spot and forward) dollar sales to the banks, but total sales only amounted to $411.8mn. We think this suggests either of two things: 1) there is a level of artificial demand in the market, with customers overestimating the size of their FX demand; or 2) the banks failed to bid on behalf of their customers, because naira liquidity held on behalf of customers waiting to source FX has been lent on. We think it is more the former than the latter – given the difficulty in accessing FX, customers have been frontloading demand.

The recent increase in oil prices has been complemented by an increase in oil production, following steps to resolve the Niger Delta crisis. We think this makes the outlook for the economy somewhat better than a few months ago – a sentiment the banks we met with shared.

Valuation and rating

We think the operating environment for the banks remains challenging, and we continue to have a preference for quality. In this report, we focus on our top picks, and why we think they are better able than peers to weather the storm. We believe the Nigerian banks’ earnings will continue to come under pressure in the short term, but following our recent discussions with management teams we are relatively more confident in their ability to survive headwinds. We think the tier 1 banks have sufficient capital buffers in the event of naira devaluation, and asset quality trends – while they have deteriorated – have been much better than sector-wide trends. For the sector overall, we think the challenges are mainly around capital and asset quality. FX liquidity challenges should improve in the short term, and we think there is scope for the CBN to improve naira liquidity if the need arises – the effective cash reserve requirement (CRR) is currently 27.5%, and it could be reduced if the banks are challenged for naira liquidity.

On average, the share prices of the tier 1 banks are up by 3% YtD, vs +2% and -6% for the NSE Banking Index and the NSE All Share Index (ASI). We look at historical trends and observe that since the start of 2014 (prior to the decline in oil prices and FX issues), the share prices of FBNH, Zenith, GTBank, UBA and Access are down by 79%, 41%, 11%, 46% and 26%, respectively.

We expect decent FY16 numbers for the bigger banks, and think that could provide a trigger for an increase in share prices. However, in the absence of any clear reforms in the FX interbank market, we think this could be short-lived. The banks are trading on an average P/B of 0.6x for FY17E, for average FY17E RoE of 18%, on our estimates. This compares with the Kenyan banks trading at FY17E P/B of 0.9x for an average RoE of 22%, on our estimates.

We have updated our forecasts for the five tier 1 banks, largely maintaining our CoE assumptions. On the back of this, our TPs have increased by an average of 15%. We made the biggest TP changes for Zenith (+28% to NGN25.6) and Access (+24% to NGN11.3), on the back of better-than-expected earnings in 9M16. Our GTBank TP moves to NGN32.6 (from NGN29.0) and our UBA TP moves to NGN9.6 (from NGN9.4). We maintain our OUTPERFORM ratings on these four banks. Our TP for FBNH increases to NGN5.0 (from NGN4.6) and we maintain our MARKET PERFORM rating.

Ogunsanya is Analyst, Sub-Saharan Africa Banking and Financials, RenCap.