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Banks earnings to remain under pressure as profitability trajectory uncertain – EFG Hermes

Nigerian banks’ Earnings Per Share (EPS) for Full Year 2021 (FY2021) is expected to decline by 21.1% Year-on-Year (Y-O-Y) and the average Return On Equity (ROE) drop by 580bps Y-o-Y to 13.7% in a base case scenario of 55% probability, according to EFG Hermes, an Egyptian financial services company.

EPS is the portion of a company’s profit that is allocated to every individual share of the stock. ROE simply means measure of financial performance calculated by dividing net income by shareholders’ equity.

The firm gave four reasons for the expected decline. One was due to a 60bps Y-o-Y reduction in Net interest margin (NIM) to 3.8%. NIM is a measurement comparing the net interest income a bank generates from loans and mortgages, with the interest it pays holders of savings accounts and certificates of deposit (CDs).

The second reason was the banks’ risk charge to remain elevated at 1.6%. the third was NIR to fall 4.2% Y-o-Y due to non-recurrence of exceptional revenue and weaker trading revenue; and the fourth reason was a 0.8% Y-o-Y decline in total assets due to a partial reversal in system liquidity.

In a report titled “Nigerian Banks – Remain cautious despite higher earnings estimates”, EFG Hermes forecast banks’ ROE to recover to 19.4% by FY25e driven by NIM recovery, normalisation of risk charge, acceleration of asset growth, and improving operating efficiency.

“Given numerous uncertainties, we continue to model three distinct asset quality scenarios; in our bear case (25% profitability), we forecast the average ROE to drop to 10.5% in FY21e before recovering to 18.3% by FY25e. In our optimistic scenario (20% probability), we forecast the avg. ROE to drop to 15.6% in FY21e before recovering to 21.3% by FY25e,” the fir stated.

The report noted that Nigerian banks’ reported 9M20 EPS exceeded the firm’s previous base case for FY20 EPS by 21x. The outperformance was largely attributable to, much lower-than-expected loan loss provisions; and exceptional revenue from the banks’ trading portfolios and mark-to-market gains.

Regarding loan loss provisions, the firm noted that banks reported an average cost of risk of 1.5% for 9M20, which was materially lower than our FY20 forecast of 5.3%.

“We attribute the materially lower risk charge to the CBN’s lenient forbearance policy, which we think allowed banks to restructure a significant proportion of loans impacted by COVID-19 (43.02% of total sector loans were restructured as of September 2020) and not requiring them to make adequate provisions on these loans”.

Looking ahead, given other challenges and the CBN’s priorities, the firm thinks the regulator will continue to adopt a more lenient policy on recognition and provision of Non-Performing Loans (NPLs).

In addition to a favorable policy environment, it thinks the rebound in oil prices and economic activity should mitigate a full scale asset quality crisis, as it had anticipated in its last update. “Therefore, we reduce our average FY20e and FY21e cost of risk estimates to 1.6%, from 5.3% and 4.7% respectively,” EFG Hermes, said.

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