Explainer: How Moody’s rating of Nigeria affects economy, banks

Barely four days after Nigeria’s worst-ever Moody’s rating came another downgrade, but this time of nine banks in Africa’s largest economy. On Tuesday January 31, Moody’s Investors Service (Moody’s) downgraded to Caa1 from B3 the long-term deposit ratings, issuer ratings as well as the senior unsecured debt ratings (where applicable), of all the Moody’s rated banks in Nigeria. The affected banks are: Access Bank, Zenith Bank, First Bank of Nigeria Limited, United Bank for Africa, Guaranty Trust Bank Limited, Union Bank of Nigeria, Fidelity Bank, FCMB (First City Monument Bank) Limited and Sterling Bank.

At the same time, Moody’s changed the outlook to stable on the long-term deposit ratings, issuer ratings as well as senior unsecured debt ratings (where applicable) of the nine rated Nigerian banks. The rating actions follow Moody’s downgrade on January 27 of the long-term issuer rating of the Government of Nigeria to Caa1 from B3, and change in the outlook to stable.

Moody’s ratings downgrade of the banks’ long-term deposit ratings to Caa1 from B3 was due to: a deterioration in the sovereign’s credit profile, a significant weakening in the operating environment in Nigeria, and a material deterioration in the banks’ solvency and liquidity.

Here are the nine banks and what led to their downgrades

Moody’s said its downgrade of the long-term ratings of nine Nigerian banks reflects a combination of (a) the weakening operating environment, as captured by Moody’s lowering of its Macro Profile for Nigeria to “very weak” from “very weak+”; and (b) the interlinkages between the sovereign’s weakened creditworthiness (as indicated by the downgrade of the sovereign rating to Caa1 from B3) and the banks’ balance sheets, given the banks’ significant holdings of sovereign debt securities.

“The revised Macro Profile for Nigeria reflects Moody’s expectation that depressed and uncertain oil production, capital outflows amid flight to quality and the government’s constrained access to external funding will likely continue to weigh on Nigeria’s external position in 2023. The revised Macro Profile also captures the risks that foreign currency shortages in the country pose to the liquidity, capitalisation and asset quality of Nigerian banks,” Moody’s said.

Banks have significant direct and indirect exposure to Nigerian sovereign

The rating agency said rated Nigerian banks have significant direct and indirect exposure to the Nigerian sovereign, with a significant portion of their assets located in the country, and sovereign debt holdings representing 28percent of their aggregate total assets as of June 2022. “Government exposure links the banks’ credit profiles with the sovereign’s, whose rating was downgraded on January 27, 2023, to reflect Moody’s expectation that the government’s fiscal and debt position will continue to deteriorate. The government faces wide-ranging fiscal pressure while the capacity to respond remains constrained by Nigeria’s long-standing institutional weaknesses and social challenges,” Moody’s added.

It went further saying that, “The stable outlooks on the long-term deposit, issuer and senior unsecured debt ratings (where applicable) of the Nigerian banks are in line with the stable outlook of Nigeria’s government rating. The stable outlook on the sovereign rating reflects the fact that, while a new administration could reinvigorate the reform impetus in Nigeria after the general elections planned for February 25, 2023 and thereby support fiscal consolidation, implementation will likely remain lengthy amid marked social and institutional constraints.”

“Indeed, the government has long-held the aim of raising non-oil revenue and phasing out the costly oil subsidy, but these objectives necessitate reforms that are institutionally, socially and politically challenging to carry through. Meanwhile, funding conditions are likely to remain tight,” Moody’s stated.

The downgrade … the implication

Aside weakening in the government’s fiscal capacity to support banks in case of need, there is also the interlinkages between the sovereign’s weakened creditworthiness and the banks’ balance sheets, given the banks’ significant holdings of sovereign debt securities. Though, this does not pose an immediate risk to the banks’ issued debt, but the potential for any further foreign debt raises in 2023 are close to non-existent.

Is Moody’s painting Nigerian banks with single brush?

“This was going to come, following the downgrade of the Nigerian Sovereign, which is considered the anchor for the credit ratings of all corporate institutions operating in the country. The exemption to this mass downgrade of Nigerian banks and broader corporate rating would be corporates with head offices outside of Nigeria and only subsidiary operations in the country, as such entities are seen to have the inherent support of their parent entities in the event of a credit default event,” said Abiola Rasaq, former economist and head investor relations at United Bank for Africa Plc.

Speaking further on the ratings, the former economist and head investor relations at United Bank for Africa Plc said, “This rating downgrade, in my view, is not representative of the strength of Nigerian banks and definitely calls to questions the veracity of the anchoring effect of Sovereign ratings on domestic corporates, especially for diversified financial institutions that have not only proven to be independently sustainable but also demonstrate capacity to independently mobilise and effectively manage their foreign currency exposures”.

“Whilst it may be presumed logical to initiate these mass downgrade of Nigerian banks, such approach is unduly blind to the notable diversification of Nigerian banks, with Groups like UBA having about a third of its assets offshore, and generating about half of revenues and liquidity outside of the Nigerian jurisdiction, including in markets such as the United States and United Kingdom.

“Thus, painting Nigerian banks with this single brush may be unduly punitive to corporate entities and unfortunately undermines their foreign currency operations, liquidity and as well as pricing of FX liabilities. It sends a wrong signal on the strength of these banking groups, many of which are independently strong and deserving of better credit ratings,” Rasaq said.

“Indeed, comparatively to banks in peer markets, where Sovereigns have better credit rating, Nigerian banking groups, especially the top-5 lenders, are indeed unfairly punished. Over the years, the top-5 lenders in Nigeria have proven the sustainability of their models and defied sectoral and economic crisis, including some which have rocked the system,” he added.

Are banks are weathering the market storm?

In their 2023 outlook, analysts at Lagos-based Vetiva noted that the biggest risk to banks non-performing loans (NPLs) this year is the precarious situation of the local currency. They said in the 2023 outlook titled “A walk in the dark” that, “Overall, our outlook for the banking sector in 2023 is fairly positive, with significant upsides for core banking and minimal downsides for NPLs and impairments,”

In their noted titled “Nigerian Banks: Weathering the market storm”, Vetiva said should a material (greater than 20percent) devaluation in the official rate come at any point in 2023, the banks, whose loan book is split 60-40 at in favour of local currency (LCY) against foreign currency (FCY), could see a severe deterioration in asset quality.

“However, it is also important to note that the Basel-III framework, which began running at the end of 2021 parallel to Basel-II, is more or less in full use by the banks. This means that, although there has been a slight decline in capital adequacy, the banks have taken on increased capital, through increased retained earnings in some cases and unsubordinated loans in others. Therefore, we are confident that, in a scenario where the banks see their asset quality sharply deteriorate due to a currency shock, the effect on capital adequacy will likely be minimal (a 1 to 2 percentage-point change),” Vetiva said.