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Nigerian banks – Navigating choppy & oily waters

Nigeria’s big banks see 13% dip in interest expense as customers’ deposits hit 4-year high

In early May, the Nigerian government relaxed a hitherto five-week lockdown of the two main cities of the country, Lagos and Abuja, with activity in most parts of the country similarly constrained. The justifiable stringency was in order to limit the spread of the coronavirus, which has killed hundreds of thousands around the world. A downside, however, has been the economy. Because even as banks were allowed to operate as essential service providers during the lockdown period, many opted to shut their doors entirely, limiting their services to online channels and the automated teller machines (ATMs) at their branches.

Evidence that these did not suffice for their customers’ needs emerged on the first week day of the eased measures. Queues were seen at bank branches with little regard for advised health safety guidelines of physical distancing and wearing of face masks. Other than the health concerns, the deluge was not particularly a matter for great concern. No, people were not rushing to get their money out of their bank accounts to hide somewhere else. And no, there is no Nigerian bank suffering any form of reduced confidence. However, the seeming normalcy masks the probable headaches of the various managements of the country’s almost two dozen banks.

Diminished livelihoods & low oil prices to weigh on banks

Amidst their laudable donations of billions of naira to the government’s pandemic-curbing efforts, Nigeria banks have also been coming to terms with the mounting losses in their loan books. As many of their borrowers were unable to conduct their businesses during the lockdown period, many failed on their obligations. And even as curbs are now being eased, many firms and individuals may remain inhibited for a little while. The pandemic is only one part of the problem for Nigerian banks.

A bearish turn in the international crude oil market is another. While primarily, the direct effects of these circumstances were mostly on the Nigerian government’s revenue, since crude oil is the source of almost all of its hard currency earnings, Nigerian banks, which altogether made about a quarter of their loans to firms in the oil and gas sector, have been similarly hit.

According to Moody’s, a rating agency, about 41 percent of bank loans are denominated in foreign currency and extended to customers which earn in naira, the local currency. Although about 25 percent of total deposits are in hard currency, this would hardly be a source of comfort. Economic and policy uncertainties owing to the aforementioned headwinds tend to instigate a flight to safety. There is usually not only a rush to store value in hard currency but also to move the deposits to venues where they cannot be easily appropriated by governments.

Banks are also complicit in this regard. Reports have emerged that some banks have been hedging their bets unscrupulously by playing outside of the official foreign exchange market, drawing the ire of central bank governor Godwin Emefiele, who warned them to cease and desist. But with a 15 percent devaluation of the naira to 360 units of the local currency to an American dollar in March, from 306 over the past two years hitherto, and a series of further weakening of the naira later in the year suggested by the futures and black markets, the governor’s warnings may fall on deaf ears.

Moody’s estimates about $12.5-$15 billion of government paper are held by foreigners. Against a backdrop of a little over twice that amount in FX reserves, with foreign portfolio investors looking to return their money home, there might be hard times ahead. Thus, it is not improbable that capital controls and restrictive foreign exchange measures might be implemented by the central bank. All these do not bode well for Nigeria’s deposit money banks.

The clouds are not entirely dark. Output cuts by OPEC+ oil producers have begun to push up prices. With demand recovering, as China and other economies ease lockdowns and economic activity pick up, there is a high probability that the momentum would be sustained. And almost counterintuitively, deposits of big banks are rising, up by about a quarter in late May, according to BusinessDay, a respected local newspaper.

Ideally, the current state of things should spur consolidation in the industry. But would that be the case this time around? Moody’s Mushangwe reckons this would depend on how long the pandemic and low oil prices last. The longer the crisis, the more banks would erode their capital buffers and liquidity, Mushangwe adds

But it is abundantly clear that there would almost certainly be recessions all around, as negative outputs for the second and third quarters in almost all of the world’s economies are all but certain. Estimates of the diminution in 2020 GDP for Nigeria range from 3-8 percent. But a good first quarter, with economic growth of about 2 percent, has calmed nerves a little bit, ahead of what are almost certainly two consecutive negative quarters thereafter.

While the extent of the damage on Nigerian banks from the current challenges are yet to be determined, the reckoning is that things have not totally gone awry just yet. Besides, some of their hard currency and oil bets are hedged, albeit still at levels that suggest they would likely take on some losses. Still, it would not be out of place to reckon that some banks would be casaulties of the current crisis. Bigger banks are rightly thought to be well-heeled to weather the storm, though. Smaller banks, not so much.

Negative medium-term outlook

Peter Mushangwe of Moody’s, which changed its outlook on the Nigerian banking sector to negative in late April, gives a good synopsis of the current state of things. “In Nigeria, banks will face weakening loan quality and foreign currency liquidity as low oil prices and the pandemic weigh on the economy. These new challenges add to existing headwinds from slow economic growth and rising regulatory costs. Banks’ exposure to the oil and gas industry is substantial, at around 27 percent of total loans at the end of 2019, making the system susceptible to the oil price slump.

The banking system is also highly dollarised, putting pressure on both assets and liabilities in the event of a naira devaluation. Nigeria’s largest banks, however, will continue to benefit from high government support.” Rating agencies Fitch and GCR, which also have negative outlooks on the Nigerian banking industry for much of the same reasons, agree by and large, with this overview.

So, what do these challenges portend for Nigerian banks over the short to medium-term? Yinka Olowofela, senior analyst at GCR Ratings in Lagos, expects non-performing loans (NPLs) to rise to at least 9 percent in 2020 from 6 percent last year, with expectations of further deterioration the longer the pandemic lasts. Moody’s Mushangwe already expects NPLs to more than double to over 12 percent, with profitability tanking in tow to lower than 1 percent of assets from 2.5 percent in 2019.

On his part, Mahin Dissanayake, senior director of banks for Africa and the Middle East at Fitch Ratings, expects asset quality to deteriorate over the next twelve months, owing largely to banks’ exposure to the oil and gas sector. Fitch’s Dissanayake also sees similar risks for sectors hit by social containment measures like manufacturing and trade. Understandably, he finds it difficult to predict how bad things could get or provide a forecast of impaired loan ratios for the year (see interview for more details).

Ideally, the current state of things should spur consolidation in the industry. But would that be the case this time around? Moody’s Mushangwe reckons this would depend on how long the pandemic and low oil prices last. The longer the crisis, the more banks would erode their capital buffers and liquidity, Mushangwe adds. Still, while GCR’s Olowofela would not rule out mergers and acquisitions in the industry on these challenges, his interactions with banks suggest most would be able to raise additional capital to shore up their capital bases. Besides, Fitch’s Dissanayake draws attention to how much fewer banks there are now than during the last systemic crisis. “Banks will only merge or be acquired these days only if they are facing significant problems”, Dissanayake adds, stressing “it would not be a commercial decision to merge or be acquired.”

An edited version was first published in the Q3-2020 issue of African Banker magazine