Moody’s Investors Service, a leading provider of credit ratings, research and risk analysis, on Monday changed its outlook for Nigeria’s banking system to negative from stable.
The change reflects the firm’s view that banks will face weakening loan quality and foreign-currency liquidity challenges as depressed oil prices and the coronavirus pandemic weigh on Nigeria’s economy.
These new difficulties add to existing headwinds from weak economic growth and rising regulatory costs.
Nigeria’s largest banks, however, will continue to benefit from a high probability of government support.
Ayodele Akinwunmi, relationship manager, investment banking at FSDH Merchant Bank Limited, said the current challenges are real, but “what we should concentrate on is how we should develop structures to harness the opportunities in the crisis. And banks will facilitate this development”.
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, Moody’s said.
The quality of banks’ oil and gas loan portfolios will further deteriorate as a majority of these loans were extended to the upstream and service segments, where borrowers are more sensitive to oil price movements than downstream. However, a substantial amount of upstream and midstream loans were restructured to match borrowers’ cash flows during the 2015-16 oil price slump, and some banks have hedged against a low oil price. Lower oil revenue for the government could also hurt downstream oil and gas borrowers that receive federal subsidies, as these payments may be delayed.
“We expect problem loans to rise to between 8 percent and 10 percent of total loans from 6 percent in December 2019, with risk tilted to the downside should the depressed oil price persist for more than a year. Loan restructuring and forbearance will lessen the impact of loan quality deterioration,” Moody’s said.
Despite the measures taken by the Nigerian central bank to support the economy, the firm expects the creditworthiness of most Nigerian corporate borrowers to weaken. Since corporate borrowers account for around 90 percent of banks’ loans, banks’ asset quality will deteriorate. In addition, Nigerian banks have extended large volumes of outsized loans to single customers. Analysts at Moody’s believe the top 100 customers represent more than 40 percent of total gross loans in the banking sector, leaving the banks disproportionately vulnerable to defaults by one or a number of borrowers.
The Moody’s report revealed that Nigerian banks’ high exposure to foreign-currency loans will be a further asset quality pressure point in the event of a naira devaluation. Some 41 percent of loans extended by Moody’s-rated Nigerian banks are denominated in foreign currencies, predominantly dollars. Some of these borrowers are vulnerable to a devaluation of the naira, as they do not earn foreign-currency income. A weaker naira would increase their debt repayments so reducing their repayment capacity.
“We expect some foreign-currency loans to be converted into local currency if persistent low oil prices pressure the naira exchange rate,” Moody’s said.
The US-based investor services firm expects Nigerian banks’ profitability to weaken substantially due to lower lending margins and higher costs, with return on assets falling to 0.5 percent-1 percent in 2020 from about 2.5 percent at year-end 2019. Constrained interest income because of limited loan volumes and lower asset yields, cost pressures from investments in IT, a levy to cover the cost of banking resolution and higher loan-loss provisions will strain banks’ profits.
“We expect provisions to increase to 2.0 percent-2.5 percent of gross loans from about 0.5 percent in 2019 for the Moody’s-rated banks. Nigerian banks’ efficiency will also deteriorate as costs outpace revenue, raising their cost-to-income ratios. Nigerian banks were already inefficient compared with other large sub-Saharan banking systems, with an average cost-to-income ratio of close to 70 percent,” Moody’s said.
“Nigerian banks’ capital ratios are expected to decline but remain sufficient to absorb unexpected losses under our baseline scenario. We expect system-wide tangible common equity (TCE) to decline to 13 percent of risk-weighted assets (Moody’s adjusted) at year-end 2021 from 14 percent at the end of 2019.
This is primarily because of higher risk-weighted assets and an anticipated increase in loan-loss provisioning costs, which will erode the banks’ profitability. In the event of a naira devaluation, banks’ risk-weighted assets will further increase due to their large volume of foreign-currency denominated loans.
“We expect Nigerian banks to counter pressures on capital ratios by reducing their dividend payouts. In addition, banks have high loan-loss reserves at about 90 percent of nonperforming loans,” Moody’s said.
According to Moody’s, Nigerian banks’ local currency liquidity and funding profiles will remain strong. The banks’ proportion of liquid assets to overall deposits was high at about 38 percent in 2019, surpassing the regulatory requirement of 30 percent. However, Nigeria has historically been susceptible to outflows of dollar deposits in times of financial and exchange-rate policy uncertainty or low oil prices.
“We expect the growth of foreign-currency deposits, which contribute about 25 percent of total deposits, to fall substantially. This will lead to renewed foreign-currency shortages if low oil prices persist,” analysts at Moody’s said.
