Fortunes of Nigeria’s banks tied to the oil price

The rally in the price of oil over the past year is far from a universal benefit to Nigeria’s economy, which is dependent on crude oil revenue but cannot meet domestic fuel demands from its own supply. However, the rise has come as a welcome respite for the country’s banks, whose fortunes are tied to fluctuations in the oil market.

About a third of all domestic commercial bank credit is extended to the oil and gas industry. If its entire upstream, midstream and downstream operations and supply chain were added together, analysts estimate oil and gas lending would make up as much as half of banks’ loan books.

The system-wide non-performing loan ratio — a key metric for banks’ health — fell to 12.5 per cent in June from 15 per cent a year earlier, according to official figures. But by August, it had risen to 14.7 per cent.

In a communiqué the following month, the Central Bank of Nigeria’s monetary policy committee said it was “concerned with the rising level of NPLs in the banking system, traced mainly to the oil sector”.

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The top-tier banks are generally improving. First Bank of Nigeria, the second largest by assets, is recovering from a slump that saw NPLs peak at 24.4 per cent at the end of 2016 — they were down to 20.8 per cent at the end of June.

The rise in the oil price has “direct implications” for Nigeria’s banks given their exposure to the sector, says Olamipo Ogunsanya, banking analyst at Renaissance Capital in Lagos, speaking when oil had topped $80 a barrel. “NPLs were primarily driven by lower oil prices and a slowdown in the economy — the rate of new NPL creation has slowed.”

But smaller banks are struggling. Last month, the Nigerian government announced it would prosecute those responsible for the collapse of Skye Bank, a local lender, and several banks are still being kept afloat almost entirely by support from the central bank.

Meanwhile, Diamond Bank recently announced the resignation of four of its board directors, amid a streamlining programme that has offloaded assets, in part because of the poor performance of its oil-heavy loan book.

Last year, the sector was shaken when telecoms operator Etisalat’s Nigeria business, under pressure from the recession and the impact of capital controls, defaulted on a $1.2bn syndicated loan from 13 local banks.

The rise in the oil price should help alleviate some of the pressure, although it fell back in early November. Most of the loans on banks’ books were restructured when oil was $35 to $40 a barrel. Low foreign exchange liquidity, which was a big driver of bad loans, has improved significantly as dollars return to the country via oil sales.

Analysts say Nigerian banks are severely undervalued. “In fact, they are trading at valuations close to those of Turkish banks, which have suffered from rapidly increasing cost of funding and concerns about asset quality following the collapse of the Turkish lira, in stark contrast to the improving sector trends of the Nigerian banking sector,” says Renaissance Capital in a recent research note.

Despite weathering Nigeria’s first recession in a quarter of a century, many banks made record profits in the past couple of years. Return on equity for the sector doubled to 20.5 per cent between the end of 2016 and October 2017, according to Oxford Analytica, a consulting firm. The banks fed on “the government’s desperation for money amid falling oil receipts”, vacuuming up tax-free profits on high-yielding treasury bills.

At the same time, the central bank’s multiple exchange rate regime — which set different exchange rates for different industries, beginning in 2016 — created a unique arbitrage opportunity that the banks exploited.

“It creates all kinds of opportunities and gaps [for banks] without forcing them to add value in other ways,” says a top Lagos-based banking executive. “It’s true of all the banks, all of us, because people do what’s safe . . . and that is what makes sense for shareholders.” That arbitrage opportunity has shrunk as the central bank has regularised its forex regime.

But weak economic growth and slumping oil prices have since sent private sector credit growth slowing to a crawl — up just 0.8 per cent year on year in August, according to the central bank. That is because Nigerian banks mostly lend to multinationals and a few local corporate clients.

The slowdown has forced the central bank to intervene in its “own sort of mini QE [quantitative easing]”, says George Bodo, banking analyst at Ecobank — in which it is willing to buy certain types of corporate bonds “because there’s a market failure they’re trying to address”.

Retail lending remains under-developed. About 63m Nigerians lack a traditional bank account, according to the World Bank’s Global Findex database.

“Banks seem to be locked in price wars [over corporate clients] — they’re vying for the same piece of cake and we’re looking for them to bake a new cake,” says Mr Bodo. “I think the next growth story is when they start doing consumer lending . . . that can drive valuations.”

If lenders do not act quickly, they may be left behind. Nigeria’s central bank is opening the system to non-financial companies such as telecom operators, to follow Kenya’s example in developing a thriving mobile banking industry.

South Africa’s MTN, which has more than 50m subscribers in Nigeria, plans to launch its Mobile Money service next year. For many Nigerians, their introduction to the formal banking sector may not be directly with a bank at all.