Thursday, June 07, 2012 / ARM Research

• Fidelity Bank (Fidelity) reported gross earnings of N22.4bn for 3 months ended March 2012; a 46% YoY growth. PBT and PAT rose 140% and 137% YoY, respectively, to N4.2 billion and N3.4 billion. Topline growth driven by interest income.

• In line with industry trend in Q1 2012, Fidelity reported robust top-line performance which largely reflects significantly higher interest rates during the quarter compared to the corresponding period in 2011. Interest income rose 76% YoY to N17.6 billion in tandem with 40% loan growth and over ten-fold increment in investment securities YoY.

• On the other hand, non-interest income was 10% lower YoY, possibly as a result of the reclassification of some items into interest income category based on IFRS, as reported by other banks.

This was also apparently reflected in quarterly figures where interest income was 11% stronger QoQ in spite of a 3% decline in revenues over Q4 2011 which had a similar interest rate environment. Nevertheless, the sharp 33% contraction in non-interest incomes QoQ suggests underlying weakness in this category.
 

Higher rates ups funding costs

• Though higher market yields supported revenue growth, it naturally led to higher interest expense across the industry, with a disproportionate adverse impact on smaller banks. Fidelity was no exception.

• Interest expense jumped 114% YoY to N7.6 billion compared to a 66% rise in deposits which forms the bulk of Fidelity’s funding. Similarly, interest expense rose 18% QoQ in the face of a 7% contraction in loan volumes to N522 billion. Consequently, WACF worsened 130bps YoY and 260bps QoQ to 5.9%. Lower opex and provisions drive earnings surprise

• Fidelity saw a 21% YoY rise in opex to N9.8 billion for the quarter but nevertheless witnessed a break in the accelerating quarterly trend through 2011 after a 26%QoQ decline. QoQ figures came in at a slightly lower run-rate than we envisaged based on expected costs from new branches as Fidelity continues to implement its roll out programme.

• Similarly, provisioning was 62% lower YoY at N725 million, tracking well below our FY 2012 forecasts and possibly indicating some success in Fidelity’s efforts to improve asset quality. Management asserts that the bulk of the additional charges in Q4 2011were exceptional, linking these to actuarial adjustment for pension obligations.

• Overall, the lower charges, in conjunction with topline improvements contributed significantly to the YoY improvement in profitability. PBT and PAT margins both expanded 600bps to 19% and 15% respectively.
 

We revise our estimates upwards on performance surprises

• We estimates, CAR at 35%, which is more than sufficient to drive growth in the medium term, in our view, but have tempered our expectations for risk asset creation in the near term in view of heightened competition in the industry and elevated money market yields. We however expect some recovery in the contribution of non-interest income with increasing throughput from Fidelity’s larger branch network.

Based on recent branch expansion, we expect Fidelity will be able to sustain deposit growth and expect this to be the main driver of balance sheet growth going forward. Furthermore, in line with Fidelity’s resurgent risk appetite, having systemically reduced NPLs over the course of the last two years, we expect loan deposit ratio will recover to historical four-year average over our forecast horizon.

• Factoring in our view that current asset yields have peaked and will decline gradually over the medium term, and our perception of Fidelity’s position in the industry, we estimate a gradual downtrend in the bank’s earnings yields over the next few years.

Nevertheless, we expect interest income to remain the main driver of revenue growth and have revised our gross earnings estimates higher to N90 billion for FY 2012 to account for the stronger run-rate in Q1 figures, driven by higher asset yields (13.4%) than we expected (9.5%). However, recalling the dip in asset yields in 2011 after a similarly strong start as well as the possibility of some monetary easing, we adjusted our forecasts to reflect a 40% decline from current yield levels and arrive at a 10.7% estimate in making our estimates.

• Similarly, we have revised our estimates for FY interest expense 28% higher to account for the evident funding pressures for smaller banks. This brings estimated funding costs in line with current run-rate which is likely to persist with monetary policy still tight, although a moderation in rates later in the year could provide some support.

• In spite of the lower opex run-rate, which brought in CIR 10ppt lower than FY 2011 to 66%, we have been conservative with our downward revisions to 65% for FY 2011 which represents the midpoint between Q1 level and the potential 64% which could be achieved if current run-rate persists in our operating income forecast. Unlike other banks which have released Q1 results, Fidelity failed to provide a breakdown of the components of opex, making it difficult to ascertain full drivers of the dip and its sustainability.

However, considering the wide disparity between our provisioning estimates and reported results as well as efforts to tighten standards and increasing focus on government securities over the past year, we adjust our forecasts to reflect more significant cuts (11%) to our provisioning estimates. Nevertheless, this has been tempered by the fact that a trend is yet to be established as well as relatively high NPL ratio of 13% as at FY2011 which could still result in further impairment especially with aggressive risk asset creation in H2 2011. Consequently, we adopted the middle ground between our previous estimates and FY2011 levels.

• Overall, we have revised our PAT estimates higher to N12.9 billion from N10.7 billion previously, with the possibility for further upward revisions if the improvements in provisioning is sustained.
 

Significant upside potential underpins BUY rating

• The combination of earnings drivers discussed earlier translate into moderate 9% CAGR in revenue over our forecast horizon. In addition, we think the recent rapid improvement in cost-to-income ratio may have captured most of the benefits from cost-cutting initiatives and we expect current levels of ~65% to persist over our forecast horizon.

• Our expectations for provisioning are similarly benign over our forecast horizon, driven by similar factors for the current year and we expect cost of risk to remain stable at ~2%.

• Based on these drivers we arrived at fair value estimate of N3.28 for Fidelity.

• Since our last report Fidelity has dipped a further 20% on the back of sector wide pressures making valuation multiples all the more attractive. Current PE of 4.5x and P/Bv of 0.3x are at significant discounts compared to industry averages of 9x and 0.9x, respectively.

• Based on the significant upside potential relative to our fair value estimate and supported by attractive valuations, we maintain a BUY rating on the stock.

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