•FCMB reported gross earnings of N53.8billion for 6 months ended June 2012, a 54% YoY growth. PBT and PAT rose 17% and 26% YoY to N7.8 billion and N6.7 billion, respectively –which is a significant slowdown from the of 28% and 54% YoY growth rates in Q1 after profitability weakened in Q2 2012.
•Annualized revenue was in line with our estimates while PBT and PAT were 19% and 23% ahead respectively; weakness in profitability was more moderate than we expected owing to FCMB booking writebacks in contrast to further provisioning we had envisaged in FY 2012.
Sustained revenue growth on higher yields
•FCMB’s acquisition of Finbank remained the broad underpinning of revenue growth with investment securities (+121% YoY) being the principal driver while loans increased a modest 8% YoY.
•However, on a quarterly basis, FCMB’s 10% QoQ revenue growth largely reflected its focus on retail asset creation since 2011 evidenced by steady rise in asset yields—which has risen a cumulative 220bps to 10% over the period—for the bank. After a dip in Q1 occasioned by the expanded base from the initial consolidation of Finbank, asset yields recovered 70bps in Q2 to 10.6% offsetting a 3% QoQ contraction in loans and leading interest income 14% higher.
•On the other hand, non-interest income contracted a mild 3% which possibly reflects slowdown in structured finance platform which had typically driven growth in this segment.
Funding and restructuring costs impair topline gains
•The mild contraction (-2%) in balance sheet as nearly every category of earnings assets declined (except interbank placements) was driven by 8% QoQ shrinkage in deposits. FCMB attributed the loss of deposits to the bank unwinding “exposures to corporate clients in volatile sectors of the economy”. Notwithstanding, we believe the outcome also reflected challenges with securing cheap funding as interest expense jumped 11% QoQ to N10.6 billion. As a result, WACF deteriorated 50bps to 6.2% in line with the industry trend.
•Similarly, opex jumped 20% in the quarter to N14.4 bn and was 45% ahead of management’s earlier guidance of N9.9bn for Q2 which, as we had concluded in our earnings estimate report, “was too low especially in light of restructuring charge of N3bn expected to crystallize in the quarter”. After a flat cost profile at N8bn/quarter through 2011, recent jumps in opex appear to undermine management’s attempts at driving CIR lower by keeping costs flat while growing revenue. As a result of the faster jump in Q2 opex relative to gross earnings, CIR increased by 370bps to 79% after a 14ppt rise in Q1.
Damage to bottom-line contained as writebacks sustained
•Although gross earnings, interest expense and operating income were all in line with our estimates, opex was 18% ahead and appeared set to push profits below our expectations. However, in contrast to its N1.6bn provisioning guidance, FCMB booked an additional N214mn write-back which stood in sharp relief to our conservative N10bn provisioning estimate for FY 2012 (Q2: ~N2.5 bn). Our view was informed by recent industry history, a doubling of NPL ratio to 5.6% in Q1 2012, as well as our belief that further charges could yet materialize from the specific government exposure which contributed to the significant provisioning in FY 2011, considering the corresponding coverage was only 50%. The deviation on this line item primarily accounted for annualized PBT and PAT clocking 19% and 22% ahead our estimates, respectively.
•Nevertheless, largely due to the impact of opex PBT and PAT fell 23% and 36% QoQ to N3.4bn and N2.6bn, respectively. Management attributes the fall in PBT to “a 20% onetime surge in expenses, occasioned primarily by the on-going consolidation of Finbank.” The corresponding PBT and PAT margins crashed ~300bps and 400bps from Q1 levels to 14% and 12%, respectively.
Longer wait for synergies
•In line with the broad negative impact we expect recent monetary policy to have on industry loan growth, we expect slower revenue accretion to FCMB going forward. However, we believe it has further scope to leverage the combined balance sheet. We also take cognizance of the manner in which its retail asset creation drive helped sustain revenues in Q2 2012 as well as its relatively diversified revenue base. These considerations have tempered our downward revisions and we now expect FY 2012 gross earnings of N103bn which reflects steady asset yields relative to current levels.
•In spite of the evident pressure on funding costs, we increasingly lean towards the view that the enlarged network has likely limited the deterioration in funding costs. We take our cue from Q2 2012 results for peers which showed greater deterioration for a bank like Fidelity (+120bps) with little significant branch increment compared to Sterling (+20bps) fresh from its ETB acquisition. Thus, while we reflect our view that smaller banks will remain under pressure from higher rates going forward in our interest expense forecast for FCMB’s, we estimate a more tempered outcome after adopting the H1 average of 52% as our FY estimate for net interest margin. In support of this, we note that in spite of higher interest expense in Q2, our estimates show this ratio posted a mild 80bps increase from Q1as the higher yields from retail lending compensated for the higher funding costs. FCMB also reports that NIM improved 50bps QoQ to 6.6% in Q2 2012.
•Although the recent trend in opex appears worrying, it has been linked with restructuring charges which may not persist, and we expect a more moderate trend going forward. Nevertheless, we expect the cost base of the combined entity to remain elevated relative to 2011 levels and estimate that opex could decline closer to Q1 2012 levels by year end as restructuring charges ease. We target CIR of 77% over this horizon, slightly below current levels.
•On a positive note, we have significantly cut back our provisioning estimates based on 1) overall high coverage ratio (113% as at Q1) 2) management’s assertion that the bulk of FY 2011 charges was related to exposure booked pre-2010 and 3) <1% of loans impaired thereafter, appear to be reflected in recent trend. Furthermore, FCMB explains the 60bps increment in NPL ratio in Q2 2012 relates to additional NPLs from Finbank consolidation but which have been fully provided for.
Lower profits reduce fair value but BUY rating intact
•Our revisions culminate in a moderate 6% cutback in 2012 PAT estimates to N10.3bn as higher funding and operating costs has been offset by the sharp reduction in provisioning estimates. However, over the medium term the impact of upward revisions to expected costs outweighs this especially as current monetary policy tone could persist longer than anticipated. In particular, considering we believe efficiency initiatives would have to begin afresh to manage the larger entity, the upward revision we made to CIR over our forecast horizon (in contrast to the sustained improvement from 2011 we initially estimated), has played a key role in the downward revision of our fair value estimate to N7.6 from N10.9, previously.
Nevertheless, the upside potential of 143% relative to current price remains significant even as P/Bv of 0.4x is still attractive compared to industry average of 1x. Consequently, we maintain a BUY rating on the stock.
ARM now employs a two-tier rating system which is based on systemic importance of the security under review and the deviation of our target price for the stock from current market price. We characterize systemic importance as a function of a stock’s ranking among the group of top 20 stocks by NSE market capitalization over a trailing 6 month period (minimum) to the review date. We adopt a 5 point rating system for this category of stocks and a 3 point rating system for stocks outside this group. The choice of top 20 stocks arises from the consideration that this group of stocks constitutes >75% of overall market capitalization and stocks outside this group are generally less liquid and individually account for <<1% of market capitalization. For stocks in both categories, the basis for ratings subject to target price deviation is outlined below:
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