Bank NPLs (4) - A Short History of Recovery Efforts - A Time Series Analysis

Monday, May 17, 2020 06:50 AM / by Debtors Africa/ Header Image Credit:   EcoGraphics

Loan recovery has had a colourful history in Nigeria. Indeed, resolving the issues of bad bank loans has existed for at least three decades but the problem became more challenging as bank capital grew larger and lenders had access to bigger loanable funds. The lending capacity of banks grew significantly between 2005 and 2010 and between 2010 and 2015. Nevertheless, with bigger lender capacity came larger loan headaches, with the economy in a recessionary tailspin in 2015 and 2016, NPLs also rose with banks making larger loan impairment adjustments on their income statements. By 2018 banks were gearing up for the implementation of new accounting rules by the International Financial Reporting Council (IFRC) and the new IFRS9 provisions which required banks to take impairment charges from a forward-looking perspective as against the rear-view approach adopted by the previous International Accounting Standard (IAS).   

Trinity of Credit - Regulation, Bank, Debtor...

Example of How New Impairment Adjustments Affected a Nigerian Bank In 2018

As an example of how the new impairment calculations under IFRS9 affected financial service providers in 2018, FBN Holdings, in its FY 2018 Accounts Statement noted that, "The resultant impact of the transitional adjustment to IFRS 9 was charged directly to equity during the financial year resulting in a decline in our loans and advances to customers from N2.0trn in 2017 to N1.7trn in 2018 and a commensurate reduction in our shareholders' funds. Also, due to amendments to the AMCON Act, our statement of financial position and income statement for the financial years ended 31 December 2016 and 2017 was restated".

In other words, with IFRS9 rules in play from FY 2018, local deposit money institutions have had to slice off part of their outstanding shareholder equity and reduce the size of their current loan books. But this has helped them clean up their statements of financial positions and optimize their operations for stronger and more reliable future earnings. Analysts have argued that FBNH's hefty IFRS9 adjustment of N209.6bn in 2018 alone, has helped the Group reestablish underlying confidence in their lending business. The impairment provisions have depressed the group's earnings but it has also enabled the subsequent financial outlook of the lender to become more credible.

International Financial Reporting Standard 9 ("IFRS9") was to make reporting of bad and doubtful loans more of a predictive routine than a reactive stab at containing crisis; it was to make financial company's CFOs attentive to risks inherent in their organizations credit decisions and lure them into cutting back on the previously rampant incidences of Non-performing Loans ("NPLs"). Nigerian banks started to implement IFRS9 in 2018 with telling effects on both their Profit and Loss statements and their Statements of Financial Position. A few of the consequences include but were not limited to the following:

• IFRS9 cancelled roughly a trillion naira (N1trn) in bank equity in FY 2018
• Virtually all local deposit money banks took advantage of day-one provisions of the rule to strengthen FY 2018 profit before tax. First Bank of Nigeria saw the highest IFRS9 adjustment of N209.5bn while GT Bank Plc came a close second with an adjustment of N151.9bn
• For most banks in Nigeria IFRS9 provisions will result in leaner short-term earnings in 2019
• The provisions should lead to cleaner bank loan books which should in turn set the stage for better quality earnings in FY 2019
• Capital Adequacy Ratios (CARs) were mixed in 2018; for some banks they went up, for others they slipped. Access Bank saw CAR slide from 20.1% in 2017 to 19.9% in 2018, while Wema Bank saw its CAR rise from 14.3% in 2017 to 18% in 2018. First Bank's CAR went flat at 17.7% in 2017 and 17.3% in 2018, a difference of a mere 40 basis points.
• The Cost of Risk (CoR) of Nigerian banks fell in FY 2018, but a few institutions managed to achieve notable improvement; Zenith Bank Plc's CoR declined from 4.3% in 2017 to 0.9% in 2018, while Wema Bank's CoR increased from 1% in 2017 to 1.3% in 2018, other banks saw a variety of outcomes somewhere in between both banks. 

Moving into 2019, most of the banks needed varying levels of capital injection to improve their Capital Adequacy Ratios (CARs). Ecobank Nigeria, for example, saw an additional capital injection of $62m in 2018. Indeed, as a result of its IFRS9 adjustments, the bank's CAR fell from 28.8% in 2017 to 13.6% in 2018. The fall in CAR led analysts to anticipate a further rise in equity or medium to long-term debt funding by 2019; an event that took place in Q1 when the bank raised a five (5) year Eurobond Issue of $450m at a coupon rate of 9.75%. Equally notable was that Nigeria's new banking giant, Access Bank, saw its CAR slump marginally from 20.1% in 2017 to 19.9% in 2018.  It close rival Zenith Bank saw its CAR fall from 27% in 2017 to 25% in 2018. The major oddball was Unity Bank which had a CAR that rose from -198.1% to -198.6%, Unity Bank's negative CAR reflected its negative shareholder's fund and its need to either raise fresh equity or go into a merger with another bank with adequate capacity to absorb the negative equity position.

In sum, IFRS9 has had two major effects on the bank's financial positions. First, the day one adjustment has allowed banks to reduce the size of their bad loan provisioning and improve their operating incomes before tax. Second, IFRS9 has, nevertheless, taken a bite out of the shareholder's capital of the different local banks to varying degrees.

International Financial Reporting Standard 9 ("IFRS9") hit Nigerian banks with the force of a sledgehammer; the regulation started to slowly eat away at bank books since January 2018 and then tore up shareholder value by the financial year ended December 31, 2018. By replacing the previous reporting standard (IAS39), the new provisioning requirement became forward-looking; predicting prospective credit challenges and then making provisions based on expected losses. This is in contrast to the previous accounting method of making provisions against actual or known loan problems.  

The new accounting rule compelled banks to be proactive rather than reactive in their loan quality assessments, hence, making concepts of credit risk containment dynamic rather than static, as they make provisions for unknown credit risk within predictive frameworks. This has taken some toll on bank books in 2018 but could have milder consequences in 2019. The implications of IFRS9 in 2018 have been compelling:

• The adjustments for IFRS9 provisions as against the old IAS39 have led to several banks seeing lower share capital as they charge off their provisions against shareholder's funds. 

First Bank saw the highest IFRS9 adjustment of slightly over N200bn, followed by GT Bank at roughly N152bn, Union Bank at N133bn, Zenith Bank at N108bn, ETI at N92bn, Access Bank at N81bn and then UBA at N24.5bn. These banks have been termed Systemically Important Banks ("SIBs") by the Central Bank of Nigeria ("CBN"). The banks reviewed were responsible for about 88% of adjustments made the Industry's statement of financial position for FY 2018. A bank not included in the calculations in chart 1 above is Sterling bank which made an IFRS9 adjustment of N9.2bn in FY 2018; this was higher than Unity and Wema Bank but lower than Stanbic IBTC.

• Shareholder funds for the SIBs collectively shed weight but the industry as a whole lost N1trn and the banks that are captured in this report lost a combined N881bn.

Did 2019 repeat 2018's performance? No, not likely, as banks were no longer able to bring day-one adjustments to their books and for this reason lenders saw major impairment charges already reflected in their 2019 results as CFOs made predictive provisions for bad and doubtful loans. A lot, however, depends on the growth in the sizes of bank loan books (against the backdrop of the CBN's loan-to-deposit ratio (LDR) of 65%) and the extent to which non-interest transactions as a proportion of total bank earnings continued throughout the year; most banks saw their non-interest incomes as a proportion of total income grow sizably. The rise in non-interest income in 2019 resulted from an increase in trade-related businesses (such as the opening of LCs, APGs and so on) and growth in contingent liabilities in the form of off-balance sheet transactions.

A deep dive into how the provisions of IFRS9 affected each of the banks under review for FY 2018 will give insight into the likely strengths and vulnerabilities of each bank in particular and the domestic deposit money banking sector as a whole in 2019.  

Related Reports (PDF)

1.      Download the Full PDF Report - Debtors Africa, May 13, 2020

2.     Executive Summary PDF - Proshare, May 14, 2020

3.     AMCON and Financial Services Debt Burden in Nigeria - Aug 17, 2018

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