Bank NPLs (18) - Understanding The Impact Of IFRS 9 On Selected Nigerian Banks

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Tuesday, June 02, 2020 / 06:38 AM / by Debtors Africa/ Header Image Credit:   EcoGraphics


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IFRS9 Implications for FY 2018 and 2019

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Profitability

 

IFRS9 took a hand in aiding the performance of Access Bank in 2018. The bank declared a profit before tax (PBT) of N103.2bn in the year as against N78.2bn in 2017, a growth of +32%. The rise in PBT came majorly from an IFRS9 day one provisioning adjustment which in addition to the bank's net interest income growth increased from N163.5bn in FY 2017 to N173.6bn in FY 2018 (+6%). Another cause for the huge reduction in impairment charges was the repayment made on EMTS loans with the bank resulting in its declassification. The bank's net interest margin, therefore, went up from 4.9% in FY 2017 to 6.2% in FY 2018. Access Bank's IFRS9-compliant impairment charges subsequently fell by -57% from N34.5bn in FY 2017 to N14.7bn in FY 2018. This resulted in the bank growing earnings per share (EPS) by +52% from N2.18 in FY 2017 to N3.31 in FY 2018. In Q1 2019 the bank's net interest income rose by 27% from N44.7bn in FY 2018 to N56.8bn in FY 2019; showing sustained growth in lending activity net income. Gross Earnings equally showed strong performance by rising 16% in Q1 2019 from N137.5bn in Q1 2018 to N160.1bn in Q1 2019. Evidently, the old Diamond Bank difficulties have not bothered the new Access Bank. More accurately, however, it seems that the bank's Q1 2019 quarterly numbers do not reflect the merged position of the two former legacy institutions. The Q1 2019 results are still essentially those of the non-merged Access Bank entity. However, that may not be entirely true. It appears that Access Bank merged the statement of financial position of both entities but adopted the profit and loss account of its old pre-merged institution for the recent Q1 result. This explains the sudden rise in the banks NPL ratio from 2.5% in FY 2018 to 10% in Q1 2019.

 

Asset Quality/Operating Ratios

 

The banks Non-performing Loans (NPLs) ratio fell from 4.8% in 2017 to 2.5% in 2018. This demonstrated an improvement in the bank's loan asset quality during the year as the bank seems to have spit out its more toxic loan assets and slowed down the pace of growth of its loan book.  Loans and advances grew by a mere +3% between FY 2017 and FY 2018 from N2.06trn in 2017 to N2.14trn in 2018. The reduced challenges to the bank's loan book resulted in a reduction in its Cost of Risk ("CoR") which slid from 1.7% in FY 2017 to 0.7% in FY 2018.

 

In Q1 2019, the bank's CoR dropped to 0.5%. But what has come as a surprise is the sudden leap in Access Banks Q1 2019 NPL ratio which stood at 10% (up from 2.5% in FY 2018). The clear explanation for this is that the bank has since Q1 2019, consolidated the books of its merger partner, Diamond Bank, and the recent rise in the new Access Bank's NPL ratio reflects the poor quality of Diamond Bank's previous loan book which took a medium-sized hammer to the larger Access Banks once enviable lower NPL statistic. Analysts expect that it will take another two years for Access Bank's NPL ratio to return to below 5%, even though the bank itself in its recent April 2019 stakeholders conference call indicated that NPLs in FY 2019 will be less than 10%. 


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IFRS9 adjustments resulted in the bank's capital adequacy ratio dipping slightly from 20.1% in FY 2017 to 19.9% in FY 2018. This was brought about by a fall in shareholder's equity that was as a result of a mild charge-off of IFRS9 adjustments to the bank's statement of financial position; Access Bank's shareholder funds dropped by -4% from N511.2bn in FY 2017 to N490.5bn in FY 2018.

 

Analysts note that Access Bank's falling cost-to-income ratio (CIR) is in line with the bank's expectations for Q1 2019, as lower cost of funds and gains from rescaling operations begin to kick in. The bank had anticipated that by the end of Q1 and the beginning of Q2 2019 some of the gains of the Access Bank/ Diamond Bank merger would begin to take hold.  

 

Liquidity

 

The banks liquidity ratio rose mildly from 47.2% in FY 2017 to 50.9% in FY 2018. The improvement was on the back of a slower growth in loan assets and an uptick in customer deposits. Customer deposits grew by 14% Y-o-Y from N2.24trn in FY 2017 to N2.57trn in FY 2018 with the bank's larger number of low cost customers making up to 50% of the bank's total deposit liabilities. The new and larger Access Bank may begin to see strains on its liquidity in Q2 2019 as tries to resolve legacy challenges from the poor loan book of the former Diamond Bank. Some observers have said that the situation may require the fresh injection of capital as its Q1 2019 result show that its liquidity ratio dropped to the 2017 value of slightly over 47% (actual Q1 2019 liquidity ratio for Access Bank was 47.8%). Analysts are still figuring out why despite Diamond Banks well-known poor-quality loan book, Access Bank's Q1 2019 financials do not fully reflect this reality.

 

From analyst's perspective, Access Bank's CAR for Q1 2019 was expected to fall below 19% especially since it saw a reduction in shareholder funds in FY 2018 which would have led to a dampening of CAR at the consolidation of the books of both the old Access and Diamond banks (the official minimum CAR threshold is 15% for banks with international licenses and 10% for banks with national licenses). IFRS9 adjustments on the consolidated books should have provided massive day one reductions in impairments but they would also have led to large charge offs against the shareholder equity of the new bank leading to a sizable fall in shareholder funds and a reduction in CAR. To explain the low impairment charges and the modest reduction in shareholder equity in Q1 2019, a number of outcomes seem plausible; either the new bank did not make full impairment provisions for Diamond Bank's legacy loans or the legacy loans were not fully consolidated into the new Access Bank's Q1 2019 results.

 

Leverage

 

Access Bank has, over the years, been dynamic in managing its statement of financial position by optimizing assets and liabilities to gain best operating leverage. The banks total asset to total liabilities ratio of 1.11 is modest for a financial institution but it is not certain whether this ratio takes into account the equity diminution expected from the impairment adjustments required for the poor performing loans on the former Diamond Bank books. Access Bank's IFRS9 adjustment for FY 2018 was roughly 9% of the total N881bn adjustment for the 12 banks under review (total industry adjustment was in the region of N1trn).

 

Table 12: Leverage Ratio of Access Bank for FY 2018
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Conclusion 

Access Bank has transitional IFRS issues and perhaps IAS21 issues also, given its foreign operations and foreign currency (FCY) translation considerations for its African subsidiaries. But since the bank has from the beginning of last year, 2018 adopted the NAFEX rate as its rate of currency conversion this may not be too important a challenge for now. 


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The more pressing problem seems to be the full consolidation of the accounts and the adoption of the right impairment costs to the merged profit and loss account and the required charges to the shareholder funds. As things stand, the bank does not appear to have fully adjusted the merged entities accounts for proper IFRS9 accounting rules application. 


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ETI

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IFRS9 Implications for FY 2018 and 2019

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Profitability

 

ETI's profit before tax (PBT) grew 53% from $288.3bn in FY 2017 to $435.9bn in FY 2018. The climb did not reflect the slow growth in Gross Earnings which skipped forward by 1% from $2.49bn in FY 2017 to $2.48bn in FY 2018. The slowdown in Earnings was a reflection of the global fall in trade and GDP growth rates as an increasingly bad-tempered trade relationship between America and China stalled global expansion. Net interest income (a measure of the underlying profitability of the bank's core business) fell by -3%, sliding from $977.3m in FY 2017 to $929.8m in FY 2018.  However, fees and commissions (none interest income) grew by +10%. The rise in fees and commission was similar to that of other local banks as deposit money institutions shy away from straight lending to either contingent (or off balance sheet) obligations to trade-related activities such as standby letters of credit (SLCs), advance payment guarantees (APGs) and bank guarantees (BGs). On the shoulders of larger non-lending transactions ETI's fee income last year rose from $469.5m in FY 2017 to $507m in FY 2018, a growth of 8%.

 

IFRS9 adjustments for impairment losses on financial assets pulled down the bank's impairment charges by -36% from $411.05m in FY 2017 to $263.92m in FY 2018. This helped buoy profitability as distributable earnings rose by +44% from $227.6m in FY 2017 to $327.8m in FY 2018.

 

Other Comprehensive Income (OCI)

 

A quiet part of ETI's improved statement of financial position that has caught analyst's attention is the bank's Other Comprehensive Income (OCI) which saw the bank harbour a loss of 371.9m net of tax (see page 174 of the Group's Audited Account FY 2018). This line item reflects the adverse impact of IAS21 foreign exchange translation costs on the bank's books. In other words, it reflects the effect of provisions of IAS21 on the procedure for converting foreign exchange from the currency of domestic transactions to the currency of financial reporting. In the case of ETI this involves consideration of a bouquet of 21 currencies across the continent. Francophone West African operations (UEMOA countries) are a little less complicated as the CFA Franc is linked to the French Franc and therefore had some underlying stability in relation to an international reserve currency. The same cannot be said of the naira to dollar exchange rate.

 

When considering the naira to dollar exchange rate a number of issues are pertinent here. In an earlier report last year, 2019, Proshare Nigeria had insisted that ETI was adopting the wrong foreign exchange translation rate of N306/$ as against the autonomous market rate, NAFEX, rate of N364/$ in compliance with IAS21 rules (A-Second-Look-At-Ecobank-FYE-2018--Takeaways-From-The-Most-Recent-Conference-Call). This had the following impact on the bank's Q1, Q2, Q3, and Q4 results in 2018:

  • It exaggerated the bank's profit in dollar terms
  • It exaggerated the size of the bank's shareholder funds
  • It boosted its total assets (this grew by a foreign-exchange translation induced excess of $1bn in Q3 2018) and,
  • It boosted ROE (from 7.8% in FY 2017 to 11% in FY 2018) and,
  • It reduced Cost-of- Risk (CoR) from 3.3% in FY 2017 to 2.4% in FY 2018

 

2019 outlook

 

In 2019 analysts believed that the bank would not be able to take advantage of day-one adjustments as the adjustment has been fully made in FY 2018 under the permissible IFRS accounting rules. This will mean:

  • Profit before tax may decline as huge write offs and reversal of impairment provisions would be difficult to justify, especially for the Nigerian subsidiary where the Central Bank (CBN) still perceives that there is a certain level of inadequate provision for NPLs on the bank's books.
  • The bank would have to calculate the full year on the basis of a NAFEX rate for FY 2019 in Nigeria rather than the FY 2018 calculations that involved the application of official rate for the first eleven months and the application of NAFEX in the last month of the year December 2018. 
  • Unlikely growth in loans and advances in 2019 would suggest that profit in the year would be muted except the bank is able to make up for lower interest income by bolstering non-interest income from trade and off -balance sheet earnings by way of charges on contingent liabilities such as bank guarantees. 

 

Asset Quality/Operating Ratios

 

ETI's assets have deteriorated, especially in Nigeria, as a result of the slow growth of the broad economy which grew by 1.93% in Q4 2018. The various domestic and international headwinds were fairly well mirrored in the banks very modest 1% growth in dollar gross earnings in FY 2018 (ETI group has had difficulty growing gross earnings since 2014) and the reduction in loans and advances in the Nigerian market (loans fell -15% from $2.7bn in FY 2017 to $2.3bn in FY 2018). This was when loans to UEMOA countries rose +3% from $3.8bn in FY 2017 to $3.9bn in FY 2018.

 

Table 16: ETI Abridged statement of financial position 2014-2018 ($'000)

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However, IFRS day one provisions in FY 2018 allowed the bank post a stronger-than-would-be-expected profit before tax in FY 2018. Impairment provisions fell from $411m in FY 2017 to $263.9m in FY 2018, representing a Y-o-Y fall of -36%. The Impairment decline raised a few IFRS9 issues. 


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The bank had a direct IFRS9 adjustment of $279.2m in FY 2018 but provision for impairment were up $810.6m soon to witness a large charge reversal of $570.6m described in its report as provisions no longer required. Supporting this was a massive loan write of $830.6m. The combination of these fiscal actions supported the bank's earnings leap in FY 2018.

 

 Equity Concerns

 

Total equity as at 31 December 2018 was US$1.8 billion, down US$360 million compared to as at 31 December 2017. The decrease was primarily as a result of the adverse impact from other comprehensive income (OCI) items and the full impact of the implementation of IFRS 9. The primary OCI drivers were the foreign currency translation reserves, which moved by US$295 million, and negatively impacted equity. Factors responsible for the adverse movement include the Group's decision to adopt the NAFEX rate in December 2018, resulting in a US$158 million impact.


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Liquidity

 

Liquidity ratio for ETI dipped a bit in 2018; most of the decline was as a result of a modest leap of +0.4% in Group's total assets from $22.4m in FY 2017 to $22.5m in FY 2018 and an equally mild rise in deposit liabilities of +0.5% from $15.3bn in FY 2017 to $15.7bn in FY 2018. The bank's capital adequacy ratio tumbled from 28.8% in FY 2017 to a much more sober 13.6% (or lower than the CBN's minimum statutory threshold of 15%) in FY 2018. 

 

Leverage

 

ETI's leverage ratio more or less sat somewhere in the middle of other domestic Nigerian banks which ranged from a high of 1.21 (GT Bank) to a low of 0.49 (Unity Bank). With the recent $450m, 9.75% Eurobond Issue in 2019 ETI's leverage ratio may worsen. A lot will depend on the extent to which the new bond Issue retires old debts that have fallen due and how the bank uses the remainder of the Bond amount to drive growth in interest earning assets in the course of the year, 2019.  ETI's leverage ratio was 1.09 in FY 2018. 


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Conclusion

 

1)     ETI (Ecobank's) foreign exchange translation accounting still appeared to have exaggerated its performance in 2018. In addition, the IFRS9 day one provisioning seemed to have enabled the bank strengthen its profit & loss account. The day one adjustment impact on P&L and shareholder funds was definitely not unique to ETI. All local deposit money banks to varying degrees took advantage of the IFRS9 day one adjustments to paint a prettier picture of their books.  But ETI seems to be singular in its use of IAS21 in a way that allowed it to pick and choose when to apply the NAFEX rate of exchange and when to apply the official rate (see www.proshareng.com/news/Stock Analyst Updates/Compliance-With-IFRS-IAS21-ETI-and-The-Effects-of-Changes-in-Foreign-Exchange-Rates/43175)

 

A few things are clear about the bank's FY 2019 accounts:

  • No day one IFRS9 adjustments would reoccur in FY 2019
  • IAS21 rules concerning the use of NAFEX rates for conversion between the currency of transaction (naira) and the currency of presentation (dollar) will apply from January to December 2019, unlike in 2018 when it was applied only to the last month of the year, December 2018.
  • Shareholder funds are not likely to shrink to increase the bank's return on equity (ROE) for the local Nigerian subsidiary as there will be no day one IFRS9 adjustments to be charged against shareholder funds by FYE December 31, 2019.
  • Slow loan growth may improve in 2019 as the bank's management in a conference call communication with Proshare assured that guidance growth for loans in 2019 will be in the neighbourhood of 10%.
  • Q1 2019 results of ETI showed that the bank would likely grow gross earnings by more than +1%, although it would still be below +6% for FY 2019.
  • To keep CAR above the CBN regulatory requirement of 15%, the bank would need to raise further equity; the recent $450m Eurobond Issue stretches out the banks debt profile over an additional five year horizon but ETI's Nigerian subsidiary will need equity to strengthen its books and prepare it for the steady growth in the lenders loan portfolio

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ETI's principle challenge in 2019 would be to increase gross earnings and operating profit on the back of growth in the bank's loan book. It would be recalled that the bank's gross earnings had actually declined over the past five (5), therefore, increasing revenue growth was a strategic imperative for the bank, and would make or mar its 2019 business outlook.

 

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Zenith Bank

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IFRS9 Implications for FY 2018 and 2019

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Profitability

 

Zenith Bank's profit before tax rose from N199.3bn in FY 2017 to N231.7bn in FY 2018, representing a rise of +16%. Most of the growth came from day one IFRS9 adjustment gains as gross earnings tumbled -15.4% from N745.2bn in FY 2017 to N630.3bn in FY 2018.  Net interest income rose +14.6% from N257.9bn in FY 2017 to N295.6bn in FY 2018, but the real boon to Zenith's profit and loss account in FY 2018 was the -81.3% fall in IFRS9 day one adjusted impairments from N98.2bn in FY 2017 to N18.4bn in FY 2018. 

 

However, the banks improved earnings is no thanks to worsening loan quality as the bank's non-performing loan portfolio rose from 4.7% in FY 2017 to 4.9% in FY 2018; this was about 2 basis point lower than the statutory 5% upper bar but it indicated that a few of the banks loans were becoming increasingly toxic. This could harm FY 2019 profit figures without the comfort of a day one IFRS9 accounting safety net.

 

The bank's books also received a nudge from its other comprehensive income (OCI) which rose from N2.7bn in FY 2017 to N6.3bn in FY 2018, a growth of +133%. The large part of this growth was as a result of adjustments for fair market valuation of profit on tradable equity instruments on the bank's balance sheet which reversed from a negative value of N5.2bn in FY 2017 to a positive value of N4.8bn in FY 2018.

 

Asset Quality/Operating Ratios

 

Zenith's rising NPL was an early warning signal concerning the reduction in the quality of its loans and advances; admittedly the size as at FY 2018 was not a problem as it was conveniently tucked slightly under the 5% statutory ceiling, but its rising orientation would need to be addressed against apprehensions about the falling quality of risk assets. The N108.2bn IFRS9 adjustment in FY 2018 would have had an impact on the banks shareholders fund resulting in an increase of bank capital by 0.4% (in sharp contrast to the decline in capital of its competitors in FY 2018, for example Union Bank's capital shrunk by as much as -34.3% in FY 2018). 


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Chart 171: Impairments of Selected Nigerian Banks FY 2018

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Source: Audited Annual Accounts of Selected Nigerian Banks FY 2018

 

Liquidity

 

Between 2017 and 2018 the banks liquidity ratio rose by 2.3% from 69.7% in FY 2017 to 72% in FY 2018. Zenith is easily one of the sector's most liquid banking institutions, which can, perhaps, be understood from the perspective of its long institutional retail banking memory. This explains why Zenith Bank is more liquid than most of its fellow tier1 counterparts such as GT Bank and Access Bank that come from a more preeminent corporate banking background. 

 

This explains why Zenith Bank also has one of the lowest cost-to-income ratios (CIR) in the sector. Zenith Bank's CIR fell from 52.8% in FY 2018 to 49.3% in FY 2018. The banks large low-cost retail liabilities were a major factor in keeping finance costs down.

 

The banks cost-of-risk equally fell between FY 2017 and FY 2018, from 4.3% in 2017 to 0.9% in 2018, a difference of 3.4%. Going into the year, 2019, the deposit battle will be a straight fight between the new and larger Access Bank and the sturdy Zenith Bank, with both banks trying to retain a permanent grip on lower cost liabilities to improve net interest margins.  

 

Chart 172: Deposits of Selected Nigerian Banks 2018

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Source: Audited Annual Financial Statements of Selected Banks

 

Leverage

 

The bank had a total asset- to- liabilities ratio of 1.16 in FY2018, this indicated a modest but tolerable asset coverage ratio; one of the highest for a Nigerian DMB in FY 2018.


The bank grew its total assets from N5.96bn in FY 2017 to N5.60bn in FY 2018, a growth of +6.4%. The bank's Q1 2018 total assets rose from N5.68trn in 2018 to N5.88trn in Q1 2019, a rise of N220bn. Zenith's total liabilities in turn rose from N4.78bn in FY 2017 to N5.14bn in FY 2018, a forward skip of +7.5% Total liabilities took off slightly from N4.94trn in Q1 2018 to N5.1trn in Q1 2019, a modest rise of +4%.

 

Conclusion

Zenith Bank, so far, has been a smooth-running retail banking franchise. However, two primary issues that the bank would have had to tackle in 2019 are growing its loan portfolio without compromising its cost of risk (CoR) and growing its low-cost liability base. With the banking sector showing signs of consolidation as reflected in the recent Access Bank-Diamond Bank merger, the competitive imperative for acquiring a larger number of savings and current account customers has become pressing.

 

IFRS9 provisions have helped to clean up Zenith Bank's books without destroying shareholder funds (unlike fellow tier 1 counterparts). The bank's shareholder funds rose from N812.12bn in FY 2017 to N815.75bn in FY 2018, a growth of +0.4%

 

Zenith's forward FY 2019 performance would rely on sustaining lower cost-to-income ratios and larger fee-based revenues. The fact that a new managing director, Ebenezer Onyeagwu (who took over from Peter Amangbo in April 2019), had been ushered in meant that the bank would stay focused on strategic intent for five years which is the normal duration of a first tenor for the MD of the Bank. 


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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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