Bank NPLs (3) - The State of NPLs


Sunday, May 16, 2020 / 4:17 PM / by Debtors Africa / Header Image Credit:  EcoGraphics


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The Current State of NPLs in Banks

In the last decade, NPLs have been creatures of a weak global and domestic economy and poor loan administration in different banks to different degrees, depending on the bank.


How We Got Here - NPLs in Nigeria Banks 2008 - 2018

The global financial crisis of 2007-2008 created challenges in the Nigerian economy, the drying up of global liquidity put increased pressure on the domestic financial market as interest rates went up and weak domestic spending resulted in growing corporate inventories and climbing debt. As the stock of finished goods grew, the liquidity position of many companies worsened. The deteriorating state of corporate finances led to an increase in bank NPLs. Sanusi became CBN Governor just at the end of the crisis and had to contend with a domestic financial system just wriggling from the impact of the hostile global economy. It was understandable that between 2009 and 2014, credit market stability and low NPLs were of major priority. The rise in global NPLs was mirrored in the weakening of the local credit market, especially as credit exposures to the Oil & Gas and Power sectors became toxic. 


Distribution Analysis of Bank Debtors

The distribution of delinquent bank loans across industries is difficult to pin down; banks typically do not publish this information in their audited financial statements. Delinquency of credit appears not to be isolated to particular industries but reflects the underlying strategic distribution of credit by banks. For example, First Bank of Nigeria (FBN) got into trouble in 2007-2008 as a result of its large exposure to the Oil & Gas and Power sectors. FBN's decision to lend to these sectors at the time was intelligent and consistent with a strategy of lending large amounts to big companies to reduce the administrative cost of lending to a larger number of smaller companies and to improve the risk/reward ratio of loan portfolios. FBN's large exposure to two economically vulnerable sectors between 2007 and 2008 dragged down the credit quality of the bank's loan assets and damaged it's top and bottom-line earnings over the period as the bank increased its impairment provisions. FBN was not the only bank with a loan portfolio skewed to a narrow base of credit assets.    

Factors/Causes of NPLs

The causes of non-performing loans are varied. The principal factors that lead to NPLs in the local Nigerian credit market include but are not limited to, the following:


1.      Poor credit appraisal. Bank credit officers do not take into account the full dynamics of the credit. Credit officers tend to skip environmental, social and governance (ESG) issues that could force a prospective credit to go bad. Further, in analyzing the credit, the absence of proper political, economic, social and technological (PEST) frameworks lead to weak appraisals that compromise the integrity of the credit process.


2.      High incidence of insider-related transactions.  Directors of banks and their friends have had unique access to credit that has, over time, led to asymmetric information bias. The bias means that some groups of borrowers have had better information than others, and this superior knowledge has allowed them a competitive credit advantage. Unfortunately, the advantage equally creates situations of adverse selection where banks lend to the worse creditors. The increasingly poor credit selection processes of banks explain why CBN Governor, Sanusi, a former head of risk management at First Bank of Nigeria (FBN) before becoming the bank's managing director, removed eight MDs from bank boards on assuming office as the CBN Governor.


3.   Weak systemic buffers.  The Nigerian financial system has a low tolerance for downturns in the international oil market as falling oil prices tend to disrupt oil and gas sector revenues, which in turn weaken banking sector liquidity and loan asset quality. Between the drop in oil prices in 2014 and 2016, local Nigerian banks saw their credit exposures spiral into a downward spin as banks with disproportionate loans to the sector had to make large impairment provisions. The large provisions adversely affected both their profit level and growth. Another sector that has pulled down loan quality between 2015 and 2019 is the energy sector, which as a result of the difficulty in recovering cost at the retail end of the market (the distribution companies or "discos"), has led to higher levels of impaired risk assets. A few banks found themselves pulled into an overpowering vortex of bad loans as they got squeezed between both the oil and gas and energy sectors. The lack of depth of other sectors (such as agriculture and mining) meant that the domestic money banks (DMBs) had a little buffer against the contagion of a downturn in international oil prices and a poor cost recovery capacity in the local power sector.


4.  Asset concentration. The concentration of jumbo loans and advances in narrow economic segments has resulted in banks being subject to loan default vagaries in a few markets that could upturn their underlying asset quality. Banks have argued that asset concentration could be justified where industry default risks are low, and the prospects of sustained industry growth are strong.  In particular, they have argued that the oil and gas business is still a safe medium-term bet and that underlying industry cash flows are predictable and sustainable.


5.    The challenges of rising interest rates and higher default risks.  Rising interest rates tend to increase the riskiness of loans. As interest rates rise, borrowers need to guarantee higher operating income to cover higher finance charges. If the commodity or service sold has a close substitute or is not an essential (in other words, what economists refer to as having relatively elastic demand), finding the extra income to cover rising interest charges could prove difficult and perhaps impossible. The result of not being able to pass on higher charges to third parties is that either profit margins thin down or disappear totally, this puts further strain on the ability of the borrower to pay back the loan. An environment of rising interest rates, therefore, fosters loan repayment uncertainty.

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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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