Nigerian Banks - Positive Developments, but Uncertainties Remain

Proshare

Thursday, July 07, 2016 4.35PM / Exotix Frontier Research

Valuation Update
In this report, we update our earnings forecasts and valuations for our Nigerian Banks universe which consists of Access Bank, Diamond Bank, FBN Holdings, FCMB Group, Fidelity Bank, Guaranty Trust Bank, Stanbic IBTC Holdings, Skye Bank, United Bank for Africa, Wema Bank and Zenith Bank.

Clear (and mostly positive) Developments
Compared to our February 2016 update, the FY15 and Q1 16 earnings announcements indicate a clearer trend across many of the banks’ profitability drivers, the outlook for many of which we think are positive following recent macro-economic and regulatory developments.  

In particular, we highlight:

·         Strong loan growth: on average 42% of banks’ loan books are FX denominated. We therefore expect the recent devaluation (we are assuming a 50% devaluation) will push up average loan growth to 16.2% yoy (from 5.6% in FY14) and thus support top-line growth.

·         Rebound in NIR: compared to earlier this year (when we were forecasting NIR for Tier 1 banks to decline by 32.3% on average), we now forecast it to grow by 5.9% yoy in FY16 due to a) introduction of account maintenance fees to replace commission on turnover; b) aggressive growth in other fee income streams by the banks; c) liberalisation of FX trading should lead to a recovery in trading revenue and letters of commissions income; and d) the positive net open FX position should translate to significant revaluation gains. We believe the outlook in the medium term also remains positive as the impact of various regulatory changes over the past three years gradually eases up.

·         Improving operating efficiency: the tough operating environment has forced many of the banks to implement cost-cutting strategies over the past couple of years, resulting in their operational leverage (opex to total average assets) declining from 6.4x in FY11 to 5.4x in FY15. We therefore estimate banks’ operating efficiency ratios should benefit significantly from any turnaround in top-line growth - we forecast the CIR will decline from an average of 66.2% in FY16 to 52.1% by FY20.

·         Margins to remain suppressed in the short term: we believe banks will be unable to retain the 50bp yoy increase in NIMs in Q1 due to the recent surge in money market rates (due to the decline in Naira liquidity in the system following the liberalisation of the FX rate) and increase in FX-denominated assets (due to the devaluation). We expect average NIMs to drop to 5.9% by year end (from 6.0% as at Q1) and 5.8% in FY17 before recovering to 6.2% by FY20.  

But Uncertainties Remain
The dominant investment theme for Nigerian banks remains their underlying asset quality trajectory and ability to absorb any major shocks to the same, and in this regard there remains a significant amount of uncertainty. We therefore continue to base our investment thesis on a probability-weighted sensitivity model first introduced in September last year. In this regard, we observe the recent accommodative stance of the CBN towards the banking sector.  

Thus unlike in our February update, we believe banks will be given a number of years to absorb any major deterioration in asset quality. We thus set up the various scenarios as follows:                            

·         Bull case scenario (2% probability):  in line with management guidance, we estimate asset quality ratios remain muted - we forecast a 50bp yoy decline in NPL ratio to 4.3% and a 20bp yoy decline in average cost of risk to 1.9%.

·         Base case scenario (50% of probability):  we estimate average sector NPL ratio increases to 7.8% based on an assumption of a 10% NPL ratio in the upstream oil and gas, power, general commerce, retail and manufacturing sectors and a 3% NPL ratio in other sectors. Accordingly, we estimate average cost of risk increases to 3.1% over the next three years.

·         Bear case scenario (48% probability): estimate average sector NPL ratio increases to 15.6% based on an assumption of a 25% NPL ratio in the upstream oil and gas and power sectors, 20% in general commerce, retail and manufacturing sectors and 5% NPL ratio in other sectors. Accordingly, we estimate average cost of risk increases to 4.9% over the next three years.  

On a probability-weighted basis, we estimate the average ROE will drop from 9.1%% in FY16 to 5.2% in FY16 and 6.4% in FY17 before recovering to 19.8% by FY20. Likewise, we estimate the probability-weighted capital adequacy ratio will drop by 160bp yoy to 15.6% before recovering to 16.5% by FY20.  

We remain NEUTRAL on the Sector
On a probability-weighted basis, we estimate an average justified P/BVPS of 0.6x which is moderately lower than the average FY16f P/BVPS of 0.7x, validating our Neutral stance on the sector.  

Specific Take on Nigerian Banks - GTB remains Top Pick
GTB remains our top pick (Buy, target price NGN33.3) due to the bank’s ability to sustain capital adequacy above the regulatory minimum even under all three scenarios and sustain a market leading probability-weighted ROE of 23.0% Likewise, we continue to like Zenith (Buy, target price NGN27.0) and UBA (Buy, TP NGN11.6) as, like GTB, we estimate both banks will be able to sustain regulatory capital ratios under all three scenarios. We rank both banks below GTB due to their low profitability profile – average probability-weighted ROE of 18.1% for Zenith and 17.3% for UBA.  

We upgrade Access to Hold (TP NGN6.4) as the bank makes progress in replacing its derivative gains by improving its margins and operational efficiency. Despite significant potential upside, we maintain our Hold recommendation on FBNH (TP NGN6.4) due to concerns about its asset quality and capital adequacy. Likewise, despite the potential upside we remain cautious on Skye (TP NGN3.0) and Stanbic IBTC (TP NGN26.9) as both banks are yet to release FY15 and Q1 16 earnings estimates, thus reducing the visibility of their forecasts.  

We upgrade FCMB (TP NGN1.6) and Fidelity (TP NGN1.3) to Hold on the back of the significant declines in their share prices and thus lower valuations (both banks are trading at FY16f P/BVPS of 0.3x).  

We maintain our SELL recommendation on Wema Bank (TP NGN0.5) due to its poor profitability profile and ability to absorb NPL shocks.  

READ THE FULL REPORT

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