Increased general provisions on performing loans - CAR at risk


Tuesday, November 17, 2015 8:46 AM / CardinalStone Research

Following the circular issued to banks last week Friday by the Central Bank of Nigeria, mandating all banks to immediately increase the general provision on performing loans to 2% from 1%, we highlight below our views on the implications for the banks in our coverage.

Generic impact - higher strain on CAR, FBNH and SKYE at greater risk:
The generic impact of this directive is an increase in equity as banks charge to regulatory or credit risk reserve (the difference between the IFRS-based provisions and general provisions based on CBN's prudential guidelines where the latter is greater), will increase.

However, the increase in regulatory risk reserve cannot be included as part of qualifying capital for the computation of capital adequacy ratio (CAR), which therefore means that capital adequacy ratios will generally be lower.

Banks with relatively lower CAR (below 20% as compared to 16% regulatory minimum for Systemically Important Banks) will be the ones under immediate pressure as their CARs may fall below or come close to the regulatory acceptable minimum. ETI - 16.9%, SKYE - 17.3%, DIAMONDBNK - 18.8%, FBNH - 19.0%, STERLNBANK - 19.3%). If this happens, these banks cannot pay dividends.

Absolute impact on qualifying capital computation higher for Tier 1 Banks: 
Beyond these banks, we believe the absolute impact of this policy on capital computation will be most grim for banks which already have RRRs. For a bank to have credit/regulatory risk reserve, it means the general provisions (even at 1%) was more than the provisions required by the IFRS, which implies that bank is under some strain by the prudential guidelines to recognize higher provisions despite their relatively healthier or lower risk loan portfolio.

The banks that fall under this category include ACCESS, ZENITHBANK, GUARANTY etc. From the 9M results, assuming a linear run-rate in the IFRS-based provisions by these banks by FY, the impact of a 100% increase in general provisioning will widen the margin by which the general provision of these banks is higher than IFRS-based provisions.

Hence, the absolute reduction in qualifying capital (for the purpose of CAR computation is more). Notwithstanding, given a robust capital adequacy ratio for banks like ACCESS, ZENITHBANK etc, the relative impact on CAR will be insignificant.

By CSR analysis, assuming a constant run-rate in risk weighted assets and qualifying capital for banks by FY, a 10% reduction in qualifying capital may lead to a 200bps reduction in capital adequacy ratio.

EDITORS NOTE – Nov 17, 2015 1513hrs:
After publishing the above report, we note the following guidance /exchanges:

Pharez Ratings CEO:
“Loan-Loss Provision does not negatively impact a bank’s Capital Adequacy Ratio. It actually boosts it as Reserves”.  He went on to add that “Loan loss provisions are treated as Tier 2 Capital in the computation of Capital Adequacy Ration (CAR). So the higher it is, the better for the bank since they are like reserves”.

Cardinal Stone Research responded thus Nov 17, 2015 1605hrs:
CBN guidelines for general provisioning is very clear. If the general provisions, which is now 2% of total performing loans exceeds the IFRS-based provisions of the bank, the difference is booked as regulatory/credit risk reserve in shareholders' funds. Yes, it boosts reserves; .but because CBN guidelines clearly excludes this component (the regulatory risk/credit risk reserve) from the computation of CAR (it does not qualify as capital when computing CAR), there's a negative impact on Capital Adequacy Ratio. Capital Adequacy Ratio is Total Qualifying Capital/Risk Weighted Assets.

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