Afrinvest Special Report on Nigerian Banking Sector – July 2013

Proshare


Sunday, July 14, 2013 / Afrinvest

 

Prologue 

We provide herewith an executive summary of the Afrinvest special report on the 2013 Nigerian Banking Sector Report. Needless to say, it summarizes in a rather unique way, a rating of the reform process for the first time, without losing sight of the most important objective of the reform programme – to cleansed and de-lever the country’s banks. Yet, the banking reforms did more than this – it gave us a central bank, more sensitive to Naira values and inflation targeting.
 

The Nigerian banking sector (which constitutes about 31% of the stock index), has since 2008, seen more than doubling in foreign participation. With a price-to-book ratio of 0.93x; average dividend yield of over 5.8%; and a PE ratio of only 5.92 the sector remains supremely attractive in a world of global quantitative easing with no end in sight.
 

As Damina Advisors  pointed out in their December 2012 periscope – “The bullish economic and capital market sentiments emanating from Nigeria are in sharp contrast to the growing investor unease over the seemingly radical adoption of the faddish new theory of ‘nominal GDP targeting’ promoted by a new quasi-orthodox school of economists, dubbed the ‘market monetarists.’ This group essentially argues that instead of central banks pursing standard orthodox policies focused primarily on checking inflation and maintaining the purchasing power of national currencies, countries potentially caught in a deflationary spiral should stop targeting forward looking inflation indicators, and target backward looking nominal GDP and figures such as unemployment”.
 

Like all initiatives out of Africa, our financial sector reform, nay macro-economic stable growth in GDP and steadiness of exchange and inflation rates within a band was expected to fizzle out. It has not, indeed analysts like Sebastian Spio-Garbrah, Managing Director & Chief Analyst, African Frontier Markets concludes thus:
 

In contrast, Nigeria, after a hiatus of almost four years, 2013 will likely see a strong influx of new international fixed income equity investors into its capital markets in search of high stable yields and returns in an appreciating currency environment. Nigeria’s stock market sentiment, which is heavily influenced by banking stocks, may in 2013 see its strongest run in years, as foreigners and Diaspora Nigerians seek to re-invest in the country’s cleansed and de-levered banks. Over $35 billion worth of bad loans have been siphoned from the sector over the past three years by the government “bad bank,” Asset Management Corporation of Nigeria, leaving Nigerian bank balance sheets, governance structures and quality of assets as among the best in world (OECD inclusive). Unlike in most other emerging and frontier markets, in Nigeria, all pre-2008 bank CEOs have been replaced across the entire sector; and an open forensic audit has been done on all the country’s banks - a regulatory feat not even equaled in the UK, Spain, Russia, China, Brazil or the US.”
 

It is against this background that local and international interest in the Afrinvest Special Report on Nigerian Banks is seen as understandable - if not for the insight and teachable lessons it should provide about the reform undertaken; it must therefore be because of the prominence of Nigeria as a leading economy in Africa and the butterfly effect its banking sector wields. Needless to add, a clean bill of health for Nigerian banks (as envisaged by Proshare Analysts) should easily translate into a revalidation of the reforms programme embarked upon and a strong pillar of force to support economic growth and confidence in the banks - as they go through a new competitive landscape; and as they transit into the ‘era of real banking’.
 

We share with you below the executive summary of the report due on July 24th , 2013.
 

On the Brink of Financial System Collapse 

Since August 2007, with the crisis in US subprime loans, the world economy has been reeling from an unprecedented series of interrelated and contagious crises. The sub-prime crisis led to the collapse in the US, first, of Bear Stearns, then Lehman Brothers, and subsequently other globally renowned and lesser known financial institutions around the world. The ensuing global credit crunch bankrupted Greece, and shortly thereafter Ireland, Portugal, Spain and Italy were negotiating bailouts in quick succession with the EU, IMF and bond markets; leaving today’s investors with fundamentally unanswered questions regarding the political structure and long-run viability of the EU in its present form.
 

Nigeria was not insulated from these events by any means. Shocks to our economy arrived through trade and investment conduits to the global economy. A precipitous decline in oil prices in 2008 put government revenues into a tail-spin and there was no soft landing. Continuing fiscal expansion contributed to depreciating exchange rates for the naira; with damaging knock-on effects on Nigerian oil marketers and their bankers’ substantial market risk exposures (i.e. oil and currencies).
 

Most international investment funds had long since exited Nigeria. Being a mainstay of our stock market’s lofty pre-crises rise, subsequently departing foreign patrons initiated what culminated in a 70% dive in the value of the NSE Index. The stock market’s collapse was the final straw for what, in reality, was an already embattled banking system with significant and rapidly souring exposures to equity market risk. Finally, in the 2nd Quarter of 2009, the Central Bank of Nigeria officially acknowledged growing alarms within professional quarters of the public. A number of Nigerian banks had been dallying with solvency issues, with potentially catastrophic, system-wide implications.
 

First Bank of Nigeria’s MD/CEO, Mallam Sanusi Lamido Sanusi was appointed Governor of the Central Bank of Nigeria in June 2009. The appointment galvanized Central Bank into taking critical steps to preserve depositor confidence and liquidity. These included suspending Expanded Discount Window operations, injecting N640bn into 8 distressed banks, and orchestrating the dismissal and investigations of their managements. Such unprecedented actions by regulators threw rich and politically connected debtors into their own mini-crisis. Predictably, various speculative narratives surfaced about the CBN Governor’s “grandiose northern agenda against southern Nigeria” or an alleged “Islamic agenda being pushed by a Muslim fundamentalist”. Some even posited “that the CBN had no agenda at all and was making plans on the fly”.
 

These events provided the backdrop against which, in February 2010, Mallam Sanusi delivered a convocation lecture at Bayero University, Kano titled, “The Nigerian Banking Industry: what went wrong and the way forward”. The new governor outlined the CBN’s vision and roadmap for the Nigerian banking sector, highlighting the key interdependent factors that led to the creation of an extremely fragile financial system. These factors were:
 

1. Macro-economic instability caused by large and sudden capital inflows;

2. Major failures in banks’ corporate governance;

3. Lack of investor and consumer sophistication;

4. Inadequate disclosures and transparency on the financial position of banks;

5. Critical gaps in the regulatory framework and regulations;

6. Uneven banking supervision and enforcement;

7. Unstructured governance & management processes at the CBN / Weaknesses within the CBN; and

8. Weaknesses in the business environment.
 

While each of these factors was serious on its own right, acting together they conspired to bring the entire Nigerian financial system to the brink of collapse.
 

Outpacing the Giants in a Global Recovery 

Since the events of 2008/2009, the global economy has reeled from one socio-political or economic crisis to another. From the potential breakup of the Euro zone, to the Arab Spring, to the contraction that would have followed a U.S. fiscal cliff plunge, to the Syrian crises, to the dilemma of bailing out Greece and more recently, to Egypt’s political upheaval, the frequency of global issues and challenges are such that central bankers have learnt to sleep with one eye on the computer screen. It is within this context that the 2013 Nigerian Banking Sector Report berths, coming at a time of positive economic growth in both emerging markets and developing economies.
 

According to the World Economic Outlook (WEO) Update published in July 2013, the world economy is projected to grow by 3.0% in 2013 as against actual growth of 2.3% in 2012. However, growth in Sub Saharan Africa (SSA) is expected to be weaker as some of the largest economies (Nigeria and South Africa) struggle with domestic problems and weaker external demand. The SSA region is poised to deliver growth of 2.0% in 2013 lower than the 2.5% growth achieved in 2012.
 

Domestically, the Nigerian economy grew by 6.9% in 2012 and has sustained a Q-o-Q growth in excess of 6.0% in 2013, driven by agriculture (33.6%), wholesale and retail trade (23.8%) and crude oil and natural gas (14.8%). This is coupled with declining single digit inflation rate (12.0% Q1 2012 – 9.5% Q1 2013) and a fairly stable exchange rate.
 

2012 Banking Landscape 

In 2012, Nigerian banks management faced the challenge of trying to beat high earnings expectations which encouraged them to leverage on the high yield environment and increase exposure to fixed income securities in order to maximize tax free returns. We expect this “treasury focused” investment strategy to moderate in 2013 as outlook on yields and fee income decline. Tier-1 Banks account for 68.0% of the N21.3 trillion of industry assets, with First Bank alone racking up a N3.2 trillion asset base (or 15.0% of industry assets). A look at banks profitability in 2012 shows a clear separation of the boys from the men as all Tier-1 banks recorded gross earnings in excess of N200 billion compared to Tier-2 banks’ N102.0 billion average. Our DuPont analysis of banks 2012 ROE also revealed that most Tier-1 banks’ impressive earnings resulted from high profit margin whereas Tier-2 banks depend more on asset turnover to grow earnings.
 

The 4 Pillars of Banking Reform 

In advocating solutions that the CBN was going to be pursuing to right the then ills of the financial system in 2010, Sanusi laid out a blueprint for reforming the Nigerian financial system built around 4 pillars as follows:

Pillar 1: Enhancing the quality of banks

Pillar 2: Establishing financial stability

Pillar 3: Enabling healthy financial sector evolution

Pillar 4: Ensuring the financial sector contributes to the real economy
 

Afrinvest Research has scored the performance of the CBN against Sanusi’s 4-point “Transformation Agenda” on a scale of 1-5 with “1” representing “Work-in-Progress”, “2” representing a “Weak Pass”, “3”representing“Good Performance”,“4” representing “Very Good Performance” and lastly “5” being equivalent to “Outstanding Performance”.
 

1. Enhancing the quality of banks: In the first pillar, the CBN intended to initiate a 5 part programme to enhance the operations and quality of banks in Nigeria. The programme was expected to consist of industry remedial programmes to fix the key causes of the crisis. It would also include implementation of risk based supervision, reforms to regulations and regulatory framework, enhanced provisions for consumer protection, and internal transformation of the CBN. Afrinvest Research hereby awards the CBN a 3, equivalent to a Good Performance on the implementation of this reform pillar.
 

2. Establishing Financial Stability: The key feature of the second pillar centred around strengthening the financial stability committee within the CBN, establishment of a hybrid monetary policy and macro-prudential rules, development of directional economic policy and counter-cyclical fiscal policies by the government and further development of the capital markets as an alternative to bank funding. Afrinvest Research hereby awards the CBN a 4, representing Very Good Performance on the implementation of this reform pillar.
 

3. Enabling healthy financial sector evolution: The 2009 stress tests exposed huge toxic assets on bank’s balance sheet. Consequently, the creation of Asset Management Corporation of Nigeria (AMCON) was the first step towards easing the burden of over N3.0trillion of Non-Performing Loans. In addition, the hitherto Universal Banking Model of banking was to be restructured into International, National, Regional mono-line and specialized licenses. Afrinvest Research hereby awards the CBN a 4, representing Very Good Performance on the implementation of this reform pillar.
 

4. Ensuring the financial sector contributes to the real economy: Rapid financialisation in Nigeria has not benefited the real economy as much as had been anticipated. Domestic development financial institutions set up for specific purposes such as mortgage/housing finance, trade finance and the Bank of Industry (BOI) are far from fulfulling their mandates. The outcome of the banking consolidation was expected to deliver advantages of scale boosting growth in the real economy though the provision of credit. With the implementation of the preceding three pillars, banks were expected to begin to engage the real economy through initiatives such as development finance, foreign direct investment, venture capital and public private partnerships. Afrinvest Research hereby awards the CBN a 2, representing Weak Pass on the implementation of this reform pillar.
 

Emerging Trends and Outlook 

Afrinvest Research believes that the future of the Nigerian banking space will rest on ancillary banking services such as Merchant Banking and Primary Mortgage Institutions; as well as Retail and SME banking. The industry is now confronted with the reality of declining fee incomes, mobile money and dollar denominated capital sourcing. The era of “real banking” appears to be gradually re-emerging as traditional sources of high income/profitability continue to come under threat from increased competition and tighter regulation.
 

On a balance of options, we expect a blend of the following service models to characterize the Nigerian banking space within the next 5 years:

  • ·Outlook on yields and fee income remain downwards, necessitating the need for banks to focus on lending to the real sector.
  • · Banks need to develop and grow the depth of their core retail banking business to retain and amplify cheap deposits.
  • · Banks need to expand their geographic footprint and business scope as urbanization gradually remodels cities and sub-urban areas.
  • · Mid-Tier banks will need to consolidate and integrate vertically in order to compete with Tier-1 banks as economies of scale and scope increasingly become differentiating success factors.

 

Editors Note: The Afrinvest Special Report on Nigerian Banks in 2013 will be formally presented to the public on July 24, 2013 at the Oriental Hotels, Lagos.

 


Disclaimer/Advice to Readers:
While the website is checked for accuracy, we are not liable for any incorrect information included. The details of this publication should not be construed as an investment advice by the author/analyst or the publishers/Proshare. Proshare Limited, its employees and analysts accept no liability for any loss arising from the use of this information. All opinions on this page/site constitute the authors best estimate judgement as of this date and are subject to change without notice. Investors should see the content of this page as one of the factors to consider in making their investment decision. We recommend that you make enquiries based on your own circumstances and, if necessary, take professional advice before entering into transactions. This article is published with the consent of the author(s) for circulation to the online investment community in accordance with the terms of usage. Further enquiries should be directed to the author Afrinvest West Africa, whose e-mail is aresearch@afrinvest.com

READ MORE:
Related News
SCROLL TO TOP