Nigerian Banks' IFRS 9 Shows Asset Quality Is Still Weak


Wednesday, April 15 2019  03:43PM / Fitch Ratings


Nigerian banks' recent IFRS 9 disclosures support Fitch Ratings' view that asset quality continues to be a weakness for the sector. The end-2018 results, the first under IFRS 9, gave new forward-looking information on asset quality. Stage 3 (impaired) loans under IFRS 9 were broadly stable at 9.4% of gross loans at end-2018, helped by recoveries and write-offs during the year as well as more favourable operating conditions. However, high levels of other problem loans and low reserve coverage continue to weigh on the sector and on ratings for all Nigerian banks. 

The IFRS 9 disclosures showed high levels of Stage 2 loans, which exhibit significantly increased credit risk but are not yet impaired. Stage 2 loans weigh on our assessment of banks' profitability, asset-quality and capitalisation metrics given their risk of migrating to Stage 3. The extent of this risk is linked to the direction of Nigeria's operating environment and particularly to oil prices and production. We combine Stage 2 and 3 loans to generate a 'problem loans' ratio, an assessment that gives a better indication of asset quality than Stage 3 loans alone, in our view.


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In Nigeria, Stage 2 loans mostly comprise restructured loans, particularly to the oil and gas sector. They also include loans that are 30 or more days' overdue and model-driven classifications caused, for example, by credit rating downgrades. Stage 2 loans ranged from 7.5% to 25.7% of gross loans across Fitch-rated Nigerian banks at end-2018, with an average of 16%. Banks with above-average exposure to the oil and gas sector, and those with previously weaker underwriting standards generally reported higher proportions. 

Stage 3 loans likewise reflected the weak domestic operating conditions and sluggish economic growth, averaging about 9% of gross loans. Stage 3 loans comprise credit-impaired loans, including all loans that are 90 days' overdue. 

Reserve coverage of problem loans (Stage 2 and 3 combined) is weak, averaging 29% among Fitch-rated Nigerian banks at end-2018. This is primarily due to low coverage of Stage 2 loans. While some loans are backed by collateral, enforcing collateral can be difficult in Nigeria.


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FBNH (B-/Positive), Union Bank of Nigeria and FCMB (both 'B-'/Stable) are the most exposed to a potential spike in reserve needs given their high proportion of Stage 2 loans and thin capital buffers over minimum regulatory requirements. However, we do not expect substantial migration of Stage 2 loans to Stage 3, given the slowly improving operating environment for Nigerian banks and our relatively stable forecast for oil prices. 

The additional provisions required by IFRS 9 for expected credit losses reduced Nigerian banks' Fitch Core Capital and tangible leverage ratios. They had less impact on regulatory capital as they were offset against 'regulatory credit risk reserves' (RRR). However, some banks with insufficient RRR to meet the extra provisions faced large erosion of regulatory capital as they had to make use of retained earnings. Based on our assessment, three banks would have fallen below minimum regulatory capital requirements at end-2018 without the Central Bank of Nigeria's transitional arrangements to spread the impact over four years.


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Strong pre-impairment operating profitability should help Nigerian banks to meet regulatory capital requirements as the transitional allowances amortise, and we expect some small and medium-sized banks to issue Tier 2 subordinated debt to strengthen their capital buffers

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