Banking System Outlook Update - Nigeria Outlook Changes to Negative Due to Oil Price Collapse


Tuesday, April 28, 2020 / 6:06 PM / by Moody's Investors Service / Header Image Credit: Ecographics


We have changed our outlook for Nigeria's banking system to negative from stable. This reflects our view that banks will face weakening loan quality and foreign-currency liquidity challenges as depressed oil prices and the coronavirus pandemic weigh on Nigeria's economy. These new difficulties add to existing headwinds from weak economic growth and rising regulatory costs. Nigeria's largest banks, however, will continue to benefit from a high probability of government support.

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Economic conditions will weaken due to coronavirus and low oil prices. We expect low oil prices and fallout from the coronavirus pandemic to place further pressure on the Nigerian economy, which was already falling short of growth rates required to increase per capita income. We expect real GDP to contract by 0.8% in 2020 before expanding by 0.9% in 2021, still below the rate of population growth. The economy will remain sensitive to oil price movements because a large part of the country's foreign-currency earnings are derived from oil exports. We expect credit growth to slow, mainly as a result of reduced corporate lending, but facility drawdowns by companies, whose cash flows have tightened, will likely support short-term loan growth. In addition, the Central Bank of Nigeria, as part of its response to the coronavirus pandemic, is making funds available via banks, helping to ease the slowdown in loan growth.


Loan quality will deteriorate due to the challenging economic conditions. Weaker economic growth and the collapse of the oil price will lead to a deterioration in banks' loan performance. We expect problem loans to rise to between 8% and 10% of total loans from 6% in December 2019, with risk tilted to the downside should the depressed oil price persist for more than a year. Loan restructuring and forbearance will lessen the impact of loan quality deterioration.


High levels of corporate loans pose further asset risk. Despite the measures taken by the Nigerian central bank to support the economy, we expect the creditworthiness of most Nigerian corporate borrowers to weaken. Since corporate borrowers account for around 90% of banks' loans, banks' asset quality will deteriorate. In addition, Nigerian banks have extended large volumes of outsized loans to single customers. We believe the top 100 customers represent more than 40% of total gross loans in the banking sector, leaving the banks disproportionately vulnerable to defaults by one or a number of borrowers.


Banks' exposure to the oil and gas industry is substantial, at around 27% of total loans at the end of 2019. The quality of banks' oil and gas loan portfolios will further deteriorate as a majority of these loans were extended to the upstream and service segments, where borrowers are more sensitive to oil price movements than downstream. However, a substantial amount of upstream and midstream loans were restructured to match borrowers' cash flows during the 2015-16 oil price slump, and some banks have hedged against a low oil price. Lower oil revenue for the government could also hurt downstream oil and gas borrowers that receive federal subsidies, as these payments may be delayed.


Nigerian banks' high exposure to foreign-currency loans will be a further asset quality pressure point in the event of a naira devaluation. Some 41% of loans extended by Moody's-rated Nigerian banks are denominated in foreign currencies, predominantly dollars. Some of these borrowers are vulnerable to a devaluation of the naira, as they do not earn foreign-currency income. A weaker naira would increase their debt repayments so reducing their repayment capacity. We expect some foreign-currency loans to be converted into local currency if persistent low oil prices pressure the naira exchange rate.

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Capital ratios will reduce but remain adequate in our base-case scenario. Nigerian banks' capital ratios will decline but remain sufficient to absorb unexpected losses under our baseline scenario. We expect system-wide tangible common equity (TCE) to decline to 13% of risk-weighted assets (Moody's adjusted)1 at year-end 2021 from 14% at the end of 2019. This is primarily because of higher risk-weighted assets and an anticipated increase in loan-loss provisioning costs, which will erode the banks' profitability. In the event of a naira devaluation, banks' risk-weighted assets will further increase due to their large volume of foreign-currency denominated loans. We expect Nigerian banks to counter pressures on capital ratios by reducing their dividend payouts. In addition, banks have high loanloss reserves at about 90% of nonperforming loans.


Profitability will deteriorate due to strained revenue and rising loan losses. We expect Nigerian banks' profitability to weaken substantially due to lower lending margins and higher costs, with return on assets falling to 0.5%-1% in 2020 from about 2.5% at yearend 2019. Constrained interest income because of limited loan volumes and lower asset yields, cost pressures from investments in IT, a levy to cover the cost of banking resolution and higher loan-loss provisions will strain banks' profits. We expect provisions to increase to 2.0%-2.5% of gross loans from about 0.5% in 2019 for the Moody's-rated banks. Nigerian banks' efficiency will also deteriorate as costs outpace revenue, raising their cost-to-income ratios. Nigerian banks were already inefficient compared with other large subSaharan banking systems, with an average cost-to-income ratio of close to 70%.


Local currency funding and liquidity will remain robust, but foreign-currency liquidity will decline. Nigerian banks' local currency liquidity and funding profiles will remain strong. The banks' proportion of liquid assets to overall deposits was high at about 38% in 2019, surpassing the regulatory requirement of 30%. However, Nigeria has historically been susceptible to outflows of dollar deposits in times of financial and exchange-rate policy uncertainty or low oil prices. We expect the growth of foreign-currency deposits, which contribute about 25% of total deposits, to fall substantially. This will lead to renewed foreign-currency shortages if low oil prices persist.


The likelihood of government support for the largest banks if required will remain high. We assume a high likelihood of government support for the largest, systemically important banks and a moderate probability for all other banks in the financial system.


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Overview of Banking System Outlooks

Banking system outlooks represent our forward-looking assessment of fundamental credit conditions that will affect the creditworthiness of banks in a given system over the next 12-18 months. As such, banking system outlooks provide our view of how the operating environment for banks, including macroeconomic, competitive and regulatory trends, will affect asset quality, capital, funding, liquidity and profitability. Banking system outlooks also consider our forward-looking view of the systemic support environment for bank creditors.


Since banking system outlooks represent our forward-looking view on credit conditions that we factor into our bank ratings, a negative (positive) outlook suggests that negative (positive) rating actions are more likely, on average.


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