Monday, September 27, 2021 / 11:13 AM / by Fitch Ratings / Header Image Credit: Union Bank of Nigeria
Fitch Ratings has affirmed Union Bank of Nigeria PLC's (Union) Long-Term Issuer Default Rating (IDR) at 'B-' with a Stable Outlook. The National Long-Term Rating has been upgraded to 'BBB(nga)' from 'BBB-(nga)'.
The upgrade of the National Long-Term Rating reflects the bank's improved creditworthiness relative to other issuers in Nigeria.
Key Rating Drivers
IDR and Viability Rating
Union's Long-Term IDR is driven by its intrinsic creditworthiness, as defined by its 'b-' Viability Rating (VR). The VR reflects still weak loan quality and risks to capital mainly from relatively low reserve coverage of Stage 2 and 3 loans and large single-obligor and sectoral credit concentrations. The VR also reflects Union's concentration and sensitivity to Nigerian operating environment risks and moderate franchise. This is balanced by a stable funding and liquidity profile and adequate profitability for the bank's risk profile.
The Stable Outlook reflects Fitch's view that risks to Union's credit profile are captured in the current rating, with sufficient headroom under our base case to absorb the fallout from operating environment pressures.
Operating conditions in Nigeria are gradually stabilising and Fitch forecasts 1.9% GDP growth in 2021, following a 1.8% decline in 2020. Our baseline scenario is that business volumes and earnings should continue to rebound in 2021, while the rally in oil prices is also a positive factor. Nevertheless, downside risks linger, given inherently volatile market conditions, with banks still exposed to foreign-currency (FC) shortages, potential further currency devaluation, rising inflation and regulatory intervention by the Central Bank of Nigeria (CBN).
Union has a well-established brand and nationwide presence and operates across multiple customer segments, but lacks competitive advantages compared with larger Nigerian banks due to its modest franchise (market share of around 5% of sector assets). Union's decision to divest its UK operations (subject to UK regulatory approval, expected by end-2021) will not fundamentally alter the bank's franchise, although it will be capital accretive.
Asset quality is weighed down by large credit concentrations and high Stage 2 loans (end-1H21: 20.5% of gross loans), on which reserves are only 7.4%. Union's Stage 3 loans ratio underperforms peers - rising slightly in 1H21 to 8.7%, down from 24.0% at end-2018 - while total reserves coverage (65%) is relatively low reflecting reliance on collateral.
Our asset quality assessment also captures substantial non-loan assets (end-1H21: net loans accounted for 33% of total assets), largely comprising Nigerian government securities (B/Stable) and restricted placements with the CBN. We expect asset quality pressures to ease, given the improving growth outlook and recovering oil prices, and notwithstanding operating environment challenges.
Union has demonstrated resilient profitability to date reporting an average operating profit/risk-weighted assets ratio of 2.3% over the past four years. Profitability metrics are lower than higher-rated peers due to weaker margins and a high cost/income ratio (76% in 1H21). Its net interest margin contracted to 3.2% in 1H21 from 4.9% in 2020 due to the low-interest rate environment, although earnings were supported by recoveries and growth in fee income.
Union's 16.1% total capital adequacy ratio at end-1H21 is modestly above its 15% minimum regulatory requirement and is supported by qualifying subordinated debt of NGN30 billion (equivalent to 17% of eligible capital), which matures in 2029. Union's Fitch Core Capital (FCC) ratio fell to 14.5% at end-1H21 (end-2020: 16%), underperforming peers. This was mainly due to loan growth, which we expect to continue in 2H21, but largely be offset by internal capital generation.
Capitalisation remains sensitive to asset quality risks and naira devaluation. Pre-impairment operating profit (around 3% of average loans) provides a moderate buffer to absorb loan impairment charges. Stage 3 loans net of total reserves were 15.3% of FCC at end-1H21, down from a peak of 51.0% at end-2018.
Union's loans/customer deposits ratio (end-1H21: 67%) is fairly low, reflecting a high share of reasonably diversified, stable customer deposits (47% retail) and high non-loan assets. FC liquidity is well managed, with sufficient coverage of short-term FC liabilities (mainly deposits and bank borrowings).
Support Rating and Support Rating Floor
Sovereign support to commercial banks cannot be relied on given Nigeria's weak ability to provide support, particularly in FC. The Support Rating Floor of all Nigerian banks is 'No Floor' and all Support Ratings are '5'. This reflects our view that senior creditors cannot rely on receiving full and timely extraordinary support from the Nigerian sovereign if any of the banks become non-viable.
Union's National Ratings reflect its creditworthiness relative to other issuers in Nigeria and are driven by its standalone strength. The upgrade of Union's National Long-Term Rating reflects its increased creditworthiness relative to other Nigerian issuers. Its National Short-Term Rating is the higher of the two possible options for a 'BBB(nga)' National Long-Term Rating under Fitch's criteria, reflecting the relative strength of the bank's funding and liquidity profile, which reduces the vulnerability of default on its short-term local-currency obligations within Nigeria.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The National Ratings are sensitive to Fitch's view of the entity's creditworthiness relative to other Nigerian issuers.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.