Tuesday, October 06, 2020 / 11:43 AM /by Fitch Ratings/ Header Image Credit: Nigerian Banker
Fitch Ratings has maintained Wema Bank PLC's Long- and Short-Term Issuer Default Ratings (IDRs), Viability Rating (VR) and National Ratings on Rating Watch Negative (RWN).
The RWN on Wema's ratings reflects continued near-term risks resulting from the bank's weak core capitalisation and leverage, pressured by growth and by the impacts of the economic downturn that have also started feeding through into deteriorating asset quality and profitability. The bank intends to have a significant capital raising over the next 12-18 months but Fitch recognises a degree of uncertainty as to whether the capital increase will materialise.
As for peers, it will take several quarters before the full extent of the crisis on corporates and households is seen in its financial metrics. Since the previous rating action in March, regulatory forbearance on asset classification and banks' own debt relief measures have significantly eased sector asset quality pressures. Debt relief measures are, nevertheless, temporary and with the eventual easing of fiscal and monetary support from the Central Bank of Nigeria (CBN), there remains a material risk that bank asset quality could deteriorate faster, unless economic recovery gathers pace.
Fitch expects to resolve the RWN in the next six months once it gets more clarity on the recapitalisation plan and after it has assessed the bank's capital and leverage position in the context of the weaker operating environment and the impact this will have on the bank's financial profile.
Key Rating Drivers
Issuer Default Ratings And Viability Rating
Wema's IDRs are driven by its standalone creditworthiness, as expressed by its 'b-' Viability Rating (VR). The VR primarily reflects Wema's weak core capital ratios that are lower than peers' and the increased vulnerability of its capital in the context of weakened earnings generation, continued credit growth and asset quality pressures as the bank's loans season in the weaker domestic operating environment. Capitalisation and leverage is a key rating weakness and is a factor of high importance to the VR. The ratings also incorporate Wema's small franchise, high credit concentrations and a weak funding structure.
Wema's Fitch Core Capital (FCC) ratio of 12.1% at end-1H20 is markedly below the peer average and has been declining in recent years due to strong loan growth. The bank's tangible common equity/tangible assets ratio of 4.4% at end-1H20 is also considerably below peers'. Wema's total capital adequacy ratio (11% at end-1H20) had only 100bp headroom over the bank's 10% regulatory minimum requirement; however, we recognise that 1H20 unaudited earnings are excluded from this calculation.
A weak pre-impairment operating profit provides limited room to cushion the impact on capital from a potential spike in loan impairment charges. Wema plans to increase core capital through a significant rights issue within the next 12-18 months but uncertainty remains about these plans. High risk concentrations and growth remain the main risks to capital.
Wema's profitability metrics are considerably lower than those of rated peers due to a relatively weak net interest margin (NIM) and high cost-to-income ratio. Operating returns over risk-weighted assets declined to 1.2% in 1H20 (on an annualised basis, from 2.6% in 2019) despite relatively small loan impairment charges incurred in response to the pandemic, driven by a decline in the bank's NIM and net fees and commissions. Similar to peers, we expect the bank's profitability to remain under pressure over 2H20 and 1H21 as operating conditions remain challenging.
Wema's impaired loans (Stage 3 loans under IFRS 9) ratio increased moderately to 5.6% at end-1H20 (from 3.0% at end-2019) due to the classification of several large exposures. It is broadly in line with the sector average. Strong loan growth in recent years has flattered the bank's impaired loans ratio and may lead to a lag effect on loan quality. Specific coverage of impaired loans (49% at end-1H20) is considered adequate when regarding collateral coverage and recovery expectations. Stage 2 loans (10.7% of gross loans at end-1H20) are lower than peers' but are highly concentrated by single-borrower, including one large upstream oil and gas exposure. Fitch considers that these loans, in addition to a material proportion of loans that are benefitting from debt relief measures (around 30% of gross loans at end-1H20, primarily repayment moratoria), may lead to pressure on asset quality.
As for peers, credit concentration is a key risk. Single-borrower concentration is exceptionally high, with the largest 20 customer exposures at 4.5x FCC at end-1H20. Exposure to the oil and gas sector is material, representing 20% of gross loans or 196% of FCC, but exposure to the riskier upstream segment is more limited than for peers. Foreign currency lending (10% of net loans at end-1H20) is lower than peers and Wema's balance sheet is less dollarised and, therefore, we have less concerns around foreign exchange devaluation risks than we have for other banks.
Funding is mainly in the form of a customer deposits. Wema's deposit base is less stable than peers' due to a very high reliance on term deposits (59% of customer deposits at end-1H20) and only a moderate volume of retail deposits (33% of customer deposits). Single-depositor concentration is high, with the largest 20 depositors accounting for 24% of customer deposits. Liquidity coverage in both local and foreign currency is considered adequate.
Wema is a small Nigerian bank, accounting for 2% of domestic banking system assets and customer deposits, respectively, at end-2019. Wema operates exclusively in Nigeria under a national banking license.
Support Rating And Support Rating Floor
Sovereign support to banks cannot be relied on given Nigeria's weak ability to provide support, particularly in foreign currency. 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.
Wema's National Ratings reflect its creditworthiness relative to other issuers in Nigeria and are driven by its standalone strength. They are at the lower end of the scale, primarily reflecting Wema's small franchise, weak capitalisation and weak funding profile.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Factors that could, individually or collectively, lead to negative rating action/downgrade:
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.
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