February 15, 2018 /5:10 PM / ARM Research
Across our Tier 1 banking universe, we beam our spotlight on FBN Holdings (FBNH). The bank trades at a P/B of 0.7x compared to peer average of 1.4x, and its FY 17E P/E of 6.6x is at a sizable discount to current P/E of 18.8x. Furthermore, at current pricing, our 2017E dividend translates to dividend yield of 6.8%.
Our View: Following a dramatic share price decline (-21.7% from the year-peak of N14.75), FBNH looks increasingly attractive underpinned by improving asset quality and above par core banking metrics. Precisely, we see further potential upside from lower provisioning, resilience in Net Interest Margin (NIM), operational efficiency and possible streamlining of branches. Consequently, we estimate FY 17E EPS of N1.72 (9M 17: N1.28) and N3.18 for FY 18F – implying a 260% and 85% growth in EPS in FY 17E and FY 18F accordingly, given the materially low base in 2016.
Lower Provisioning Guides To Earnings Expansion
Over the last 11 quarters, FBNH has booked ~ N442 billion on loan loss provision stemming from deteriorating loan quality with NPL ratio and Cost of Risk (CoR) printing at 25% and 10.8% respectively as at FY 2016 (FY 2015: 18.1% and 6.1%). Much of the provisioning stemmed from concerns on its exposures to Oil & Gas, ICT and Manufacturing sectors with Atlantic Energy, 9mobile, Oando, amongst others posing specific risk to loan quality. Irrespective, over the first nine-months of 2017, asset quality has recovered with NPL and cost of risk declining to 20% and 6.4% respectively.
Much of the improvement has come from the downstream oil and gas sector where NPL concentration declined to 11% in 9M 17 from 35% in FY 16. According to management, the bank has achieved noteworthy progress with regards to the remediation of its two largest delinquent assets in the subsector. Management also noted that it has restructured the credit facility and received cash flow required to make interest payments over 2017. Consequently, the bank reclassified the assets as performing in the third quarter.
Going forward, we expect to see sizable improvement from its upstream Oil and Gas (O&G) exposure which currently constitutes 43% of NPL as at 9M 17. Given the recovery in crude oil production and higher crude oil prices, we expect upstream O&G NPL to moderate to ~30% in FY 18. Thus, Atlantic Energy loan, of ~ N140 billion, is expected to remain the major NPL in its upstream O&G books. On that front, though management is optimistic on a possible resolution even as assets (8 oil fields) remains productive, government delays has informed our cautious view on NPLs reclassification. Furthermore, we expect the collateral of dragging downstream assets to be disposed, which supports further contraction in downstream NPLs.
Elsewhere on 9mobile and Oando, the resolution of 9mobile’s debt is progressing well. The infrastructure of the business is quite modern being the last of the licensed Telcos with significant interest from a number of investors. In addition, the business has not significantly lost customers and its revenue remains very strong. We expect conclusion of sale by YE 2018. Oando is essentially an ownership dispute. The operational activities of the business have not been curtailed by any means. Similarly, we do not expect any significant impact on Oando’s capacity to meet its obligations. Notwithstanding, FBNH’s exposure to 9mobile and Oando is relatively low at 1.25% and 0.05% of the bank’s loan book respectively.
More of reclassification than write-backs: While the prospect of reclassifying NPLs to performing loans guides to a possibility for write-backs, we note concerns on exposure to manufacturing, trade, and real estate. Though regulatory guidelines remain pending, the adoption of IFRS 9 signifies a shift from incurred to expected losses. Thus, we think the long-term outlook on crude oil price, which ties to the fragility of these sectors, guides to the prospect of reclassification of impairments. Consequently, we tilt towards the side of prudence and expect sector reclassification on collective provisioning which cools off the possibility of complete write-backs. Overall, we forecast NPL and Cost of Risk in FY 18F to print at 18% (FY 17E: 20%) and 3.5% (FY 17E: 6.5%) respectively. This implies FY 2018 loan loss provisioning of N78.5 billion relative to N138.1 billion for FY 17E.
Asset quality risk and earnings: We present a sensitivity analysis of Cost of Risk and provisioning (impairment) to earnings. Our analysis shows a 300bps increase in Cost of Risk to 6.5% (same as 2017) which according to our estimates imply a 7% decline in EPS for FY 2018E. We highlight that our stress test analysis here is based on a worst-case scenario where the bank may have to provide more for specific assets with concerns. The possibility of this scenario playing out is small, in our view. Consequently, we maintain our base case assumption of 3.5% Cost of Risk, which guides to provisioning of N78 billion and PAT of N114 billion for FY 2018F.
Operational Efficiency To Remain Resilience
On asset yields, despite our expectation of a 200bps decline in yields on investment securities, the largely sticky nature of interest rate on loan books should moderate the impact of a lower yield environment. Accordingly, we forecast asset yields of 15% for 2017E and 2018F, and an average of 14.8% for the period 2019F-2021F. Overall, we forecast NIMs of 10.7% for 2017E and 2018F.
According to Management, the aim is to protect NIMs, leveraging on its low-cost funding structure even as it remains focused on optimizing income from interest earning assets while further driving increased non-interest income contribution. On the latter, Management noted that the bank has ~13 million active customer accounts with at least 80% of the customer induced transactions done on its digital platform. The bank has at least 35% of all electronic traffic in Nigeria either by count or value on the Interswitch platform and remains the only bank to process over 100million transactions per month on the Interswitch platform multiple times. The bank is currently setting up a digital lab to further drive innovative solutions.
Further down, operational efficiency has been upbeat with Cost to Income ratio (CIR) in 9M 2017 of 53.4% lower than its 5-year average (excluding 2016 where FX-induced income drove CIR lower to 47%). We now estimate FY 17E OPEX of N230 billion (9M 17: N175 billion). Further out, we forecast a 3% average growth in OPEX over 2018F – 2021F. The foregoing, alongside our gross earnings forecast guides to relatively flattish CIR over our forecast period. To note, management guides to a possible review of some branches as the bank is currently piloting the agency banking model.
Sustained Recovery To Drive Earnings Growth In FY 2018F
In summary, with a focus on leveraging lower funding cost, operational efficiency, adequate capital buffer, no plans to grow risky assets, and lower loan-loss provisioning, downside risk to 2018 earnings now seems moderated than was earlier expected. Overall, we forecast 2018F EPS of N3.18 (+85% YoY) and DPS of N1.43. FBNH trades at a P/B of 0.7x compared to peer average of 1.4x with FY 17 P/B of 0.4x at a discount to peer average of 0.9x. Furthermore, at current pricing, its 2017E dividend translates to dividend yield of 6.4%. Our FVE of N16.69 translates to a 32% upside from current pricing. Consequently, we rate the stock a STRONG BUY, reflecting attractive valuation and a view that fundamentals will improve going forward.