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FCMB Group Plc: No ‘Legacy’ is so rich as Funding

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Wednesday, November 29, 2017 3:33PM /ARM Research

 

At the start of the week, the management of FCMB hosted a conference call to review its nine-months 2017 result, provide guidance on outlook and update investors on its acquisition of Legacy Pension Managers. From the details provided, management intends to leverage on its holding of Legacy Pension (Legacy) to diversify the group’s earnings and increase profitability.

 

This aligns with our view in our recent report ‘Tier 2 Banks - Playing a catch-up game’ where we forecast a growth in Legacy’s contribution to the group’s PBT from ~3% to 7% in FY 2018. Irrespective, we hold the view that a material change in FCMB’s fortunes in the near term is contingent on its ability to combat funding cost pressures which resonates with the words of Williams Shakespeare ‘No legacy is so rich as Honesty’ or as Funding cost in the case of FCMB.

 

Earnings weighed by funding cost and lower NIR. FCMB’s nine-months 2017 result was in line with our expectation. Interest expense of N46.4 billion (+15.8% YoY) grew faster than interest income (+3.3% YoY to N96.3 billion) to drive net interest income lower by 6.2% YoY to N49.9 billion.

 

Further down, the impact of a high-base in Non-Interest Revenue (NIR) for 9M 2016, which captured N35.3 billion in foreign exchange gain, marred NIR in the review period (-58% YoY to N18.7 billion). Consequently, despite lower loan-loss provision (-63% YoY to N12.3 billion) and flat operating expenses, the impact of higher funding cost and lower NIR drove a 58% decline in EPS to N0.28 (9M 2016: N0.66).

 

That said, the breakdown of standalone Q3 17 results reveal improvement in core performance. In the review quarter, interest income of N39.4 billion (+3.8% YoY) outpaced funding cost (+3% YoY) to drive a 4.5% increase in net interest income. Consequently, Net Interest Margin (NIM) expanded 1.5pps YoY (+0.4% QoQ) to 7.4%.

 

More so, despite the absence of sizeable FX gains which underpinned lower NIR in the quarter, FCMB reported robust fee income (+34% YoY) and trading income (+49% YoY). Against this backdrop and markedly lower loan-loss provision of N2.7 billion (Q3 2016: N21 billion), FCMB reported PAT of N2.5 billion relative to loss after tax in Q3 2016 of N2.7 billion.

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O&G and Commerce mar asset quality. In the review quarter, asset quality deteriorated with NPL ratio rising 130bps to 4.7%. Breakdowns provided by FCMB links the sharp deterioration in asset quality to the O&G Downstream (4.6x YoY), O&G Services (25.5x YoY) and Commerce (50.8% YoY) sectors even as Education, Manufacturing and Transport also posed mild quality concerns.

 

Across these sectors, FCMB states that a prudent stance informed increased provisioning for NPLs with coverage ratio at 108.2% for its entire NPL book. CAR improved by 90bps QoQ to 17.9%. 

 
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Key Takeaways from conference call.

Liquidity: Management confirmed the refund of prior excess CRR of ~N30 billion (est. N23 billion) in the third quarter which supported improvement in liquidity ratio to 35% (Q2 17: 30.1%) and interbank funding.

Loan Restructuring: Management guided that 90% of loans to Upstream O&G sector has been restructured mainly by means of tenor extension in line with current cash flow. Also, 65% of loans to the power sector has been restructured to allow for timing with dollar sourcing as revenue are naira denominated.

NPL and provisioning: Asset quality issues majorly stems from specific loans to the downstream and services segments of the O&G sector. Management guides to a marginal increase in loan-loss charge in Q4 17, though it is expected to remain well within guidance of 2.8% by FY 2017. No guidance on NPL was provided.

Exposure to 9mobile: Due to the secured nature of FCMB’s N4 billion exposure to 9mobile, management has made no specific provision on 9mobile but expects collective provision booked so far to cover any future need for specific provisioning.

Cost efficiency: Management confirmed that its flat operating expenses despite AMCON levy stemmed from streamlining of its branches but guided to no further bank closure in the coming year.

Funding cost: Management expects a mild loosening in monetary policy in 2018 to support moderation in funding cost and improve NIMs.

Legacy Pension Managers Acquisition. According to management, additional 60% stake in Legacy was acquired for N6.96 billion.

 
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Although FCMB’s coverage ratio of >100% appears adequate, persisting concerns in the services and downstream segment of the Oil & Gas sector as well as economic contraction in the Commerce and Manufacturing sector (exposure of 7.3% and 6.8% respectively) remains a key risk to asset quality in the near term.

 

In any case, FCMB’s adequate provisioning limits scope for sharp increases in cost of risk from these sectors. In sum, we forecast NPL ratio of 5% and 4% for 2017 and 2018 respectively. The foregoing alongside management guidance raises our Cost of Risk estimate for 2017E and 2018F to 3.5% and 2.5% respectively. Consequently, loan-loss provision for 2017 and 2018 should print at N20.5 billion and N18.2 billion accordingly.

 
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That said, we have adjusted our funding base for the excess N6 billion from excess CRR refund relative to our N23 billion estimate. The foregoing increases our interest income for Q4 17 to N39.4 billion (+16% QoQ) while funding cost in the period is expected to print at N17.7 billion (+7.3% QoQ) to drive a 24% expansion in net interest income with corresponding margin (NIM) printing at 8.8% (1.3pps QoQ).

 

Thus, with a focus on capturing higher yields on the naira curve, no plans to grow risky assets, lower loan-loss provisioning relative to prior year, increased prospects of recoveries, adequate capital buffer, and moderate funding cost pressures on the back of lower yield environment, downside risk to 2017 and 2018 earnings now seems moderated than was earlier expected.

 

In all, we forecast FY 17 EPS of N0.36 (previously N0.55) which is 49% lower YoY. Excluding FX gains in prior year, FY 17 EPS should be four-fold higher YoY. Adjustment to earnings bring DPS at N0.07 (previously N0.11). Over 2018, we forecast EPS of N0.92 (+153% YoY) and DPS of N0.18. Net impact of our revision lowers our FVE for FCMB by 6% to N1.27 which translates to a NEUTRAL rating on FCMB. The stock trades at a current P/B of 0.1x relative to peer average at 0.2x.

 

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