Polaris Bank: Confirms a Resurrection, Tackles Loan Bullets

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Tuesday, April 28, 2020   /12:27PM / By Teslim Shitta-Bey, Adesola Borokinni et al / Header Image Credit: Polaris

 

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Polaris Bank Limited, the Central Bank of Nigeria (CBN) backed bank created from the legacy Skye Bank Plc, over the weekend announced the approval of its 2019 financial statements, and appears to be clawing back to 'sustained' profitability as it recorded a financial year end (FYE) 2019 profit before tax figure of N27.34bn (Group figure; Bank is N27.85bn) which was 1,110% higher than the pre-tax profit number between September and December 2018 of N2.46bn (the comparison between both periods is simply a "low-base" place holder to suggest direction rather than scale of Polaris Bank's profit movement as the two periods are technically incomparable).

 

Related Link: Polaris Bank 2019 Annual Financial Statement  

 

The improved profitability of the bank reflects a combination of hardnosed cost cutting and gradual rebuilding of the bank's loan book quality and efficient allocation of assets. The key highlights of the bank's 2019 performance were characterized by the following:

 

Highlights/Takeaways

  1. Gross earnings ended 2019 at N150bn, this reflected a push for greater market share of industry gross revenues and a conscious effort at gathering cheaper deposit liabilities which were converted to loan assets that pushed earnings up a few notches.

 

  1. The Bank had a modest return on asset (RoA) of 2.3% which compares favourably with Nigeria's tier-1 banks and is arguably best-in-class for the sectors second-tier deposit money lenders (DMBs).

 

  1. The bank's equity return (RoE) in 2019 of 33% was impressive and signpost a cheery outcome for the new managers that took over the running of the bank in 2018. The new management led by Mr. Tokunbo Abiru has had a tough but successful stab at turning the bank from a hard stop to a hand break swerve towards stability.

 

  1. A return on Gross Earnings (GE) of 18% was also comparatively remarkable and reflected efforts of the bank's management to widen its net interest income as a proportion of gross revenue. The statistic emphasizes attempts at improving core business revenue relative to cost with interest income rising faster than interest expenses. The management has deliberately forged a strategy of increasing low cost deposits as opposed to the strategy of the old Skye Bank which depended heavily on public sector placements with attendant uncapped interest arbitrage expenses. 

 

  1. The ghost of the old Skye Bank still haunts Polaris Bank as the persistence of huge non-performing loans characterize an otherwise impressive turnaround story. Nevertheless, the new bank has been able to cut non-performing loans as a proportion of total loans outstanding from 80% in 2018 to 46% in 2019. The delinquent loan book of the bank is still heavy but the direction of delinquency as proportion of loans outstanding has declined, creating more wiggle room for the bank's management to grow its assets without hurting liquidity.

 

  1. However, in a COVID-19 situation and a soft economic meltdown, IFRS 9 requirements may see Polaris suffering a disproportionate fall in 2020 FYE gross revenue and operating profit due to an economic slowdown.

 

  1. It must be noted that for some unexplained reason the bank's 2019 financial result was juxtaposed with what was essentially its Q4 2018 result with an added week from September 2018. The odd reporting made it difficult to discern the precise extent of improvement in the banks audited account between 2018 and 2019. The fact that Polaris bank is a legacy bank that started in September 2018 does not obliterate the history of the bank from its Skye Bank days, unless AMCON suggests that the banks delinquent loans had been totally written off and that fresh capital had been injected into the bank by way of equity. Since no such statement was available from AMCON or any other sector regulator, we are of the opinion that it would have been more transparent to have presented a full year report for 2018 with the necessary caveats concerning AMCON intervention; and highlighting improvements in performance achieved by the new management.

 

In the course of writing this report, the bank represented that "AMCON injected fresh capital and the bank has been relieved of the burden of carrying delinquent loan through the take-over by AMCON and derecognition from the Bank's books."

 

While we have no reason to doubt the representation, the validation of course, would be our reference to AMCON's statement of accounts for 2018. Unfortunately, this document was not available as at the time this report was put together, and remains a document to be reviewed in the near future.

 

 

Table 1 Summary Financial Performance of Polaris Bank FYE 2019

Metrics

POLARIS Bank 2019

Gross Earnings (N'bn)

150

PBT (N'bn)

27.34

Deposits from customers (N'bn)

857.9

Total Assets (N'trn)

1.16

Capital Adequacy (%)

14.67

Return on Assets (%)

2.27

Return on Equity (%)

30.26

Liquidity Ratio (%)

74.38

Cost-to-income ratio (%)

40.67

NPL (%)

46

Source: Polaris Bank Financial Statements, Proshare Research

  

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Profitability, Good but Fragile 

The bank made a group profit before tax of N27.34bn (N27.80bn for the bank alone) in FYE 2019 which was decent for a bank of its size. The profit resulted in an RoA of 2.3% and RoE of 33%. The figures indicate deliberate and strategic managerial manoeuvring to expand income opportunities. Nevertheless, the profit numbers appear to have been generated on the back of a smaller loan book. Loans to customers fell from N340bn in FYE 2018 to N188.74bn in FYE 2019, the fall in bank lending to customers came to -44.49%.

 

So, from where did Polaris Bank make its FYE 2019 profit?

 

Without the full year 2018 results, this may be difficult to determine but a few pointers may provide context.

 

The bank has cut down on its loans sizably and so impairment costs may have been reduced significantly enough to improve operating income (see chart 1 below). Indeed, with the forward-looking nature of IFRS 9 impairment requirements, it is likely that Polaris Bank's management wrote off loans taken over by AMCON (reducing potential reportable income) while ensuring that subsisting loans are healthy enough to manage in a sustainable manner. 

 

Chart 1 Total Loans/Receivables of Polaris Bank 2017-2019

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Source: Bank's Financials, Proshare research

 

The likelihood is that the loans sliced off the bank's books were those of its erstwhile Chairman, Tunde Ayeni, and a few other big borrowing insiders at the liquidated Skye Bank. These loans may have been totally written down. Therefore, the major gains in Polaris Bank's profit & loss account may have come from tidier book keeping and efficient asset allocation.

 

The tidier loan book and better asset quality would prepare the bank for a strong performance in subsequent years save for the consequences of the 2020 grey swan; the novel coronavirus pandemic (COVID-19) fathered recession. Forward forecast by the International Monetary Fund (IMF) says that Nigeria's economy will shrink by -3.4% in 2020, if this happens then Polaris Bank like other companies/banks may see earnings come under extreme pressure as corporate clients see sales and production cutbacks and individual retail customers see a fall or total elimination of periodic incomes.

 

In other words, Polaris Banks earning numbers in FYE 2019 were good but in the face of the ongoing global pandemic, the bank's operating performance in 2020 appears fragile. The reduction of loans between 2018 and 2019 may have had strategic importance but it may also throw up a Cobra Effect problem, with certain unintended consequences of a lighter lending portfolio hurting the bank in 2020. 

 

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Loans...Where are the Loans? 

Lending was not at the heart of the bank's management calculations in 2019, Polaris's management appears to have stayed focus on two primary objectives:

  • Reduce the size of non-performing assets on the bank's statement of financial position for the FYE 2019; and
  • Improve technology development and deployment to prepare for an aggressive penetration of the digital banking market; and grow retail businesses through agency banking outlets

 

The bank's decision seems to have been wise. By shuffling off large delinquent assets from its books, the management created an opportunity to rebuild the banks' balance sheet and repair its profitability.

 

However, going forward critical decisions will need to be made on sustaining profitability and growth in a recessionary environment. Reducing its cost to income ratio (CIR) was clever and could serve as a critical survival handle bar in 2020. Polaris currently has one of the lowest CIRs of banks in Nigeria (see chart 2 below).

 

Chart 2 Comparative CIRs of Nigerian Banks FYE 2019

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Source: Selected local Nigerian Banks, Proshare Research

 

Amongst peer Tier 2 banks Polaris recorded the best CIR in 2019, even going ahead of several Tier 1 competitors. Available figures suggest that only GT Bank had a better CIR of 36.11% in the previous year, 2019.

 

Be this as it may, Polaris bank saw over 40% decline in loans to customers, this has stirred some concern in the financial analyst community. Deposit money institutions are expected to make the most of their incomes from lending and investment activities but with loans declining and investment yields tanking in the local capital and money markets, the prospects for stronger gross earnings and operating profit for Polaris Bank in 2020 is at best modest.

 

Loans to customers slid from N340.05bn in FYE 2018 to N188.74bn in FYE 2019, meaning interest income for the full year would have dipped year-on-year (Y-o-Y).

 

The Little Big Matter of Capital Adequacy

Polaris ended the year 2019 with one of the strongest capital adequacy ratios amongst Tier 2 banks reviewed for the year. The impressive improvement in capital was a demonstration of the new management's determination to repair the previously broken capital base of the reformed money lender, the bank's capital adequacy ratio ended 2019 at 14.67% (see chart 3 below).

 

Chart 3 Capital Adequacy Ratio (CAR) of Selected Nigerian Banks FYE 2019

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Source: Selected local Nigerian banks, Proshare Research

 

A closer look at Polaris Bank's statement of financial position for 2019, however, plays up snapshots of line items that may be considered "unusual".

 

For example, the bank reported an interesting line item called "Reorganisation Reserve" which was explained in its annual financial statement (AFS) for 2019 as "the net liability assumed by Polaris Bank Limited in line with its establishment as a bridge bank to assume the assets and liabilities of Skye Bank Plc. The net liability assumed was transferred to reorganisation reserves". The amount came to N848.02bn.

 

In other words, this was the amount that AMCON committed to stabilizing the old Skye Bank and providing operational support when the new Polaris Bank came into being. Indications are that the total amount may have been higher, but of particular worry is the current unclear treatment of this balance sheet item. Does reorganization reserve represent quasi-equity or debt, or neither? Since the figure in question is negative it discounts the size of the banks shareholder fund and appears to be a thinly veiled attempt at warehousing AMCON's intervention funds until a sell-off becomes possible and liability recovery can be achieved.

 

Another adjustment to the bank's balance sheet of note is a line item the bank called its "share premium reserve". The AFS 2019 of the bank explains this to be, "the excess paid by shareholders over the nominal value of their shares". But since the bank does not have any shareholders (except AMCON) and the value of its shares cannot be assessed by open market valuation of buyers and sellers of the bank's equity, the financial statement is unclear about how the reserves was valued at N873.45bn which, by the way, conveniently knocked off the negative value posted against the bank's reorganization reserves. If the bank's share premium reserve was removed from the bank's liability, Polaris Bank would record a negative shareholders funds and a capital adequacy ratio far less flattering than that which appears on its financial statement for 2019. In this regards the bank, however, represents that the amount considered as share premium was part of the capital injected by AMCON and therefore qualifies as core capital. Considering this interpretation, Polaris Bank would be within its rights to take the reserve as part of its underlying capital.

 

Another challenge for the bank is the cleaning up of its legacy loans. The bank is still in the throes of wriggling out of a deeply frustrating delinquent loan asset position with the bank posting one of the highest non-performing loan ratios in the industry (See chart 4 below).

 

Chart 4 Non-performing Loans of Selected Nigerian Banks FYE 2019

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Source: Selected local Nigerian banks, Proshare Research

 

As dark as this may look at first it actually represents progress as the previous management had successfully created a situation where toxic loans as a proportion of loans outstanding were in the region of 80%. As at the time AMCON took over Skye Bank two years ago the bank had gone beyond a dead cat bounce to being dead on arrival (DOA). The present management of the successor bank, Polaris, have done a brilliant job of getting the books to steer in the right direction. It may not yet be uhuru, but the signs of bad performance reversal and recovery are bright.

 

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Liquidity; Staying Healthy with Funds and Friends, But...

 

The bank showed robust liquidity in 2019 with a liquidity figure of 74.38% (Proshare Research calculations, see chart 5 below), this should serve as buffer to the headwinds that may hit the sector after Q2 2019 as customers begin to draw down savings to maintain standards of living as recession, lower incomes and job losses begin to bite.


Already sectors such as Aviation, Oil and Gas and Manufacturing have started to feel the strains of supply chain disruptions, demand pullbacks, and inventory accumulation, these situations will translate to worsening bank credits, rising non-performing loans (NPLs) and a decline in banking sector gross earnings.

 

Chart 5 Comparative Liquidity Ratios of Selected Banks in Nigeria FYE 2019

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Source: Selected local Nigerian banks, Proshare Research

 

 

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Looking Ahead with Promise

 

Beyond the observed glitches to its balance sheet, Polaris bank seems to be gradually on the mend. However, how well the legacy bank's recovery sticks will depend heavily on the outlook for the Nigerian economy during, and post COVID-19. The outlook so far appears dim with international oil prices on a continuous dip and Nigeria's fiscal balance looking increasingly orphaned. Nigeria's fiscal breakeven oil price is US$133 per barrel but the recent price for Brent Oil (the closest grade to Nigeria's Bonny light) sells at roughly US$20.07c per barrel meaning that Nigeria is trapped in a fiscal dilemma and this could put pressure on domestic interest rates, thereby slowing private sector growth, even though fixed income government securities may begin to look attractive again.

 

Polaris like other banks in 2020 will have to manoeuvre around several known unknowns (grey swans) and a few unknown unknowns (black swans) as both types of swans represent major operational challenges for all banks in 2020. Polaris Bank will in 2020 look ahead with promise just as it did in 2019 but the dibia (shaman's) cowries are not looking friendly.

 

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About the Authors

By Teslim Shitta-Bey, Managing Editor with Adesola Borokinni, Proshare Research and support team of researchers. They can be contacted via content@proshareng.com and research@proshareng.com

 

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Visit Polaris Bank IR Page in Proshare MARKETS

 

  1. Polaris Bank 2019 Annual Financial Statement  - Apr 26, 2020
  2. Polaris Bank - Our Story 2019 Financial Year  - Apr 26, 2020 

 

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