Global Oil Crisis, Harsh Macro-Economic Environment Put Banking Sector in Dire Straits

CBN Governor, Godwin Emefiele

Nigerian banks are now contending with the spiraling negative effects of global oil crisis, challenging macro- economic environment, coupled with fiscal and monetary headwinds which have taken significant toll on the banking system and forced some of the operators to issue profit warnings, writes Kunle Aderinokun

Indications that banks are having serious challenges became rife recently when some of them issued profit warnings. The profit warnings by the banks, quoted on the Nigeria Stock Exchange (NSE) may be confirmation that they are already bearing the brunt of the slump in oil prices at the international market. Indeed, the banks have become the latest to feel the unfriendly harsh realities of the price slump as it appears the overarching adverse effects of the oil crisis are by and large reflecting on their bottom lines. The indications, economic watchers observe, point in the direction of the banking system exposure to the oil and gas sector.

One of the consequences of the current scenario is that about N5 trillion loans granted to energy firms might have been impaired due to the prevailing oil crisis, which has also led to a 53 per cent drop in NNPC cash call payments to Joint Venture operations between 2005 and 2015. Besides, the low price has also led to a 62 per cent drop in Joint Venture (JV) production.

While the size of exposure to the oil sector of individual banks could not be ascertained, there are indications that loans totaling about N2trillion granted to oil and gas firms are stuck as the oil prices fall below the loan threshold of $45 per barrel leading many of the banks to re-price the loans and reschedule the tenor from as much as five years to 10 years.

Apart from the adverse impact of the volatility in the oil market on the nation’s foreign earnings (as evidenced in the retarded accretion to the foreign reserves), the scarce foreign currencies – especially the United States dollar, which has forced federal government through the Central Bank of Nigeria (CBN) to discourage importation, particularly of goods that could be produced locally- and the attendant pressure on the naira has continued to haunt the commercial banks in the country.

So far, five quoted banks, namely FCMB Group, First Bank Holding, Diamond Bank Plc, Ecobank Transnational Incorporated and Skye Bank have sent notices of profit warning to the stock exchange, and there is likelihood that more will do so, for compelling reasons given the prevailing unfavourable economic condition. Profit warning is a statement issued by a company advising the stock market that profits will be lower than expected.

Just last week, Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with Nigeria and noted in its report that the “Nigerian economy is facing substantial challenges.”

It was also noted that: “Exchange restrictions introduced by the Central Bank of Nigeria (CBN) to protect reserves have impacted significantly segments of the private sector that depend on an adequate supply of foreign currencies. Coupled with fuel shortages in the first half of the year and lower investor confidence, growth slowed sharply from 6.3 percent in 2014 to an estimated 2.7 percent in 2015, weakening corporate balance sheets, lowering the resilience of the banking system, and likely reversing progress in reducing unemployment and poverty.”

Banks Send Notices to Stock Exchange

Earlier in the year, specifically on January 16, FCMB Group, ahead of its third quarter 2015 results, issued a profit warning that the earnings for the quarter will be “materially below earnings for the same period in 2014.”

According to the managing director of the Group, Peter Obaseki, the warning was as a result of two factors, namely an increase in impairments particularly in the energy sector and the significant reduction in trade finance-related revenues due to foreign exchange illiquidity.

“This trend continued in 4Q15 and largely emanated from wholesale banking activities, while retail banking showed greater resilience and earnings momentum. 2016 will be characterised by continued growth in retail contribution, stabilisation of wholesale banking revenues and increased focus on cost efficiencies (opex, funding and risk) in order to restore earnings levels,” he however added.

For First Bank Holding, on February 24, it forewarned shareholders and investors that its earnings for the year-ended December 31, 2015, will be “materially below that of the prior year.”

According to the group, “the reduction in earnings is as a result of the recognition of impairment charges on some specific accounts resulting from a reassessment of the loan portfolio within our commercial banking business. This reassessment was driven by the challenging macro environment, coupled with fiscal and monetary headwinds which have resulted in a marked reduction in domestic output.”

The bank group, however, added that “this is a prudent measure being taken while the bank has commenced active remedial action on the specific impaired accounts. Our Merchant Banking and Asset Management as well as Insurance businesses remain strong and resilient.”

Similarly, on March 11, Diamond Bank told its shareholders and investors on both NSE and London Stock Exchange (LSE) that “the continuing deterioration in Nigeria’s macro-economic conditions has resulted in Diamond Bank Plc recognising higher than expected impairment charges on loans made to the Energy and Commercial Business sectors. In the light of these deteriorating conditions.” Consequently, the bank warned that following “the review Diamond Bank Plc’s management accounts for the financial year ended December 31, 2015, preliminary indications are that earnings will be lower than in 2014.”

Besides, Ecobank Transnational Incorporated (ETI), parent company of the Ecobank Group stated that it “expects to report materially lower profit for the year ended 2015, driven by a number of factors.”

The factors, according to ETI, included, “the macroeconomic challenges faced by most African economies, lower crude oil prices, depreciating currencies, monetary and fiscal bottlenecks, due to global developments, negatively impacted expected revenue growth. Thus, revenue growth for 2015 will be below our target guidance. Also, higher impairment losses on loans were recognised in the last quarter of 2015 across our loan portfolio.”

The pan African bank added: “Key actions have been implemented to strengthen our credit risk management processes. As a result, our revised growth targets communicated during our third quarter 2015 analysts and investor conference call for deposits and loans will not be achieved. We also expect our efficiency and asset quality metrics to be worse than targets. Based on the aforementioned, we expect our full year 2015 profit in US dollar terms to be lower than the nine-months to 2015 reported profit.”

The previous Friday, Skye Bank Plc informed its shareholders and investors of “anticipated material decline in its profits for the full year ended December 31, 2015 compared with that of 2014.” The expected decline in performance is attributable to Management’s decision to recognise increased impairment on loans to sectors severely affected by the prevailing economic headwinds which are yet to abate, especially the lull in Oil & Gas and Real Estate Sectors,” it pointed out.

Analysts Not Surprised

Economic and equities analysts, some of whom were not surprised, stated that the profit warnings by the banks were necessitated by the prevailing economic realities

One of them, Managing Director of Dunn Loren Merrifield Asset Management Ltd, Tola Odukoya, who saw the profit warnings coming, noted that it came out of the banks because of “the exposure of many banks to the oil and gas sector” and “the effect of TSA on most banks’ revenues and profits for the 2015 financial year” as well as due to “some of the CBN’s currency policies in 2015.”

He believed that, “depending on the bank, an admixture of these issues provided strong headwinds to revenue and profit growth in the sector; hence the flurry of profit warnings.”

Likewise, Executive Director, Corporate Finance, BGL Capital Ltd, Femi Ademola, holds the same position. According to him, “the profit warnings given to investors by some banks are expected given the current economic realities. The most common reasons adduced to the poor or decline in performance are the implementation of the Treasury Single Account (TSA), the complete phasing out of the COT, and the oil price decline. However most of the issues highlighted were expected by the banks except the oil price decline which led to the volatility in foreign exchange.”

He explained: “The TSA was mooted in 2011 and preparation towards it started at that time. Although it wasn’t implemented until recently, most of the banks have been preparing scenario analysis on its impact since 2012. The likely impact is in the increase in interest expense as banks compete vigorously for liability generation.

“The phasing out of the COT was also not new. It was discussed and agreed at the Bankers Committee and the implementation that started since 2013 has been well prepared for. And to cushion the effect, the CBN has graciously agreed (although not agreeable to customers) that banks should replace the N1/mille COT with maintenance fee of the same amount (negotiable). Hence that part is also well covered.

“The oil price was definitely unprepared for. Although Nigerian banks lend to oil companies based on cash flow rather than reserves, the average benchmark of $45/barrel has been breached which could mean that some of the assets may become non-performing. And the size of their exposures to the sector despite concentration limits appears to be very significant.

“The continuous decline in oil price also resulted in foreign exchange volatility with the Naira suffering a huge devaluation. This will mean that banks with huge exposures to foreign currency liabilities such as on-lending facilities or other types of Tier 2 Capital would suffer significant balance sheet effect. Those that grant loans in foreign currencies to local businesses with earnings in Naira would also suffer asset deflation as Naira falls in value. However, I don’t expect such exposures to be significant.

“Overall, I expect banks’ performance for the year ended 2105 to decline but do not expect them to make losses. I also expect that they will make appreciable profit that can be accepted as fair. A decline of up to 40 per cent from 2014 figures appears to be fair in this regard. However, this will be considerable lower than the previous year, profit warnings from some of the banks mostly affected are in order.”

To the Head of Equities Research of FBNQuest Ltd, Bunmi Asaolu, who said it was “not a complete surprise given what has happened to oil prices.”

The former chief economist of the African Finance Corporation (AFC) and chief executive officer of Nextnomics Advisory, Temitope Oshikoya, gave four reasons why some banks issued profit warnings.

“First, the unfavourable global macro environment encapsulated in the precipitous decline in oil prices by more than two thirds and capital outflows from emerging markets recorded at $735 billion in 2015 have both affected Nigerian economy and banks negatively.

“Second, some banks have been over exposed to the oil and gas industry, the power sector, and trading sector, all of which have weighed heavily on the banks with rising NPL especially in these sectors.

“Third, several banks are over exposed with the proportion of loans in foreign exchange nearly doubling to 40 per cent in some banks over the past 5 years, with a large size going to the oil and gas sector.

“Fourth, macro-prudential and regulatory pressures in the past few years have taken their tolls on bank earnings from the introduction of AMCON levy, tighter rules on capital requirements, reduction in some fee incomes, and the CRR volatility.”

Nevertheless, Oshikoya, who is a former director-general of West African Monetary Institute (WAMI), noted that “the Tier 1 banks are showing better resilient than most Tier 2 banks as the former benefit from economies of scale and scope, pricing power, and execution.

Possibility of Another Round of M & A

The former director of Research, African Development Bank, therefore predicted that, with the ensuing scenario, “we might see another round of merger and consolidation within the banking industry, especially if profit warnings among the Tier 2 banks linger for too long and the oil prices and the economy do not sustain an upward trend in 2016.