February 15, 2017/InvestmentOne Research

We maintain our negative near term outlook on the Banking sector on our expectation of muted loan book growth in the immediate as the prospects for economic recovery remains fragile. This is in addition to concerns about asset quality, resulting from increasing non-performing loans and their negative impact on ROE over the medium term informs our view.

·         Our outlook stems from the sector’s Q3 2016 results which were reflective of the mixed impact of the depreciation of the local currency, weak macro environment, rising inflation, and the higher yield and interest rate environment.

·         The current macro headwinds has seen a slowdown in economic activities, which has led to non-performing loans (NPL) in the sector rising,  according to CBN, to 11.7% as at Q2 2016 (c.5% as of Q4 2015).  As a result, loan impairment charges remained high in Q3 2016, surging by +195% y/y on average.

·         On the other hand, sector’s Q3 2016 earnings were supported by the +73.3% y/y surge in non-interest income, largely driven by the improvement in FX related gains and income. We highlight that in the absence of a further depreciation in the local currency, this may not be sustainable going forward

·         While loan book growth may remain uninspiring due to weak economic growth, we expect banks to continue to benefit from the higher yields and interest rate environment which should be supportive of net interest margin (NIM) performances.

·         However, the difficult macro environment, FX scarcity, in addition to the disruptions to oil production (negatively impacting the quality of loans to Oil & Gas companies), may see NPLs increase further. This may keep loan impairment charges high in the immediate as banks try to maintain adequate NPL coverage.

·         Conversely, if the administration adds more flexibility to its FX policy, we may see the local currency depreciate further at the interbank market. Although this should boost FX related gains and income, it may also lead to an expansion in risk assets. This may pressure  capital adequacy levels, particularly for tier 2 names, thereby increasing the need to raise fresh capital to maintain adequate buffers.

·         Nonetheless, as the CBN moves to a more accommodative stance, the budget implementation kicks in, and investors’ confidence improves, we may see a slight pickup in lending to the private sector in H2 2017. While no decision regarding AMCON 2 has been made, we believe that the creation of a company to acquire toxic assets and free up the balance sheet of banks, may also support lending activities.

·         Our recently revised ratings are below.

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