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Nigerian banks’ credit profiles face severe risks from the oil price slump and operating environment disruption due to the coronavirus pandemic, Fitch Ratings says. Asset quality deterioration linked to high exposures to the oil and gas sector is the biggest threat to ratings.
Operating environment risks inevitably rise in Nigeria when oil prices fall. Oil exports represent 95% of the country’s export revenue and strongly influence the broader economy. Falling oil revenue may also lead to further currency devaluation. Accordingly, the slump in oil prices raises the risk of a recession. Operating environment risks are compounded by economic and financial market disruption amid measures to counter the pandemic, putting pressure on all borrowers.
Forbearance measures announced by the Central Bank of Nigeria (CBN) will provide some relief to businesses and households and help the flow of credit into the economy. This will support reported asset quality metrics in the short term (the average Stage 3 loans ratio for Fitch-rated banks was 5.7% at end-2019) but asset quality could deteriorate significantly depending on the duration and severity of the oil price shock and coronavirus turmoil.
Fitch recently downgraded three Nigerian banks’ Long-Term Issuer Default Ratings (IDRs) to ‘B’ from ‘B+’ and placed all 10 Nigerian banks’ Viability Ratings and IDRs on Rating Watch Negative, reflecting our expectation that banks will face material pressures from the weaker operating environment in the coming months (see here). The resilience of banks’ asset quality, profitability and capital during the economic downturn will influence, among other considerations, how we resolve the Rating Watches.
The oil and gas sector represented about 30% of Nigerian banks’ gross loans at end-3Q19. Accordingly, loan quality is highly correlated to oil prices, as seen during previous oil price shocks in 2008-2009 and 2015-2016. Impaired loans have decreased since 2017 due to rising oil prices as well as recoveries and write-offs, but the current shock could lead to a significant increase. Any closures of oil fields due to a collapse in global oil demand would exacerbate the impact.
Asset quality risk is exacerbated by the rapid step-up in lending to certain riskier sectors, including retail, agriculture and SMEs, which banks took on to help meet the minimum loans-to-deposit ratio of 65% introduced in 2019. Unhedged US dollar loans to corporates expose banks to potential further naira devaluation, pushing up debt-servicing costs. Devaluation also affects SMEs, particularly in the manufacturing and services sectors given Nigeria’s dependence on imports for raw materials and finished goods. However, the direct impact of devaluation on banks’ regulatory capital is mitigated by their net long foreign-currency positions.
Problem loans (Stage 2 and Stage 3) averaged 23% of gross loans for Fitch-rated banks at end-2019, which is high. Stage 2 loans averaged 17% and include a large proportion of loans to the oil and gas sector already restructured due to the 2015 oil price shock.
The CBN’s forbearance measures include the restructuring of loan tenors and terms for households and corporates most affected by coronavirus disruption, including loans to the oil, manufacturing and agriculture sectors. Banks will not have to classify these as Stage 2 or Stage 3 loans and this will mask the true extent of asset quality deterioration.
We expect a rise in restructured loans to 25%-30% of gross loans in 2020-2021 as banks extend tenors and lower interest rates to help borrowers. This could lead to a significant rise in impaired loans if low oil prices and severe coronavirus disruption are long-lasting. Loan-loss coverage of total loans of 4.9% at end-2019 was modest given loan concentrations by sector and operating environment risks. Loan-loss coverage of Stage 3 loans was reasonable at 97%, but coverage of problem loans was much lower due to low coverage of Stage 2 loans.
The weighted-average cost of risk for Fitch-rated Nigerian banks rose by 200bp during the 2015 oil price shock. We do not rule out a similar increase in 2020. The oil price shock and sharp macroeconomic deterioration will lead to higher expected-credit-loss provisions, undermining banks’ profitability. Lower lending growth and subdued business activity negatively affecting non-interest revenues will also weigh on profitability.