COVID-19 Pandemic – Nigerian Banks in 2020

COVID-19 Pandemic – Nigerian Banks in 2020

The outlook for Nigeria and indeed the global economy has worsened owing to the COVID-19 pandemic. Prior to the emergence of COVID-19, Nigeria’s economy had been on a dire strait characterised by a 2% post-recession GDP growth. Thus, the Nigerian post-recession economy could best be described as being fragile even before the COVID-19 effect.

In the last two years, the banking industry has had its fair share of these macro-economic headwinds, which has resulted in declining margins and significant write offs of impaired credits. While on the path to recovery, the banking industry is now faced with the COVID-19 pandemic, which comes with greater uncertainties and unpredictability of events in the business environment. Agusto & Co has assessed the impact of these current realities on the Nigerian banking industry taking into cognisance expected changes in the credit landscape, earnings and capitalisation in the short term.

The Credit Landscape

The Nigerian credit landscape witnessed a notable slowdown in the years that followed the 2016 recession. Banks adopted a cautious approach to risk asset creation, with a preference for short-tenored credits because of the fragile macroeconomic environment and the desire to preserve asset quality. Thus, the Central Bank of Nigeria (CBN) introduced the minimum loan-to-deposit ratio (LDR) in July 2019 to stimulate lending to the real sector and drive economic growth. At the introduction in July 2019, banks were mandated to maintain a minimum LDR of 60%; however, this was increased to 65% in September 2019. The largest exposure of the banking industry’s credits is to the oil and gas sector, which accounted for over 30% of the loan portfolio as at 31 December 2019. Other significant sectors are manufacturing, public sector, real estate, construction, and general commerce (trade). In terms of currency distribution, approximately 47% of the Industry’s gross loans were foreign currency denominated (FCY), predominantly in the United States Dollars (USD) as at FYE 2019.

Loan Book by Sector
Source: Agusto & Co Research

We believe the COVID-19 pandemic will weaken the banking industry’s asset quality in view of the expected impact on the finances of state governments, the performance of businesses and the purchasing power of households. Although the degree of the impact will vary across different sectors, key sectors that will bear the brunt are oil and gas (upstream and services), real estate, construction, transportation (aviation) and manufacturing (non-essentials). The sectorial distribution of the Industry’s loan portfolio will also determine the extent to which asset quality will deteriorate in the near term.

Source: Agusto & Co Research

The Industry’s exposure to vulnerable sectors threatens asset quality in the short term for the following reasons. Firstly, the decline in global crude oil prices elicited by a slump in demand (due to economic lockdowns in several countries) will result in lesser revenues for oil and gas firms and the government as crude oil proceeds account for about 60% of the sovereign’s revenues and 95% of the country’s export proceeds. Being the largest spender, a decline in the government’s revenues has a ripple effect on key sectors such as construction, manufacturing, real estate and general commerce. In addition, the Central Bank’s ability to defend the naira is threatened by lower FCY revenues, which results in weaker macroeconomic indicators (such as high inflation and currency depreciation) and directly affects businesses and households. The recent Organisation of Petroleum Exporting Countries (OPEC) quota adjustment – leading to supply cut – are aimed at easing pressures from the oil supply side to some extent. We estimate an average crude oil price of $30-$35 per barrel, bearing in mind that in the first quarter of the year, crude oil averaged $55.9 per barrel.

Secondly, an anticipated further devaluation of the naira will bloat the Industry’s foreign currency loan book, which is dominated by the oil and gas, manufacturing, general commerce and other import dependent sectors. This could weaken capitalisation ratios via higher risk weighted assets and increase the level of delinquent FCY loans.

Thirdly, the disruption in the global supply chains is expected to increase demand for domestic alternatives for inputs used in the manufacturing sector. While this is good for the domestic market, the higher cost implications will adversely impact the margins of producers as increased costs are not easily transferable to final consumers especially in a period of weakened consumer purchasing power. Fourthly, the revenues of most business in the ‘non-essential’ manufacturing sectors will be hit by the general lockdown in the largest commercial centres in Nigeria. Considering that the underlying issues of testing and contact tracing are still gradually progressing, with less than 8,000 tests carried out as at 20 April 2020, Nigeria faces increasing uncertainties that could push the economy into recession with as high as 7% contraction in GDP in 2020.

Our preliminary forecasts (pre-COVID-19) for the Industry’s non-performing loans (NPL) ratio for the 2020 financial year was 9.4% based on our expectations that major impaired loans would be written off, there would be growth in the loan portfolio and that the IFRS 9 impact would have moderated. However, with the COVID-19 pandemic and associated risks, we have revised our NPL ratio expectations to 13% in the short term. Our revised forecast is a moderated revision of CBN’s 2016 stress test on the impact of the lower oil prices on the banking industry’s loan book. Our forecast assumes that with crude oil prices averaging $30-$35 per barrel, a proportion of the oil and gas loan book will be impaired. We also expect a rise in impairment levels in other sectors.

However, our prognosis may be somewhat moderated by the forbearances granted by the CBN to banks to cushion the impact of the pandemic on the Industry’s performance. These forbearances include the allowance for restructurings of loans to businesses and individuals highly impacted by the pandemic, such as hospitality, manufacturing and oil and gas firms, to reflect challenges in the sectors. In addition, the banking industry tightened credit risk management following the 2016 recession, shifting to short dated, cash backed trade transactions that self-liquidate and converting some unhedged FCY loans to naira loans for instance. Notwithstanding, we recognise that some banks are still in the process of cleaning up the loan portfolio from the last recession.

Earnings and Profitability

Earnings from the Industry’s core business will decline in the short term on account of an expected rise in impairment charges, lower yields on the loan book and a contractionary monetary policy stance, exacerbated by discretionary cash reserve requirement (CRR) debits by the regulator. The interest rate on Federal Government of Nigeria (FGN) intervention funds (granted through BOI and CBN) to targeted sectors, which account for about 10% of the loan portfolio was reduced by 400 basis points to 5% in March 2020, as part of the palliatives to support businesses. This translates to a 300 basis points decline in yields on such loans for banks.

Officially, the cash reserve requirements (CRR) for banks is 27.5%. However, the effective CRR for some banks are as high as 50% due to the CBN’s non-refund policy and the discretionary excess debits seen in the last few months. Penalties for breaching the minimum loans-to-deposit ratio (LDR) implemented as additional CRR debits also contributed to the spike. Thus, restricted funds with the CBN account for as high as 15% of total assets and are non-earning. In February 2020, the CRR for merchant banks was raised to 27.5% from 2%. Assuming the CBN were to normalise CRR to 10% of total assets; it would need to release about 5% of total assets. If these funds were granted as loans to the low risk names in the private sector at an average of 14% per annum, this would add ₦300 billion to the Industry’s projected pre-tax income which translates to an additional 0.8% to our forecasted pre-tax return on assets. Based on our expectations that the Industry’s interest income will moderate and that funding costs will remain elevated owing to the high effective CRR and a possible increase in the prevailing interest rates, we foresee a decline in the Industry’s net interest spread by up to 500 basis points in 2020.

Source: Agusto & Co Research    

Non-interest income accounts for approximately 42% of the industry’s net earnings, and is largely driven by electronic banking activities, account maintenance fees, credit related fees and securities trading income. With the lockdown resulting in skeletal operations, banks have leveraged their electronic banking platforms to boost income as more banking transactions are only consummated through digital channels during the lockdown period. However, minimal trade activities will moderate credit related fees. We expect some correspondent banks to pull back on their lines of credit. We also anticipate repricing by correspondent banks to reflect the elevated credit risks emanating from lower liquidity in the foreign exchange market. Outstanding obligations to foreign portfolio investors seeking to exist Nigeria stood between $700 million and $900 million as at April 2020. The regulatory induced reduction in bank charges which became effective in January 2020 will also moderate non-interest income. Nonetheless, expected revaluation gains from a further devaluation of the domestic currency will support the earnings of banks with net foreign currency assets positions.

With expected pressure on revenue generation, cost containment will be top burner in 2020. While the Industry’s operating costs are expected to increase on account of a rise in inflation and a growth in foreign currency denominated costs (such as technology-related expenses), we believe that cost management strategies will be paramount to sustained profitability. Nonetheless, Agusto & Co expects the Industry’s pre-tax return on average equity (ROE) to moderate to between 12% and 14% in 2020 unless regulatory support is granted in some areas such as reduction in CRR.


In recent times, the capital base of the banking industry has come under pressure owing to the IFRS 9 adoption and other asset quality issues that have resulted in major write offs. Thus, tier II capital-raising activities heightened in the 2019 financial year up until the first quarter of 2020. Based on the asset quality challenges and the naira devaluation highlighted earlier, we envisage some strain on the Industry’s capitalisation ratios in the near term. However, this will be moderated by slower risk asset growth owing to the static business environment, increased profit retention, revaluation gains and the use of excess qualifying tier II capital to uphold capital adequacy ratios. We also believe that CBN’s forbearances will cushion the impact of the COVID-19 pandemic on the Industry’s capital base.

The banking industry will need to recapitalise in the short to medium term. However, this will be challenging considering the current environment and weak investor sentiments. For banks that may be seeking to raise tier 1 capital, the weak valuations at this time – which has led to all the quoted banks trading at a discount to book values – may be a deterrent. The three most valuable banks are currently trading below book values with Guaranty Trust Bank Plc trading at 0.89x its book value, Zenith Bank Plc at half its book value and Stanbic IBTC Bank Plc (0.97x its book) as at 20 April 2020. Tier II capital will be raised to support CAR up to the extent that it is permissible by the CBN and that market conditions are favourable. We believe that regulatory support will be required to implement rules aimed at protecting the banking industry’s profitability.

Conclusion and bright spots

The full impact of the COVID-19 pandemic will be difficult to measure in the near term. These are indeed difficult times for an industry that just barely recovered from the recession. Despite various identified risks, opportunities exist. For instance, working capital needs of companies in key economic sectors will increase because of the naira devaluation and higher inflation, presenting prospects to grow loans to obligors with good business fundamentals in resilient economic sectors. We expect more bank customers to embrace digital banking platforms which could result in higher electronic banking income for banks. Furthermore, banks can leverage intervention funds provided by the CBN to susceptible sectors during this pandemic to grow loans. The Nigerian banking industry remains resilient and we expect this narrative to remain.


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