Nigeria has sunk into its second recession in less than five years as the Covid-19 pandemic and oil price crash squeeze its hydrocarbon industry. Crude oil production shrunk by 3.6% in the third quarter, after declining 6.1% in Q2, according to official data. GDP is expected to contract by 3.8% in 2020, according to S&P Global.
The oil and gas sector in Nigeria accounts for more than 85% of export receipts and at least half of fiscal revenue. Combined with its sensitivity to currency depreciation and high inflation, this exposes banks to high economic imbalances and short credit cycles, wrote Samira Mensah, a credit analyst at S&P Global in a recent report.
“The banking sector has high credit risk because of the structure of the economy, and high single-name and industry concentrations,” Ms Mensah wrote.
THE BANKING SECTOR HAS HIGH CREDIT RISK BECAUSE OF THE STRUCTURE OF THE ECONOMY
Samira Mensah, S&P Global
On top of this, the sector faces liquidity risks because banks’ balance sheets are dual currency. “The [banking] sector also has foreign currency-denominated financial obligations that could strain its US dollar liquidity if foreign currency reserves dropped because of declining oil prices,” Ms Mensah added.
Oil sector exposure
Banks’ material exposure to the oil sector typically averages about 30%, which weighs on asset quality and earnings.
S&P Global expects restructured loans will double to about 20% in 2020, from about 10% in 2019 on the back of lower oil prices.
Meanwhile, loans under forbearance will reach 20%-25%, according to S&P Global. Non-performing loans (NPLs) are also expected rise, to 10%-12% through 2021 from 6.1% in 2019.
S&P Global forecasts credit losses will increase to about 2.5% in 2020-21 before dropping to around 2% in 2022, from an estimated 1.2% in 2019.
Net banking sector external debt persists but will remain at manageable levels around 13% of systemwide loans in 2020-2021.
“Most banks have overcome their short-term liquidity challenges following the introduction of the Nigerian Autonomous Foreign Exchange Fixing Mechanism (NAFEX) window in April 2017 but foreign exchange shortages have re-emerged,” Ms Mensah wrote.
“Profitability will be weaker on the back of higher impairments and lower net interest margins, due to a combination of weakening asset quality and limited participation in the central bank’s securities auctions.”
Central Bank flexibility
Despite weaker profitability, S&P Global still expects top-tier banks’ financial performance to remain resilient, with return on equity averaging 14% in 2020 for the sector.
The biggest banks in Nigeria by total assets are Access Bank, Zenith Bank, First Bank of Nigeria, United Bank for Africa and Guaranty Trust Bank, according to The Banker Database.
The Central Bank of Nigeria has some flexibility to release additional liquidity through the reserve requirement ratio, which sits at 27.5%.
However, bank credit to the private sector is likely to be subdued, despite the central bank introducing a minimum loan-to-deposit ratio of 65% to boost credit growth, according to S&P Global.
Lower foreign currency inflows tied to lower oil receipts are likely to make it more difficult for the central bank to set exchange rate and foreign-exchange-reserve policy.
“We think some banks could breach minimum capital adequacy ratios if the naira weakens by more than 20%, but this is higher than our current assumption for 2020,” Ms Mensah wrote.
Two-speed recovery
While Nigeria’s Q3 GDP data showed ongoing weakness in the oil sector it was more than offset by a rebound in the non-oil economy, wrote Virág Fórizs, Africa economist at Capital Economics, in a report issued November 23.
Compared to a 6% year-on-year drop in non-oil GDP in Q2, output in the non-oil economy was down by just 2.5% year-on-year in Q3, according to Capital Economics.
The manufacturing and construction sectors recovered strongly as restrictions on activity were gradually eased. The telecommunications sector continued to post double-digit growth. The finance and insurance sector was up 3.2% in Q3 this year compared to Q3 2019.
The 23-country Opec+ coalition agreed to slash production this year to offset a collapse in the oil price and the quotas are likely to weigh on oil output in the coming months, keeping growth in the sector depressed. However, the recovery in other parts of the economy will continue, albeit with some headwinds, according to Capital Economics.
The Central Bank of Nigeria held its benchmark lending rate at 11.5% in its November meeting following 100 basis point cuts in May and September to boost the economy.
“Looking ahead, the two-speed recovery in Nigeria’s economy will probably continue over the coming quarters as the oil sector struggles and activity in non-oil economy picks up further,” Mr Fórizs wrote.
– The Bankers