Rencap: Assessing Impact of Lower Oil Price on Banks’ Asset Quality

Two weeks after a new monetary policy regime was unveiled by the Central Bank of Nigeria in response to the volatility in the prices of crude oil in the international market, the focus of discussion has shifted to how the oil shock may affect each sector of the Nigerian economy. Analysts however believe a cocktail of measures in banks will shield the sector from being gravely hit, reports Festus Akanbi

For obvious reasons, the banking sector appears the most vulnerable to the anticipated shock from falling oil price. Financial analysts who raised the prospect of potential risks that could affect banks’ asset values in the aftermath of the falling oil price drew inference from the oil shocks and the attendant currency devaluation of the 2008 and 2009 episode.

The question raised is will the current situation lead to rise in non-performing loans in banks as we had it in 2009 in view of banks’ exposure to oil sector?

The international financial advisory firm, Renaissance Capital Limited, which released a comprehensive study on the vulnerability of banks to the prevailing oil shocks, however said based on its discussion with a number of the nation’s leading banks, there is no sufficient reason to anticipate a repeat of the 2009 scenario in banks.

It however pointed out that unlike in 2009 when CBN argued that Nigeria would not be greatly affected by deteriorating global conditions due to low level of foreign investment in domestic assets, the situation has changed considerably under the present dispensation.

New Oil Benchmark
Meanwhile, the Federal Government last week slashed the 2015 budget oil benchmark price from $73 to $65 per barrel because of the unabated fall of oil prices at the global market.

The Coordinating Minister of the Economy and Minister of Finance, Dr. Ngozi Okonjo-Iweala said the new oil price benchmark of $65 a barrel, which is in sync with the recommendations of economic analysts, was workable. A Reuters poll forecasts Brent will average $82.50 a barrel in 2015.

“It ($65) is definitely more realistic,” said Bismarck Rewane, CEO of Lagos-based consultancy Financial Derivatives, adding that at about $12 lower than the actual “gives them more headroom.”

Higher Foreign Exchange Exposure
Writing under the title: ‘Nigerian Banks, The nature of growth and risk,’ Rencap analysts said, “We recall from 2009 the defence from the CBN as to why Nigeria would not be greatly affected by deteriorating global conditions was that the level of investment by foreign investors in domestic assets was quite low. Fast forward five years to 2014 and it is a completely different picture,” adding “When we look at the structure of the Nigerian banks’ balance sheets, FX exposures are significantly higher across the board.”

Using banks 2013 financial report as a standard, Rencap noted that “By assets in FY13, the top three banks by FX exposure were UBA (39 percent vs
30 percent; GTBank (39 percent vs. 29 percent and First Bank (FBNH) (38 percent vs. 20 percent).
“By liabilities in FY13, the top three banks were FBNH (39 percent vs. 20 percent); GTBank (39 percent vs. 29 percent), and UBA (37 percent vs. 30 percent).

“By loans in FY13, the top three banks were FBNH (47 percent vs. 21 percent); GTBank (45 percent vs. 27 percent), and Access (42 percent vs. 18 percent).

“By loans in 9M14, the top three banks were Access (45 percent); GTBank (45 percent), and FBNH (40 percent – Nigeria bank only).
“By deposits in FY13, the top three banks were UBA (37 percent vs. 37 percent); FBNH (33 percent vs. 13 percent), and GTBank (30 percent vs. 20 percent).”

The report said much of the FX funding growth has been by demand. The development was largely caused by a number of factors which include the on-going divestment of marginal fields to indigenous companies and further penetration of the federal government’s indigenisation policy in the oil and gas sector.

Another factor highlighted by the report was the relative stability of the naira, which encouraged corporates to convert to US dollar loans and benefit from a lower interest rate.

Oil and Gas Proportion
To underscore the vulnerability of Nigerian banks to the oil price shocks, Rencap pointed out that oil and gas (solid minerals) now takes the lion’s share of Nigerian banks’ credit, with its proportion doubling to 22 percent in FY13, vs. 11 percent in 1Q08.

Other sectors with rising shares are: transport and communication, more than doubling to 14 percent in FY13, vs. 6 percent in 1Q08; State and local government lending, which has also more than doubled to 7 percent, vs. 3 percent in 1Q08; agriculture has doubled to 4 percent vs. 2 percent in 1Q08; real estate and construction peaked at 9 percent in 4Q10, reaching a low of 6 percent the subsequent year, but has continued to stage a steady rebound, reaching 8 percent in2Q14.

Others include public utilities, driven by power sector lending, which now represents 2.3 percent of system loans in 2Q14, up from 0.5 percent in 1Q08.

Upstream and Services
From all indicatio, oil and gas facility (upstream, services and downstream) still dominate banks’ loan book. Rencap said in the report that “Looking at the bottom-up data as at 1H14 or 9M14 for the banks under our coverage, we find a similar picture to the system data, with oil and gas loans representing an average 25 percent of the loan book, ranging from 16 percent at UBA to 40 percent at First Bank.”
Most oil and gas upstream and services loans are FX-denominated. As mentioned earlier, the growth in these two sectors has been largely driven by the divestment of assets by the international oil companies to indigenous players and the federal government’s indigenisation policy.

The report said that the international oil companies (IOCs) were typically self or internationally funded but they have stepped up the rationalisation of their onshore assets mainly due to increased oil bunkering and uncertainty around the Petroleum Industry Bill (PIB). “Consequently, the noticeably higher participation of Nigerian banks in this sector should not be surprising, as there has been increased credit demand from indigenous firms buying assets from the IOCs and other firms functioning within the services segment,” Rencap said.

Partnership with Nigerian Banks
The increased participation of the Nigerian banks in the upstream/services sector has led to the development of innovative financing schemes, particularly for the operators in the services segment. Over the past two years, the IOCs have announced contractor financing initiatives in partnership with the Nigerian banks, leading to funding commitments of over $20billion. These initiatives have improved access to finance for the indigenous companies at reduced interest rates, shorter loan processing times and relaxed collateral requirements. For the contractors to access these funds from the banks, a key pre-condition is the existence of a contract with the IOC and the typical structure involves a financial commitment from the participating banks to the scheme.

Risks to Asset Quality Issues
Analysts pointed out that there are a number of potential risks that could lead to asset quality issues for the banks here, including price (oil and interest rate) and production risks. The area raising the most questions for us today is the implication of lower oil prices on asset quality within this segment. Lower oil prices mean lower revenues, which could translate to: 1) strains in the credit repayment ability of the upstream oil companies; (2) delayed payments to contractors; and (3) the possible cancellation or delay of contracts or planned projects, among others.

Hedge against Risk of Exchange Rate
Relying on its discussions with the banks and some operators in the upstream segment on the underlying risks in this area, Rencap said its key take-away include the fact that the bulk of credits to upstream/service companies are in FX and considering their revenues are in FX, there is a natural hedge in place that helps to reduce the potential risk of exchange rate fluctuations.

Its findings also showed that the loans to the indigenous companies were mostly structured. However, it noted that feedback on the break-even price for these loans is a range between $50-55/bbl. for the most part.

The banks are also said to have put hedges in place (although not in all cases), which we start to kick in at about the $65-75/bbl. price levels for the most part. Some upstream companies have hedges in place at much higher prices.

The report said that in the event that oil prices test the break-even levels, a couple of banks expect these loans to get restructured. This is by taking a cue from Kenyan banks, which avoided a bout of rising NPLs by restructuring portions of their loan books in 2011 when interest rates spiked significantly. Rencap noted that restructured loans are not NPLs but represent stress in the asset quality of the institution.

Stronger Risk Management Structure
“Overall, we think that the Nigerian banks have stronger risk management structures in place to mitigate potential risks in the upstream space. The increased participation by some international banks such as Standard Chartered and BNP Paribas in domestic transactions points to much better structuring in some of these deals. Having said this, given the significantly higher involvement of the banks in syndicated transactions owing to the large size of some of these loans, default by one obligor will affect a string of banks,” the report said.

Further analysis showed that Zenith Bank had the lowest exposure to the upstream/services segment at 6.5 percent in 9M14 (9M13: 3.2 percent) and is only just beginning to play catch-up. The report said, “The bank was wary about getting involved in the flurry of oil and gas divestments, which is partly a function of internal skills development and its preference to fund only established large corporates with “Zenith-comfortable” risk profiles.

Speaking to some upstream companies on the banks they believe have a relatively stronger understanding of the risks involved in their business, the following banks were highlighted: GTBank, Access, FBNH, Zenith, FCMB and Stanbic.”

Downstream Oil and Gas
Unlike the upstream sector, the report said the downstream sector, which has multiple players on different levels is one of the sectors where risk management has been significantly stepped up on the back of the sector’s historically poor corporate governance practices, weak asset quality, high level of government intervention and high level of cross-currency lending. The sector remains high risk but a number of things have changed.

It is a fact that the sector had quite a number of fragmented players, risk management by the banks was poor and many of these players had significant open trading positions such that when the naira was devalued, the companies struggled to make repayments based on their naira sales proceeds.

However, the report warned that the potential delay in subsidy payment at a period of dwindling oil prices could hurt the banks in a way. Rencap said that from its recent meetings with the banks and some downstream oil companies, the value of presently outstanding subsidy payments was put at c. NGN300billion, with the FGN committing to clear about half of this amount before the end of the year. The implication of these delays is that the banks intermittently halt lending to the petrol importers when their subsidy debts reach internal limits, which has often led to queues in the country.

According to the report, “Considering that the recent currency movements were initially a creeping depreciation of the exchange rate unlike the sudden devaluation witnessed in 2009, we believe that between the downstream companies and the banks, they are better prepared to manage the currency risks involved in these cross-currency loans. A few banks also convert these downstream loans to naira depending on certain time and product delivery conditions, as well as specified exchange rate triggers.”

The financial advisory firm believed there will be some pain arising from the currency devaluation, but in pockets and not as significant as what we saw in 2009. “We expect banks to cautiously approach establishing new LCs (letters of credit) for refined crude imports until there is some clarity around the exchange rate outlook.” the report said.

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