The Governor of the Central Bank of Nigeria (CBN) announced that a limit on banks’ government securities holdings may be introduced to further incentivise lending to the real sector, at the Monetary Policy Committee (MPC) meeting briefing on 21 May. Improved credit delivery to the real economy is expected to enhance economic output, hence the MPC has urged banks to increase lending via its proposal to the CBN. The CBN is yet to confirm if the proposal will be adopted or disclose details of a possible implementation. At the same meeting, the CBN retained its benchmark interest rate at 13.5%, cash reserve ratio at 22.5% and liquidity ratio at 30%.
Potentially negative, but top picks remain GTB, Zenith and Stanbic. While the news present downside risks to our valuation, we maintain our current ratings, pending further clarity on the proposed policy from the CBN. In our view, key risks relating to this development include: 1) a decline in margins in the absence of loan growth opportunities; and 2) potential asset quality issues in the event that banks lower their risk criteria and aggressively grow risk assets. Our top picks remain GTB, Zenith and Stanbic – banks that generate the highest ROEs (24-34% range in FY 18 versus 12% median for other banks) and are best positioned to absorb negative shocks to the sector. Nigerian banks currently trade at median FY 19f PB of 0.4x, a 51% discount to our frontier banks universe.
We do not rule out an implementation. We see the possibility of banks being pressured into lowering their investments in government securities, even without explicit directives from the CBN. This is based on a recent history of unorthodox actions from the regulator (such as stabilisation operations and the artificially high Cash Reserve Requirement), as well as the re-elected Federal Government’s socialist leaning, which we expect the CBN to follow. That being said, reduced participation by banks might actually push interest rates higher, given their substantial involvement in the capital markets and government treasury holdings (banks held 47% of T-bill and 36% of Federal Government bond stocks in December 2018, according to CBN data). This would, however, go against promoting improved access to cheaper credit and the fiscal arm’s goal of cutting the country’s debt service burden.
CBN should focus on normalising the Cash Reserve Requirement (CRR), which according to banks, remains over 30% for most (versus the 22.5% headline rate) and has been a major constraint to local currency lending. Although FX stability has been the motivation for the high CRR, we believe greater focus should be on growth stimulation. The tax-exempt status of treasury securities could also be revoked ahead of the 2022 expiration, making those assets less attractive to banks while also raising the government’s tax revenues. In addition to low risk appetite from banks towards certain segments (such as real estate), many have reported weak credit demand from quality borrowers as a headwind to loan volume growth, which the MPC’s proposal does not initially address. For instance, manufacturers continue to mainly source working capital financing, as weak consumer demand currently dissuades capital expenditure. The CBN’s Differentiated CRR Policy (introduced in July 2018) was intended to grant banks access to restricted deposits for loans to certain sectors. However, feedback from banks suggests that no approvals have been granted yet by the CBN for disbursements under the programme.
Private sector credit trend is a concern, having declined by 3% pa in 2016-18 and loan volumes for our covered banks were flat qoq in Q1 19. The key drag has been the oil and gas book (c31% of total) where banks have reported paydowns following improved oil prices. The weak macroeconomic backdrop has also resulted in no growth in the manufacturing book over the same period, as well as contractions in the real estate and general books. Consequently, for our covered banks, c27% of total assets are currently allocated to investment securities (Q1 19) from 22% at end-FY 16, while loans account for 34% from 48% at end-FY 16 with loans/deposits declining to 56% from 75%.