Nigeria's banks huge exposure to oil sector threatens operations

First Bank of Nigeria's modest head office is stationed at the marina in Lagos. Beyond the mid-morning traffic on the road in front of the building, past the shores of the marina, are two rather imposing oil rigs.
When they first turned up, their presence confused locals. Oil rigs are usually stationed in oil producing regions in Nigeria, close to the Niger Delta, so why were they at the marina? Curious onlookers initially assumed that the rigs, which were owned by indigenous oil company SeaWolf Oilfield Services, were undergoing repairs and need not be in an oil producing region. But a closer look revealed that there was little, if any, maintenance work going on.
The truth is, Nigerian banks are hugely exposed to the oil and gas sector," says Dolapo Oni, oil and gas analyst at Ecobank. "Despite central bank regulations limiting exposure by banks to 20 percent of their total loan book, some have already exceeded this, Dolapo Oni, Ecobank
It was only once local media dug a little deeper that they found out why the oil rigs were there. They discovered that First Bank - Nigeria's largest lender - had seized the oil rigs after SeaWolf failed to make a payment on a N25 billion ($125.6 million) loan. Following the debacle, Nigeria's Asset Management Corporation (Amcon) took over SeaWolf and the rigs in question. The full story behind the repossession is yet to emerge.
"It's become something of a joke in the market," says an analyst based in London. "I mean, what exactly is First Bank going to do with two oil rigs parked out the front of their head office? I don't think they could use it as extra work space, do you?"
But at the heart of the problem appears to be something more profound. The repossession of SeaWolf's rigs is not simply the result of failure to pay back some loans. It is also related to the plummeting oil price globally, and the pressures oil companies in Nigeria more generally are beginning to feel as revenues inevitably come down.
Afren is another Nigerian oil and gas company that has fallen on hard times. Once hailed as one of Nigeria's success stories, Afren carved a path for itself as a leader in the oil and gas sector, culminating in its listing on the London Stock Exchange in 2009. It was an indigenous company setting an international example for others in Nigeria to follow.
But as the oil price tumbled in 2014, Afren began to find it difficult to honour its loan repayments. This year, it has failed to pay interest on any of its loans: Access Bank and Zenith are direct lenders to Afren, while First Hydrocarbon Nigeria, an Afren subsidiary, banks with First City Monument Bank and Guaranty Trust Bank. Over the past year, shares in Afren have fallen by
97 percent.
Bankers argue that cases such as Afren's and SeaWolf's are isolated, due mostly to management problems rather than the fall in the oil price. In fact, they say, banks are well placed to deal with the volatility in commodity prices as they have in place various strategies to avoid a meltdown. "We've done some of our own stress tests," says one international banker based in Lagos. "We believe most banks will be fine, with a few exceptions. But even these exceptions will be able to pull themselves out of trouble, given time."
While stress tests may provide some comfort, it is too early to rule out a severe shock to the banking system. "The truth is, Nigerian banks are hugely exposed to the oil and gas sector," says Dolapo Oni, oil and gas analyst at Ecobank. "Despite central bank regulations limiting exposure by banks to 20 percent of their total loan book, some have already exceeded this." According to data compiled by Renaissance Capital, 40 percent of First Bank's loan book is exposed to the oil and gas sector; for Skye Bank the figure is 33 percent; Guaranty Trust Bank 28 percent; Diamond Bank 27 percent; Access Bank 25 percent; and for Fidelity Bank it's 24 percent. To gauge the scale of the issue: First Bank has a loan book of $11.4 billion.
Being above the 20 percent threshold could mean that these banks will incur central bank fines, although none have been levied as yet. At the very least, they will be forced to increase provisions. By September 2014, First Bank, which has an NPL ratio of 2.9 percent, recorded that around one-seventh of those NPLs were from loans to the downstream oil and gas sector. For Access Bank, which has an NPL ratio of 2.5 percent, downstream oil and gas represented more than a third of distressed lending. That was before the sharpest decline in the oil price. Analysts are waiting nervously to see updated figures. Pressure is building. Is a potential fallout on the way?
Nigeria's oil and gas landscape began to change around five years ago when international oil companies (IOCs) in Nigeria were forced to divest assets to local oil companies (LOCs) under new regulations outlined by local content laws
laws with incentives for local procurement and local employment. In a scramble to get these new assets on their balance sheets, local banks doled out loans, about N2.2 trillion to indigenous companies to acquire oil-related property. Consequentially, banks' allocation to the oil and gas sector changed dramatically. In September 2009, before divestment and local content laws, 13 percent of banking credit in Nigeria was allocated to the oil and gas sector. Three years later, this rose to 22 percent and has stayed flat since.
"There was a sort of 'bandwagoning' effect going on," says Muyiwa Oni, west African bank analyst at Stanbic IBTC. "As all of these assets became available to local companies, banks rushed to finance them, with some taking a blanket view of the assets and corporates that they were backing."
This rush was limited to the local banking sector. International banks were, and still are, exposed to the oil and gas sector, but have largely done so through syndications. Moreover, local banks had much more of an appetite, given the new circumstances. "In any case, if the international banks were to run into serious trouble, they would be able to leverage off of the balance sheet of their parent bank - not something that local banks generally have the privilege of doing," says Oghogho Akpata, partner at Nigerian law firm Templars.
This was the first time that local banks were financing upstream and midstream activities in Nigeria. And it became the first time that many of these banks were exposed to the related risks. Exploration and production are closely related to volatility in commodity prices. "The composition of banks' lending to the oil and gas sector has completely changed, with mixed exposure to downstream, midstream and upstream sectors. This was good for banks' diversification, but it depended to what extent they were exposed to each area," says Adedayo Adesanmi, oil and gas client coverage at Stanbic IBTC.
"And there were some concerns," Oni from Stanbic IBTC says. "This type of lending and the related structures were new to local banks, and some of these banks are still developing the skills needed to do this successfully." With the acquisition of some of these assets, there was the acquisition of related skills but this was not the case for all. As one local banker admits: "Up until around three years ago, we were a solid downstream financing bank with little exposure in the upstream sectors. Now this has all changed. It's been a steep learning curve." Despite these concerns - concerns that have become much clearer with hindsight - bank loans and other debt products were easily extended to local corporates. And this was at a time when oil prices were at all-time highs: at around $110 a barrel, the banks thought they were in for a good deal.
Now, with oil around $60 a barrel, it's a very different story. "For some oil and gas companies in Nigeria, there will be pressures on revenue because the oil price has dropped dramatically, especially for the smaller oil and gas companies," says Oni at Ecobank.
The international banker based in Lagos says: "No matter what banks tell you, banks lent to oil and gas companies in Nigeria with price decks of $90 a barrel. Then prices plummeted to $45 a barrel and are only starting to recover to around $60. With this fall in revenue, how easy is it going to be for corporates to repay their debt?"
Then add to this the fact that some of these companies were given pioneer status by the government when they first acquired assets, which meant a three- to five-year tax break to LOCs depending on their level of capital expenditure. These tax breaks were often factored in to earnings when local banks offered loans to indigenous companies.
"When the government commenced single five-year pioneer status certificates to oil and gas companies in the early 2000s, it was fully supported by the government as part of the incentive available under existing law. But now, the ministry of finance has turned around and deemed a single five-year grant of pioneer status to oil and gas companies as illegal because, according to the ministry, there is no legal basis for a single grant of five years. There is a chance that these five-year tax holidays will be cut short to three years, or that the government will seek to claw back tax reliefs that have already been enjoyed above three years. Essentially, the government needs to shore up its revenue, which has been hit by the falling oil price, and back pedalling on the five-year grant of the pioneer status is one tool they can use," says Akpata. "This will affect around 22 indigenous companies that were granted pioneer status. So far, 10 of these companies are being assessed by the tax authorities."
Since picking up these assets, local banks have also seen their exposure to foreign currency grow. In 2010, Fidelity Bank's and Skye Bank's exposure by loans to foreign exchange was 0 percent and 2 percent respectively. By September 2014, exposure had risen to 38 percent for Fidelity and 34 percent for Skye Bank. Those that already had substantial exposure to FX in 2010 also saw bullish growth. Access Bank saw exposure rise from 18 percent to 45 percent, while First Bank saw a rise from 21 percent to 40 percent.
"Some analysts expected the oil price to recover by now," says Dele Kuti, head of oil, gas, power and infrastructure at Stanbic IBTC. "The truth is, it hasn't and I don't see the price surpassing $60, or $65 a barrel in the next nine to 12 months. In light of a deal with the US, Iran could flood the market with another 2 million barrels of oil a day and the fact that large shale gas producers in the US are becoming much more active and managing costs better, global oil prices could remain low."
But is the situation really so bad? As the international banker in Lagos points out: "In the last 12 to 18 months, around $7 billion to $8 billion-worth of assets divested by the IOCs which were acquired by the LOCs. The estimation of debt for these acquisitions is about half - say, $4 billion - so we're not talking big numbers when compared with total banking assets. Unless banks structured loans in a rush and didn't do their due diligence, most loans will be OK."
Akpata says: "A couple of banks and their borrowers did structure loans well, taking into account a variety of risks. In particular, they ensured corporates had hedges in place. With hedges at around $90, these companies have cashed in and are still making profits. In such cases, the banks and companies are happy."
And there are other options open to banks. For example, the central bank has put in place an intervention fund for the oil and gas sector that is expected to fill some of the shortfall in oil revenues.
"In my opinion, the intervention fund was something put together by Goodluck Jonathan's [Nigeria's recently defeated president] government to appease some shareholders of oil and gas companies who were friends of government," says Bismarck Rewane, CEO of Financial Derivatives Co, a financial services institution based in Lagos. "Now government has changed hands, what will happen to these people's interests? Could the fund be closed? I wouldn't expect much clarity until May 29 when the new government is sworn in. We should keep an eye on this."
There could even be a chance that the government itself may find it difficult to meet payment obligations on existing contracts for infrastructure and development projects throughout the country because oil revenues have taken a hit Dele Kuti, Stanbic IBTC
As for the corporates, they can cut back on exploration, renegotiate contracts with the midstream sector, increase production - many still haven't reached full capacity in terms of output - and some can even look towards diversification into the gas industry.
Gas is a potentially attractive area: exploration has largely been carried out and infrastructure is already in place. "In most cases, we extended loans to companies that were already diversified away from the oil and gas sector so they already have other channels of revenue to leverage off of," says the local banker based in Lagos. "Where they haven't, we would advise them to do so as there are increasingly tax incentives associated with gas production and exploration."
Remi Oni, executive director, corporate and institutional clients at Standard Chartered in Lagos, is optimistic. "I genuinely think things will be OK," he says. "Firstly, because there is a sense that there will be a recovery in the second half of this year and secondly, if there isn't a recovery, Nigeria will be able to survive with oil prices around $45 a barrel with all the cuts to capex and opex that companies are putting in place, as well as austerity measures by the government."
The knock-on effects, however, are numerous. Renegotiating contracts, for example, will have repercussions on the service sector and other midstream-sector companies. "Then these companies could have issues honouring their debt repayments if they are out of work," says Kuti at Stanbic IBTC.
"Put simply, services and the midstream sector are driven by drilling more wells," says Oni at Stanbic IBTC. "But companies aren't drilling any more wells. While the upstream sector has underlying assets to protect them and can cut back on capex, the midstream sector doesn't really have any of these tools and could begin to find it difficult to maintain revenue levels where they are."
As Kuti highlights, "there could even be a chance that the government itself may find it difficult to meet payment obligations on existing contracts for infrastructure and development projects throughout the country because oil revenues have taken a hit."
There can also be problems if the acquirer of an oil and gas asset used a bank loan to finance their equity portion of the acquisition, says the regional head of a South Africa-based bank. "Where that is the case, issues like their ability to pay back the loans within the stipulated tenor also becomes a problem in a lower oil price environment. Acquirers themselves could see lower dividends, which will take it longer to service debt," he says.
His observation comes with a caveat: "Don't forget, this is not happening in a vacuum. This will only affect banks where appropriate collateral, such as provisions, hedging and restructuring are not in place," he says. As the international banker says: "Corporates will service debt but profitability will be gone and thus dividends will be impacted. This is the new reality."
One remaining option open to banks is the ability to restructure loans, which will give them the breathing space needed to stay in shape and keep NPLs off their balance sheets. "Assets are prolific so owners should focus on increasing production before they begin to restructure loans. Restructuring should be the final option," says the local banker.
But in some cases, assets aren't so "prolific". Before the most recent period of divestment, before local content laws and before pioneer status, there was a period in 2003 where the federal government transferred the operations of 24 marginal fields to 31 Nigerian companies. This marginal field program was one of the first initiatives to promote indigenous participation in the upstream sector of the petroleum industry. But more than 10 years on, few LOCs have made much of the opportunity.
For banks that didn't insist on a hedge, and for those that can't rely on production, restructuring existing loans will probably be the next best option. For instance, banks may need to revise terms of existing facilities, and corporates may have to give away more equity, or bring in new parties through farmouts, Rolake Akinkugbe, FBN Capital
Of the 24 marginal fields, around nine are producing oil; banks involved in lending to these LOCs could be under more pressure than others. "I've been there, I've seen some of the fields, and there is nothing going on at all. It seems like such a waste," says one analyst in Lagos. Some believe that licences for the fields could be revoked because of the lack of activity.
"For banks that didn't insist on a hedge, and for those that can't rely on production, restructuring existing loans will probably be the next best option," says Rolake Akinkugbe, head of energy and natural resources origination and client coverage at FBN Capital. "For instance, banks may need to revise terms of existing facilities, and corporates may have to give away more equity, or bring in new parties through farmouts."
Simply extending tenors, however, will create liquidity mismatches for banks, limiting activity as well as appetite for additional assets in other sectors. Some banks are already teetering on the edge of capital adequacy ratios (CARs), set at 10% for national banks, 15% for international banks and 16% for systematically important banks in Nigeria, which include the likes of First Bank, Guaranty Trust Bank, Zenith Bank and UBA among others. According to Adesoji Solanke, sub-Saharan Africa analyst for Renaissance Capital, First Bank's capital position at 15% to 16% is the most cause for concern because it's so close to the recommended threshold.
Banks will be forced to adjust their risk portfolios by selling down oil-related assets to give them access to liquidity and increase CARs. "Restructuring can mean higher risks and liquidity mismatches, but banks will work with clients to try and limit these issues," says Akinkugbe. "And trying to help banks sell down exposure, bringing in international counterparties on secondary deals not only frees up liquidity and capital for banks but it also has the knock-on effect of helping develop Nigeria's capital markets."
She adds: "For some banks, there will be additional fees for those involved in origination and restructuring. Some banks will see benefits through additional business." It's one potentially encouraging side-effect to Nigeria's oil crisis.
Analysts, bankers and experts are split over how Nigeria's banking sector will cope with the onslaught of oil price-related issues. "Banks are overexposed and there is a huge concentration of risk in the oil and gas sector as a whole. Smaller banks in particular will be in trouble," says Rewane, highlighting Skye Bank and Heritage Bank
Says Kuti: "Let's look at it this way: at least this time, banks are backing real assets as opposed to vapour [as they did] back in 2009 when Nigeria experienced its first banking crisis. I don't think we will see a full blown crisis as we did back then as banks and the regulator are in a better position to deal with the fallout."
It was a different when Nigeria's banking system fell into crisis in 2009. Looking for quick profits, banks played the stock markets but with the onset of the sub-prime crisis, repercussions were felt in Nigeria. The stock market plummeted by as much as 70 percent and the banking sector collapsed. To try to save what it could, the central bank reacted with a N620 billion liquidity injection and created Amcon to absorb the bad debt. Banks are in a much stronger position today.
But the mood surrounding the oil and gas sector, and banks' loans to it, will remain subdued for some time. "At the moment, banks generally have a policy to wait and see what will happen," says Gbenga Sholotan, equity research analyst at Stanbic IBTC. "Corporate loans to the downstream oil sector have basically come to a halt. For now, there is very little going on in this part of the value chain."