Exotix Partners on Nigerian banks: Just a flesh wound

·   Back under coverage, with a mix of Buys and Holds. We reinstate coverage on Nigerian bank bonds with Buy recommendations on the First Bank of Nigeria, Zenith Bank, GT Bank and Access Bank 2017 bonds and Hold recommendations on the Access Bank 2021, Ecobank Nigeria, Diamond Bank and Fidelity Bank securities. Most bonds’ prices have recovered relative to YTD lows, but valuations do not appear stretched relative to other frontier market peers. Further, spreads on Nigerian bank bonds are still between 1.5x and 6.1x the spreads on equivalent sovereign bonds.

·   We see GT Bank as the most resilient. We think GT Bank is best placed to navigate the challenging operating environment. Zenith Bank also has solid fundamentals. Like GT Bank, this lender fares relatively well in our currency-based stress test. Access Bank has so far exceeded expectations on almost all fronts, including capital and asset quality, and profitability compares well to most peers. We believe valuations of the FBN bonds already reflect the challenges there.

·   Fundamentals are weaker than before. It has been a difficult year for the Nigerian banks. There have been a number of profit warnings and delayed results. There have also been rating downgrades and the banks have had to deal with the impact of a currency devaluation. In most cases, asset quality and capital metrics are weaker than at the start of the year. It is hard to see all this as ‘just a flesh wound’. However, a number of lenders booked very significant gains as a result of the devaluation. This helped offset some of the impact of much higher provisions and weaker core revenues on net income. Having said that, the economic slowdown has clearly taken its toll on bank fundamentals and things may get worse before we see a meaningful recovery.

·   NGN1,000 to US$? We estimate the impact that significant currency weakness could have on banks’ capital ratios in four exchange rate scenarios. We do not expect local currency weakness of the magnitude in our more severe scenarios, but given lingering concerns about the disparity between parallel and official exchange rates and the ability of the CBN to continue to support the NGN, we believe it is useful to assess the potential impact of significant NGN weakness on the banks. We believe GT Bank and Zenith Bank are best placed to weather further potential NGN weakness. These two banks’ capital ratios remain the highest in the peer group in our currency stress test.

·   Handle stress test results with care. Our stress test does not take into account any impact on Tier-1 or total capital from currency weakness. Further, the stress test assumes no change in NGN-denominated risk-weighted assets as FC-denominated RWAs rise, and assumes the banks take no remediation measures (such as asset sales) to offset the impact of a weaker local currency. These are important caveats as in our stress test, all the banks end up with single-digit total capital ratios in the most extreme scenario of NGN1,000/US$.