22 July 2012

Nigeria: Rush for Blue Chip Corporates Put Banks' Non-Interest Margins Under Threat

As the reality of the new stratifications in the banking industry dawns on the Nigerian banking public, there are fears that the shift of focus from oil and gas sector and capital market to blue-chip corporates by Tier 2 banks may adversely affect the non-interest margins (NIM) of the affected banks.

Non-interest margin is the spread between interest income generated by banks and the amount of interest paid out to their lenders, relative to the amount of their interest earnings.

Industry affairs commentators maintained that as some banks develop phobia for exposure to capital market and oil and gas sector, some operators, especially among those in the Tier 2 brackets have decided to challenge their Tier 1 counterparts for a piece of action for blue-chip corporates' accounts and cheap funds.

Banks classified in the Tier 2 category in terms of assets and capitalisation include Diamond Bank Plc, Sterling Bank Plc, Fidelity Bank Plc, Skye Bank Plc, Stanbic IBTC Plc and First City Monument Bank Plc, among others.

Analysts however said what may hurt the operations of the Tier2 banks is their growing appetite for less-yielding accounts, which they feared may affect their non-interest margin given the challenge of generating cheaper funds. Providing an insight into the emerging scenario, the international financial advisory firm, Renaissance Capital said Tier 2 banks' increased focus on the top end could come at the expense of NIMs.

According to a report titled "Tier 2: When the going gets tough," a copy of which was made available to THISDAY last week, "the key problematic sectors for the Tier 2 banks since the Nigerian banking crisis, from a quality perspective, have been oil & gas and general commerce. The Tier 2 banks have stated their intention to improve the quality of their loan books by focusing more on top-tier blue-chip corporates and less on high-yield lending to smaller clients.

"They have approached this goal by attempting to compete with the Tier 1 banks on pricing. Our concern is that this increased focus on the top end could come at the expense of NIMs. The raising of Tier 2 capital and/or external debt by some of the Tier 2 banks is also likely to put pressure on NIMs going forward."

Rencap however argued that "the funding structure of the Tier 2 banks will be critical to their success going forward. Across the board, Nigerian banks would like to increase their share of cheap deposits. Tier 1 banks have a natural advantage in this regard, given their extensive retail networks and well-known brands." The firm believed that because of certain disadvantages, the Tier 2 banks, however, have historically had to rely more on relatively expensive wholesale funding.

Incidentally, some of the Tier 2 banks have been scaling down their reliance on wholesale funding.

For instance, Rencap reported that "over the past two years we have seen Diamond and Fidelity Banks drive down their portion of wholesale funding to 22% and 29%, respectively, in FY11, from 49% and 42% in FY09. FCMB is hoping to improve its deposit composition via its acquisition of Finbank. This leaves Skye Bank as the standout Tier 2 bank that still relies heavily on wholesale funding, at 47% of deposits in 1Q12 (FY11: 41%)." The financial advisory firm, which had discussions with managements of some of the banks, said part of the strategy of some Tier 2 banks was to improve their cost of funding.

"According to our discussions with management at several Tier 1 banks, they are seeing some pricing pressure coming from the Tier 2 banks in the top-end corporate segment. This forms part of the Tier 2 banks' strategy to improve the quality of their books. For those Tier 2 banks that already have a low cost of funding and for those that made acquisitions in FY11 and increased their share of cheap deposits, a move up the corporate ladder could make sense. However, we question the logic of this strategy for the remaining Tier 2 banks, as they are still saddled with comparably higher reliance on term deposits, and as such face higher funding costs. We believe their NIMs could come under increased pressure.

We think a driving factor behind this strategy, however, is the NPL experience the Tier 2 banks had from the low-to-mid corporate sectors where they historically dominated before the banking crisis. The flip side is that the Tier 1 banks are now looking to move down the risk ladder (First Bank and Guaranty Trust Bank are cases in point). Thus, we may be looking at a near-to-medium-term scenario of higher NIMs for some Tier 1 banks as they increase retail/mid-corporate penetration and NIM squeeze for the Tier 2 banks as they move up the risk ladder.

The company noted that since the banking crisis there has been a reduction in Tier 2 NIMs, as a build-up in NPLs resulted in higher levels of suspended interest income. It therefore maintained that having higher asset yields than the Tier 1 banks has been a characteristic of the Tier 2 banks historically. This, according to the report, is partly due to their historical strategies, whereby some were more heavily slanted to merchant and investment banking (FCMB, Skye Bank), and hence had greater exposure to high-yielding assets and transactions.

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