How banks outsmart the market, making profits despite bad loans

Banks are money market players in any economy. But under harsh economic conditions, they incur bad loans that usually eat into profits.  CHIMA NWOKOJI in this report reveals how lenders made profits despite grappling with bad loans and economic headwinds for most of 2017 financial year and first quarter 2018.

BUSINESS environment in Nigeria worsened in 2016 when the economy plunged into recession. So, for most of 2017, Nigeria struggled to exit the bad economic condition. “If the economy is doing very well, some of those businesses that are defaulting on their loan obligations will also be doing well. If the economy is not doing well, then those underlying businesses would also not be doing well, thereby finding it difficult to pay back their loans,” Managing Director of the Asset Management Corporation of Nigeria (AMCON), Mr. Ahmed Kuru said while giving a clear picture of the situation.

Incidentally, lenders needs to extend new loans for greater development and provision of faster stimulants for economic recovery, but most of them  got their fingers burnt as those who borrowed money from them could not pay back.

When a borrower stops paying back money borrowed, it is regarded by the lender as a Non-performing Loan (NPL). An NPL by definition is the sum of borrowed money of which a debtor has not been able to meet up in scheduled payments for at least 90 days, and is either in default or close to being in default. Once a loan is non-performing, the odds that it will be repaid in full are considered to be substantially lower, while the NPL ratio is the amount of NPLs over total loans, usually expressed as a percentage. Such loan in effect reduces current profits because the banks will account for expected losses known as impairment charges. These are basically money that is put aside by a bank in case its customers cannot make the required loan repayments, but which will leave a huge dent in a company’s profits.

Historically, bad loan kills banking business across the world, yet banks exist to give loans. For decades, the Nigerian banking industry has suffered so much under the yoke of NPLs.

Incidentally, they cannot stop lending because the business of banking is the business of taking money from those who have, and making it available at a cost, to those who don’t have, but need it for investment and other purposes.

However, when banks go out of this intermediation role to make money from other sources, it becomes a subject of argument whether the banks are being innovative or compromising professional ethics and standards.

The central bank is aware of this when it set a rule that says lenders with “NPL ratios above 10per cent shall not be allowed to pay dividend.”

Apparently, the apex banking regulator is aware that it is a misnomer to have huge hole dug by NPLs in the books of a bank while the same lender claims to be recording jumbo profits and giving out dividends to shareholders.  This reality was captured by the Acting Chairman of the Economic and Financial Crimes Commission ( EFCC) Ibrahim Magu during a session with the Association of Chief Compliance Officers of Banks in Nigeria, May 2018.

His words:“We must work together to save this country. Most of the banks are sitting on the water. In fact, some of these banks are almost collapsing.”

So, it is interesting to have a good number of banks with huge NPLs declaring impressive profits in 2017 and first quarter of 2018.

Some stakeholders see this as innovative, arguing that thinking outside the box in this case is when a lender discovers other possible ways of delivering value to shareholders in periods when traditional methods fail. Others argue that these banks are cutting corners, and violating credit management and professional banking rules. This view is supported by Kuru when he explained that at the point when some transactions that resulted in bad loans were entered into, some of the banks did financial engineering. “They raised the interest payable and instead of the obligor paying N4billion, it becomes N7billion.  So there are some loans that are unrecoverable.”

To this end, “There must be due diligence, even in this practice of private banking. There must be accountability; there must be transparency in our transactions. You don’t have to wait until anything goes awry before you begin to find a solution to it,” Magu on his part warns.

The menace of bad loans

When the former Governor of the Central Bank of Nigeria now the Emir of Kano, Sanusi Lamido Sanusi, sacked five Chief Executive Officers of banks in 2009, he cited N1.1 trillion bad loans, liquidity ratio below minimum, over reliance on interbank and central bank borrowing as their undoing.

Ever since, the lenders have continued in this trajectory. They violate CBN regulatory five per cent ratio threshold on NPLs. This means that banks are not allowed to have an NPL ratio higher than five per cent.

It is instructive to note that although increasing NPLs and its ratio is a warning signal, a performing loan, however, will provide a bank with the interest income it needs to make a profit. This is the core of banks’ profit making. For the sake of emphasis, where lending is threatened, banks’ profits should ordinarily be under threat too. So, following the 2016 recession, Nigerian banks’ loan books contracted 15.4 percent in 2017, according to data from ratings firm Moody’s investors’ service. The decreased lending environment should therefore affect interest income, but did it?

Last year, economic challenges in the country made the level of non-performing loans in the Deposit Money Banks to rise by 50 per cent from ₦1.639trillion in December 2016 to ₦2.424trillion by September 2017 according to the Nigeria Deposit Insurance Corporation data.

Also, just as the banks whose CEOs were sacked borrowed from CBN, available records show that banks’ borrowing from the CBN shot up by 80 percent to N52 trillion in 2017, from N29 trillion in 2016, due to pressure to survive the impact of harsh economic condition, high interest rate regime and ceaseless liquidity mop-up, driven by the tight monetary policy of the apex bank.

The CBN’s non-performing loans ratio in the banking industry is five per cent, but the banks’ NPLs moved from 10.13 per cent to 15.18 per cent last year. In April 2018, a member of the monetary policy committee of the CBN Asogwa Robert Chikwendu, revealed that it had increased to about 16.21 per cent as at February 2018.

He believes that the banks are in difficulty because the rise in their average daily request from the CBN Standing Lending Facility (SLF) window and the continued reliance of many banks on operations in the government debt market to remain solvent is all early warning signs of future threats in the banking industry. The SLF is the window through which banks borrow money currently at 16 per cent from the CBN to enable them meet their short-term cash needs.

Afrinvest, a Nigeria-based investment and research firm, supported this view in a research note, concluding that, “small and medium-sized banks are kept afloat through continuous recourse to the CBN’s lending facilities.”

Commercial and merchant banks in the country visited the Central Bank of Nigeria’s (CBN) Standing Lending Facility (SLF) window more frequently in 2017 to play their intermediation role, a sign that they are cash trapped. According to the CBN financial sector report for 2017, the average daily request for SLF was N216.34 billion in 246 days, out of which Intra-day Lending Facility (ILF) conversion was N130.63 billion, amounting to 60.38 per cent of the total request.

There is no doubt that disruptions experienced in the economy with declining oil prices and government revenue resulted in an increase in the non-performing loans in the banking industry. Yet, under this condition, the banks are said to be strong, made profits in 2017 and even in the first quarter of 2018.

This raises doubts as to the sources of these returns and the credibility of most financial statements. Most analysts have even gone further to accuse some lenders of engaging in ‘book-cooking’ rather than book keeping.

NPLs in other climes

Non-performing loans are not just a Nigerian phenomenon; they are common in all economies. It is the way they are handled that makes the difference. In Europe, for instance, countries such as Greece, Cyprus, Portugal, Ireland and Italy are among the most affected. In Greece, it led to the collapse of 12 banks. According to a KPMG report, NPLs, as of June 2016, stood at 47 per cent in Greece; 45 per cent in Cyprus, and “around 20 per cent in Bulgaria, Hungary, Ireland, Italy, Portugal and Slovenia.”

Among other measures, these countries tackle NPLs through the state creation of an asset management company to buy off the debts, a venture that has not worked so smoothly in Nigeria. The Council of European Union advocates regulatory reform and establishment of a banking union to handle banking policies instead of doing so by individual countries.

Harvest of profits in 2017/Q1,2018

Nigerian Tribune’s analysis of 10 lenders’ results show that they recorded significant growth across financial indices with total Profit After Tax (PAT) of N632.241 billion. The banks are :  Zenith Bank Plc., Guaranty Trust Bank Plc., UBA Plc., Ecobank Plc., Access Bank Plc., Stanbic IBTC Plc., FCMB, Sterling Bank Plc., Wema Bank and Coronation Merchant Bank. Further analysis revealed that leading Tier 1 banks, Zenith Bank and GTB accounted for over 55 per cent of the total profits with N348.403 billion during the period under review.

Specifically, Zenith Bank Plc.’s Full Year 2017 PAT grew by 37.24 per cent to N177.933 billion from N129.652 billion recorded a year earlier. Guaranty Trust Bank Plc. reported a PAT of N170.470 billion for 2017 as against N132.281 billion posted in 2016, accounting for a growth of 28.87 per cent.

Other big banks such as UBA, Access Bank and Ecobank Transnational Incorporated, also reported impressive results. For instance, UBA posted a PAT of N78.590 billion in the period under review as against N72.264 billion recorded in 2016, accounting for a growth of 8.82 per cent. Access Bank posted N61.991 billion PAT in its full year 2017 results as against N71.439 billion recorded a year earlier, accounting for a decline in PAT of -13.23 per cent.

Ecobank Transnational Incorporated (ETI) Plc’s full year 2017 PAT jumped to N70 billion from a loss of N33.71 billion recorded in 2016.

In the first quarter (Q1) of 2018, most lenders equally made profit. For example, PAT for Zenith Bank grew faster than PBT by 33 per cent when compared with that of last year. The PAT’s growth was attributed to other comprehensive income (N4.8bn), thanks mainly to foreign exchange translation gains. Similarly, UBA’s Q1 2018 results showed that PAT grew by 45 per cent to N33.0billion, largely driven by a positive result of N11.2billion in other comprehensive income (OCI).

However, the eleventh bank within the scope of this article, Diamond Bank Plc, made a loss. Loss Before Tax for the bank during the year ended December 2017 is  ₦11.5 billion as against a profit before tax of ₦3.36 billion in full-year 2016.

The bank made a loss after tax of ₦9.01 billion during the year ended December 2017 as against a profit after tax of ₦3.49 billion in full-year 2016, underscoring the effect of harsh operating environment.

Further analysis of 10 banks showed that as profits of some of them grew, so also did their impairment charges/ write back grew, while for some lucky lenders, their impairment charges decreased as profit grew. For others, rising impairment charge means decreasing profits in the year under review.

New sources of revenue generation

For a bank under the strangle-hold of NPL and eroding capital to make profit, it has to go beyond normal financial intermediation. There have been cases where lenders engage in buying and selling of goods and services among others. Exactly a year ago, after accessing over $300 million offered to the Small and Medium scale Enterprises (SMEs) wholesale forex window, Deposit Money Banks deliberately frustrated efforts by many SMEs to access forex from the window created by the CBN. They allegedly applied the funds to currency trading. This prompted the apex bank to bar 17 banks from dealing in the SME wholesale forex window. When the banks did sell to SMEs, they equally sold same at black market and made gains.

Sanusi was quoted last year as having said that, “As an Emir, I can seat in my garden and make phone calls to access $10 million at N197 per dollar, then sell it off at nothing less than N300. With just a phone call, I’m making a profit of over a billion naira. That is what people are doing now.

“Any system that allows you sit in your garden and make a billion naira without investing a kobo is a wrong system.” This is a pointer to the fact that most banks made profit from trading in foreign currencies.

It should be remembered that when in April 2017,  the Senate investigated revenue leakages in the import and export value chain, it was discovered that there were unutilized Form ‘M’, abandoned Form ‘M’, partially utilized Form ‘M’, abandoned assessments of Custom Duties and foreign exchange allocation manipulations. The result is that the amount of official foreign exchange government gave out to commercial banks and importers for the purposes of importation were not utilized as agreed, but diverted to parallel market and round tripped. This was before the introduction of CBN’s exchange rate multiple windows. So, banks that bought dollar at the official rates of between N301/$ to N306/$ sold same at about N445 to dollar at the parallel market.

Another area where banks made gains was predicted by the Renaissance Capital (RenCap). RenCap predicted that Nigerian banks’ fourth quarter 2017 earnings are likely to be boosted by revaluation gains, which will, “offset any negative asset quality surprises.”

The firm, which stated this in a research note, added that banks are using an exchange rate of N330/$ – an average of the official rate and Investors and Exporters (I&E) window rate as against N306/$ they used earlier to value their foreign currency portfolios. This means that banks valued their assets at a unit value of $330 but as the Naira weakened against the dollar, value of their investments increased by $24 and this is a boost to revenues.

On average, 45per cent of net lending in the Nigerian banking sector is extended in FC (almost entirely US dollars). Balance sheets tend to be reasonably well-hedged, although Capital Adequacy Ratios (CARs) are primarily affected by the revaluation of their FC risk-weighted assets into Naira.

Ordinarily, currency devaluation affects banks’ capital ratios largely because total risk-weighted assets are inflated when foreign currency (FC) assets are translated back into naira, while capital is denominated in local currency, but lenders instead gain.

“We believe capital buffers will rise as profits improve and note that the banks are increasingly more comfortable using an exchange rate of N330/$ – an average of the official rate and Investors and Exporters (I&E) window rate (vs N306/$ previously) – to value their foreign currency portfolios. We take this to mean potential revaluation gains in 4Q17, which we think could offset any negative asset quality surprises,” says Rencap in a note to investors.

On the other hand, Fitch rating agency noted that Nigerian banks are highly reliant on net interest income for profitability and treasury bills proved to be an important source of profits in 2017.

For example, 11 Nigerian banks: Zenith Bank Plc, Access Bank Plc, Fidelity Bank Plc, First City Monument Bank (FCMB), Guaranty Trust Bank (GTBank) Plc, Union Bank Plc, First Bank Nigeria Holdings (FBHN) Plc, Sterling Bank Plc, Wema Bank Plc, Diamond Bank Plc, and United Bank for Africa (UBA) Plc., made N829.20 billion income from treasury bills (T-bills) in 2017 as they took advantage of high yields environment.

The above figure represents a 47.70 percent increase from N561.41 billion recorded in 2016 . Treasury bill (T-Bill) is a type of government security issued on behalf of the Federal Government by CBN to control money supply in the economy. T-bills are short term securities issued at a discount for a tenor ranging from 91 to 364 days, which yields no interest. Yields from T-bills hovered around 18 percent and 22 percent from April and September last year as the CBN sold more of short term securities to help fund the budget deficit and control inflation.

Analysis of the numbers of some banks shows FBHN Plc’s income from T-bills increased by 50.22 percent to N173.28 billion from N115.35 billion the previous year. Zenith Bank’s income from short term government securities increased by 82.33 percent to N109.74 billion in December 2017 from N60.18 billion as at December 2016. Access Bank’s income from T-bills was up 85.43 percent to N83.23 billion in the period under review from N44.88 billion as at December 2016. UBA’s income from short term government securities increased by 30.10 percent to N115.58 billion in the period under review from N88.81 billion as at December 2017.

“High yield environment boosted bank’s interest income. Yields were between 22 percent and 18 percent at some point in 2017,” said Wale Okunrinboye, analyst at Sigma Pensions Limited.

Fears for 2018 earnings

Yields on treasury bills now hovers between 11 percent and 13 percent while bond yields that were between 16 and 17 percent last year now hovers around 12 percent and 13 percent.

But a  drop in T-bills yields from August last year to date could signal the end of free money for these lenders as margins are expected to shrink; an unavoidable event that could force them to start lending. For instance, analysts at Fitch in a recent report said they expect banks’ profit to take a hit in 2018 on the back of the decision of federal government to cut back on the issuance of treasury bills in 2018.

“We expect falling T-bills yields and lower issuance to put pressure on Nigerian banks’ profitability in 2018. The CBN’s latest issuance schedule shows N1.1 trillion (USD3.6 billion) of rollovers in the first quarter of 2018 against N1.3 trillion of maturing bills,” said Fitch. Volatility in foreign-exchange related gains, limited scope for cost efficiencies and rising political risks before elections are other challenges that could cloud industry outlook.

Views from other stakeholders

The International Monetary Fund (IMF), in its recent World Economic Outlook report raised concern that the rate of non-performing loans in some countries including Nigeria is alarming. It stated that some low income countries (Mozambique, Nigeria) have experienced financial stress or deteriorating loan quality in recent years, as growth becomes moderated and corporate balance sheets weakened.

It warned in the report that further deterioration in loan quality will impair credit intermediation and the ability of the banking sector to support growth.

In his reaction, the Chairman of House of Representatives Committee on Banking and Currency, Hon. Jones Onyeyeri, said: “That’s why the government introduced Asset Management Corporation of Nigeria (AMCON). I think that we are in a worse grave situation, that’s the honest truth because the non-performing loan is far beyond the usual industry threshold and for me it is embarrassing.

“We won’t allow AMCON II. They need to solve that problem and if you look at what we are doing especially in the House of Representatives, we are amending the Banks and Other Financial Institutions Act (BOFIA) and what we are trying to achieve is to curb as much as within reasonable limits the whole idea of non-performing loans. The core of non-performing loans is because of insider abuse.”

Commenting on the issue of NPLS, Mr. Ademola Adeleke, Director, Bank Examination Department of Nigeria Deposit Insurance corporation (NDIC), at a recent workshop for Business Editors and members of Finance Correspondent Association of Nigeria (FICAN) in Kano, said the volume of non-performing loans continued to grow up till September 2017, while the total loans advanced by the industry continued to decrease in volume as banks curtailed lending and concentrated on loans recovery drives.

His words: “A high NPL ratio requires greater loan provisions, which reduces capital resources available for lending, and adversely impacts banks’ profitability. NPLs inhibit banks ability to intermediate and grow the economy.”