beyondbrics

It takes guts to put out a buy note on Nigerian banks. After all, it was only two and a half years ago that the sector was teetering on the brink of collapse. A spat of reckless lending and alleged malpractices left many Nigerian finance houses nursing big losses and resulted in a $4bn central bank bail-out.

But in a sign of how far regulators have reformed the market – or perhaps just what short memories investors have – Renaissance Capital, the Russian investment bank, has this week restarted its coverage of the sector and the message is: Buy, Buy, Buy.

In a bullish 109-page note entitled Nigerian banks: Tabula rasa, Renaissance, which issued a “buy” rating on six banks and a “hold” rating on three other banks, argues that the sector is set for a renewed period of growth following the bust in late 2008/ early 2009.

While transparency, governance and risk performance still leave much to be desired compared to western banks, structurally, the Nigerian banking sector has a lot going for it, Renaissance says.

First, Nigerian banks are strongly capitalised, with capital ratios in the range of 17-44% and equity/asset ratios of 11-28%. Second, balance sheets are predominantly deposit-funded (61-78% for the nine banks in this note) and the majority of these deposits are low-cost sight and savings accounts. Finally, asset structure is overly liquid with liquidity ratios running on average at 45%. The sector loan/deposit ratio is 83%. Essentially, Nigerian banks have the capital, funding and excess liquidity to support another credit growth cycle, all while deposit growth remains robust.

Moreover, with the country’s GDP expected to grow 7-8 per cent this year and oil price still north of $100 a barrel, Renaissance is expecting demand for loans from blue chip companies – still the mainstay of many Nigerian banks’ loanbooks – to remain aplenty.

Credit growth has started to recover and should deliver 15% sector-wide in 2011E, while margins should see upward pressure from a rising-rate environment. Cost focus at many banks is already paying dividends while provisioning charges are falling fast, in line with improving asset quality. On heavy capital bases, RoEs are trending to double-digit territory while RoAs of 2%-plus are the norm by 2012-2013E, and are more indicative of
profitability.

But do cheap capital, strong growth and demand for credit necessarily add up to a profit bonanza for Nigerian banks and their investors?

It is, afterall, a story we have heard before. Hailed as white-hot investment opportunties during the heady days of 2006 and 2007, Nigerian banks became a byword for scandal after the credit bubble it help inflated burst spectacularly in 2008.

Backed by a glut of liquidity from the country’s oil wealth, Nigerian banks at the time pumped credit into equities speculation, helping to ramp up their own shares. But when market ebullience gave way to panic, those margin loans, often backed only by the stocks they were used to buy, went bad.

Renaissance argues that much of this bad debt (or “local asset-quality meltdown” as it calls it) has been mopped up. And while the investment bank is right to point out the vast potential of the Nigerian banking sector – low retail penetration rate (there are only 5m bank accounts in a nation of 156m), growing demand for credit from an expanding middle class and non-oil sectors like telecom – ultimately, much will depend on whether banks will channel their capital into productive businesses.

You can’t fault Renaissance for taking an upbeat stance. The investment bank, which has struggled to compete against state-owned banks in Russia, is now betting heavily on Africa. It has built up a substantial presence in Africa in the past four years.

But perhaps recommendations from such a committed player should be taken by investors with a pinch of salt.

Related reading:
Crisis to recovery: Charting Nigerian markets, FT
Nigeria file, beyondbrics