Another round of devaluation of the naira will compound the woes of Fist Bank Plc as over 50 percent of the lender’s spiralling non performing loans (NPLs) are dollar denominated, analysts at Ren Cap say.
First Bank has suffered a significant drop in profit caused by huge impairments on financial assets otherwise known as loan loss expense. NPLs increased to 22 percent in the first quarter of the year, fuelled by exposure to the oil and gas.
This figure crosses the 5 percent threshold questioning the risk management strategy and portfolio management of the bank. The bank’s risk assets managers failed to diversify or minimise risk and maximise return.
A possible devaluation of the currency is inevitable given the continued depletion of the external reserves and rising inflation.
Nigeria, Africa’s largest economy has been grappling with a fall in oil price by 65 percent to $45 a barrel, forcing the Central Bank to impose capital control and restricting dollars to banks.
The CBN pegged the naira at N197-N199 at the official rate while selling at N325 at the parallel markets.
“Another related asset quality concern is that 56% of the bank’s NPLs are FX, which implies that if devaluation occurs, coverage levels would fall, with the bank needing to set aside more naira earnings to cover these greenback NPLs. In light of this, it is quite difficult for us to get comfortable with a coverage ratio of 37 percent”, said analysts at Rencap.
I am trying to figure out how Naira devaluation will further compound First bank’s woes in respect of NPLS. The Loans are already impaired I presume. Can you shed more light?
A non performing loan has not necessarily been written off hence devaluation will probably add to the risk of the loans definitely going bad which means first bank will have to write off larger sums in naira
When a firm has debt in its capital structure, it could either be in local currency or foreign currency. In the case of a Nigerian bank, the loan portfolios has some dollar denominated debt in it. That said, When a loan is non performing, it means the possibility or likelihood of repayments is shaky. That doesn’t mean such loans will not be paid but it has laspsed the period stiputed for repayments. So, when a currency devaluation occurs, the non performing Loans element in a lender’s balance sheet will spiral and hence putting the it
in more precarious situation.
Following from Victor’s point on the borrowers needing to source for more naira to meet loan repayments, it further undermines the quality of the underlying collaterals and sources of funds for repayment. Consequently, facilities that were collectively impaired may then be considered for specific impairments; while some loans that were already specifically impaired may suffer further charges as a result of poor quality of the cash generating assets and collaterals. Note, if the borrowers earns incomes in dollars, their repayment ability may not be affected by a naira devaluation.
So far, all indications points to a possible devaluation any time now.
What effects will such a devaluation have on the economy? And sectors will be most impacted?
The possible effects include the following:
i) imports and payment of foreign debts becomes more expensive (as importers and borrowers will need more naira to meet their dollar obligations).
ii) exporters will be better off as they will get more naira values for their foreign currency denominated proceeds. Hence, export is encouraged.
iii) If Nigeria were an exporting country, our products will be cheaper and more attractive to importing countries, hence increasing national income in the long run. Sadly, Nigeria is still an import-dependent country.
Since FirstBank must report its dollar-denominated loans in naira, what this means is that every $1 loan was stated as N199.00 in its balance sheet as at the last reporting date. Now, should naira be devalued to, say, N290:$ then the bank would have to make an additional provision of N91 (N290 – N199) for every $1 loan if the loan is already classified as lost; or N45.50 if the loans are doubtful; or N9.10 if the loans are substandard. In whatever case, the bank’s NPL exposure would be larger with devaluation. This is the FX downside risk that could further hurt its balance sheet should naira be devalued. Same way the FX upside risk would improve its balance sheet should naira appreciates (officially) against the dollar.
Great Analysis Victor.
Coming from Impairment perspective, and using your example of $1 loan. If I recorded in my asset $1 loan as N199, then the rate goes to N290, I thought I will first of all write up my loan to N290 i.e Dr Loan Asset N91 and Cr Exchange gain 91. Then I will impair by Dr Impairment(PnL) 91 and Credit Impairment (BS) 91. If this is so, there is no impact in my PnL. N91 going in as credit from exchange gain and 91 going in as debit from impairment.