Investors court rapid growth and often reward this with lofty valuations. In the banking sector where maturity in business is prevalent, growth in loans and advance, investments and profits are hugely rewarded. But growth does come at a cost.
A recent report from the Nigerian based consulting outfit Augusto Consulting believes Nigerian Banks may have no choice but to raise significant equity in 2020. The founder of the firm, Bode Augusto made this submission in a paper delivered via Zoom and titled Impact of COVID-19 on the Nigerian Economy.
According to the report, banks are expected to have a net asset to total assets ratio of at least 12.5% considering the effect of the crash in crude oil prices and the impact of COVID-19. Net Assets to Total Assets ratio is basically a bank’s total equity as a percentage of its total assets. Its total assets will include loans and advances, investments, fixed assets, cash etc.
“Based on the benchmark we believe some players in the industry should raise capital” the report noted. The report also noted that were banks to raise capital today, they will have to “offer shares to the public at huge discounts” in view of the sell-offs on the Nigerian Stock Exchange.
What this means: According to the report Nigerian Banks currently have on average 12.2% net assets to total assets ratio and estimate the ratio to be 11.5% in 2020. Typically, a commercial bank’s financial strength is measured using a term called the Capital Adequacy Ratio (CAR).
However, the so-called “crude measure”, which is also acceptable as Augusto Consulting explained, is a sign of how strong a bank is in the event that its assets start to deteriorate if its borrowers’ default on repayment of loans. The Central Bank assigns a Capital Adequacy Ratio of 15% for Nigerian banks
Banks in focus – So which banks fall within this bracket? According to data from Nairalytics, the research arm of Nairametrics, some banks fall below the 12.2% ratio and thus may be under pressure to recapitalize according to the Augusto Reports. Some banks, however, seem to be comfortably above the benchmark. First is GT Bank with about 19.5% as of December 2019.
Stanbic IBTC also has a ratio of about 17% while Zenith Bank and Union Bank is at 15.7% and 15.1% respectively. For the other banks, they are either hoovering within the level or very much below.
The upshot: The implication of this recommendation by Augusto Consulting is that banks below this threshold may have to raise capital this year. With most banking stock market currently just above historical lows, it is unlikely that banks will want to raise capital at these price levels which is why the report proposed that in its stead, the CBN should increase Cash Reserve Requirements “CRR” so banks can book more profits while also advocating for a dividend freeze. Whilst this is in view, it is still quite plausible that some banks may need to raise capital.
Whatever decision they do will have a significant impact on their share price and investors should be guided accordingly.