When Loans Go Bad.

Despite a turbulent decade, FBN Holdings, Nigeria’s oldest financial market lender, has demonstrated remarkable resilience in overcoming odds associated with a legacy institution. It has effectively tackled issues such as board governance recalibrations, high cost-to-income ratios (CIRs), poorly balanced loan asset distribution, large non-performing loans (NPLs), and overweight bank clearing house exposures to lower-tiered deposit-taking institutions. This period of adversity may potentially strengthen the financial group, making it more resilient, better managed, and focused; even as it looks into management resource capacity building and resolution of structural adjustments needed to reposition the bank post-recapitalization.

Recent public information will suggest that while the bank moves to quickly affirm a substantive managing director and set about the task of recapitalization; the work done to date by the previous management will further benefit from a swift resolution of the numbers from a post-CBN-oversight review around balances arising from digital banking operations returns, unreconciled balances, FX-related deposit movements, and standard loan balances review.

Analysts believe the CBN’s payment of Heritage Bank’s debt, as determined, not only signaled a positive outlook for the bank with the reduction of the forbearance balances on FBNH’s books; but strengthened its position as a systemically important bank (SIB).

Speaking anonymously, an insider expressed optimism about the bank’s future, stating, ‘With the Heritage Bank issue resolved, we can now focus on regaining an industry position more consistent with the bank’s age, pedigree, and collective staff expertise.’ This positive outlook should inspire confidence among stakeholders in FBN’s future since the banking arm continues to dominate the group’s operation.

Analysts observed that FirstBank has shown resilience in the face of internal and external difficulties, showing relatively strong financial performances in FY 2023 and Q1 2024. The asset repricing on loans and advances and off-balance sheet asset gains nudged gross earnings forward, thereby cushioning the heavy foreign exchange losses and rising operating expenses. FBNH’s gross earnings and pre-tax profit grew by +95.70% and +126.86% to N1.60trn and N350.59bn in FY 2023, and even higher growth performance was recorded in Q1 2024 (+181.43% and +325.15% for gross earnings and PBT, respectively).

The strong gross earnings and profit growth resulted in improved financial ratios, except for the cost of risk (CoR) and the non-performing loan (NPLR) ratios, reflecting rising funding costs and the deterioration in loan quality. However, the group’s niggling operating headache eased in Q1 2024 as the lender’s cost-to-income ratio (CIR) fell below 50% or below a 5-year average of 60.31%.

The improvement came partly from higher interest and non-interest incomes and sustaining this in 2024 is crucial, considering the forecast direction of macroeconomic indicators and monetary policy. For instance, rising inflation and currency volatility may lead to higher interest rates, a situation usually favourable to banks’ loans & advances and interest-based investments. Analysts believe the group’s improved core financial metrics in FY 2023 should re-establish its tier 1 status in the Proshare Bank Strength Index (PBSI) 2024 and raise its ranking ahead of competitors.

FBNH’s earnings have grown steadily by an average of 41.5% in the past five years, and its price-to-earnings (P/E) ratio sits at 2.74x compared to the industry average of 7.5x. The price-to-book value (PBV) is below 1 at 0.48x. Analysts expect investors to remain cautious about banking stocks while awaiting their recapitalisation strategies and future earnings projections.

Board of Directors

FBNH’s ability to manage post-leadership changes, whilst emerging as an institutional learning advantage, will continue to be tested; The market watches keenly how this recent change is managed.

With four (4) board members resigning, FBNH’s board members dropped to eight in FY 2023 from eleven (11) in FY 2022. However, Holdco appointed two directors (non-executive and independent non-executive directors) in Q1 2024, raising the total number of board members to ten (10). Also, FirstBank appointed two (2) new board members, raising the total number of board members to 14 in Q1 2024.

Gross Earnings

FBN Holding’s gross earnings have grown by an average of 19% annually. It settled at N1.60trn in FY 2023, rising by +95.70% from N815.16bn in FY 2022. The earnings growth came from interest and non-interest income, narrowed down to investment securities, loans and advances, gains from FVTPL (derivatives), and fees and commission income. Interest income had a higher contribution at 60% relative to 40% from non-interest income, reflecting that core operation drove the income growth. The +153.67% growth in non-interest income to N601.70bn stemmed from net gains from financial instruments at FVTPL (N246.08bn), net gain on sale of investment securities (N34.85bn) and fee and commission income (N226.45bn). The commercial banking segment remained the lead gross earnings driver, contributing 94%, while Merchant bank and asset management contributed 6%

The persistence of naira depreciation and aggressive rate hikes sustained interest and non-interest growth in Q1 2024. The group’s gross earnings grew by +181.43% to N730.30bn in Q1 2024 from N259.50bn in Q1 2023. The growth came from higher investments, loans & advances, fees and commission income, and net gains from financial instruments at FVTPL.

Profitability

FBNH’s strong gross earnings translated to profitability as the profit before tax and post-tax profit grew by +126.86% and +127.92% to N350.59bn and N310.37bn in FY 2023, respectively. The income from sales of investment securities, gains from financial instruments, FVTPL, dividend income, and other operating income cushioned the foreign exchange loss of N332.79bn, personnel expenses growth (+52.58%) and operating expenses growth (+49.59%). In addition, the group earned N66.34bn from digital banking in FY 2023, +20.41% higher than N55.10bn in FY 2023. This shows an improvement in digital penetration and product usage. The substantial profit growth nudged earnings per share to N8.59k in FY 2023 from N3.75k in FY 2022. Analysts expect the aggressive rate hike and naira volatility to sustain profitability performance in most of the 2024 quarters.

The group’s profitability tripled in Q1 2024 despite the foreign exchange loss incurred (N94.79bn) and higher operating expenses (+22.49%). The strong earnings translated to profitability, cushioning operating costs and FX exposure. The group’s pre-tax and post-tax profits rose by +325.15% and +315.78% to N238.53bn and N208.11bn respectively.

Financial Position

The group’s financial position improved in FY 2023. The total assets rose by +60.13% to N16.94trn in FY 2023 from N10.58trn in FY 2022, with a distribution of 50% to loans and advances, 17% to Investment securities, and Cash and balances with the CBN at 15%. Loan advances and investment securities dominating the total assets favour the group, ensuring the continuous inflow of interest income.

The group’s customer deposits rose by +49.68% to N10.66trn, and deposits from banks increased by +70.88% to N1.89trn in FY 2023. The customer’s deposits have a distribution of 28% current, 27% savings deposits, term deposits at 19%, and domiciliary deposits at 26%; the high savings deposits contributed significantly to the +118.04% growth in interest expense. The group’s shareholders’ funds improved by +75.45% to N1.75trn, driven by a +48.09% rise in retained earnings, +531.43% growth in foreign currency translation reserve, and +35.38% in statutory reserve. The sudden spike in foreign currency translation reserves is due to the CBN’s directive on prudent management of revaluation gains.

In Q1 2024, total assets climbed to N21.58trn from N11.09trn in Q1 2023. Increased loans & advances, investment securities, cash and balances with central banks drove the growth. While share capital remained constant, shareholders’ equity rose by +91.44% in Q1 2024 to N1.92trn, driven by a +83.57% rise in retained earnings and foreign currency translation reserve (+1292.46%).

Financial Ratios

FBNH’s key financial ratios improved in FY 2023. Underpinned by improved gross earnings and profitability, return on equity (ROAE) and Average Assets (ROAA) rose to 22.60% and 2.30% in FY 2023 from 14.50% and 1.40% in FY 2022. The net interest margin improved to 6.10% in FY 2023 as the group earned higher interest income over interest expense. The robust earnings scaled down the group’s cost-to-income ratio to 49.10%, implying better cost optimization. However, the heightened risk environment weighed on the cost of risk and nonperforming loan ratio, rising to 3.30% and 4.70%, respectively. The group’s loan-to-deposits ratio increased to 62.20% above the 65% statutory limit, exempting it from discretionary CRR debits.

The group’s financial ratios, especially profitability ratios, stayed positive in Q1 2024, except for the cost of risk and NPL. The return on equity (ROE) and assets (ROA) grew to 45.40% and 4.30%, respectively, with the cost-to-income ratio (CIR) falling to 43.10% from 60.40% in Q1 2023.

Valuation

In FY 2023, FBNH’s Price-to-Earnings (P/E) ratio dropped to 2.74x from 3.12x in FY 2022, reflecting higher market attraction relative to the previous year. The P/B ratio slightly increased to 0.48x but remained below 1, signifying that the bank is valued below its book value.

Share Price Movement

After downward fluctuations in Q1 2023, FBNH’s share price rebounded in April 2023, rising from N11.00k on April 27, 2023, to N23.55k on December 29, 2023. Analysts attributed the share price rally in July and beyond to the battle for ownership between Oba Otudeko and Femi Otedola. The share price rally persisted in Q1 2024, rising to a resistant price of N43.95k on March 19, 2024. By the beginning of Q2 2024, the share price began to tank, possibly due to investors’ pessimism about banking stocks, considering concerns about bank recapitalisation and falling earnings per share. The Holdco’s share price finally settled at N22.90k on June 11, 2024, leading to a negative year-to-date (YTD) return of -2.76%.

Peer Analysis: Climbing Along a Steep Ladder

Recapitalisation, consolidation and the emergence of new players in the Nigerian banking industry have shuffled the ranking of banks; some were forced behind as technology-driven ones took the spotlight. The oldest Nigerian bank was not exempted from the reshuffle; the bank slipped from the fourth position in asset size in 2019 to the fifth position in 2022 and has remained in the position, outran by UBA.

In terms of profitability, FirstBank climbed from 7th in 2019 to 4th in 2023 and 3rd by Q1 2024. The rapid growth was driven by the group’s strategic plan despite the corporate governance struggle.

FBNH’s consistently low dividend payout (hovering below N1) has kept the dividend yield behind that of other industry players. The group’s dividend yield slumped to the rear end by 2023, with ten (10) banks ahead of the entity, compared to six (6) banks in 2019.

The banking industry saw gross earnings and profitability climb to record highs, benefitting from MPR increases and naira devaluation. Among the tier 1 banks, Access Holding saw the highest gross earnings at N2.59trn, followed by other two banks with gross earnings above N2trn and FBNH and GTCO with earnings below N2trn at N1.59trn and N1.19trn respectively. The positions were slightly different coming to profitability, with Zenith Bank taking the lead at N795.96bn, ahead of UBA (N757.68bn) and Access Holding (N729.00bn), while FBNH had a more modest figure at N350.59bn behind GTCO. Analysts noted that despite GTCO being behind FBNH in gross earnings, GTCO was more profitable.

The banks’ high earnings caused earnings per share for most banks to grow to double digits except for FBNH, which had a single-digit EPS of N8.59k. Zenith Bank had the highest EPS at N21.55k ahead of Access Holding, implying that Access Holding incurred higher operating costs, eating into its profit relative to Zenith Bank. Nevertheless, Access Holding retained its position as having the largest customer deposit at N15.32trn ahead of UBA and Zenith, while GTCO had the lowest tier 1 bank deposit base size at N7.41trn.

GTCO, however, had the highest net interest margin (NIM), return on equity (ROE), and return on assets (ROA). Also, GTCO was the most cost-efficient financial lender, with a cost-to-income ratio (CIR) of 29.10%, while FBNH was the least efficient with a CIR of 49.08%. The fundamental valuation of the banks showed that GTCO had the highest price-to-book value at 0.96x, but FBNH had the highest price-to-earnings at 2.74x, while Access Holding had the least at 0.39x and 1.39x, respectively. This suggests that GTCO’s market value reflects its underlying book value and earnings more than its rivals.

Despite the high-interest rate environment, GTCO had a 1.80% cost of funds, significantly lower than its peers, with Access Holding having the highest at 4.90%. However, Zenith had the highest Cost of risk at 7.30%, while Access Holding had the lowest at 1.00%. GTCO shows better financial health than its rivals based on comparative financial statistics despite having the country’s top six banks’ lowest gross earnings, profit, and asset size.

Closing Thoughts

FBNH’s positive financial numbers would suggest that the internal governance challenges it experienced had a modest impact on its financial performance in FY 2023 and Q1 2024. To make this sustainable, analysts believe that it is important that the group resolves and tightens its governance architecture to prevent spillover effects in investors’ perceptions and consequently market valuation. We however do not believe that this will have a significant impact on its capital-raising efforts.

Based on FBNH’s banking license, the group intends to raise an additional N300bn in Tier 1 equity (CET 1) either through a public offer or a private placement. Although the capital raise plan is subject to shareholder approval, market intelligence suggests the group is more than capable of raising these sums from existing shareholders and select entities; and might not therefore proceed with the public offer. This is however subject to the Holdco’s reading of the recapitalization end-game of competitors; the opportunities related to funding size and actions taken around M&A’s (for which preliminary intel suggests the Holdco would not be involved in merger talks or contemplate a license adjustment).

First Bank’s future starts anew after the industry adjudged the successful tenure of the Adesola Adeduntan era. Our analysts anticipate HoldCo’s more hands-on involvement in the bank’s strategic direction in this new dispensation.