October 8, 2020/Fitch Ratings
Fitch Ratings has affirmed Union Bank of Nigeria PLC’s (Union) ratings, including the bank’s Long-Term Issuer Default Rating (IDR) at ‘B-‘, and removed them from Rating Watch Negative (RWN). The Outlook is Negative.
The removal of the RWN on Union’s Long-Term IDR, Viability Rating (VR) and National Ratings reflects Fitch’s view of receding near-term risks to the bank’s credit fundamentals from the economic fallout arising from the oil price slump and coronavirus pandemic.
In our opinion the impact of the economic downturn on Union’s credit profile is largely contained at the bank’s current rating level and it will take several quarters before the full extent of the crisis on corporates and households is seen in its financial metrics. Since our previous rating action in March, regulatory forbearance on asset classification and banks’ own debt relief measures have significantly eased the sector’s asset-quality pressures. Debt relief measures are, nevertheless, temporary and with the eventual easing of fiscal and monetary support from the Central Bank of Nigeria (CBN), we see a material risk that bank asset quality could deteriorate faster, unless economic recovery gathers pace.
The Negative Outlook on the Long-Term IDR reflects our view that Union’s capitalisation and leverage are highly vulnerable to unreserved Stage 3 loans, which were equivalent to 19.1% of Fitch Core Capital (FCC) at end-1H20.
Key Rating Drivers
IDR and VR
The Long-Term IDR of Union is driven by its intrinsic creditworthiness, as defined by its ‘b-‘ VR. Sensitivities to capitalisation and leverage from persistent weakness in asset quality highly influence the VR. Union’s asset-quality metrics have been volatile since 2016, reflecting weak historical underwriting standards that have resulted in high borrower concentration and culminated in a large stock of Stage 2 and 3 loans. Our expectation is that Union’s asset quality will remain weak over the medium term given sustained downside risks to Nigeria’s operating environment.
Union’s impaired (Stage 3) loans ratio increased to 12.4% at end-1H20 from 9.9% at end-2019, due mainly to the reclassification of a large oil-related exposure (equivalent to 26.1% of Stage 3 loans and 2.8% of gross loans). Union’s Stage 3 loans ratio was the highest of Fitch-rated Nigerian banks at end-1H20, while its loan loss allowances-to-Stage 3 loans of 62.6% at end-1H20 (end-2019: 76%) was among the lowest.
Additionally, Union’s level of Stage 2 loans, equivalent to 21% of gross loans at end-1H20, and very high loan concentrations by sector and single obligor are credit-negative. Union’s exposure to the volatile oil and gas sector was 32% of gross loans at end-1H20, above the sector average of 28%. Union’s 20-largest loans represented 65% of gross loans and 2.7x FCC at end-1H20.
Union’s FCC ratio of 16.2% at end-1H20 was in line with other tier-two Nigerian banks’. Union’s total capital adequacy ratio of 19.2% at end-1H20 was comfortably above the current minimum regulatory capital requirement of 15%, supported by Tier 2 qualifying debt of NGN30 billion. However, Union’s capital buffers are sensitive to high loan concentrations and the performance of lowly-reserved Stage 2 and 3 loans.
The VR also reflects Union’s position as a tier-two bank with operations concentrated mainly in Nigeria. Union has an established brand and a nationwide presence and operates across all business segments but lacks clear competitive advantages compared with large Nigerian banks due to its small franchise and market share (around 5%). Union’s decision to divest the UK operations (subject to regulatory approvals) will not fundamentally alter the bank’s franchise.
Union’s operating profit/risk-weighted assets (RWAs) ratio of 2.4% in 1H20 compares well against small and medium-sized bank peers’, but remains sensitive to loan impairment charges (LICs) given weak coverage levels. Trading income, up 2.4x year-on-year in 1H20, boosted earnings but Union’s still high cost structure (cost/income ratio of 69.4% in 1H20) is a constraint on profitability, which has gradually improved over recent periods as business-reorganisation initiatives are being completed. Profitability in 2H20 will be under pressure from net interest margin compression, lower trading gains, and our expectation for higher LICs given the weak economic environment.
Union benefits from a stable retail deposit base, which accounted for 51% of customer deposits at end-1H20, providing a low-cost source of funding. Union complied with the regulatory minimums for the loans-to-deposits ratio, the cash reserve requirement and the liquidity ratio at end-1H20. Union’s loans/customer deposits ratio (63% at end-1H20) is low and liquidity coverage is adequate in local and foreign currencies.
Support Rating and Support Rating Floor
Sovereign support to banks cannot be relied on given Nigeria’s weak ability to provide support, particularly in foreign currency. The Support Rating Floor (SRF) of all Nigerian banks is ‘No Floor’ and all Support Ratings (SR) are ‘5’. This reflects our view that senior creditors cannot rely on receiving full and timely extraordinary support from the Nigerian sovereign if any of the banks become non-viable.
National Ratings
Union’s National Ratings reflect the bank’s creditworthiness relative to that of other issuers in Nigeria and are driven by the bank’s standalone strength. Union’s National Ratings are among the lowest of Fitch-rated Nigerian banks, given the bank’s weak asset quality and capitalisation and leverage relative to peers’.
Rating Sensitivities
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Rating upside is limited. The Outlook could be revised to Stable if the bank’s level of unreserved Stage 3 loans relative to FCC, which has been highly volatile, reduces to below 10% for a sustained period, and the bank’s FCC ratio remains above 15%.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A sharp increase in the bank’s unreserved Stage 3 loans/FCC ratio to near its recent peak of 51% at end-2018 and/or a drop in the bank’s FCC ratio below 15% could trigger a rating downgrade.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
