Bank stocks rally as investors place bet on CBN forex fix

May 26, 2016 Haruna Magaji BANKING

Nigerian bank stocks rallied yesterday as investors cheered the central bank’s move to free up foreign exchange (FX) trading even though a move to a lower naira level could erode capital buffers for some lenders.

Local currency devaluations will increase default from bank borrowers who are not naturally hedged and erode Nigerian banks’ capitalization via the inflating of foreign currency denominated risk-weighted assets in local currency terms, Moody’s Investor Services said in a Feb., 25 report on the sector.

The IMF in a recent report outlined that devaluations frequently coincide with banking crises.

Traders for now seem to be shrugging all that off.

“ I think investors are simply excited, given that FX has been the ‘elephant in the room’ to foreign investors. I don’t think many are fully aware of the impact of the new policy on individual banks. Yesterday’s MPC announcement on FX policy is a much needed catalyst for the market, hence the positive sentiments,” said Oluwatosin Ojo, head of Research at investment firm Cardinal Stone Partners, in response to BusinessDay questions.

Foreign currency loans make up around 40 percent of total loans in Nigeria, according to data from Moody’s.

On Tuesday, the central bank of Nigeria(CBN) said it would adopt a flexible exchange rate policy, a shift from a peg for the naira seen as overvalued, which had hampered investment.

Nigerian stocks soared to near a 5-month high in response with the main stock index closing at 28,260 points, up 3.78 pct to levels last seen on Jan. 5.

Financial stocks led the gains with the banking index up 5.9 percent, erasing losses for the year and bringing it to the highest since Nov. 23.

“While revaluation gains and FX trading income improvements should materialize near term, asset quality risks and capital erosion are valid risks,” said Renaissance Capital bank analysts led by Adesoji Solanke, in a May 25 note to investors.

“ Investors could get engaged in the event of a reasonable devaluation but it is important to focus on quality names in such an event. Capital strength is critical, coupled with strong earnings buffers to take through higher impairments. You also want to stick with banks with relatively higher lending exposure to high quality corporates.”

Analysts say the impact of a devaluation will vary from bank to bank when the CBN provides the framework on the appropriate exchange rate for bank’s FX books, with those with higher exposure of foreign currency (FCY) loans likely to be more affected.

FBN Holdings has the highest FCY loan composition at 59 percent of total loans followed by Diamond Bank (50%), UBA (49%) and GTBank (46%).

Ojo of cardinal Stone Partners says the impact of the foreign currency loans (assuming a higher exchange rate) on capital adequacy needs to be properly balanced with possible revaluation gains for banks that are net long in dollars.

“That said, the inclusion of revaluation reserves other than fixed asset revaluation gains in capital computation as part of Tier 2 capital is subject to the limitations specified by the CBN,” Ojo said.

Bond prices rose and yields fell yesterday as traders bought debt driven by hopes that a flexible foreign exchange policy adopted by the central bank will help boost dollar supply and lure foreign investors.

The yield on the 20-year benchmark paper, the most traded on Wednesday fell 11 basis points from Tuesday’s close to 13.24 percent.

Rates on one-month naira non-deliverable forward contracts climbed to a record 270 per dollar, suggesting traders see the currency weakening close to that level in a month.

Equity investors may be getting ahead of themselves as there are downside risks from the extent of the flexibility that will be introduced by the CBN and the effect of a slowing economy on corporate performance, according to Olutola Oni, head of research at investment firm, WSTC financial services Ltd.

“FX flexibility should be net positive for banks that have net long FX positions. But importantly, investors’ perception about the impact of an adjustment in the FX policy on a bank will be significantly influenced by the quality of the foreign denominated assets held by the bank,” Oni said.

About Haruna Magaji 2484 Articles

Haruna Magaji is a journalist, foreign policy expert and closet musician. He is a graduate of ABU Zaria and a member of the Nigerian union of journalists. JSA, as he is fondly called, resides in Suleja, Abuja. email him at - harunamagaji@financialwatchngr.com