Nigerian Stock Market and the Aches of Non-Performing Loans


Recently, non-performing loans (NPLs) have taken the centre stage in the narratives of bank and bank instruments performances at the Nigerian Stock Exchange. The NPL discourse again gained stridency in response to the 18th February publication of the CBN directing banks with NPL’s above 10% and inadequate capital requirement not to pay dividends to shareholders. Investors largely still seem worried over potential consequences of the same directive on their investments. This apprehension is easily understandable as within three days of the announcement sentiments around the directive had influenced the performance of the market.

Bank stocks recorded losses. In two trading days, investors lost 100.8 billion naira. Despite slight share price appreciation by the Monday which followed the 18th
February directive, all the banking stocks joined the losers table on Tuesday the 20th of February. Only UBA which gained 8 kobo was spared. But this effect did not quickly abate. It continued up till Wednesday except for three; Access, Diamond and Zenith.

Consistent with literature and historical experiences, the moment risk assets such as total loans and advances go bad, the well-being of the reference bank becomes negatively affected and may signal a near end to the banks’ commercial activities. Regardless of the location, it is generally accepted that non-performing loans have a great linkage with bank failures and financial crises.

Since the CEOs of these banks failed to appreciate and live by the key to the survival of banks in the industry which is good corporate governance, they were penalized. Insider dealings approved questionable transactions among many others were the order of the day. Some notable banks such as Afribank, Oceanic Bank, Intercontinental Bank and Bank PHB were not left out. In response to the enormity of the crisis, the CBN created a new code of corporate governance which led to the removal of CEOs and executive directors of banks with high rate of NPLs.

Table 1 below shows the prices of some banking stocks for the three consecutive trading days after CBN’s directive on dividend payment by banks to shareholders in the financial year 2017.

Non-performing loans have a negative impact on banks as they expose the institution to credit risks which in the absence of strong corporate governance standards eventually results in bad debt. NPLs has also led to some notable Nigerian banks liquidation or sell out in the long run. As of Dec 2010, the banking industry recorded a capital adequacy ratio (CAR) deterioration of 5.92 percentage points from the 10.24% in Dec. 2009 to 4.32% which is far below the prudential minimum of 10%.

This significant decline could be attributed to the inability of some banks to make adequate provision for their toxic loans as recommended by CBN/NDIC examiners during the year. Consequently, Tier (II) Capital declined by 8.47% over the same period. Similarly, primary capital (Tier I), which is the adjusted shareholder’s funds, depreciated by over 30% from N448.99bn reported 2009 to N312.36bn as at Dec. 2010. At the end of the period under review, 11 banks recorded CARs grossly blow minimum requirement of 10% due to the aforementioned reasons.

Because of a significant drop in reserve, the banking industry’s Total Qualifying Capital (i.e Unadjusted Shareholder’s Funds), declined from the N2.20trn recorded at Dec. 2009 to N429.60Bn as at Dec. 2010. In Dec. 2015, CBN recorded N649.63 billion in NPLs compared with N363.31 billion recorded at the end of December 2014.

One of the pointers to the performance of a company is the size of her dividend. It is believed that a company that is doing well will undoubtedly pay good dividend. Banks are not left out; and since all investors expect good returns, a bank that pays high dividend (over a considerable period) is considered more profitable.

This consequently earns her more confidence from her shareholders. Data show that over the years, a high rate of NPL births low dividend to shareholders and consequently, if it goes on for a significant period of time, a drop in the stock price.

Taking two instances – First Bank of Nigeria (FBN) and Access bank – as case studies, the figures are presented below. In the case of FBN, 2015 was a bad year as their NPL rate took a leap from 2.6% in 2014 to 17.8% (Figure 2). This caused an uproar amongst shareholders when the results were released even though speculations about it were already flying around. A resulting crash of about 75.5% (between 2013 and 2015) in the price of stock seemed inevitable.

Access Bank, on the other hand, one way or the other, managed to keep her head above water. All through the years of crises when banks like Oceanic Bank, Bank PHB, Intercontinental Bank and others went under, Access bank appeared to even get better. Her NPLs didn’t rise above 3%. The resultant effect was an increase in the confidence of shareholders in her, subsequently, manifesting in her share price value. See the stock prices between 2015 and 2017 which kept rising even though the dividend payout did not increase as expected.

High NPL is a strong factor of share price depletion. When demand for bank’s stocks drop along with their prices, there is a negative impact on the NSE. This effect can be significant depending on the number of banks affected. A significant number would mean a significant negative effect on the NSE since the banking sector only consists of about 18% of the NSE. Low dividend payout factor appears to be less a determining factor for the drop in stock price as much as investor confidence on a banks’ corporate governance standards. Nevertheless, consistent payment of little or no dividend is still likely to affect the confidence of shareholders and may eventually, bring about a drop in the stock prices.

As smoke comes before the fire so are bank failures often preceded by accumulated NPLs. NPLs are birthed from weak corporate governance. Weak governance, in turn, comprises undesirables like insider dealings, director’s abuse of privileges, lowering of standards to outdo competitors amongst others.

There are three major channels through which banks’ NPLs directly distort the NSE. The first is the demand channel. Typically, when there is a red flag on a bank’s performance because of its NPL shooting beyond the acceptable threshold, the market reaction is usually in the form of a depleted demand. Shareholders also start exiting the bank’s shares. Overall, the price of the stock expectedly drops and consequently reduces NSE’s market valuation.

The second is the own corporate performance channel. Increased banks’ NPLs often leads to increased provision for impairment. This typically results in weak or lower profit after tax that will be released on the floor of the NSE. It usually leads to weak EPS- a function of dividend payment capacity.

The third route is the weakened dividend payment channel. With the company reporting a weak EPS, chances that lower or insignificant dividend will be paid heightens. This usually reduces investors’ interest in the bank’s shares thereby impacting negatively on NSE’s market valuation.

With these recent CBN’s rules and the fact that most of Tier 2 and 3 banks are with NPLs that has/is breached/breaching the limit (10%), it is advisable for investors to take an appropriate precautionary stance on them. For Tier 1 banks, their current NPLs levels are still accommodative and way below the benchmark limit. The chances that they will maintain their dividend payout ratio is high. We advise investors to look more into this investment space.