Fitch Ratings has affirmed Union Bank of Nigeria PLC’s (Union) Long-Term Issuer Default Rating (IDR) at ‘B-‘. The Outlook is Stable. Fitch has also affirmed the bank’s Viability Rating (VR) at ‘b-‘ and Support Rating at ‘5’.
KEY RATING DRIVERS
The IDRs of Union are driven by its standalone creditworthiness, as defined by the VR. They are constrained by Nigeria’s operating environment and factor in a high impaired loans ratio, some weakness in loan loss reserve cover, which puts pressure on capital adequacy and performance metrics which, although improving, are still impacted by high loan impairment charges. Risk appetite is now lower and management is focusing on loan restructuring and recoveries. Union is a second-tier bank, with a market share of about 4%, operating primarily in Nigeria.
The bank is 100 years old and its brand is well-established, which helps to attract cheap retail deposits that make up 60% of deposit funding. Corporate lending represents around 70% of loans but Union’s strategy is to establish itself as a leading mid-tier bank in Nigeria, developing deeper customer relationships particularly in the corporate and SME segments, and ultimately expand its retail lending capabilities. This expansion is likely to be supported by shareholders, particularly Atlas Mara Limited, which owns around 21% of the bank, a financial company whose primary goal is to support retail banking across the African continent.
During the initial years under new ownership (2011- 2015), risk appetite at Union was high, resulting in a loan portfolio that is highly concentrated on the oil sector (38% of loans). Our assessment shows significant weakness in asset quality measures. Impaired loans represent around 9% -10% of gross loans. In addition, the bank has a high level of non-performing and restructured loans not captured in the impaired loan ratio. Loan loss reserve cover, at around 80% of impaired loans, exposes the bank to unexpected losses even after factoring in the availability of collateral for some large impaired loans.
Management’s focus on recoveries and loan restructuring is showing positive initial signs but the sustainability of these trends will be assessed over time. Union’s margins compare favorably with peers’ and overall operating profit metrics are broadly in line with peers’. Operating profit reflects some pressure on efficiency ratios impacted by the cost of maintaining a large branch network and the impact of inflation.
Union’s funding profile is improving. Customer deposits are growing steadily, reliance on interbank deposits is declining and all public sector deposits have been repaid, in line with local requirements. Union’s foreign currency (FC) liquidity position was tight in 2016 and, along with several Nigerian peers, Union restructured some trade finance obligations with international correspondent banks. These are being repaid in line with restructured terms, but our assessment is that the bank’s FC liquidity position remains tight. The bank’s history of accessing term FC funding under new management is limited to a small number of counterparts.
Given asset quality challenges, capital ratios have become strained. Union raised NGN49.7 billion of Tier 1 capital in 4Q17 and we believe that prudential capital shortfalls have been addressed. However, capital levels may still not be commensurate with risk despite the capital injection, largely because unreserved impaired and non-performing loans still represent a high proportion of equity.
Union’s National Ratings reflect the bank’s creditworthiness relative to the country’s best credit and to peers operating in that country.
SUPPORT RATING AND SUPPORT RATING FLOOR
Fitch believes that sovereign support to Nigerian banks cannot be relied on given Nigeria’s (B+/Negative) weak ability to provide support, particularly in FC. In addition, there are no clear messages from the authorities regarding their willingness to support the banking system. Therefore, the Support Rating Floor of all Nigerian banks is at ‘No Floor’ and all Support Ratings are at ‘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.