Surprise, surprise, there is (yet again) trouble brewing in Nigeria. Nope, this time the spotlight is not on the Niger Delta rebels, but on something potentially far more deadly: the country’s banking sector. Sounds familiar? Indeed, as attentive Risk Watchdog readers might remember, way back in January I mentioned how opaque reporting standards and large margin loans posed serious structural risks to Nigerian commercial banks. And now, the day of reckoning appears to have finally arrived.

Ever since taking office in June 2009, Central Bank Governor Lamido Sanusi has not hesitated to rock the boat, and his latest banking sector audit quite clearly exposes the enormous weaknesses Nigerian financial institutions are currently facing. Following an initial audit of 10 Nigerian banks on August 14, the results were worse than many feared, with five banks – Afribank, Finbank, Intercontinental Bank, Oceanic Bank and Union Bank – revealed to be on the edge of failure. In response to the findings and in keeping with his aggressive style, Sanusi fired the CEOs of these banks and appointed five caretakers to replace them. Furthermore, Sanusi injected NGN420bn (US$2.7bn) into the banks in the form of Tier 2 capital, to be repaid at an unspecified future date.

The five banks that failed the audit were not minor players – indeed, they collectively accounted for nearly a third of banking sector assets, confirming our long-held concerns that the Nigerian banking sector faced a potential systemic crisis. According to Sanusi’s August 14 address, these five banks had non-performing loan ratios ranging between 19% and 48%, or a collective 40.8%, mostly on the back of heavy exposure to margin loans and oil and gas. Indeed, these five banks alone account for nearly half the estimated NGN1trn in total banking sector margin loan exposure. All five banks are also undercapitalised, with one unnamed bank having a capital adequacy ratio of just 1.0%.

Hardly Out Of The Woods

Sanusi noted ‘on the basis of the information available to us so far, we are confident that the banking system is safe and sound and we have dealt with the major sources of systemic risk.’ That said, given the lack of transparency in the sector and that some of the banks that failed had previously reported strong earnings, it is impossible to rule out further failures. With 24 banks still to be audited, I point towards the fact that the five failed banks accounted for slightly less than half of total margin loan exposure, meaning there are still a lot of bad loans to account for among the remaining banks.

Against this backdrop, I believe it will be a volatile year for Nigerian equities. Nigerian banks account for the bulk of the weighting in the Nigerian all-share index, and in the short-term uncertainty surrounding the health of banks will weigh heavily on share prices. That said, over the past year, difficulties in differentiating between good banks and bad has led to a discounting of all banks, but going forward, I expect the performance of ‘good banks’ and ‘bad banks’ to diverge. While shares of the five failed banks will likely be suspended, I believe they are likely to sell off once they are reactivated. At the same time, the five banks that passed the audit are likely, in our view, to see a rise in share prices, once fears of a systemic crisis have passed. Despite all the bad news, the Nigerian banking sector has tremendous upside potential over the long term, and I continue to believe the ongoing shake-up is good for confidence going forward.