Sunday 18, June 2017 by Matthew Amlôt

Moody's assigns first-time ratings to Union Bank of Nigeria PLC

Moody's Investors Service has today assigned first-time ratings to Union Bank of Nigeria plc (Union Bank): long- and short-term Local and Foreign Currency Deposit and Issuer Ratings of B2/Not Prime, and a b3 Baseline Credit Assessment (BCA).

Moody's also assigned long- and short-term Counterparty Risk (CR) Assessment of B1(cr)/Not Prime(cr), long- and short-term National Scale Local Currency Ratings of, and long- and short-term National Scale Foreign Currency Ratings of The overall outlook on the bank's ratings is stable. A full list of assigned ratings can be found at the end of this press release.

The standalone BCA of the bank reflects (1) Moody's expectation of robust levels of tangible common equity over the next 12 to 18 months, following recent approval by the bank's board and shareholders to raise capital via a rights issue; and (2) a stable deposit-based funding structure and moderate local currency liquidity buffers. These strengths are balanced against (3) Nigeria's challenging operating environment, which takes into account both institutional and structural weaknesses and the strong growth potential of the system; (4) elevated credit risks on the back of single-name and sector concentration risks; and (5) relatively modest profitability levels versus larger local peers.

The deposit ratings incorporate one notch of uplift from the bank's b3 baseline credit assessment (BCA), based on our assessment of a 'moderate' likelihood of government support in the event of need. Our assessment of support reflects the bank's importance within the Nigerian banking system, with an estimated four per cent market share of total assets (N1.3tn, $3.5bn) as of December 2016, and the government's willingness to support banks, as indicated in past crises.

Our methodology comprises an assessment of a bank's operating environment which, for Union Bank, is based on our assessment of Nigeria's macro profile, where the bank conducts most of its business. We assign a 'Very Weak +' macro profile score to Nigeria, reflecting the country's fiscal and economic dependence on the oil and gas sector and its high dollarization, which pose asset quality volatility and liquidity challenges, as well as Nigeria's evolving institutions. While the banks' operating environment is difficult, the Nigerian financial system has also shown strong resilience to shocks and it presents sizable growth opportunities given low banking penetration, especially in the profitable retail and SME space, which will allow the banking sector to expand steadily.

A primary driver of our standalone credit assessment of Union Bank is our expectation of robust levels of capital over the next 12 to 18 months. As of December 2016, the bank's adjusted tangible common equity-to-risk weighted assets ratio (TCE) was 15.94 per cent, in line with other rated Nigerian banks. We expect the bank's capital ratios to increase markedly over 2017 following shareholders' recent approval of a N50 billion rights issue. However, Moody's notes that capital is vulnerable to exchange rate volatility, though the ultimate impact would be modest, given the bank's exposure to foreign currency loans (46 per cent of gross loans); as a depreciation of the local currency will lead to a nominal increase in risk weighted assets, thus reducing capital ratios.

Our scenario analysis shows that the bank can adequately absorb losses under our stress case and we expect that the bank's retained profitability will be sufficient to meet credit costs this year.

The bank's pre-provision income-to-average total assets ratio of 2.4 per cent, as of December 2016, is modest relative to other larger Nigerian banks but is a significant improvement on 2014's level of 1.3 per cent, as the bank begins to reap the benefits of its recent investments in information technology and infrastructure. Net income-to-tangible assets ratio fell to 1.21 per cent in 2016 from 1.40 per cent in 2015 as credit costs increased. Higher impairment charges offset the positive impact of cost management initiatives, however, the bank's efficiency (cost-to-income) ratio remained resilient over the last 15 months at 77 per cent. We expect pre-provision income levels to remain resilient over the next 12 to 18 months as the bank invests its newly raised capital into growing its business and the high yields on government securities continue to support net interest margins.

A secondary driver of our standalone credit assessment of Union bank is the bank's stable liability profile. Like other Nigerian banks, Union Bank is predominantly deposit funded with a low reliance on more sensitive market funds. As of March 2017, customer deposits made up 68 per cent of liabilities. Additionally, the majority of deposits are retail (55 per cent of deposits), which compares favourably to Union Bank's peers, which are predominantly funded by more volatile corporate deposits.

The bank reported a liquidity ratio of 37 per cent (March 2017), which provides some cushion above the 30 per cent required by the CBN but is a substantial eight percentage points less than the 45 per cent reported in December 2016, as the bank used some of its liquid resources to pay off its foreign currency borrowings that matured in the first quarter of 2017. Compared to peers globally, the bank's loan to deposit ratio (LDR) remains relatively low at 75 per cent, as of March 2017. A low LDR is supported by the bank's shrinking loan portfolio (gross loans declined by three per cent in the first quarter of 2017).

Union Bank, however, exhibits significantly tighter liquidity in foreign currency. Its dollar LDR was 305 per cent as of December 2016, and as such, the bank will continue to rely on dollar market funds to support its dollar assets for the foreseeable future; though we note deliberate efforts by the bank in recent years to curb foreign currency lending and grow foreign currency deposits.

Unlike other Nigerian banks, Union Bank's reported non-performing loans (NPLs) ratio has remained fairly resilient since 2015. The bank's reported NPL ratio of 7.3 per cent, as of March 2017, is well below the banking system average of 14 per cent as of December 2016. However, we expect that Union Bank's asset risk will face upward pressure over our outlook period on account of (1) Union Bank's loan portfolio, which like many similarly rated banks, is concentrated. Single name concentration risk is indicated by the bank's top 20 borrowers, which make up over 200 per cent of the bank's tangible common equity as of December 2016, exposing Union Bank to material erosions of capital if even a few of the top obligors default. Furthermore, the bank's exposure to the oil and gas industry is high at 43 per cent of the loan book (30 per cent for the banking system), as of March 2017, leaving the bank exposed to the risks associated with oil price volatility; and (2) Union Bank's large exposure to foreign currency-denominated loans, which were 46 per cent of total loans and advances, as of the end of March 2017 (slightly below the banking system average of about 51 per cent), leaving borrowers exposed to exchange rate volatility of the naira. Further depreciation of the naira would reduce the repayment capacity of foreign currency borrowers, especially those borrowers that do not earn foreign currency revenue.

The long-term B2, stable deposit ratings incorporate one notch of rating uplift from the b3 BCA, based on Moody's assessment of a `moderate' probability of support in case of financial stress. The willingness to support the banks by the Nigerian government was demonstrated in the last crisis, when banks were rescued through recapitalisations and balance sheet clean ups via outright purchases of NPLs by the Asset Management Corporation of Nigeria (AMCON). Furthermore, Nigerian regulatory authorities do not currently have bail-in powers that would allow them to impose losses on creditors outside of a liquidation process.

We assign a Counterparty Risk Assessment of B1(cr) /Not Prime(cr) to Union Bank. The CR Assessment is one notch higher than its deposit rating, reflecting our view that authorities are likely to honour the operating obligations that the CR Assessment refers to in order to preserve the bank's critical functions and reduce the potential for contagion.

CR Assessments are opinions of how counterparty obligations are likely to be treated if a bank fails and are distinct from debt and deposit ratings in that they (1) consider only the risk of default rather than the likelihood of default and the expected financial loss suffered in the event of default; and (2) apply to counterparty obligations and contractual commitments rather than debt or deposit instruments. The CR Assessment is an opinion of the counterparty risk related to a bank's covered bonds, contractual performance obligations (servicing), derivatives (e.g. swaps), letters of credit, guarantees and liquidity facilities.

Union Bank's national scale ratings (NSRs) of for local currency deposits and for foreign currency deposits are generated from the bank's global scale ratings through maps specific to each country. NSRs are not intended to rank credits across multiple countries; instead they provide a measure of relative creditworthiness within a single country (Nigeria in the case of Union Bank). Moody's NSRs are given a two-letter suffix to distinguish them from the agency's Global Scale Ratings. For example, NSRs in Nigeria have the country abbreviation "ng".

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