Analysts want bank investors to take comfort in windfall tax being one-off event

• Say this should not dampen appetite for ongoing rights issue, public offering
• Tax on 2023 realised FX gain spread over two years

PHILLIP ISAKPA IN LONDON, UK

“The levy is on the banks’ realised forex gain. It is also a one-off levy arising from the devaluation of the naira by the CBN in the wake of exchange rates unification. To the extent that it is not a normal feature of the banking sector in Nigeria, I do not see it as a reason to dampen [investors’] enthusiasm,” said Uche Uwaleke, a professor of capital market and finance, and director, Institute of Capital Market Studies, Nasarawa State University.

Payment of the windfall tax on the 2023 realised foreign exchange gains are expected to be spread from 2024 to 2025.

The Nigerian banking sector has been receiving serious attention from both domestic and foreign investors and this is understandable, say analysts at Coronation Asset Management Research, who point to the fact that in 2023 the Nigerian Exchange (NGX) Banking Index gained 108.7 percent against the NGX All-Share Index’s return of 45.9 percent. That remarkable performance alone, they further argued, was enough to pull investors into banking stocks at the beginning of 2024.

However, while the 2023 returns level has not materialised so far this year, investors have found other reasons to keep a keen eye over banking stocks in Nigeria. For instance, on March 28, the Central Bank of Nigeria issued a circular requiring a higher level of capitalisation for banks. Although the banks have been given until March 28, 2026 to achieve this new capital requirement, a number of them have already hopped on the train in an effort to achieve this. They have unveiled strategies that involve either stand alone rights issues or in combination with public offering designed to attract existing and new investors.

Some of the banks that have approached old and potential investors include Fidelity Bank Plc, which is combining a rights issue and a public offer for a total of N205.45 billion; Access Holdings Plc has gone for a rights issue to raise N351 billion; Guaranty Trust Holding Company (GTCO) is doing a public offer to raise N400.5 billion; Zenith Bank aims to raise N290 billion through a combination of rights issue and public offer; while FCMB Group embarked on a public offer of N110 billion at N7.30 kobo per share to meet the capital requirements placed on banks by the Central Bank of Nigeria (CBN).

As the banks roll out these capital raising drives, domestic and foreign investors, especially portfolio managers abroad, have been studying the fundamentals underpinning these banks and their offerings. They are also scrutinising the offer details that the various banks have released in their prospectus, to enable them to make informed decisions. But they have also been drawn to the new directive by the Federal Government of Nigeria (FGN) on the matter of a windfall tax on the profits made on foreign exchange gains in the 2023 financial year.

Investors who may be concerned about any possible effect now or in the future that this might have on the banking sector are being told by analysts not to make much of it. For instance, Coronation analysts say there are already two questions that when answered should create a comfort zone for investors.

“We can begin with the question of whether the proposal refers to realised or unrealised foreign exchange gains (or losses),” the analysts said. Attempting to answer this question, they noted: “If they are realised then there is likely to be cash with which to pay tax: but if they are unrealised, as most of them are, then the cash is not so ready. Most of the 2023 gains, in our view, arose from booking US dollar loans at the prevailing Naira/US dollar exchange rate, creating paper profits in Naira. (The Naira fell from N460.8/US$1 to N911.7/US$1 last year),” they pointed out in their briefing note on the matter.

One of the major points that investors appear to be concerned about is how deep this would hit the profit pots of the banks, hence impacting on potential dividend payout at the end of any possible financial year when this levy is implemented.

Uwaleke, who also doubles as the president, Association of Capital Market Academics of Nigeria (ACMAN), maintains that investors should hold strong to the fact that this is a one-off event in the life of the banking industry.

“I do not think the windfall levy should have any significant adverse impact on banks’ quest to attract investors,” the professor of capital market and finance, stressed.

A much broader take on the matter relates to the possible amount of money that could potentially be involved. Here Coronation Asset Management Research analysts say it might not really be much, therefore reducing any worries that investors might have concerning the impact on the profit pots of banks, and consequently distributable dividends.

Using their coverage of six banks most likely to be affected, the analysts wrote in their briefing note: “Finally comes the question as to whether we are talking about a truly large sum of money. True, and given all the caveats listed above, our estimate of the total putative tax that could be paid by the six banks under our coverage may not be close to the mark; but even as an approximate figure, N360.8 billion does not appear to be a lot in the context of the requirements of a government that recently announced a N6.1 trillion supplementary budget.”

PricewaterhouseCoopers (PwC), the professional and financial advisory firm, agrees with the above point by noting that “if the final legislation taxes only realised profits in 2023, there would only be a marginal revenue that would be generated, and this would not fulfil the revenue objectives of the government. For most banks, the gains were only realised in 2024 when the CBN mandated banks in February 2024 to adjust their net open position.”

But bank investors also need to see the broader picture as the windfall levy relates to the government’s overall drive to enthrone fiscal and monetary stability in the economy. For instance, the levy, apart from being seen as an attempt to take money from the banking sector, is also a balancing act. Analysts say that it was the attempt to enthrone a market driven foreign exchange regime that resulted in the domestic currency, the naira, finding a market-determined level that led to the forex windfalls for the banks. They argued that in the long run an environment conducive for banking operations and the overall economy would ultimately be beneficial to bank investors.

PricewaterhouseCoopers (PwC), the professional and financial advisory firm, had noted in its briefing on this matter: “The Central Bank of Nigeria’s (CBN) commendable efforts to harmonise exchange rates and curb inflation have led to a significant devaluation of the Naira. This monetary policy shift has had a profound impact on the financial sector, particularly on banks, which have experienced a windfall due to their foreign currency holdings.”

It acknowledges that this has also introduced a complex tax dilemma regarding the nature of these gains — whether they should be considered revenue or capital, noting, however, that the proposed windfall tax on Nigerian banks aims to address this issue, notwithstanding a host of challenges and implications for the banking industry, the broader economy and investors.

But PwC also provide bank investors some more comfort by stating that it can be argued that the revenue would ultimately benefit the economy, as in this case, the windfall tax would be used to fund the N2 trillion accelerated stabilisation and advancement plan and the additional N6.2 trillion for infrastructure and the federal government wage bill with increase in minimum wage.

And in a note prepared by KPMG, the financial services advisory and tax firm stated: “Undoubtedly, the current revenue challenge being experienced by the government and the need to enhance debt sustainability have triggered this windfall tax response despite its initial commitment not to introduce new taxes. The question that has always arisen is how the government would fund the initial projected deficit of N9 trillion (4% of GDP) considering the inability of [the] government to even meet the specified minimum crude oil production of 1.78 million barrels per day.

“While we may understand the reasons why the government has opted for the windfall tax on realised forex profits (which may be considered extraordinary and which are not due to any creative efforts but just unusual favourable market factors) of banks, we believe that it would have been able to secure the necessary buy-in of the banks if there had been adequate consultation from the outset,” KPMG admonished.

With investors concerned about how this whole windfall tax will affect banks’ earnings, some analysts continue to provide reassurance noting that they are better off as the ongoing recapitalisation and reforms will ignite beneficial economic growth.

For instance, analysts at Meristem in a recent research note stated: “It is worth noting that at the onset of the recapitalisation exercise, the CBN mandated fresh capital raises, prohibiting the use of retained earnings. This suggests that the windfall tax may be a deliberate attempt to capture the benefits of the revaluation gains. From a valuation and earnings perspective, we expect a muted impact, as we had previously factored out revaluation gains from our projections following the CBN’s earlier directive.

“However, the extension may affect Nigerian banks’ capital adequacy, as they had earlier set aside windfall profits to bolster their capital bases. Fortunately, the recent capital raise exercise is expected to offset this effect,” Meristem’s analysts added.

For existing and potential bank investors who are examining the banks that have come out with rights issues and public offerings, Uche Uwaleke, a leading capital market professor, offers reassuring optimism about the future of the banking sector in Nigeria when he stated: “I believe investors’ interest in banking stocks will pick up in the coming months in view of the healthy state of the banking industry in Nigeria with low non-performing loans ratio and other favourable financial soundness indicators.”