Focus of the Week: FY’24 SSA Banking Outlook – Core banking to drive growth

Nigerian Banks: Core banking to drive growth

In 2023, the Nigerian banking industry recorded an impressive performance, driven majorly by the impact of the Naira devaluation and elevated interest rates.  The Naira devaluation led to most of our coverage banks recording material FX revaluation gains due to their positive net position in foreign currency-denominated assets as well as the devaluation-induced expansion of their balance sheets. Also, elevated interest rates supported the growth in our coverage banks’ Interest Income, which in turn led to growth in net interest income. 

As of 9M’23, gross earnings were up by an average of 95% y/y, while net profit grew by an average of 162% y/y. The remarkable growth in earnings came as a result of the material FX revaluation gains and the monetary authority’s efforts to keep interest rates elevated in a bid to stem inflationary pressures. This drove asset yield higher across loans and advances and in some cases, Fixed Income (FI) securities, but also raised the cost of funds (CoF). So far, the overall performance of banks on the NGX has been impressive, spurred by the policies which the new administration has implemented.

Elevated interest rates to drive growth in core banking income

Following the removal of the ₦2 billion cap on the SDF window by the CBN, we have seen fixed-income yields move upward as liquidity thins out in the financial system.  Of note, the removal of the cap on the SDF provides our coverage banks the window to earn from their excess liquid assets. Also, the adjustment of the asymmetric corridor from +100/-700 to +100/-300 basis points around the MPR increases the yields our coverage banks are expected to earn via the SDF window. In simple terms, this means that banks can now earn 15.75% (18.75% – 3.00%) compared to 11.75% (18.75% – 7.00%) yield on their assets through the SDF window.

Rising cost of funds amid shift in deposit mix to subdue NIM expansion

In the first nine months of 2023, our coverage banks’ customer deposits grew by 40%, owing majorly to the translation of the foreign-currency (FCY) portion of their customer deposits. Meanwhile, we saw a significant shift in the deposit mix of our coverage banks, particularly a reduction in some of our coverage banks’ low-cost of funding mix. Hence, the shift in the deposit mix amid rising interest rate led to cost of funds for our coverage banks on average to rise by 73bps YTD to 3.3%(ex-FCMB), which in turn pressured Interest Expenses.

What shaped the past week?

Equities:  Gains in the banking index (+7.01% w/w) extended the bullish streak we have seen in Nigeria bourse (0.22% w/w). Particularly, gains in ACCESSCORP (+9.63% w/w), UBA (+7.33% w/w), and ZENITHABNK (+6.00 w/w) drove the Banking index northwards. Meanwhile, it was also a green close in the Consumer Goods space (+0.21%) as well, due to renewed buy interest in CADBURY (+9.93% w/w). Similarly, gains in BUACEMENT (+0.52% w/w) led to the Industrial index (+0.24% w/w) closing in the green. On the other hand, the other sectors closed in the red led by Oil & Gas index (-0.27% w/w).

Fixed Income: Bullish sentiments dominated the fixed income market this week owing to buoyant liquidity levels. Notably, at the bond and NTB’s auction held this week stop rates contracted due to stronger than expected demand. Particularly, in the bond auction held on Monday stop rates inched lower by  50bps, 100bps, 100bps, and 85bps on the 2029, 2033, 2038, and 2053 papers to close at 15.50%, 16.00%, 16.50%, and 17.15% respectively compared to the previous auction (16.00%, 17.00%, 17.50%, and 18.00%), while at the NTB’s auction held on Wednesday,  stop rates contracted in contrast with the previous auction by 275bps, 200bps, and 225bps on the 91-, 182-, and 364-day papers to 6.25%, 11.00%, and 13.50% respectively. Similarly, at the secondary market buy-side dominated trading activities, as yields fell by on average in the bond and NTB’s market.

Currency: At the NAFEM, the Naira rebounded, gaining ₦209.09 w/w to close at N889.86 per dollar.

Domestic Economy: In an appearance before the National Assembly, the Governor of the Central Bank, Yemi Cardoso highlighted his outlook for key economic indicators. He opined that inflation could fall in 2024, while exchange rate pressures could subside. This is hinged on the unification of FX windows to reduce arbitrage and speculative behaviour in the foreign exchange market. While we see inflation decelerating in H2’24 due to base effects, we note that higher pump price adjustments could keep inflation elevated. Should encumbrances (FX forwards, OTC futures and swaps) on the external reserve become due for redemption over the near term, this could impede the apex bank’s intervention efforts in the foreign exchange market and contribute to further Naira depreciation. However, the ramp-up of oil production, oil exports, and refined crude exports could be the bull trigger than can boost reserves organically and assuage both exchange market pressures and inflation.

Global: US Treasury yields fell, and stocks surged after central bank officials projected a 75-basis-point reduction next year. This spurred investor optimism for lower borrowing costs. The Fed maintained interest rates at a 22-year high but announced new forecasts pointing to a 75-basis-point cut next year, a more dovish stance than previously anticipated. If borrowing costs fall in 2024, yields will likely drop alongside them. That could push some investors to deploy cash into stocks and other risky investments, while others rush to lock in yields in longer-term bonds.

The European Central Bank held interest rates steady for the second consecutive meeting amid revised lower growth forecasts. With euro zone inflation sharply declining, the decision to maintain the current policy was widely expected. Investors are now focused on cues for the timing of the first rate cut and the ECB’s balance sheet reduction strategy. European markets rallied, with the regional Stoxx 600 index reaching its highest level since January 2022, alongside a surge in European bonds. These moves were influenced in part by the US Federal Reserve’s decision. Meanwhile, last quarter, the euro zone economy contracted 0.1%, official data has shown, and December’s Purchasing Managers’ Index (PMI) – seen as a good gauge of economic health – suggested activity has now declined in every month of this quarter. That would mark two consecutive quarters of economic contraction, meeting the technical definition of recession.

In the Asia-Pacific region, markets reacted with mixed results following the US Federal Reserve’s announcement of the end of its interest rate hike cycle and indications of forthcoming cuts in the next year. Australia’s S&P/ASX 200 climbed 1.65%, reaching levels not seen since August 1, closing at 7,377.9. Japan’s Nikkei 225 dropped by 0.73% to close at 32,686.25, while the Topix slipped 1.43% to 2,321.35. Declines in Japan were driven by the financial sector, awaiting the Bank of Japan’s upcoming policy decision. South Korea’s Kospi stood out, rising 1.34% to 2,544.18. While in China, leaders agreed at an annual meeting on the economy this week to run a budget deficit of 3% of gross domestic product in 2024, three sources with knowledge of the matter said, while other fiscal support may be covered by off-budget debt.

What will shape markets in the coming week?

Equity market:  After five straight sessions of positive activity, we saw some profit taking in the banking sector today. However, the sector returned 7.01% w/w compared to last week’s 6.08%. On the back of that, we anticipate mild profit-taking activity to start off the week in that space. 

Fixed Income:  In the next trading session, we expect muted trading activities to persist as liquidity remains constrained. Meanwhile, in the bond space, we expect some profit-taking across the curve.