GCR Downgrades FBNQuest Merchant Bank over Capital Stress

GCR Ratings has downgraded FBNQuest Merchant Bank Limited’s national scale long and short term issuer ratings to BBB (NG) and A3 (NG) respectively, with the Outlook revised to Rating Watch Negative from Negative.

In a rating note, GCR explained that the ratings downgrade reflects sustain strain on FBNQuest Merchant Bank Limited’s capital metrics, which have declined over the last three years due to faster risk-weighted assets (RWA) growth relative to internal capital generation.

The ratings also balance the bank’s stable funding structure and good liquidity profile against a modest competitive position and sound but weakening asset quality metrics.

GCR analysts said the Negative Ratings Watch reflects potential for the exclusion of group support uplift following FBN Holdings Plc’s imminent divestment from the bank.

“As a wholly owned subsidiary of FBN Holdings, FBNQuest Merchant Bank benefits from brand alignment as well as operational integration into a strong group, which is anchored by one of the country’s leading commercial banks.

“As such, FBNQuest Merchant Bank’s change in ownership -currently awaiting regulatory approval – could result in a further negative rating action if it does not meet the group support assessment requirement under its new shareholding structure”.

GCR analysts said assessment of capitalisation is a constraint to the ratings, reflective of the downward trend in the last three years, exacerbated by the bloating impact of naira devaluation.

Consequently, the GCR core capital ratio weakened to 9.3% as of 31 August 2024 from 12.8% in December 2023 and registered within the low band of assessment.

Analysts added that further pressure has come from the reduced loan loss reserve coverage of stage 3 loans, which registered at a moderate 43.3% as of 31 August 2024 from 187.5% in December 2023.

“We expect the GCR core capital ratio to register over 17.0% over the outlook period, supported by internal capital generation from stronger net interest margins, as evidenced by the profit before tax of NGN8.2 billion as of 31 August 2024 from N4 billion in 31 December 2023”

Coupled with new capital contributions from the new shareholder(s), this could help to support a recovery in the capital and leverage assessment in the next 18 to 24 months, the rating note explained.

Over the years, analysts noted that the bank’s franchise strength has been supported by its membership in FBN Holdings, a diversified financial services group which houses the third largest commercial bank in Nigeria.

This creates cross selling opportunities and operational efficiencies that provide competitive advantages compared to peers, GCR said in the rating note.

It added that the bank’s strong position in the merchant banking subsector is evidenced by its market share of loans, deposits and total assets which registered at 19.2%, 27.2% and 18.2% as of 31 December 2023.

However, the bank remains relatively small within the broader banking sector, accounting for a moderate market share of less than 1%.

While net-interest income was constrained in 2022 and 2023, the reduction of the cash reserve ratio (CRR) to 10% in August 2023 from 32.5% , reduced earnings pressure with net interest income registering at N8.3 billion as of 31 August 2024 from N1.8 billion in 2023.

“We expect the current earnings levels to be sustained over the outlook period. Looking ahead, our assessment of FBNQuest Merchant Bank’s competitive position would be dependent on the bank’s ability to defend its market share and position within the Nigerian Merchant banking sub-sector”, GCR said.

Analysts noted that the bank’s non-performing loan (NPL) ratio increased to 4.3% as of 31 December 2023 from 1.4% in 2022 due to a credit migration to the stage 3 classification.

Specifically, the rating note stated that the credit migration relates to a stressed exposures within the steel production segment of the manufacturing sector, which constituted 96.0% of the NPLs.

Additionally, the loan book remains concentrated, with the single and twenty largest loans accounting for 13.3% and 92.3% of gross loans respectively as of 31 August 2024 due to the bloating impact of naira devaluation, GCR said.

The rating noted reads that sectorial distribution of the loan book also reflects concentration to the oil and gas, agriculture and manufacturing sectors, which jointly constituted 76.1% of total exposures as at the financial year end 2023.

“While we expect the risk profile to remain sound over the next 12-18 months, further deterioration in asset quality, such that the NPL ratio registers above 5%, could negatively impact our assessment.”

GCR stated that FBNQuest Merchant Bank is mainly funded by customer deposits, which accounted for 74.5% of the funding base as of 31 December 2023.

However, given the wholesale nature of the bank’s operations, customer deposits are largely made up of time deposits, which are relatively more rate sensitive.

As such, the bank’s cost of funds have been impacted by the upward Monetary Policy Rate (MPR) reviews by the CBN, inching up to 11.3% as of 31 August 2024 from 8.4% in 2023.

The bank’ funding base is further complemented by short term borrowings and interbank deposits, which accounted for 17.0% and 5.7% of the funding base respectively as of 31 December 2023. 

In line with merchant banking trends, top 20 depositors accounted for a high 44.1% of total deposits versus 53.2% in 2022.

According to GCR, the reduction in CRR for merchant banks to 10% as of August 2023 from 32.5% positively impacted the bank’s liquidity metrics, with liquid assets coverage of customer deposits and wholesale funding registering at 73.3% and 16.2x respectively as of 31 August 2024.

GCR said these metrics are expected to remain within a similar range over the next 12-18 months, in view of the lower CRR requirements and modest risk weighted asset growth.

Outlook statement

The Rating Watch Negative reflects GCR expectations that the planned change in shareholding could result in further negative ratings movement should there be limited headroom for group support uplift under the bank’s new shareholding structure. #GCR Downgrades FBNQuest Merchant Bank over Capital Stress Naira Drops Market Wide, Exchange Rates Gap Now N102