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Shedding over N4 trillion of toxic debt to  the state-run AMCON starting in 2010 was the first step in a cycle for Nigerian banks which has now come full circle in that still subdued impairment charges have neatly correlated with rising ROEs and improved capital adequacy ratios (CAR)–now up sector-wide to  over 17 percent from sub-10 percent levels  two years ago–that reflect, in part, lower risk weighted assets–once a headwind but now collateral for high yield paper that[alongside sticky money market rates] pads net-interest margins as well as overall net interest income in the face of suddenly sluggish credit growth (a phenomenon the central bank (CBN) labeled this spring as “indicative of a disturbing trend of growth in lending to States and Local governments at the expense of the core private sector”, though as RenCap analysts point out roughly 80 percent of Nigeria’s private credit goes to sectors of the economy that account for ~23 percent of real GDP growth).

Banks’ role in developing the real economy (read providing credit) comes concurrent, however, with a continued drive to (arguably) over-provision, seen for example in Diamond Bank’s 1H12 results wherein provisioning rose 18.3 percent q/q against an annual impairment decline of roughly 10 percent–an example of the differences stemming from the newly adopted International Financial Reporting Standards (IFRS), which replaced Generally Accepted Accounting Principles (GAAP) and has had a direct impact on lowering the aforementioned impairments at certain banks while actually raising required provisions at others: analysts stated that First Bank , Zenith and UBA all saw impairment charges decline between 20-38%, for instance (in essence the method of provisioning is based upon an informed rather than prescribed rate assessment process).  Yet to what extent banks build out and/or adopt the capacity to leverage the new standard standard and moreover apply it effectively to future asset buildout is just the sort of “sustainable change” alluded to by the CBN that will define and ultimately differentiate Nigerian banks once general  impairment drivers disappear from earnings and funding profiles become more competitive.   Moreover,  some pundits also fret about how the IFRS mark-to-market ethos will impact various [hitherto opaque] credit portfolios, especially given how counter-party credit risk will imediately be passed onto balance sheets and require offsetting flexibility in reserving.

Alongside overall asset and non-interest income growth, Fitch wrote last fall that “cost management [can be] expected to take on increased focus” within the Nigerian banking sector; indeed, most explictly this sort of “efficiency”  (often proxied by non-interest expenses as compared with revenue or in some cases total assets) may be magnified given the fine line between containing risk and capturing its returns inherent to a business model that post-Lehman and under Basel III looks to discourage rather than encourage it in the first place.  Touting falling NPLs and higher capital levels  as a sign of “strength” is thus somewhat misguided.   A recent paper in fact (“Effect of Capital Adequacy on the Profitability of the Nigerian Banking Sector”) reiterates the “non-significance between CAR and selected bank profitability and performance metrics” while suggesting regulators focus rather on “intrinsic elements of bank operational activates” in terms of cultivating stability.  For Nigeria’s banks, the work has just begun.

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Following a four-month civil war and three missed coupon payments the Cote d’Ivoire ‘32 eurobond, which traded as low as 34 cents on the dollar last year but YTD remains, among hard currency sovereign debt, by far the best performing developing market credit, continues to look attractive given the recent IMF-World Bank Heavily Indebted Poor Country (HIPC) debt reduction scheme announcement of over $6bn (roughly one half of its present, public debt composition with the expectation that additional bilateral debt relief will be realized in coming years (though IMF forecasts still envision external debt as comprising around half of GDP through 2013, in spite of an expected 2x increase in gross investment which will help pad domestic output).  That yields remain relatively sticky to SSA peers, however (the bond yielded ~8.5 percent last Friday), is a testament not just to the still undeclared arrears repayment schedule (and formal exit of default) but also lingering social tensions as well as uncertainty regarding structural, institutional reforms in crucial (read cocoa/coffee) economic sectors and persistent, budget straining energy expenditures (last year’s subsidy to the electricity sector for instance, which is financed with a portion of gas revenues, amounted to CFAF 104.5 billion compared to a target of CFAF 74.8 billion) which officials hope will be offset by newly passed and thus hitherto untested tax reforms (designed to expand the revenue collection base).  To this last point, the Ouattara regime’s late-April foray into the regional debt market underscores that the need for external financing will be omnipresent, particularly with the trend of lower cocoa prices since March 2011 correlating neatly with the country’s newfound and expected current account deficit going forward which, per the balance of payments must be somehow financed.  However, said financing is largely tied to both the supply and demand prospects for the crop, and as we’ve detailed in the past the long term supply issues are highly dependent on replacing an aging tree stock and [concurrently] vastly augmenting yields.  Moreover even near-term supply concerns persist despite last season’s weather buffeted record surplus (evidenced by the market’s apparent backwardation), a signal for some at least that “reforms” may have been haphazardly rushed in part to appease Paris Club debtors at the expense of adequately addressing a host of concerns from domestic farmers.

JGW

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