FCMB’s Capital Under Pressure: Fitch Places Bank on Rating Watch Negative

Fitch Ratings has placed First City Monument Bank Limited’s (FCMB) Long- and Short-Term Issuer Default Ratings (IDRs), Viability Rating (VR), and National Ratings on Rating Watch Negative (RWN) due to the significant devaluation of the Nigerian naira. The negative watch on FCMB’s rating reflects the potential risk of breaching its minimum total capital adequacy ratio (CAR) requirement as a result of the devaluation. FCMB raised funds in the debt market this year, but the devaluation has increased risks to its core capital due to large foreign-currency (FC)-denominated problem loans that have been inflated. This may necessitate higher prudential provisions and exert additional pressure on CAR.

Fitch anticipates resolving the RWN within the next six months, by which time exchange-rate volatility may diminish, the impact on CAR will become clearer, and the second-order economic effects on loan quality will be more apparent.

The official exchange rate, known as the Investors and Exporters (I&E) window, experienced a sharp depreciation on June 14th following the Central Bank of Nigeria’s (CBN) decision to unify its multiple exchange-rate windows and allow the naira to trade at a market-determined rate. As of June 21st, the I&E window closed at 776/USD, reflecting a 62% depreciation since June 13th and a 70% depreciation since 2022.

The shift away from a long-standing managed exchange rate regime aims to restore capital inflows and reduce foreign-currency (FC) shortages that have affected the Nigerian economy in recent years. This significant policy change occurred shortly after the suspension of the CBN governor by President Tinubu, who was recently elected. President Tinubu has implemented reforms at a faster pace than Fitch had expected, including the removal of fuel subsidies within weeks of his inauguration. These reforms are positive for the country’s credit profile but present near-term macroeconomic challenges.

A considerable portion of economic activity in Nigeria has already been influenced by the parallel market exchange rate, which has traded at over 700 naira to the US dollar for most of the past year. This has mitigated the inflationary impact of the recent devaluation of the official exchange rate. However, the devaluation and fuel subsidy removal will contribute to existing inflationary pressures, including fuel prices, and increase the risks of social unrest. Fitch expects impaired loan ratios to rise in the near term, as borrowers face higher inflation and interest rates following the devaluation and fuel subsidy removal.

Foreign currency lending standards have become stricter in recent years, influenced by a CBN directive that prohibits FC loans to borrowers without FC revenues, as well as some banks restructuring FC loans into naira. However, there are still legacy FC loans to borrowers without FC revenues, and these loans are expected to weaken in the near term. Nevertheless, when assessing asset quality, Fitch considers the banks’ small loan portfolios, as they hold significant cash reserves at the CBN and have holdings of sovereign fixed-income securities.

The devaluation will lead to an inflation of banks’ FC-denominated risk-weighted assets (RWAs) in naira terms, putting downward pressure on capital ratios. Fitch believes that the direct impact of the recent devaluation on capital ratios will be manageable for the banks that have been affirmed, as they have small FC-denominated RWAs and long net FC positions. This will result in revaluation gains that help cushion the impact of inflated RWAs on capital ratios, allowing these banks to maintain sufficient capital buffers and pre-impairment operating profits to accommodate the second-order economic effects of the devaluation on loan quality and increased risks to capital from inflated FC-denominated problem loans.

Despite having small FC-denominated RWAs and a long net FC position, Fitch believes that the significant scale of devaluation may cause FCMB to breach its 15% minimum CAR requirement, given its considerable loan book dollarization relative to capital headroom. FCMB has a high proportion of Stage 2 loans (as of end-2022: 22% of gross loans, mostly FC-denominated) that will be further inflated by the devaluation. This may lead to higher prudential provisions, further pressure on CAR, and increased risks to core capital. Fitch assesses that FCMB’s pre-impairment operating profit provides only a moderate buffer to accommodate this and other loan-quality risks.