Nigeria: Union Bank of Nigeria’s Ratings Downgraded by GCR Due to Weakened Capital Base

GCR Ratings has downgraded Union Bank of Nigeria (UBN) Plc.’s national scale long-term and short-term issuer ratings, lowering them from BBB+(NG) and A2(NG) to BBB-(NG) and A3(NG), respectively. Additionally, the rating agency has downgraded the national scale long-term issue rating of UBN’s N6.3 billion Series 2 Senior Unsecured Bonds to BBB-(NG) from BBB+(NG).

The rating outlook has been revised to Evolving from Rating Watch Negative, according to a note from GCR Ratings obtained by MarketForces Africa.

The downgrade reflects a significant deterioration in UBN’s capitalization, with the bank’s capital adequacy ratio (CAR) falling below the regulatory minimum of 10% for its license category. This decline in capitalization has been attributed to additional provisions on major loans as mandated by the Central Bank of Nigeria (CBN) and the impact of the naira’s devaluation on the bank’s risk-weighted assets.

GCR noted that Union Bank’s loan book also exhibits a high concentration of obligors and foreign currency exposures, with the percentage of Stage 2 loans relative to gross loans increasing in comparison to industry peers. Despite these challenges, UBN’s strong domestic franchise continues to support a stable funding structure and good liquidity, according to the latest credit report.

The Evolving outlook reflects potential changes in UBN’s credit profile following its consolidation with Titan Trust Bank Limited. However, GCR highlighted that UBN’s capital position remains a significant constraint on its ratings, with the bank’s CAR dropping to 7.1% as of December 31, 2023, down from 14.4% in the previous year.

The rating agency also pointed out that UBN’s loan portfolio is heavily exposed to foreign currency, with 66.4% of its loans denominated in foreign currency as of 2023, up from 49.3% in 2022. The GCR core capital ratio, which includes regulatory risk reserves, also declined to 10.9% as of June 30, 2024, from 11.6% in FY 2023 and 14.5% in 2022, placing it within the low band of GCR’s assessment.

GCR expects the GCR core capital ratio to remain between 10% and 12% over the rating outlook period, driven by positive earnings generation and management’s plans to moderate risk asset creation and foreign currency exposures.

On a positive note, UBN’s loan loss reserve coverage of Stage 3 loans improved significantly to 173.3% as of June 30, 2024, up from 129.5% in 2023 and 43.2% in 2022. However, the coverage of Stage 2 and 3 loans remains low at 13.2%.

Looking forward, GCR anticipates that UBN’s capital base could strengthen over the next 12 to 18 months through equity injections from its shareholders, which may help mitigate the negative risks to the bank’s ratings. The rating agency noted that UBN’s asset quality metrics reflect high obligor concentration, rising credit losses, and increased foreign currency loans due to the naira’s devaluation and broader macroeconomic challenges.

UBN’s credit loss ratio stood at 5.2% as of June 30, 2024, above the industry average. Although the bank’s Stage 3 loans as a percentage of gross loans improved to 3.7% as of June 2024 from 3.8% in 2023 and 7.4% in 2022, this was largely due to the reclassification of some Stage 3 loans to Stage 2.

GCR also reported that Stage 2 loans, which historically averaged 22.0% of gross loans from 2018 to 2022, surged to 35.2% as of December 31, 2023, and further to 44.9% as of June 30, 2024. These loans primarily consist of foreign currency loans to the power sector and syndicated oil and gas sector loans.

While UBN’s management has indicated that these Stage 2 loans have been restructured and are performing according to the new terms, GCR remains concerned about their vulnerability to the weak macroeconomic environment.

Obligor concentration in UBN’s loan book remains high, with the top 20 obligors accounting for 68.2% of gross loans as of June 30, 2024, down from 76.0% in 2023 and 66.0% in 2022. Moreover, the bank’s top five obligors breached the regulatory single obligor limit (SOL) of 20% of shareholders’ funds as of the same date, largely due to the impact of naira devaluation.

UBN is currently benefiting from regulatory forbearance, with expectations that the planned recapitalization could address these breaches, barring any further devaluation of the local currency. GCR noted that the percentage of foreign currency loans to gross loans remains higher than industry peers, standing at 66.0% as of June 30, 2024, compared to 66.4% in FY 2023 and 49.3% in 2022.

GCR also mentioned that UBN is in the process of converting some of these foreign currency loans to local currency, although this will depend on the availability of foreign currency.

Looking ahead, GCR expects that UBN’s asset quality will continue to be pressured by the challenging operating environment. However, the bank’s competitive position remains a key strength, supported by its over ten-decade track record in the Nigerian banking industry.

The Evolving outlook also reflects the potential changes in UBN’s credit profile following its consolidation with Titan Trust Bank Limited.