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Solid Non-Interest Income Growth Masks Impact of Low-Yield Environment
Solid Non-Interest Income Growth Masks Impact of Low-Yield Environment


FBN Holdings Plc (‘FBNH’) reported a 5% year-on-year (YoY) gross earnings growth from N417.84 9M’2019 to N439.29bn in 9M’2020. A dive into the driver of gross earnings growth showed that performance was driven by non-interest income which grew by 44% YoY from N98.73bn in 9M’2019 to N141.59bn in 9M’2020. The significant non-interest income growth resulted from trading gains recorded during the period. Specifically, the Group recorded a 452% spike in net gains on investment securities from N7.46bn in 9M’2019 to N41.18bn in 9M’2020. Also, the Group recorded a 122% spike in net gains from financial instruments measured at fair value through profit or loss, from N3.47bn in 9M’2019 to N7.72bn in 9M’2020. In our view, the trading gains recorded by the Group reflected the impact of the low-yield environment on asset prices. Generally, the pass-through impact of lower interest rates is higher asset prices. Thus, we believe that the Group rode the yield curve, particularly given the inverse relationship between interest rates and bond prices. Additionally, fee and commission income rose by 15% YoY from N76.05bn in 9M’2019 to N87.59bn in 9M’2020. The combination of the increases recorded on major non-interest income line items supported the Group’s gross earnings growth.

Declining Yield Environment Weaken Earnings Potentials
Interest income declined during the period from N319.56bn in 9M’2019 to N297.71bn in 9M’2020. Although interest income on loans and advances to customers grew by 3% YoY (largely resulting from a 12% YoY growth in average total loans and advances to customers), a decline in interest income on investment securities (-20% YoY) and interest income on loans and advances to banks (-34% YoY) had a bigger effect on total interest income. We attribute the decline in the major line components of interest income to the lower interest-rates in the economy, as well as increased competition among financial institutions to create quality risk-assets, amid a challenging macroeconomic environment. According to our analysis, the Group’s average yield on interest-earning assets lowered from 10% as of 9M’2019 to 9% as of 9M’2020. Meanwhile, total interest-earnings assets rose by 2% YoY from an average of N4.27trn as of 9M’2019 to an average of N4.37trn as 9M’2020.

Low Cost-of-Fund Supports Net Interest Margins
The Group’s cost-of-fund declined by 82 basis points from 3.34% as of 9M’2019 to 2.52% as of 9M’2020, despite a 20% YoY increase in total interest-bearing liabilities from an average of N4.63trn as of 9M’2019 to an average of N5.56trn as of 9M’2020. Notably, deposits from customers (c.76% of total interestbearing liabilities) grew by 21% YoY. The Group’s significant increase in interest-bearing liabilities,despite a lower cost-of-fund, reflected the excess liquidity in the financial system. Thus, a repricing of liabilities took place, which extended to lower yields on interest-bearing assets. The decline in asset yields was more pronounced than the decline in cost-of-fund. Consequently, net interest margin lowered from 6.64% as of 9M’2019 to 6.56% as of 9M’2020

Based on our perspectives, we partly attribute the pressure on interest income to liquidity challenges faced by the Group due to the significant CRR debits by the Central Bank of Nigeria (CBN). For instance, the Group’s mandatory reserve with the Central Bank rose materially by 134% YoY from an average of N511.44bn as of 9M’2019 to an average of N1.19trn as of 9M’2020. The implication of the CRR debits, in our view, means that customer deposits are serviced whilst the funds are unavailable for lending purposes. This creates a gap that might require higher interest rates on assets to fill. However, the low-yield environment drives competition in the industry which, therefore, gives the Group a limited scope for high pricing of risk-assets. Therefore, net interest margin shrinks.

Weak Macroeconomic Outlook Drive Impairment Losses
Impairment charge for credit losses rose by 64% YoY from N28.46bn in 9M’2019 to N46.68bn in 9M’2020. We attribute the surge to weak macroeconomic outlook (particularly induced by the coronavirus pandemic),which increased the risk of default on loans. Consequent to the material rise in impairment charge for credit losses, net interest income declined by 17% YoY from N175.07bn in 9M’2019 to N146.06bn in 9M’2020. Net interest income without factoring impairment charge only declined by 5% YoY.

Cost Optimisation Enhances Bottomline Growth
Although net interest income after impairment losses declined by 17% YoY, the 44% growth in non-interest income supported a 5% YoY operating income growth from N259.73bn in 9M’2019 to N273.04bn in 9M’2020. Operating expense grew by 2% YoY from N205.28bn in 9M’2019 to N209.76bn in 9M’2020. Despite the 2% increase in operating expense, the Group’s cost-to-income ratio lowered by 200 basis points from 79% in 9M’2019 to 77% in 9M’2020. This was due to the higher rate of increase in operating income, relative to the increase in operating expense. As a result, profit before tax grew by a double-digit growth of 16% YoY, from N54.45bn in 9M’2019 to N63.31bn in 9M’2020. Profit after tax grew by 15% YoY from N47.23bn in 9M’2019 to N54.36bn in 9M’2020.

Other Information
The Group recently completed the divestment of its insurance subsidiary. According to the management of the Group, a sum of N25bn which represented a part of the net proceeds of the Group’s divestment, was injected into its commercial banking subsidiary. As a result, the Capital Adequacy Ratio (CAR) of the commercial banking subsidiary increased to 16.53% as of H1’2020. However, the Group’s CAR lowered to 15.70% as of 9M’2020. The regulatory threshold is 15%. For Systemically Important Banks (SIBs), the threshold is a little higher at 16%. As of 9M’2020, the Group’s total non-performing loan (NPL) ratio stood at 8.80%, significantly higher than the regulatory threshold of 5%. However, the NPL ratio of 8.80% as of 9M’2020 was an improvement from 9.90% as of FY’2019.

We lower our FY’2020 EPS estimate to N2.15 (previous: N2.32), owing to our expectations of a sustained low-yield environment. We also expect to see higher impairment charges for credit losses in the near term. Furthermore, we expect to see lower trading gains in the near to medium term. We also lowered our dividend expectation to N0.39 (previous N0.42). At our revised dividend, the dividend yield stands at 6%. We have a fair value estimate of N7.98 for FBNH, which implies a forward P/E of 3.26x. Using a blend of Dividend Discount Model (DDM) and Residual Income Model (RIM) valuation methodologies, we arrived at a justified P/E of 3.71x. Therefore, we believe that the stock offers a price return of 14%. Incorporating a 6% dividend yield results in a total return of 19%. A 19% potential total return is significantly higher than what is obtainable in the fixed-income markets (e.g., the FGN 10-year government bond yield stands at 6.36%). Also, the potential total return is above the inflation long-term average. Hence, we recommend a BUY.

WSTC Securities LTD
2 Maitama Sule Street Falomo, Ikoyi Lagos


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