Piece on the banking sector on Reuters yesterday - thanks BA for the link

Stellar Nigerian banking growth brings high risks

Fri 30 May 2008, 11:14 GMT
By Nick Tattersall

LAGOS, May 30 (Reuters) - Nigerian banks' ability to manage risk may lag their explosive growth, souring investors' buy-in on the back of record oil prices, an expanding middle class and corporate lending appetite, analysts say.

Nigerian banks were among the strongest performing stocks in the world last year, even as a global credit crisis took its toll elsewhere, attracting interest from private equity and hedge fund investors from Europe, Asia and the United States.

The economy in the world's eighth biggest oil producer is growing at its fastest rate for decades, global oil prices look set to continue to rally and Nigeria's government has committed to reforms which will see a growing role for the private sector.

All of this in a country of up to 140 million people, just 15 million of whom are thought to hold bank accounts, meaning huge potential growth in retail banking.

"In the last six months the growth in earnings momentum at the banks has just been stratospheric," said Fola Fagbule, a Nigerian research analyst with stockbroker Afrinvest.

"We are seeing significant growth in loan books ... The average bank I look at has doubled its loan book from the last time it reported an audited account," he told Reuters.

But there are fears that they may be growing too fast.

A wave of consolidation has seen the number of banks in Africa's most populous nation slashed from 89 to 24 in the past few years, leaving the survivors competing fiercely for millions of consumer clients as well as for large corporate customers.

"We are concerned that banks may be tempted to expand into retail banking before they are able to adequately manage the risks," JP Morgan analyst Andrew Cuffe said in a report this month, initiating coverage of the Nigerian sector.

MANAGING THE RISK

Most banks have been scaling up, tapping international and local markets to raise more than $10 billion in capital last year alone, enabling them to increase their capacity to lend.

Eight banks, including Zenith Bank and Oceanic Bank , have posted 9-month or quarterly earnings increases of more than 100 percent since the start of the year.

"We're beginning to see banks put a lot of their capital at more risk. They have no problem expanding their loan books, the challenge is maintaining the quality," Fagbule said.

Afrinvest estimates that 80 percent of Nigeria's wealth is in the hands of just 20 percent of the population, meaning a potential market of up to 28 million banking clients.

But while many of them may be potential depositors, not all will be rich enough to make them profitable to lend to.

The lack of a national identity system or a fully functioning credit bureau in Nigeria, as well as the banks' limited experience with consumer finance products such as mortgages, all means extra risk.

"Following extremely strong rates of growth in advances, and with pressure on banks to deploy capital raised over the past year, we believe the risk of a sharp increase in non-performing loans has increased," JP Morgan's Cuffe said.

Even compared to other parts of West Africa, Nigeria feels woefully underbanked. Cash machines are a recent arrival and charges for simple transactions so high that many Nigerians prefer to stash wads of cash under their beds.

While some banks are doubling their consumer loan books every quarter, analysts say they are riding with a strong tailwind in Nigeria, a country flush with record oil revenues and expecting economic growth of at least 7 percent this year.

ROLLERCOASTER RIDE

With Nigeria determined to turn itself into one of the world's leading economies by 2020, involving huge infrastructure projects partly financed by the private sector, analysts agree that the banking industry remains a compelling story.

Russian brokerage Renaissance Capital launched two new financial stock indexes this month to capture growing interest in the sector, while JP Morgan Asset Management identified Nigeria as a leading frontier market for part of its new Africa equity fund, which it hopes could reach $250 million.

But there is less consensus on whether now is the time to buy Nigerian banks after a sharp share price rally last year.

Fears that the banks' meteoric rise could turn into a bubble have also been heightened by reports that some are engaged in high-risk margin lending, loaning money to other institutions or individuals for stock market trading.

Some analysts, such as JP Morgan's Cuffe, argue their shares have run well ahead of fundamentals and do not take into account the operational and macro-economic risks to the businesses.

Any external shock, such as a drop in world oil prices or serious political instability, could leave them vulnerable.

"We believe the sector is expensive on both an absolute basis and relative to emerging market peers .... Given a price correction, we would look to enter," Cuffe said.

Others, such as Afrinvest's Fagbule, point out that last year's stock market exuberance has waned and that banks are becoming more profitable than ever as they increase lending to the country's top companies and their employees.

"For any bank in Nigeria now that has a handle on risk management, they are going to do phenomenally well," he said.

"... As long as those loans don't go bad."