Banks Bearing the Brunt of Oil Price Slump

What the prices of crude oil dictate at the international market has fallen short of banks’ projection and as such, oil projects especially in the exploration and production end of the industry have become unattractive to financial institutions, write Kunle Aderinokun and Olaseni Durojaiye

With the government still contending with the shortfall in its revenue due largely to the Southward movement  of  price of crude oil and which  is now forcing government to ponder how to shore up its foreign exchange earnings and how best to fund its budget deficit, the banking system has become the latest to feel the unfriendly harsh realities of the price slump. The reason for this, economic watchers insist is not far-fetched as it points in the direction of the banking system exposure to the oil and gas sector. 

Besides the direct threat of the volatility in the  oil market to the nation’s foreign exchange earnings and the scarce foreign exchange especially the greenback, which has forced government through the Central Bank of Nigeria (CBN) to discourage importation, particularly of goods that could be produced locally, the attendant pressure on the naira has continued to haunt the commercial banks in the country.

One of the fallouts of the current scenario is that about N5 trillion loans granted to energy firms might be impaired due to the current trend which has also led to a 53 per cent drop in NNPC cash call payments to Joint Venture operations between 2005 and 2015. Besides, the low price has also led to a 62 per cent drop in Joint Venture (JV) production.

Banks’ Exposure to Oil  and Gas Sector
While the size of exposure to the oil sector of individual banks could not be ascertained, there are indications that loans totaling  about N2trillion granted to oil and gas firms are stuck as the oil prices fall below the loan threshold of $45 per barrel leading many of the banks to re-price the loans and reschedule the tenor from as much as five years to 10 years.

FBNQuest’s Oil and Gas Analyst , Uwadiae Osadiaye, put the proportion of bank’s exposure to the upstream oil and gas sector  in relation to  the total loan portfolio in banking system at  between 15-20 per cent. This, he said represented about $5.7 billion loans assessed by the industry within the last five years , according to the figures given by the Managing Director of Seplat, Austin Avuru, recently. Osadiaye puts the total loan portfolio in the banking sector at N11 trillion.

An analyst with a Lagos-based business and economic advocacy firm, Wilson Erumebor, told THISDAY that despite the seeming improvement  in non- performing loans (NPL) in the country, the oil and gas sector’s contribution to NPL was 95.41 per cent as at October 2015.

Banks Now Avoid Oil and Gas Projects Financing
Financial and energy analysts have indicated that the current scenario in the oil and gas sector portends danger for the banking sector nay the economy. And financing oil and gas projects have become unattractive.
As such, while speaking at the monthly technical meeting of the Nigerian Association of Petroleum Explorationists (NAPE) in Lagos recently, Vice President at First City Monument Bank (FCMB), Ronke Jibodu,  revealed that banks could no longer participate in crude equity financing. According to her, projects financed by banks in Nigeria are recording a shortfall of $10 on every single barrel produced, as the price of crude oil has fallen below the $45 barrel projection by the lenders.

“What we set as worse target for oil (projection) is $45, but today it’s $35 per barrel. This is a big challenge for the banking industry,” she said, adding “And how the money could be refunded by oil firms that are also facing big task to survive the low price is a big issue,” she declared.

Speaking further, Jibodu explained that “the financial institutions are being faced with ‘what do we do scenario?’ the unstable, the uncertainty in the oil sector. What I told my colleagues is that maybe we could get bailout fund. We need to fund new projects without being saddled. We still have a need of $20 to $30 million for new project financing,” she stressed.

The same position was held by Osadiaye, who pointed out that banks had  other choices to make than to finance the oil and gas, especially the upstream end of it, given the precarious situation in which they are now.

“Remember  sectors  compete  for banks’  finances and if given where the oil and gas is today, they are possibly and relatively unattractive. Our economy is growing at a slower pace compared to what we were doing few years ago, how many sectors will the banks really consider attractive as well. So my point is, it is a difficult situation to be – the oil and gas sector is not doing very well,  but if you were to really ignore that, where do you go? It’s a difficult sector to be at the moment,” he said.

According to him, “Obviously, the banks made assumptions but the assumptions will definitely not have been at  the oil prices that we are seeing today. I know last year, the banks and the oil companies sat down to revise these assumptions but price have declined much further.”

In an interview with THISDAY, Chief Executive Officer of Heritage Capital Markets Limited and immediate past President of the Institute of Chartered Accountants of Nigeria (ICAN), Chidi Ajaegbu, noted that it was to be expected that the banks will shy away from further lending to the oil and gas sector considering the falling price of oil and current exposures to the sector by the banks.

“This is expected; the price of oil is heading south which makes the industry less profitable coupled with the fact that some of the loans to the sector in the past are being restructured in the light of what is happening in the sector. We must acknowledge that the banks are not charities,” Ajaegbu stressed.

RenCap Analysis
According to the analysis of leading financial advisory firm, Renaissance Capital, owing to the situation in the oil market, Nigerian banks have begun to re-price loans to the sector. While the other tier 1 banks appeared to have re-priced loans downwards on a selective basis, GTBank is believed to have re-priced its loan book downwards by 150-200 basis points (bpts).

The review obtained by THISDAY stated: “Given the continued decline in oil prices, clients’ questions on the banks’ oil portfolios were manifold. Within oil and gas, upstream loans are already being restructured using $30 per barrel with tenures extended to 10 years from five; midstream/service loans are also being restructured, but we could see NPLs where projects are cancelled or suspended and vessels are made idle; there were no major concerns expressed on downstream exposures. The bigger asset-quality concern of the banks is for their non-oil loans that suffer from the sharp slowdown in economic activity and worsening foreign exchange scarcity issues, and the unpredictable downward spiral these events could lead to.

That said, it remains the case that the banks are acknowledging the problems but on cost of risk guidance no-one is guiding to a blowout scenario because: the states got bailed out; the Foreign Exchange stance has allowed the banks time to significantly close their open trade positions; and the banks really believe stronger supervision and risk management makes them better prepared than during the last crisis. That said, we felt NPL crystallisation is a timing issue and it’s best to remain cautious. Overall, Access Bank came across as being most on top of risk management,” the report stated.

Renaissance Capital maintained that Nigerian banks were facing significant asset quality risks that could crystallise in the near term. The trigger of this risk was singular – the sharp and elongated decline in oil prices.

According to Erumebor, the fears being nursed by watchers of the unfolding development in the nation’s banking sector transcend the low  price of oil on direct lending that the banks have made to the sector to include the multiplier effects this has had on the economy.

This aligns with the Rencap report which stated that, “the risks arise not solely from the impact of low oil prices on the direct lending the banks have made to oil and gas firms, but the ancillary this has had on economic growth, which has declined from 5-6 per cent historically, and FX liquidity, which has materially affected the CBN’s ability to satisfy demand for FX.

“In our view, the challenge with managing the risks is not only that none of the banks  assumed an economic scenario where FX becomes scarce; but the longer the difficult conditions persists, we could see banks needing to recapitalize, or see forced mergers, with the regulators stepping in to coordinate the process,” the report stated.

Magnitude of Oil Price Slump
Examining the extent of the oil price slump, Head, Energy Research at Ecobank, Dolapo Oni, stated that  “the best statistic that shows the impact of the slump in oil prices on the banking industry is the rise in non-performing loans, which has risen over 5 per cent but remains under 8 per cent.”

He explained: “Following the drop in oil prices below the true cost per barrel levels of many operators in the upstream segment of the Nigerian oil industry, the rate of companies approaching their banks to restructure their loans has spiked. And this is largely due to the fact that at this low price, most of these operators are no longer generating enough cash to service their debts properly.

“Some now have perhaps just enough cash to cover interest or a part of their principal. Secondly, the strong impact the oil slump is having on the banks is also due to the fact that the banks had over-extended loans to the oil industry. As at June 2015, the banking sector exposure to the oil industry was about 24 per cent of its loan book, which is really high. For some banks the ratio of oil and gas loans to their entire loan book was over 30 per cent, some as high as 40 per cent, 47 per cent etc.”

Are Oil Prices Going to Recover?
Osadiaye  does “not think there is anyone in the world who knows where the oil prices are going to be over the next 12 months.”

“I think going by the EIA forecast of around $40 per barrel,  on average for this year, which is quite similar to ours. This is still very low compared to assumption that we made three years ago  when a lot of these loans were being given out.  So there is a danger and I kind of understand why  there will be an angling for a bailout. 15 per cent is sizable chunk of loans, so to speak.  Obviously, the exact details of these loans will differ from company to company. Overall, there will be a sizable chunk that will (be) at risk presently.”

As Banks Shy Away…

Oni believes “it will mark a huge difference in the funding structure of the oil and gas industry in Nigeria if the banks refuse to fund these deals going forward. It would push the oil and gas companies to list their companies on the stock exchanges, where they would be able to raise long-term (patient) capital, which does not put them under huge pressure to repay.

“More importantly since the business requires a lot of foreign exchange funding, some of the companies will look to access external financing in the form of private equity, foreign bank loans, which will also put them under pressure to clean up their books, improve corporate governance and operational structures as these things will be necessary to attracting foreign private capital. However, I can tell you the banks will still fund oil and gas deals that meet perhaps the highest levels of credit quality, i.e. a performing loan that needs to be expanded due to the expansion of the underlying project etc.”

Impact on Economy
The Ecobank energy analyst thinks “if the banks don’t finance oil and gas deals, clearly efforts to increase Nigeria’s oil production will be cut short. Our crude oil output continues to drop since 2010 and despite new fields coming onstream (Bonga phase 3 and Erha North last year), we are still shedding more barrels than gaining. “This has been largely due to lack of investment in secondary recovery from the larger fields by the IOCs and also due to the NNPC’s inability to fund its share of JV Cash Calls. The Nigerian independents, who depend more on the banks to fund their deals and operations, have been able to stake a claim on up to 15 per cent of total output in the country but this could easily be reversed without funding to continue developing their assets. Lower national oil output translates to lower oil revenues and hampers the government’s ability to invest in key infrastructure projects needed to sustain the country’s growth and development,” he added.

For Osadiaye, he advised  “the bank has to be proactive so as to be able to take advantage of other opportunities available in the economy rather than getting fixated with oil and gas sector.

“The banks will have to look for different opportunities within the economy. If they can’t find it, the economy may struggle, if they do, the economy is likely to perform as expected.  But ultimately, it’s really nobody’s fault - oil prices have crashed we had prices at $100 and above, it was a no-brainer, the oil companies have a big project, technical competence, banks did well to support growth in the sector but the sector is unattractive and you have to look elsewhere.”

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