Fitch Ratings has affirmed Union Bank of Nigeria PLC’s (Union) Long-Term Issuer Default Rating (IDR) at ‘B-‘ with a Stable Outlook. A full list of rating actions is detailed below.
Fitch has withdrawn Union’s Support Rating of ‘5’ and Support Rating Floor of ‘No Floor’ as they are no longer relevant to the agency’s coverage following the publication of its updated Bank Rating Criteria on 12 November 2021. In line with the updated criteria, we have assigned Union a Government Support Rating (GSR) of ‘No Support’ (ns).
KEY RATING DRIVERS
Union’s Long and Short-Term IDRs are driven by its standalone creditworthiness, as expressed by its Viability Rating (VR) of ‘b-‘. The VR reflects the bank’s exposure and sensitivity to the volatile Nigerian operating environment as well as a moderate franchise and stable funding and liquidity profile. The rating also captures Union’s relatively weak loan-quality metrics, low reserve coverage, below-average profitability and only moderate capitalisation in the Nigerian context.
Union’s recent shareholder change has no immediate impact on the VR, although, over time, it will be beneficial to its business profile and revenue-generation capacity.
Union’s National Ratings are driven by its standalone credit profile. They are at the lower end of the scale given Union’s weaker franchise and record of underperformance relative to other Nigerian peers’.
Downside to Operating Conditions: Rising global risks will weigh on domestic operating conditions. We expect inflation (17.75% in June 2022) to remain stubbornly high, posing downside risks to our real GDP growth forecasts of 3.1% in 2022 and 3.3% in 2023. However, downside risks are partly mitigated by strong oil prices, which should underpin growth in non-oil sectors and banks’ asset quality given their high exposure to the sector.
Moderate Franchise; New Shareholder: In July 2022, Union’s previous shareholders sold their 93.41% stake to Titan Trust Bank (TTB) a small domestic bank (total assets: USD596 million at end-2021, 10% of Union’s total assets). Upon completion of the transaction, control was passed to TTB’s parent Tropical General Investments Limited, a Nigerian conglomerate that became Union’s core shareholder. By end-2022, Union will merge with TTB. The post-merger strategy aims to strengthen Union’s business profile and embark on rapid expansion.
Tolerable Market Risks: Union’s foreign-currency (FC) balance sheet is well-matched between assets and liabilities, with the bank running a small long net open FC position equivalent to 2% of total equity at end-1H22, although loan dollarisation remains high at 46%. Other than credit concentrations, a feature among Nigerian banks, our assessment of Union’s risk profile also captures expected rapid growth post-merger.
Above-Sector Average Impaired Loans Ratio: Union’s impaired (Stage 3 under IFRS 9) loans ratio ticked up to 7.2% at end-1H22 from 6.9% at end-2021, mainly due to deterioration in retail lending. We expect the ratio to moderate closer to the 5% peer average on completion of the merger and due to planned fast growth. Loan loss allowance coverage of impaired loans remained low at 46.3% at end-1H22, reflecting good collateral and management’s expectations of good recoveries.
Modest Profitability Metrics: Union’s operating profit/risk-weighted assets (RWAs) improved to 2.3% in 1H22, but its operating profit/assets was weaker at 0.5% due to low RWA density. While metrics lag peers’ the merger should help strengthen the bank’s revenue-generation capacity. Union’s cost/income ratio (75% in 1H22) reflects high regulatory costs as well as low revenue generation.
Improving Capital Buffers: After breaching regulatory minimums at end-2021, Union’s capital adequacy ratio reached 16.4% at end-1H22 through higher retained earnings and slower RWA growth (against a regulatory requirement of 15%, which will be lowered to 10% after divestment of Union’s international subsidiary and Central Bank of Nigeria approval). Union’s Fitch Core Capital (FCC) ratio strengthened to a reasonable 16.7%, but Fitch views its capitalisation only moderate against its net impaired loans/FCC, which is among the highest in its peer group at 19.5%.
Stable Funding and Liquidity Profile: Union’s stable funding base is a relative strength for its VR. The bank benefits from a large customer deposit base reflecting its strong retail franchise. FC liquidity is well- managed, with sufficient coverage of short-term FC liabilities. The bank has a low reliance on external- market funding, while customer deposits accounted for 76.6% of total funding at end-1H22.
No Support: Sovereign support for all commercial banks cannot be relied on given Nigeria’s weak ability to provide support, particularly in FC. Union’s ‘ns’ GSR therefore reflects our view that senior creditors cannot rely on receiving full and timely extraordinary support in the event of a bank failure.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade would require a significant improvement in profitability, with the bank’s operating profit/RWAs remaining above 3% and pre-impairment operating profit/total assets increasing to above 1.5%.
Given recent pressures on capital, an upgrade would also require Union maintaining sufficient buffers above its regulatory requirements, a meaningful reduction in its unreserved impaired loans/FCC ratio and its leverage (tangible common equity/tangible assets) strengthening to above 8%.
An upgrade would also require a decrease in impaired loans ratio below 5% as well as a successful execution of the merger that will enhance Union’s franchise.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise stated, the highest level of ESG credit relevance is a score of ‘3’. ESG issues are credit neutral or have only a minimal credit impact on Union, either due to their nature or the way in which they are being managed by Union. For more information on Fitch’s ESG Relevance Scores, visit http://www.fitchratings.com/esg.