FBNQ MB Funding SPV Plc - FMDQ Group … · 2 2018 Bond Rating: FBN Quest MB Funding SPV Plc in addi tion to a capital adequacy ratio of 12.2%, also above the 10% regulatory minimum

FBNQ MB Funding SPV Plc

Series 1 Final Rating Report

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2018 Bond Rating: FBN Quest MB Funding SPV Plc

FBNQ MB Funding SPV Plc Series 1 ₦5 billion 3-year Fixed Rate Senior Unsecured Bond under the ₦50 billion Debt Issue

Programme

Rating Assigned:

A RATING RATIONALE

Agusto & Co. hereby assigns a rating of “A“ to FBNQ MB Funding SPV Plc

(“the Issuer”) Series 1, ₦5 billion 3-year Fixed Rate Senior Unsecured Bond

(“the Issue” or “the Bond”) guaranteed by FBNQuest Merchant Bank Limited

(“FBNQ MB”, “the Sponsor” or “the Bank”). The rating assigned to the Issue

mirrors the standalone rating of the Sponsor, as the Issue is unsecured and

ranks pari passu without discrimination with all of the Issuer’s existing and

future senior, unsecured obligations.

FBNQuest Merchant Bank Limited is rated “A” by Agusto & Co. The rating is

hinged on the Bank’s good liquidity profile, adequate capitalisation for

current business risks, satisfactory asset quality within regulatory thresholds,

profitability profile since obtaining a merchant banking license, as well as

membership of FBN Holding Company Plc, all driven by an experienced

management team. The rating is however moderated by sectorial

concentrations in its loan portfolio, heightening vulnerabilities to credit risk

crystallisation, as well as elevated operating expenses following changes to

the organisation’s structure as part of the FBN Quest Group and substantial

investments in information technology.

FBNQ MB commenced merchant banking operations in November 2015 after

operating for over two decades as Kakawa Discount House. With strong

support from its asset management business, alongside the investment

banking unit which has historically maintained strong market share of

brokerage and debt structuring services, the Bank’s earnings have been

boosted by related non-interest income. Though profitability dipped in the

2018 financial year owing to a lower net interest spread and elevated

operating expenses vis a vis income, the Bank’s three-year average pre-tax

return on assets and equity stood at 3.1% and 14.6% respectively.

Furthermore, the Sponsor’s current level of capitalisation provides sufficient

support for business risks. Core capital amounted to ₦25.6 billion as at 31

December 2018, higher than the regulatory minimum of ₦15 billion. This is

Outlook: Stable

Issue Date: 26 April 2019

Expiry Date: 30 June 2020 The rating is valid throughout the life of the

instrument but will be subject to periodic

monitoring and review.

Bond Tenor: 3 years

Industry: Banking

Analysts:

Yomi Akinola

[email protected]

Yinka Adelekan

[email protected]

Agusto & Co. Limited

UBA House (5th Floor)

57, Marina

Lagos

Nigeria

www.agusto.com

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in addition to a capital adequacy ratio of 12.2%, also above the 10%

regulatory minimum for merchant banks. Though in our opinion, as the Bank

further grows its risk assets in the near term, we believe this ratio will come

under pressure. Revenue reserves accounted for 37.1% of core capital as at

the same year-end period.

FBNQ MB continues to maintain a good liquidity profile. As at 31 December

2018, its liquidity ratio of 78.0% stood well above the 20% regulatory

minimum for merchant banks. We also consider its ability to refinance to be

good leveraging on the FBN brand equity and implied support of FBN

Holdings, the Sponsor’s parent company.

We hereby attach a stable outlook to the Bond as it reflects our expectation

that the financial condition of the Sponsor will remain adequate to meet the

bond obligations.

Table 1: Background Information

•The FBN brand equity

•Experienced and stable management

•Good liquidity profile

•Strength in the Investment Banking space

Strengths

•Concentration in loan book by obligors impacting credit risk vulnerabilities

•Elevated cost-to-income ratio

•Funding profile mismatches

Weaknesses

•Being competitive in the corporate banking space as it pertains to pricing.

Challenge

Financial Data FY 2016 FY 2017 FY 2018

Total assets & contingents ₦137.7 billion ₦138.7 billion ₦142.6 billion

Net earnings ₦8.1 billion ₦11.6 billion ₦9.6 billion

Pre-tax return on average assets & contingents (ROA) 4.0% 3.6% 1.6%

Pre-tax return on average equity (ROE) 17.3% 17.9% 8.7%

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THE NIGERIAN BANKING INDUSTRY The Nigerian Banking Industry is the primary and most developed segment of the financial services sector,

accounting for approximately 2.7% of Gross Domestic Product (GDP) contributions in the year ended 31

December 2018. The industry currently comprises 26 deposit money banks (DMBs) – 20 commercial banks,

five merchant banks and one non-interest bank. Of the 21 commercial banks, 10 are licensed to operate

internationally while 9 are licensed to operate nationally and 2 regionally. The banks continue to act as the

financial engine of the economy providing a variety of investment and funding solutions to all sectors as

intermediaries between depositors/investors and individuals/entities requiring loans and advances.

Over the last three years, the operating terrain has been challenging for Nigerian banks, due to various

macroeconomic headwinds, fiscal and monetary policies that have not favoured the Industry. The

contractionary monetary stance of the Central Bank of Nigeria which continues to subsist has limited funds

available for lending. In addition, aggressive borrowing of the Federal Government continues to negatively

impact real sector lending sentiments with a crowding out effect. However, in March 2019, the Central Bank

eased earlier tightening policies somewhat with a 50bps decline in the Monetary Policy Rate (MPR) from 14%

to 13.5%. Whilst we expect this to improve repayment ability for obligors, the level of interest income earned

by banks, especially from the Corporate Banking segment, is also expected to come under pressure.

A toxic credit environment continues to linger post-recession, reflecting in persistent elevated of non-

performing loan ratios recorded by a host of operators, above the 5% regulatory benchmark. This is in addition

to operating cost pressures reflective of high Inflation rate (12.15% average for 2018) despite easier access to

foreign exchange via the Investor and Exporters Window and convergence of various foreign exchange rates -

Parallel Market, I&E and NAFEX windows) to between 360 - 364 NGN/USD, compared with wide disparities

seen in 2016 and 2017.

Merchant banks are allowed to engage in investment banking activities. However, Nigerian merchant banks

are however tactically restrained from retail deposits by the regulation requiring a minimum deposit of ₦50

million per tranche. This has skewed the customer base of such banks to rate-sensitive blue-chip corporates,

high net worth individuals and other financial institutions for liability generation. Therefore, funding costs for

operators are behaviourally higher than that of commercial banks while deposits are comparatively more

volatile.

Nonetheless, despite the harsh operating terrain, Nigerian banks have been resilient. Merchant banks in

particular have leveraged the malleability of their license to optimise income. Through their investment

banking divisions, advisory services are deployed to provide bespoke products for corporates. Amidst intense

competition from the large commercial banks, constraining operational guidelines and increased focus on the

investment banking/asset management, profitability of the segment however compares favourably against the

Industry average. Nevertheless, we believe merchant banks will remain a small segment of the Industry based

on restriction on liability generation and intense competition from established commercial banks.

Effective 01 January 2018, International Financial Reporting Standard 9 -Financial Instruments were adopted,

4


impacting the classification and provisioning for financial assets in accordance with expected credit loss and

loss given default guidelines. This resulted in notable charges against capital and write-offs particularly seen

with commercial banks with larger loan portfolios. Because of the smaller, better-managed portfolios of

merchant banks, IFRS 9 related charges were minimal.

PROFILE FBNQ MB Funding SPV Plc (“the Issuer”) was incorporated under the laws of the Federal Republic of Nigeria as

a vessel for the debt issuance programmes with FBNQuest Merchant Bank Limited listed as Sponsor.

FBNQuest Merchant Bank Limited (“FBNQ MB” or “the Sponsor” or “the Bank”) was incorporated in February

1995 as Kakawa Discount House Limited and obtained a license in October 1995 to carry out discount house

business, commencing operations in November of the same year. In May 2015, the Bank was granted a

merchant banking licence by the Central Bank of Nigeria and commenced banking activities in November 2015

as FBN Merchant Bank Limited. The Sponsor is one of the five merchant banks operating in Nigeria and is a

fully owned subsidiary of FBN Holdings Plc under the FBNQuest Group, alongside FBN Capital. In 2017, the

Sponsor received approval to adopt the FBNQuest prefix for entities under the merchant banking group, and

thus became FBNQuest Merchant Bank Limited.

FBNQ MB’s head office is situated at 10 Keffi Street, Off Awolowo Road, South-West Ikoyi, Lagos. The Bank

maintains two other branches in Abuja and Port-Harcourt and employed an average of 172 staff in the 2018

financial year. FBNQ MB Funding SPV Plc has a registered address of 30 Marina Street, Lagos Island, Lagos.

Business Structure

Since obtaining a merchant banking license, FBNQMB has steadily expanded its product offering graduating

from typical fixed income and trading activities peculiar to discount houses, to core investment banking and

corporate banking activities. FBNQMB’s day-to-day banking operations include deposit mobilisation from a

variety of wholesale customers (corporates and high net worth individuals) within the acceptable merchant

banking regulations, the provision of finance and credit facilities in local and foreign currency, foreign

exchange trading, proprietary trading as well as underwriting, financial advisory and issuing house services.

FBNQ MB’s liability generation strategy focuses on high net worth individuals, corporates and financial

institutions. The Bank’s asset creation targets industrial & mid-tier corporates, value chain corporates, public

sector entities, banks and non-bank financial institutions.

FBNQ MB’s core banking business is carried out through four business divisions –

▪ Coverage & Corporate Banking overseeing risk asset creation and liability generation from financial

institutions and corporates

▪ Investment Banking comprising debt solutions (arranging & structuring), equity and debt capital markets

as well as financial advisory services

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▪ Fixed Income, Currencies & Treasury overseeing fixed-income trading, foreign exchange, treasury

activities as well as interbank liability generation.

▪ Sales, responsible for liability generation and distribution of the Bank’s products/services.

In addition, the Bank’s business divisions are supported by Corporate Services and Operations & Technology

units.

Subsidiaries & Affiliates

FBNQMB currently has two fully owned subsidiaries namely FBNQuest Asset Management with assets under

management (AUM) of ₦261 billion (as at December 2018) and FBNQuest Securities, both acquired in 2017. In

addition, FBNQuest Trustees is an affiliate company of FBNQ MB, being a part of the FBN Holdings Company

(“HoldCo”). Other affiliates include subsidiaries of the HoldCo.

THE ISSUE The Issue is a ₦5 billion 3-year Fixed Rate Senior Unsecured Bond Due in 2023 and it represents the first

tranche of a ₦50 billion FBNQ MB Funding SPV Plc Bond Issuance Programme. The Bond is a direct,

unconditional, senior unsubordinated obligation of the Issuer and ranks pari passu among other existing or

future senior unsecured obligations. Subscription to the issue would be a minimum of ₦10 million (10,000

units at ₦1,000 per unit) and multiples of ₦1 million (1,000 units at ₦1,000 per unit) subsequently.

The coupon rate is expected to be determined through a book building process. However, the Sponsor does

not anticipate that this will exceed 75-100bsp above similar tenored government securities. Repayment terms

stipulate that the principal will be a bullet payment at maturity while coupon will be paid semi-annually.

In addition, applications to dual-list on the Nigerian Stock Exchange and the FMDQ OTC Securities Exchange

platforms are expected to be made.

Purpose of the Issue

Net proceeds of the Issue will be channelled to manage asset and liability mismatches by augmenting the pool

of longer tenored liabilities. This will enable FBNQ MB create assets accordingly comprising a combination of

lending and investment in viable securities.

Source of Repayment

The repayment of the coupon and principal will be fully supported by the Sponsor - FBNQuest Merchant Bank

Limited which has an “A” rating from Agusto & Co Limited, via a Deed of Undertaking between the Sponsor,

the Joint Trustees and the Issuer, on behalf of the Bondholders. Semi-annual coupon payments (in arrears) as

well as principal will be redeemed from the operational cash flows of the Sponsor. The sum payable on the

Final Maturity Date (final Redemption Amount) is the outstanding sum in respect of the Bond, together with

applicable interest at the time of redemption, and any amount rolled over from previous years. Repayments

shall be on the Final Maturity Date or such date as the Joint Trustees in accordance with the Trust Deed declare

the Bond to have become immediately repayable, together with such premium (if any).

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Covenants & Guarantees

During the tenor of the Bond, the negative pledge in place stipulates that as long as the Bonds are outstanding,

the Issuer or the Sponsor shall not create (without written consent of the Trustees) any mortgage, charge, lien

or encumbrance on the whole of part of its present and future undertaking, business assets or revenue to

secure any indebtedness, unless the bond obligations are secured equally in such a way not to be materially

less beneficial to the Bondholders. The Issuer is further not permitted to secure any present or future

indebtedness or incur any financial indebtedness that makes obligations on the Issue subordinate. Similarly,

FBNQuest MB Funding SPV Plc is not to issue any other bond or debt instrument with ability to be listed on

any exchange without the consent of the Joint Trustees.

Trustees to the Issue

FBNQuest Trustees Limited, ARM Trustees Limited, United Capital Trustees Limited and UTL Trust

Management Services Limited have been appointed as Joint Trustees to the Issue. A deed was entered into on

22 November 2018 in this regard.

FBNQuest Trustees Limited is a wholly owned subsidiary of FBN Holdings Plc, which is one of the largest

financial services group in Nigeria. FBNQuest Trustees Limited is registered by the Securities and Exchange

Commission (SEC) and offers private trust, public trust, corporate trust and agency services. The registered

office is located at 10 Keffi Street, Off Awolowo Road, Ikoyi, Lagos

ARM Trustees Limited is a wholly owned subsidiary of ARM Traditional Asset Management Company Limited

and registered with SEC. ARM Trustees Limited in almost two decades of existence offer a bouquet of services

which can be categorised into private trust, estate planning and commercial trust services. The registered office

is located at 1, Mekunwen Road, Off Onikan Abayomi Drive, Ikoyi, Lagos.

United Capital Trustees Limited was incorporated in 1964 and is registered with SEC. Services offered by United

Capital Trustees Limited include investor protection, bond trusteeship, portfolio and asset management, real

estate investment trusts, estate planning and investment trusts. The registered office is located on 12th Floor,

UBA House, 57 Marina, Lagos.

UTL Trust Management Services Limited was incorporated in 1966 as Barclays (Nig) Nominees Limited. UTL is

registered with the Securities and Exchange Commission (SEC) and offers services such as portfolio/fund

management, trust of consortium finance, property management & family trust, nominee services, custodian

trusteeship, corporate trusteeship for debt instruments and estate & will administration. The registered office

is located at 47 Marina, Lagos.

In line with the Trustee Investment Act of 1962, trust assets held are duly separated from the accounts of the

Trustees such that trust continues to exist even if the Trustee goes into liquidation. The Securities and

Exchange Commission is also empowered to periodically monitor the activities of FBNQuest Trustees Limited,

ARM Trustees Limited United Capital Trustees Limited, and UTL Trust Management Services Limited, hence

providing an independent check on these entities.

7


REVIEW OF FINANCIAL CONDITION

Asset creation in favour of short-dated, multiple cycle transactions.

The Bank’s recent asset creation strategy has been conservative, jointly seeking to invest in government

securities - upheld by favourable interest rates, whilst adopting a cautious approach to lending through short-

dated, multiple cycle transactions as well as working capital solutions for its corporate obligors. As at 31

December 2018, FBNQuest Merchant Bank’s total assets and contingents amounted to ₦142.6 billion,

representing a marginal 2.8% year-on-year growth. Core assets accounted for the bulk at 92.5% while

contingent assets comprising guarantees and letters of credits accounted for 7.5% or ₦10.8 billion. In view of

the Bank’s operating strategy, liquid assets largely comprising government securities and money market

placement amounted to ₦62.5 billion and accounted for 43.8% of total assets and contingents while gross

loans and advances amounting to ₦36.8 billion as at 31 December 2018, accounted for 25.8% of total assets

and contingents. The Bank’s loan portfolio contracted by 7.1% in 2018 following pay-downs made by a number

of obligors. With a conservative stance to asset creation, the Bank’s loan portfolio was focused on large

corporates in various sectors such as the Manufacturing, Agri-business, Oil & Gas, Real Estate, Transport

Services and Telecommunications sectors. We believe the short-dated nature of a significant proportion of the

FBNQ MB’s credit transactions understates the Bank’s loan portfolio.

Figure 1: Breakdown of Loan Portfolio (FY 2018)

Lending to Oil & Gas obligors dominated the Sponsor’s loan portfolio as at 31 December 2018, accounting for

39.9% of gross loans and advances or ₦14.8 billion. Upstream obligors accounted for 39.8% while Midstream

– Gas obligors accounted for 36.9% and Downstream obligors accounted for 23.3%. We remain concerned

about the level of exposure to the Oil & Gas segment given historic volatilities in oil prices (though currently

stable above $65 per barrel), as well as structural issues of the downstream segment in Nigeria (impacting

repayment ability of downstream obligors seen across the banking industry).

Financial

Institutions

10.5%

Manufacturing

2.8%Information &

Communication

3.3%

Oil & Gas

39.9%

Construction

3.6%

Agriculture,

Forestry &

Fishing

21.5%

Public

Sector

10.9%

Real Estate Activities

0.9%

Transport & Storage

4.0%

Adminstrative and

Support Services

Activities

0.0%

General

2.5%

8


The second largest lending segment is the Agriculture, Forestry and Fishing segment, predominantly working

capital in favour of one obligor in a viable crop production segment of the Agriculture sector. We are however

concerned about the level of exposure to this obligor which accounted for 21.5% of FBNQ MB’s loan portfolio

as at 31 December 2018 and 31.2% of core capital. The Bank’s second largest obligor accounted for 14.7%, an

oil & gas provider while the top 5 largest obligors accounted for 63.0% of the Bank’s loan portfolio. Such

concentrations risks place the Sponsor in a vulnerable position with respect to any adverse change in the

financial condition of these obligors, and the ricochet effect on non-performing loan ratio levels. Nevertheless,

we consider the remainder of the Sponsor’s loan portfolio to be well diversified. Furthermore, foreign currency

loans accounted for a marginal 12.4% of the Sponsor’s loan portfolio deemphasising currency risks, compared

with the banking industry average of 48%.

Impaired exposures

As at 31 December 2018, FBNQ MB’s impaired loans amounted to approximately ₦1.5 billion, 17.3% higher

than the prior year and representing 4.0% of gross loans and advances. Stage 3-Lost classified exposures

however amounted to ₦1.3 billion, at par wit the prior year, largely comprising a single loan extended to a

real estate obligor guaranteed by the Federal Government. The Bank’s non-performing loan ratio thus stood at

3.6%, marginally above the 3.2% recorded in the prior year, but remaining within the 5% maximum regulatory

threshold. The Bank’s Stage 2 category comprised an impaired exposure amounting to ₦151.2 million. This

loan represented the balance portion of obligations of a transport sector operator whose cash flows have

suffered some constraints. A restructured repayment schedule has been agreed and is currently in place on

this exposure.

FBNQ MB’s stage 3 NPLs have been fully provided for. Thus, as at 31 December 2018, cumulative loan loss

provisions stood at 107.4% of Stage 3 loans, better than 34.2% of the prior year while the Sponsor’s cost of

risk has averaged 0.7% over the last three years (FY 2018: 1.2%).

Figure 2: NPL Ratio (FYE 2016- FY 2018)

We expect the Bank’s NPL ratio to remain below the 5% regulatory threshold, barring no additional

classification of top exposures. We consider the FBNQ MB’s asset quality to be satisfactory based on industry

standards, although lingering macroeconomic challenges remain a threat to the overall Banking Industry

particularly with respect to prominent, yet vulnerable sectors, such as Oil & Gas and Manufacturing.

3.4

%

3.2

%

3.6

%

F Y 2 0 1 6 F Y 2 0 1 7 F Y 2 0 1 8

9


Earnings

FBNQuest Merchant Bank’s gross earnings for the 2018 financial year amounted to approximately ₦22.4

billion, 7.4% lower than the prior year’s gross earnings of ₦24.6 billion. This decline was noted in earning lines

interest income on loans and advances as well as fees and commissions earned particularly brokerage and

structuring fees which has typically been a strong earning line for the Sponsor.

Interest income declined by 13.7% year-on-year to ₦16.4 billion for the review period, particularly seen in a

drop-in interest income from loans and advances. We attribute this year-on-year decline to the fact that in

2017, interest rates were elevated which resulted in an exceptionally strong performance on the Bank’s topline,

however as interest rates tempered in 2018, comparable earnings for 2018 appeared lower. Interest from loans

and advances accounted for 38.2% of interest income while interest earned on fixed income securities

comprising accounted for 52.9% and interest on placements with financial institutions accounted for 8.9% of

total interest income.

In the 2018 financial year, FBNQ MB issued a number of commercial papers to bridge funding gaps, following

a decline in deposit liabilities which the Bank forfeited on account of their expensive nature. Accordingly,

interest expense for the year trended up marginally by 1.8% to ₦12.3 billion. Given the decline in interest

income and marginal increase in interest expense, the Sponsor’s net interest spread (NIS)1 deteriorated to

24.7%. However, we note that prior to 2018, FBNQ MB’s NIS has remained at above 30% since the entity began

operations as a merchant bank in 2015. Considering the cut in MPR and consequent reduction in interest rates,

we hinge improvement of NIS on strategic growth in business volume, alongside ability to secure cheaper

funding. Successful deployment of net proceeds of the Issue and appropriate pricing of funded assets will thus

be instrumental to preserve margins.

Non-interest income buoys earnings

FBNQuest Merchant Bank’s non-interest income, largely comprising foreign exchange gains, trading gains on

financial assets, credit-related fees and commissions, brokerage and structuring fees, amounted to ₦6.0 billion

during the period under review, a 15.9% increase over the prior year. This growth was specifically attributable

to gains on foreign currency translation of financial assets given convergence of exchange rates in the period

towards the NAFEX rate of about 364NGN/USD, as well as net trading gains on financial assets. The bulk

contributors to non-interest income nonetheless remained brokerage and structuring fees, though declining

by 24.8% year-on-year, still accounted for 44.1% of non-interest income in 2018. Given the Sponsor’s expertise

in the debt capital markets, we believe brokerage & structuring fees will remain a strong contributor to

earnings. In view of the reduction in interest rates which typically draws corporates to the debt market, we

anticipate structuring fees for 2019 to further support non-interest earnings. Trading income on financial

assets is also expected to remain significant in our view, based on the Sponsor’s fixed income activities.

Further contributing to non-interest income was a ₦655.3 million first-time dividend income from the

1 NIS is computed as net interest income as a percentage of interest income.

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Sponsor’s subsidiaries FBNQuest Asset Management and FBNQuest Securities. We expect these subsidiaries to

continue to be a viable source of dividend income for FBNQ MB.

Figure 3: Breakdown of Net Interest Income (FY 2018)

Profitability impacted by cost pressures vis a vis earnings

FBNQ MB’s operating expenses comprising staff costs, depreciation & amortization expenses as well as other

miscellaneous administrative and operating costs, trended up by 10.3% year-on-year to ₦7.3 billion. Growth

in operating expenses were particularly noted in depreciation expense on Information Technology assets

subsequent to full deployment as well as in professional fees paid for various corporate services including a

brand awareness campaign. Consequently, the Bank’s cost to income ratio spiked to 76.3% (FY2017: 57.3%)

higher than the estimated industry average of 60.3% for the same period. Operating expenses also stood high

at 5.6% of total assets compared with merchant banking peers.

Lower year-on-year comparable earnings alongside an upward trend in operating expenses jointly contributed

to a dip in profitability for 2018. FBNQ MB’s pre-tax profit totalled ₦2.3 billion (FY2017: ₦4.9 billion).

Accordingly, profitability ratios also dipped with pre-tax return on average assets (ROA) and pre-tax return on

average equity (ROE) of 1.6% (FY2017: 3.6%) and 8.7% (FY2017: 17.9%) respectively. Though the Sponsor’s

ROE for 2018 stood below the 14.7% average return on 364-day treasury certificate for the same period, we

consider its three-year average ROE of 14.6% adequate.

Notwithstanding 2018’s standalone performance, holistically, we consider the Sponsor’s profitability to be

satisfactory leveraging on a continued sound earning potential. We expect yields on fixed income securities,

structuring fees and loan growth to support a rebound in profitability. However, this is contingent on the Bank

deploying an effective cost managing strategy as it seeks to grow earnings.

Credit-related fees

9%

Brokerage and

structuring fees

44%Letters of credit

commissions &

fees

3%

Other fees and

commissions

1%

Foreign currency

gains

11%

Trading gains

13%

Other non-

interest

income

8%

Dividend

11%

11


Figure 4: Efficiency and Profitability Ratios (FY 2016 – FY 2018)

Good capitalisation levels for current business risks

The Sponsor’s operations as a merchant bank are supported by core capital totalling ₦25.6 billion as at 31

December 2018 Though having declined by 2.7% year-on-year given the transition to International Financial

Reporting Standards 9 – Financial Instruments, at this level core capital was higher than the ₦15 billion capital

requirement for merchant banks operating in Nigeria. Core capital comprised paid-up capital (32.0%), revenue

reserves (37.1%) and other reserves (30.8%), was sufficient to fund of 18.0% of total assets and contingents.

The Sponsor’s retention ratio2 stood satisfactory at 5.3% of core capital. FBNQ MB’s capital adequacy ratio

(CAR) according to Basel II Accords also declined to 12.18% as at 31 December 2018 (FY2017: 13.47%),

nonetheless remaining above the regulatory minimum of 10% for merchant banks operating in Nigeria.

Figure 5: Core Capital and Capital Adequacy Ratio (FY 2016 – FY 2018)

We consider FBNQ MB’s capitalisation to be adequate for current business risks. However, we note that there

may be a need to shore up capital as the Bank expands operations/risk asset creation in the near term.

2 Retention ratio – retained earnings for the year after dividend payments as a percentage of core capital

36

.1%

39

.2%

4.0

%

17

.3%

36

.2%

57

.3%

3.6

%

17

.9%

24

.7%

76

.3%

1.6

% 8.7

%

N I S C I R R O A R O E

FY 2016 FY 2017 FY 2018

29.0 26.3 25.6

22.6%

13.5%12.2%

0%

5%

10%

15%

20%

25%

23

24

25

26

27

28

29

30

FY 2016 FY 2017 FY 2018

₦bil

lio

ns

Core Capital CAR

12


Funding profile and liquidity

FBNQ MB generates deposit liabilities primarily from high net worth individuals, corporates, associations and

a variety of financial institutions. The Bank’s liability generation strategy is restricted to wholesale deposits on

account of the CBN policy requiring a minimum deposit of ₦50 million per tranche. While this policy restrains

merchant banks from low-cost retail deposits, the Sponsor’s strong client relationships from previous

operations as Kakawa Discount House Limited has supported the liability generation strategy.

As at 31 December 2018, customer deposit liabilities (excluding interbank takings) amounted to ₦91.0 billion

a 4% growth over the prior year. Overall deposit growth was constrained in the review period as the Bank had

to let go of expensive funding and replaced with commercial paper issuances with yields varying from 11.31%

to 14.96%. Deposit liabilities was nonetheless sufficient to fund 69.4% of total assets and contingents. The

Sponsor’s local currency call deposits amounted to ₦3.5 billion while intermediation money (largely funds in

customer operating accounts) amounted to ₦36.9 billion and time deposits amounted to ₦50.6 billion.

Furthermore, of total deposit liabilities, approximately 16.5% were denominated in foreign currency, standing

at 3.5 times foreign currency loans to customers.

The Sponsor also currently has two outstanding commercial paper obligations totalling ₦6.7 billion maturing

in 2019 with yields of 14.957% and 13.9% respectively.

FBNQ MB’s weighted average cost of funds (WACF) stood at 12% for the 2018 financial year. Funding costs for

merchant banks are typically elevated given that funding sources are typically corporate entities with

behaviourally higher interest demands. With the ₦5 billion 3-year bond issuance expected in the second half

of 2019, we expect the Bank’s WACF to trend up by about 50-75 bps.

Figure 6: Weighted Average Cost of Funds (FYE 2016 – FY 2018)

We note mismatches in FBNQ MB’s deposit liabilities and loan maturity profile particularly for the ‘180-360’

days and ‘over 360 days’ categories as at 31 December 2018. Whilst FBNQ MB has an Asset & Liability

Management team within its Treasury department tasked with the management of such mismatches

particularly with funding from commercial papers and the interbank market, the Sponsor has disclosed that

the proposed ₦5 billion issue will help temper these mismatches, providing longer tenored funding for the

Bank.

9.1%

12.5% 12.0%

F Y 2 0 1 6 F Y 2 0 1 7 F Y 2 0 1 8

13


FBNQ MB has focused on placements with banks and investments in both treasury securities while

deemphasising outright loan growth beyond multiple cycle working capital and trade transactions. Liquid

assets totalled ₦62.5 billion as at 31 December 2018. Year-on-year, the Sponsor’s liquidity ratio3 improved to

78.0% as at 31 December 2018, higher than 61.0% recorded at the end of the prior year. At this level, the

Bank’s liquidity ratio was significantly higher than the 20% regulatory minimum for merchant banks.

We thus consider the Sponsor’s liquidity position and ability to refinance to be good leveraging on the FBN

brand.

OWNERSHIP, MANAGEMENT & STAFF

FBNQuest MB is a wholly owned subsidiary of FBN Holdings Plc (the Parent), an entity listed on the Nigerian

Stock Exchange. FBN Holdings Plc is owned by over 1.2 million shareholders spanning individuals/retail

investors (54.14%), domestic institutional investors (33.47%), foreign institutional investors (10.56%) and

government-related entities (1.83%). As at 31 December 2018, no shareholder held up to 5% equity stake in

FBN Holdings Plc while the Parent’s Board of Directors, directly and indirectly controlled 2.4% of Hold Co’s

shareholding.

FBNQ MB is currently governed by a nine-member Board of Directors, up from eight members as at 31

December 2018. The Sponsor’s Board currently comprised seven Non-Executive Directors (including two

independent directors), and two Executive Directors - comprising the Managing Director/CEO and the Deputy

Managing Director. Mr. Bello Maccido chairs the Board while Mr. Kayode Akinkugbe serves as the Managing

Director/CEO. In 2018, one Non-Executive Director, Mr Babatunde Odunayo was appointed to the Board,

effective 03 May 2018, while subsequent to year-end Mrs Oyinkan Adewale was appointed as an Independent

Non-Executive Director in Q1 2019. Oversight functions are carried out via four (4) standing Committees -the

Board Credit Committee, the Board Audit Committee, the Board Risk Management Committee and the Board

Governance Committee.

Mr. Kayode Akinkugbe as the Managing Director/CEO is directly tasked with the day-to-day management of

operations of FBNQuest Merchant Bank and subsidiaries. In addition to support from the Deputy Managing

Director- Mr. Taiwo Okeowo, management functions are also carried out through four (4) standing Management

Committees – the Management Credit and Underwriting Committee (MCUC), the Asset and Liability Committee

(ALCO), the Risk Management Committee (RMC) and the ICT Steering Committee (ICTSC) as well as other Ad

hoc Committees.

As at 31 December 2018, the Sponsor employed an average of 174 staff, relatively at par with staff numbers

as at 31 December 2017. Staff costs amounted to ₦2.6 billion, 6.9% lower than the prior year on account of

departures at the higher income cadre and replacement of some positions with lower level personnel.

3 Computed as liquid assets as a proportion of local currency deposits (excluding interbank takings)

14


Concurrently, staff costs per employee declined by 7.4% to ₦14.8 million. Productivity measured by net

earnings per staff also declined by 17.7% over the corresponding FY 2017 period to ₦55.2 million. Nonetheless,

net earnings per staff was sufficient to cover staff costs per employee approximately 3.7 times. This was

however lower than the Banking Industry’s average of 4.7 times for 2018, and the merchant banking average

of 5.4 times.

We consider FBNQ MB’s management team to be experienced and staff productivity to be satisfactory.

Table 2: Staff Productivity Indicators

FY 2016 FY 2017 FY 2018

Average Number of Employees 130 173 174

Staff Cost per Employee ₦9.4 million ₦16.0 million ₦14.8million

Net Earnings per Staff ₦62.2 million ₦67.0 million ₦55.2 million

Net Earnings per Staff to Staff Cost per Employee 6.6 times 4.1 times 3.7 times

Staff Cost/Operating Expenses 38.4% 41.6% 35.1%

MARKET SHARE

Though the merchant banking segment of the Nigerian Banking Industry has remained relatively negligible

since the re-emergence of merchant banks, the segment continues to be instrumental to the provision of trade

and debt capital market services to corporate institutions as well as the provision of asset management services

to various cadres of individuals, associations and similar customers. As at 31 December 2018, it is estimated

that the merchant banking segment contributed under 4% to total assets and contingents of the banking

industry with strong competitive activity noted amongst players in this space.

As at 31 December 2018, the Sponsor – FBNQ MB stood as the third largest merchant bank by total assets and

contingents, contributing approximately 0.4% to the banking industry’s total assets & contingents. The Bank

further accounted for 0.2% of the industry’s total net loans. Market share of net earnings stood at approximately

0.4% while market share of LCY deposits stood at 0.6% for 2018, in line with the conservative nature of

merchant banks particularly with respect to size of operations. We consider FBNQ MB’s market share to be

comparable with merchant banking peers across key parameters and expect that growth in the Bank’s funding

base alongside expanded lending activity will support further improvements in market share.

15


OUTLOOK

With an operating profile characterised by good liquidity profile and satisfactory capitalisation since

commencing operations as a merchant bank in 2015, FBNQ MB as sponsor to the issue, expects to deploy

proceeds of the issuance to address asset and liability tenor mismatches alongside growth in earning assets –

loans and investment securities. As part of a medium-term plan, this would represent a phased approach of

the registered ₦50 billion Bond Issuance Programme geared at expansion, subject to favourable market

conditions.

We believe the experience of the Bank’s management team, in addition to implicit support of the parent

company FBN Holdings Plc, a strong brand franchise, will provide a sure footing for the issuance. Concurrently,

barring no macroeconomic shocks, performance for 2019 and into 2020 is expected to be characterised by:

▪ Moderate year-on-year growth in its loan portfolio in 2019, given the strategic short-dated nature of the

Bank’s lending cycle and tepid growth of the economy, with non-performing loans remaining within

regulatory thresholds.

▪ Growth in gross earnings to be driven by investment banking fees.

▪ Satisfactory profitability ratios, though we expect this to be lower than the Bank’s internal projections of

4.3% for pre-tax return on average assets in 2019 and 26% for pre-tax return on average equity.

▪ Adequate capitalisation upheld by retained earnings.

Agusto & Co. hereby attaches a “stable” outlook to FBNQ MB Funding SPV Plc’s Series 1, ₦5 billion 3-year

Fixed Rate Senior Unsecured Bond as guaranteed by FBNQuest Merchant Bank Limited – the Sponsor.

16


FINANCIAL SUMMARY

FBNQUEST MERCHANT BANK LIMITEDBALANCE SHEET AS AT 31-Dec-2018 31-Dec-2017 31-Dec-2016

₦'000 ₦'000 ₦'000

ASSETS

1 Cash & equivalents 2,249 0.0% 1,908 0.0% 1,908 0.0%

2 Government securities 52,587,640 36.9% 53,961,271 38.9% 72,623,858 52.7%

3 AMCON Securities 9,900,496 6.9% 6,000,479 4.3% 4,278,170 3.1%

4 Quoted investments

5 Placements with discount houses

6 LIQUID ASSETS 62,490,385 43.8% 59,963,658 43.2% 76,903,936 55.9%

7 BALANCES WITH NIGERIAN BANKS 3,678,982 2.6% 1,925,509 1.4% 696,372 0.5%

8 BALANCES WITH BANKS OUTSIDE NIGERIA 1,412,550 1.0% 6,993,120 5.0% 740,005 0.5%

9 Direct loans and advances - Gross 36,770,767 25.8% 39,585,410 28.5% 42,204,312 30.7%

10 Less: Cumulative loan loss provision (1,427,942) -1.0% (432,177) -0.3% (520,210) -0.4%

11 Direct loans & advances - net 35,342,825 24.8% 39,153,233 28.2% 41,684,102 30.3%

12 Advances under finance leases - net

13 TOTAL LOANS & LEASES - NET 35,342,825 24.8% 39,153,233 28.2% 41,684,102 30.3%

14 INTEREST RECEIVABLE

15 OTHER ASSETS 6,151,414 4.3% 3,993,045 2.9% 4,644,967 3.4%

16 DEFERRED LOSSES 9,113,548 6.4% 9,113,547 6.6% 8,801,880 6.4%

17 RESTRICTED FUNDS 3,879,865 2.7% 2,172,798 1.6%

18 UNCONSOLIDATED SUBSIDIARIES & ASSOCIATES 1,381,773 1.0% 1,737,106 1.3%

19 OTHER LONG-TERM INVESTMENTS 4,902,151 3.4% 9,005,703 6.5% 2,176,604 1.6%

20 FIXED ASSETS & INTANGIBLES 3,441,472 2.4% 4,631,534 3.3% 2,028,777 1.5%

21 TOTAL ASSETS 131,794,965 92.5% 138,689,253 100.0% 137,676,643 100.0%

22 TOTAL CONTINGENT ASSETS 10,761,510 7.5%

23 TOTAL ASSETS & CONTINGENTS 142,556,475 100% 138,689,253 100% 137,676,643 100%

CAPITAL & LIABILITIES

24 TIER 1 CAPITAL (CORE CAPITAL) 25,626,030 18.0% 26,339,624 19.0% 28,959,057 21.0%

25 TIER 2 CAPITAL (2,086,380) -1.5%

26 LONG-TERM FOREIGN BORROWINGS

27 Demand deposits 20,512,253 14.4% 84,094 0.1%

28 Savings deposits 3,523,792 2.5%

29 Time deposits 50,572,349 35.5% 82,321,467 59.4% 61,340,305 44.6%

30 Inter-bank takings 8,003,945 5.6% 11,639,548 8.4% 38,863,965 28.2%

31 TOTAL DEPOSIT LIABILITIES - LCY 82,612,339 58.0% 93,961,015 67.7% 100,288,364 72.8%

32 Customers' foreign currency balances 16,368,975 11.5% 5,169,517 3.7% 3,303,260 2.4%

33 TOTAL DEPOSIT LIABILITIES 98,981,314 69.4% 99,130,532 71.5% 103,591,624 75.2%

34 INTEREST PAYABLE

35 OTHER LIABILITIES 9,274,001 6.5% 13,219,097 9.5% 5,125,962 3.7%

36 TOTAL CAPITAL & LIABILITIES 131,794,965 92.5% 138,689,253 100.0% 137,676,643 100.0%

37 TOTAL CONTINGENT LIABILITIES 10,761,510 7.5%

38 TOTAL CAPITAL, LIABILITIES & CONTINGENTS 142,556,475 100% 138,689,253 100% 137,676,643 100%

Proof

BREAKDOWN OF CONTINGENTS

39 Acceptances & direct credit substitutes 8,172,760 5.7%

40 Guarantees, bonds etc.. 2,588,750 1.8%

41 Short-term self liquidating contingencies

17


FBNQUEST MERCHANT BANK LIMITED

INCOME STATEMENT FOR THE YEAR ENDED 31-Dec-2018 31-Dec-2017 31-Dec-2016

₦'000 ₦'000 ₦'000

42 Interest income 16,389,387 73.2% 18,994,331 78.5% 12,839,870 79.5%

43 Interest expense (12,333,063) -55.1% (12,119,198) -50.1% (8,199,829) -50.8%

44 Loan loss expense (471,531) -2.1% (471,429) -1.9% 131,962 0.8%

45 NET REVENUE FROM FUNDS 3,584,793 16.0% 6,403,704 26.5% 4,772,003 29.5%

46 ALL OTHER INCOME 6,013,392 26.8% 5,187,938 21.5% 3,311,206 20.5%

47 NET EARNINGS 9,598,185 42.8% 11,591,642 47.9% 8,083,209 50.0%

48 Staff costs (2,573,040) -11.5% (2,763,435) -11.4% (1,215,888) -7.5%

49 Depreciation expense (1,507,967) -6.7% (728,022) -3.0% (140,895) -0.9%

50 Other operating expenses (3,247,066) -14.5% (3,152,120) -13.0% (1,810,516) -11.2%

51 TOTAL OPERATING EXPENSES (7,328,073) -32.7% (6,643,577) -27.5% (3,167,299) -19.6%

52 PROFIT (LOSS) BEFORE TAXATION 2,270,112 10.1% 4,948,065 20.5% 4,915,910 30.4%

53 TAX (EXPENSE) BENEFIT (212,100) -0.9% (863,601) -3.6% (16,083) -0.1%

54 PROFIT (LOSS) AFTER TAXATION 2,058,012 9.2% 4,084,464 16.9% 4,899,827 30.3%

55 NON-OPERATING INCOME (EXPENSE) - NET

56 DIVIDEND (707,000) -3.2% (8,700,000) -36.0% (1,048,000) -6.5%

57 GROSS EARNINGS 22,402,779 100% 24,182,269 100% 16,151,076 100%

58 AUDITORS PWC PWC PWC

59 OPINION CLEAN CLEAN CLEAN

KEY RATIOS 31-Dec-2018 31-Dec-2017 31-Dec-2016

EARNINGS

60 Net interest spread 24.7% 36.2% 36.1%

61 Loan loss expense/Interest income 2.9% 2.5%

62 Return on average assets (Pre - tax) 1.6% 3.6% 4.0%

63 Return on average equity (Pre - tax) 8.7% 17.9% 17.3%

64 Operating Expenses/Net earnings 76.3% 57.3% 39.2%

65 Gross earnings/Total assets & contingents 15.9% 17.5% 13.2%

EARNINGS MIX

66 Net revenue from funds 37.3% 55.2% 59.0%

67 All other income 62.7% 44.8% 41.0%

LIQUIDITY

68 Total loans & leases - net/Total lcy deposits 26.1% 30.0% 16.9%

69 Liquid assets/Total lcy deposits 78.0% 61.0% 63.1%

70 Demand deposits/Total lcy deposits 24.8% 0.1%

71 Savings deposits/Total lcy deposits 4.3%

72 Time deposits/Total lcy deposits 61.2% 87.6% 61.2%

73 Inter-bank borrowings/Total lcy deposits 9.7% 12.4% 38.8%

74 Interest expense - banks/Interest expense 10.3% 22.0% 9.9%

75 NET FOREIGN CURRENCY ASSETS (LIABILITIES) (14,956,425) 1,823,603 (2,563,255)

18


FBNQUEST MERCHANT BANK LIMITED

KEY RATIOS CONT'D 31-Dec-2018 31-Dec-2017 31-Dec-2016

ASSET QUALITY

76 Performing loans (₦'000) 35,289,594 38,322,445 40,764,509

77 Non-performing loans (₦'000) 1,329,988 1,262,965 1,439,803

78 Non-performing loans/Total loans - Gross 3.62% 3.19% 3.41%

79 Loan loss provision/Total loans - Gross 3.9% 1.1% 1.2%

80 Loan loss provision/Non-performing loans 107.4% 34.2%

81 Risk-weighted assets/Total assets & contingents 39.2% 34.8% 35.0%

CAPITAL ADEQUACY

82 Adjusted capital/risk weighted assets 20.2% 26.2% 39.8%

83 Tier 1 capital/Adjusted capital 131% 114% 100%

84 Total loans - net/Adjusted capital 2.72 3.05 3.05

85 Capital unimpaired by losses (₦'000) 16,512,482 17,226,077 20,157,177

CAPITAL ADEQUACY STRESS TEST

86 Adjusted capital (₦'000) 11,286,094 12,648,055 19,184,592

87 Cumulative loan loss provision (actual reserves) 1,427,942 432,177 520,210

88 Equity before all provision (line 86 + line 87) 12,714,036 13,080,232 19,704,802

89 Required reserves* 6,101,935 5,529,210 5,749,922

90 Equity after required reserves (line 88 - line 89) 6,612,101 7,551,022 13,954,880

91 Equity after required reserves/risk weighted assets 11.8% 15.6% 28.9%

STAFF INFORMATION

92 Net earnings per staff (₦'000) 55,162 67,004 62,179

93 Staff cost per employee (₦'000) 14,788 15,974 9,353

94 Staff costs/Operating expenses 35.1% 41.6% 38.4%

95 Average number of employees 174 173 130

96 Average staff per office 58 58 43

OTHER KEY INFORMATION

97 Legal lending limit(₦'000) 8,256,241 8,613,039 10,078,589

98 Other unamortised losses(₦'000) NONE NONE NONE

99 Unreconciled inter-branch items (₦'000) DR/(CR) NONE NONE NONE

100 Number of offices 3 3 3

101 Age** (in years) 23 22 21

102 Government stake in equity (Indirect) Nil Nil Nil

MARKET SHARE OF INDUSTRY TOTAL Estimates Actual Actual

103 Lcy deposits (excluding interbank takings) 0.5% 0.6% 0.4%

104 Total assets & contingents 0.4% 0.4% 0.4%

105 Total loans & leases - net 0.2% 0.3% 0.3%

106 Non interest income 0.6% 0.5% 0.4%

107 Net interest income 0.2% 0.4% 0.3%

*: This is calculated as 100% of non-performing loans, 5% of performing loans (including direct credit substitutes disclosed

as contingent assets) and 1% for all other assets excluding cash, federal government obligations, placements with

discount houses and balances at CBN.

19


RATING DEFINITIONS

The first four categories of ratings are investment grade while the last four ratings are speculative grade. The ratings from Aa to C may be modified by the addition of a plus or minus sign to show relative standing within the category.

Aaa Bonds rated ‘Aaa’ are judged to offer highest safety of timely payment of interest and

principal. Though the circumstances providing this degree of safety are likely to change,

such changes as can be envisaged are most unlikely to affect adversely the

fundamentally strong position of such issues.

Aa Bonds rated ‘Aa’ are judged to offer high safety of timely payment of interest and

principal. They differ in safety from ‘Aaa’ issues only marginally.

A Bonds rated ‘A’ are judged to offer adequate safety of timely payment of interest and

principal; however, changes in circumstances can adversely affect such issues more than

those in the higher rated categories.

Bbb Bonds rated ‘Bbb’ are judged to offer sufficient safety of timely payment of interest and

principal for the present; however, changing circumstances are more likely to lead to a

weakened capacity to pay interest and repay principal than for bonds in higher rated

categories.

Bb Bonds rated ‘Bb’ are judged to carry inadequate safety of timely payment of interest and

principal; while they are less susceptible to default than other speculative grade bonds

in the immediate future, the uncertainties that the issuer faces could lead to in

adequate capacity to make timely interest and principal payments.

B Bonds rated ‘B’ are judged to have greater susceptibility to default; while currently

interest and principal payments are met, adverse business or economic conditions

would lead to lack of ability or willingness to pay interest or principal.

C Bonds rated ‘C’ are judged to have factors present that make them vulnerable to default;

timely payment of interest and principal is possible only if favourable circumstances

continue.

D Bonds rated ‘D’ are in default and in arrears of interest and principal payments or are

expected to default on maturity. Such bonds are extremely speculative and returns from

these bonds may be realized only on reorganization or liquidation.

www.agusto.com

© Agusto&Co.

UBA House (5th Floor)

57 Marina Lagos

Nigeria.

P.O Box 56136 Ikoyi

+234 (1) 2707222-4

+234 (1) 2713808

Fax: 234 (1) 2643576

Email: [email protected]

Documents

FBNQ MB Funding SPV Plc - FMDQ Group … · 2 2018 Bond Rating: FBN Quest MB Funding SPV Plc in addi tion to a capital adequacy ratio of 12.2%, also above the 10% regulatory minimum