PolarisBank Limited, the Central Bank of Nigeria (CBN) backed bank created from thelegacy Skye Bank Plc, over the weekend announced the approval of its 2019financial statements, and appears to be clawing back to ‘sustained’ profitability as it recorded a financial year end (FYE) 2019 profit before taxfigure of N27.34bn (Group figure; Bank is N27.85bn) which was1,110% higher than the pre-tax profit number between September and December2018 of N2.46bn (the comparison between both periods is simply a “low-base” place holder to suggest direction rather than scale ofPolaris Bank’s profit movement as the two periods are technicallyincomparable).
Related Link: PolarisBank 2019 Annual Financial Statement
Theimproved profitability of the bank reflects a combination of hardnosed costcutting and gradual rebuilding of the bank’s loan book quality and efficientallocation of assets. The key highlights of the bank’s 2019 performance werecharacterized by the following:
Highlights/Takeaways
- Gross earnings ended 2019 at N150bn, this reflected a push for greater market share of industry gross revenues and a conscious effort at gathering cheaper deposit liabilities which were converted to loan assets that pushed earnings up a few notches.
- The Bank had a modest return on asset (RoA) of 2.3% which compares favourably with Nigeria’s tier-1 banks and is arguably best-in-class for the sectors second-tier deposit money lenders (DMBs).
- The bank’s equity return (RoE) in 2019 of 33% was impressive and signpost a cheery outcome for the new managers that took over the running of the bank in 2018. The new management led by Mr. Tokunbo Abiru has had a tough but successful stab at turning the bank from a hard stop to a hand break swerve towards stability.
- A return on Gross Earnings (GE) of 18% was also comparatively remarkable and reflected efforts of the bank’s management to widen its net interest income as a proportion of gross revenue. The statistic emphasizes attempts at improving core business revenue relative to cost with interest income rising faster than interest expenses. The management has deliberately forged a strategy of increasing low cost deposits as opposed to the strategy of the old Skye Bank which depended heavily on public sector placements with attendant uncapped interest arbitrage expenses.
- The ghost of the old Skye Bank still haunts Polaris Bank as the persistence of huge non-performing loans characterize an otherwise impressive turnaround story. Nevertheless, the new bank has been able to cut non-performing loans as a proportion of total loans outstanding from 80% in 2018 to 46% in 2019. The delinquent loan book of the bank is still heavy but the direction of delinquency as proportion of loans outstanding has declined, creating more wiggle room for the bank’s management to grow its assets without hurting liquidity.
- However, in a COVID-19 situation and a soft economic meltdown, IFRS 9 requirements may see Polaris suffering a disproportionate fall in 2020 FYE gross revenue and operating profit due to an economic slowdown.
- It must be noted that for some unexplained reason the bank’s 2019 financial result was juxtaposed with what was essentially its Q4 2018 result with an added week from September 2018. The odd reporting made it difficult to discern the precise extent of improvement in the banks audited account between 2018 and 2019. The fact that Polaris bank is a legacy bank that started in September 2018 does not obliterate the history of the bank from its Skye Bank days, unless AMCON suggests that the banks delinquent loans had been totally written off and that fresh capital had been injected into the bank by way of equity. Since no such statement was available from AMCON or any other sector regulator, we are of the opinion that it would have been more transparent to have presented a full year report for 2018 with the necessary caveats concerning AMCON intervention; and highlighting improvements in performance achieved by the new management.
In the course of writing this report, the bank represented that “AMCON injected fresh capital and the bank has been relieved of the burden ofcarrying delinquent loan through the take-over by AMCON and derecognition fromthe Bank’s books.”
While we have no reason todoubt the representation, the validation of course, would be our reference toAMCON’s statement of accounts for 2018. Unfortunately, this document was notavailable as at the time this report was put together, and remains a documentto be reviewed in the near future.
Table 1 Summary Financial Performance of Polaris Bank FYE 2019
| Metrics | POLARIS Bank 2019 |
| Gross Earnings (N’bn) | 150 |
| PBT (N’bn) | 27.34 |
| Deposits from customers (N’bn) | 857.9 |
| Total Assets (N’trn) | 1.16 |
| Capital Adequacy (%) | 14.67 |
| Return on Assets (%) | 2.27 |
| Return on Equity (%) | 30.26 |
| Liquidity Ratio (%) | 74.38 |
| Cost-to-income ratio (%) | 40.67 |
| NPL (%) | 46 |
| Source: Polaris Bank Financial Statements, Proshare Research | |
Profitability, Good but Fragile
Thebank made a group profit before tax of N27.34bn (N27.80bn for the bank alone)in FYE 2019 which was decent for a bank of its size. The profit resulted in anRoA of 2.3% and RoE of 33%. The figures indicate deliberate and strategicmanagerial manoeuvring to expand income opportunities. Nevertheless, the profitnumbers appear to have been generated on the back of a smaller loan book. Loansto customers fell from N340bn in FYE 2018 to N188.74bn in FYE 2019, the fall inbank lending to customers came to -44.49%.
So,from where did Polaris Bank make its FYE 2019 profit?
Withoutthe full year 2018 results, this may be difficult to determine but a fewpointers may provide context.
Thebank has cut down on its loans sizably and so impairment costs may have beenreduced significantly enough to improve operating income (see chart 1 below). Indeed, with theforward-looking nature of IFRS 9 impairment requirements, it is likely thatPolaris Bank’s management wrote off loans taken over by AMCON (reducingpotential reportable income) while ensuring that subsisting loans arehealthy enough to manage in a sustainable manner.
Chart 1 Total Loans/Receivables of Polaris Bank 2017-2019
Source: Bank’s Financials, Proshare research
Thelikelihood is that the loans sliced off the bank’s books were those of itserstwhile Chairman, Tunde Ayeni, and a few other big borrowing insiders at theliquidated Skye Bank. These loans may have been totally written down.Therefore, the major gains in Polaris Bank’s profit & loss account may havecome from tidier book keeping and efficient asset allocation.
Thetidier loan book and better asset quality would prepare the bank for a strongperformance in subsequent years save for the consequences of the 2020 grey swan;the novel coronavirus pandemic (COVID-19) fathered recession. Forward forecastby the International Monetary Fund (IMF) says that Nigeria’s economy willshrink by –3.4% in 2020, if this happensthen Polaris Bank like other companies/banks may see earnings come underextreme pressure as corporate clients see sales and production cutbacks andindividual retail customers see a fall or total elimination of periodicincomes.
Inother words, Polaris Banks earning numbers in FYE 2019 were good but in theface of the ongoing global pandemic, the bank’s operating performance in 2020appears fragile. The reduction of loans between 2018 and 2019 may have hadstrategic importance but it may also throw up a Cobra Effect problem, withcertain unintended consequences of a lighter lending portfolio hurting the bankin 2020.
Loans…Where are the Loans?
Lendingwas not at the heart of the bank’s management calculations in 2019, Polaris’smanagement appears to have stayed focus on two primary objectives:
- Reduce the size of non-performing assets on the bank’s statement of financial position for the FYE 2019; and
- Improve technology development and deployment to prepare for an aggressive penetration of the digital banking market; and grow retail businesses through agency banking outlets
Thebank’s decision seems to have been wise. By shuffling off large delinquentassets from its books, the management created an opportunity to rebuild thebanks’ balance sheet and repair its profitability.
However,going forward critical decisions will need to be made on sustainingprofitability and growth in a recessionary environment. Reducing its cost toincome ratio (CIR) was clever and could serve as a critical survival handle barin 2020. Polaris currently has one of the lowest CIRs of banks in Nigeria (see chart 2 below).
Chart 2 Comparative CIRs of Nigerian Banks FYE 2019
Source: Selected local Nigerian Banks, Proshare Research
Amongstpeer Tier 2 banks Polaris recorded the best CIR in 2019, even going ahead ofseveral Tier 1 competitors. Available figures suggest that only GT Bank had abetter CIR of 36.11% in the previous year, 2019.
Bethis as it may, Polaris bank saw over 40% decline in loans to customers, this has stirred someconcern in the financial analyst community. Deposit money institutions areexpected to make the most of their incomes from lending and investmentactivities but with loans declining and investment yields tanking in the localcapital and money markets, the prospects for stronger gross earnings andoperating profit for Polaris Bank in 2020 is at best modest.
Loansto customers slid from N340.05bn in FYE 2018 to N188.74bn in FYE 2019, meaninginterest income for the full year would have dipped year-on-year (Y-o-Y).
TheLittle Big Matter of Capital Adequacy
Polarisended the year 2019 with one of the strongest capital adequacy ratios amongstTier 2 banks reviewed for the year. The impressive improvement in capital was ademonstration of the new management’s determination to repair the previouslybroken capital base of the reformed money lender, the bank’s capital adequacyratio ended 2019 at 14.67% (see chart 3 below).
Chart 3 Capital Adequacy Ratio (CAR) of Selected Nigerian Banks FYE 2019
Source: Selected local Nigerian banks, Proshare Research
Acloser look at Polaris Bank’s statement of financial position for 2019,however, plays up snapshots of line items that may be considered “unusual”.
Forexample, the bank reported an interesting line item called “ReorganisationReserve” which was explained in its annual financial statement (AFS)for 2019 as “the net liability assumed by Polaris Bank Limited in line withits establishment as a bridge bank to assume the assets and liabilities of SkyeBank Plc. The net liability assumed was transferred to reorganisation reserves”. The amount came to N848.02bn.
Inother words, this was the amount that AMCON committed to stabilizing the oldSkye Bank and providing operational support when the new Polaris Bank came intobeing. Indications are that the total amount may have been higher, but ofparticular worry is the current unclear treatment of this balance sheet item.Does reorganization reserve represent quasi-equity or debt, or neither? Sincethe figure in question is negative it discounts the size of the banksshareholder fund and appears to be a thinly veiled attempt at warehousingAMCON’s intervention funds until a sell-off becomes possible and liabilityrecovery can be achieved.
Anotheradjustment to the bank’s balance sheet of note is a line item the bank calledits “share premium reserve“. The AFS 2019 of the bank explains this to be, “the excess paid byshareholders over the nominal value of their shares”. But since the bankdoes not have any shareholders (except AMCON) and the value of its sharescannot be assessed by open market valuation of buyers and sellers of the bank’sequity, the financial statement is unclear about how the reserves was valued atN873.45bn which, by the way, conveniently knocked off the negative valueposted against the bank’s reorganization reserves. If the bank’s sharepremium reserve was removed from the bank’s liability, Polaris Bankwould record a negative shareholders funds and a capital adequacy ratio farless flattering than that which appears on its financial statement for 2019. Inthis regards the bank, however, represents that the amount considered as sharepremium was part of the capital injected by AMCON and therefore qualifies ascore capital. Considering this interpretation, Polaris Bank would bewithin its rights to take the reserve as part of its underlying capital.
Anotherchallenge for the bank is the cleaning up of its legacy loans. The bankis still in the throes of wriggling out of a deeply frustrating delinquent loanasset position with the bank posting one of the highest non-performing loanratios in the industry (See chart 4 below).
Chart 4 Non-performing Loans of Selected Nigerian Banks FYE 2019
Source: Selected local Nigerian banks, Proshare Research
Asdark as this may look at first it actually represents progress as the previousmanagement had successfully created a situation where toxic loans as aproportion of loans outstanding were in the region of 80%. As at the time AMCONtook over Skye Bank two years ago the bank had gone beyond a dead cat bounce tobeing dead on arrival (DOA). The present management of the successor bank,Polaris, have done a brilliant job of getting the books to steer in the rightdirection. It may not yet be uhuru, but the signs of bad performancereversal and recovery are bright.
Liquidity; Staying Healthy with Funds and Friends, But…
Thebank showed robust liquidity in 2019 with a liquidity figure of 74.38% (ProshareResearch calculations, see chart 5 below),this should serve as buffer to the headwinds that may hit the sector after Q22019 as customers begin to draw down savings to maintain standards of living asrecession, lower incomes and job losses begin to bite.
Alreadysectors such as Aviation, Oil and Gas and Manufacturing have started to feelthe strains of supply chain disruptions, demand pullbacks, and inventoryaccumulation, these situations will translate to worsening bank credits, risingnon-performing loans (NPLs) and a decline in banking sector gross earnings.
Chart 5 Comparative Liquidity Ratios of Selected Banks inNigeria FYE 2019
Source: Selected local Nigerian banks, Proshare Research
Looking Ahead with Promise
Beyondthe observed glitches to its balance sheet, Polaris bank seems to be graduallyon the mend. However, how well the legacy bank’s recovery sticks will dependheavily on the outlook for the Nigerian economy during, and post COVID-19. Theoutlook so far appears dim with international oil prices on a continuous dipand Nigeria’s fiscal balance looking increasingly orphaned. Nigeria’s fiscalbreakeven oil price is US$133 per barrel but the recent price for Brent Oil (theclosest grade to Nigeria’s Bonny light) sells at roughly US$20.07c perbarrel meaning that Nigeria is trapped in a fiscal dilemma and this could putpressure on domestic interest rates, thereby slowing private sector growth,even though fixed income government securities may begin to look attractiveagain.
Polarislike other banks in 2020 will have to manoeuvre around several known unknowns(grey swans) and a few unknown unknowns (black swans) as both types ofswans represent major operational challenges for all banks in 2020. PolarisBank will in 2020 look ahead with promise just as it did in 2019 but the dibia(shaman’s) cowries are not looking friendly.