Friday, October 25, 2019 / 08.45PM / TheAnalyst/Header Image Credit: Proshare 

Nigeria's agricultural finance powerhouse, Unity Bank Plc, is pulling itself out of a financial ditch with its 9 months 2019financial statement. The banks top line earning spiked from N26.12bn in 9months 2018 to N31.26bn in 9months 2019, representing a year on year (Y-o-Y)growth of +20%. The September 2019 grossearnings growth was  -16.26% lower than the 2018 Financial Year end (FY)gross earnings of N37.33bn, suggesting a potential baseline Proshare forecastearning of N44.67bn for FY 2019 (see chart 1 below).

Highlights

• Gross earnings was up +20%Y-o-Y, a major unexpected spike for 9 months 2019
• Net Interest Income climbed +12%,representing a promising improvement over the previous 9 months in 2018
• Fees and Commissions soared +26%,suggesting the sterilization of the income statement from challenges withcredit assets over the 9-month period in 2019
• Net trading income was a sore point for the bank asincome from trading transactions dipped by -64%
• Profit before tax (PBT) scaled to +150% between 9 months 2018 and 2019 destroyinganalysts earlier quarterly forecast for the bank and perhaps encouraging areview of FY 2019 forecast of Unity's earnings yield and ROaE

• The bank saw its total assets leap up by +18% as deposit liabilities rose by +9%, meaning that the bank's loan to deposit ratio(LDR) would have risen marginally over the reference period
• Annualized earnings per share went from N7.71 inSeptember 2018 to N19.02 in September 2019 representing a rise of +109%, this should lead to a significant upwardadjustment to the bank's market valuation (recent NSE price N0.63)

Pushing The Earnings Truck Harder

Unity Bank  has had a rough couple of years but itappears that it is turning the corner and rising along Sigmund Freud'sanalytical S-curve, where inertia gives way to progress after the right 'nudge'. The bank's September 2019 financials indicate a remodeling of itsgrowth from stagnation to evident improvement. The rise in topline earnings of +20% is higher than that of GT Bank which saw itstopline earnings fall by -3.17% over thecontemporary period and FBNH which had to endure a flat growth of +0.17% in gross earnings between September 2018and September 2019.  The hard fight toregain earnings momentum by Unit Bank has been impressive, especially in aneconomy that has seen sluggish growth (1.94% as at Q2 2019).

Chart 1 Unity Bank Gross EarningsQ2 2018-Q3 2019

Source: Unity Bank Q2018 -Q3 2019 Financial Statements

The Profit Outlier

Unity Bank's profit feat in the third quarter of 2019,has naturally drawn analysts attention to the fact that the bank's +150% rise in profit before tax is a major outlierfor the period. Admittedly the bank is coming from a relatively low earnings base,but even at that, a growth from N644m in September 2018 to N1.61bn in September2019 is no mean feat. Does this mean that the bank is on the mend? This isdifficult to say, one pigeon does not make a flock, investors and marketoperators may wish to determine the longer-term stability of earnings growthover at least two more quarters to establish conviction concerning Unity Bank'sfinancial health. In the interim, however, the powerful surge in the bank's PBThas prompted a closer look at its going concern status with more hope. Pre-tax profitmargin for the bank climbed from 2.46% in September 2018 to 5.15% in September2019, representing an upward margin adjustment of 2.69%.

The improvement in the banks top and bottom lineperformance is not out of character with overall growth in the course of 2019as the banks Q2 review was equally strong (see table 1 below):

Table 1 Highlights of Unity Bank'sFinancial Performance Q2 2018-Q2 2019

Source: Unity Bank Quarterly Results Q2 2018 and Q2 2019, ProshareResearch

Lending and Deposits; The Balancing Act

A critical aspect of the bank's operation is thebalance between lending and deposits. With the Central Bank of Nigeria (CBN)requirement that banks by the end of September 2019 ensure that their lendingto deposit ratios were a minimum of 60% (this has since been raised to 65% byDecember 2019), banks across the board felt the pressure to increase theirlending but this was constrained by the composition of their deposits (term, savingsand deposits) and their prior investments in Treasury-bills (T-bills).

Unity Bank's loan to deposit ratio has been a bit of achallenge and may haunt its performance till the end of the year Q4 2019. Thebank's loan to deposit ratio (LDR) grew from 23.7% in Q1 2019 to 29.15% in Q22019 and 34.95% in Q3 2019. The rise in LDR has been in the right direction butthe size of the movement would likely subject the bank to heavy CBN sanctions,unless it breaks its T-bill investments and works its way through creatinglow-risk but profitable credit assets. The bank will have to sweat its balancesheet to produce a fiscal outcome that would improve lending despite a growthin deposits in such a way as to ensure an LDR of 65%. One other option would beto raise fresh equity by way of a convertible debt structure in the bank's statementof financial position with the new funds going into lending withoutincreasing the size of the bank's deposits. Of course, this would lower ROaE inthe near future but it would also allow for increase in immediate profitabilitywhile the bank works out details of improving savings and term deposits, whichtend to be more stable than demand deposit accounts. The bank will need toquickly ramp up lending on its slowly growing deposit base (see charts 2and 3 below).

Chart 2 Unity Bank Loan To DepositRatio (LDR) Q2 2018-Q3 2019

Source: Unity Bank Q2018 -Q3 2019 Financial Statements, ProshareResearch

Chart 3 Unity Bank Customer Loansand Deposits Q2 2018-Q3 2019

Source: Unity Bank Q2018 -Q3 2019 FinancialStatements, Proshare Research

IFRS 9 and the Little Big Matter ofShareholder Equity

The bank like other deposit money institutions (DMBs)made good of its day one International Financial Reporting Standard(IFRS) 9 provision, this allowed the bank achieve write backs in its 2018 FYreport. The tide will, however, change in 2019 as the impairment charges willbe fully reflected in provisions for current delinquent loan assets, which inturn will worsen the banks already steep negative shareholder equity which standsslightly below N250bn. 

Chart 4 Unity Bank ShareholdersFund Q2 2018-Q3 2019

Source: Unity Bank Q2018 -Q3 2019 Financial Statements, ProshareResearch

Capping The Outlook

Unity Bank's management is clearly working hard toimprove its operating performance, but its major problem is its ability to cometo terms with its shareholders fund. The large negative shareholders fund is asignificant drag on the banks capacity to grow its business, even thoughliquidity is not a problem, the weak equity position could cap the bank'sability to expand. Raising cheaper finance abroad, and entering strategicpartnerships with foreign financial institutions will become increasingly difficultwithout a more convincing equity structure. Negative returns on equity(ROaE) in the face of strong growth in earnings is a big bull in a small Chinashop. Strength in financial services need to be seen as well as perceived.    

With strategic corporate action taken on shareholderfunds, good can easily become better for Unity Bank Plc, Nigeria's top greeneconomy financier.

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