Union Bank: Free from credit losses, but cost of funds rising

Union Bank of Nigeria has succeeded in freeing its income statement from huge credit losses that ate up close to N130 billion of its revenue in the past five years. A substantial net write back in impairment charges provided the spur for an exceptional profit growth the bank reported in 2014. Net charges for credit losses have declined further in the current year at over 20% at the end of the third quarter.

Other operating challenges have however surfaced, which are indicating possible drops in both revenue and profit at the end of the year. One major challenge is rising interest expenses and another is revenue growth weakness. The bank reported a moderate increase of 6.4% in gross earnings year-on-year at the end of the third quarter, which was accounted for exclusively by interest income. Non-interest income is a drag on revenue growth with a sustaining decline of 13% while interest income is constrained by a continuing drop in the investment portfolio since 2013.

Union Bank is moving against the general banking industry trend in loan loss charges this year and this added a major strength to the income statement at the end of the third quarter. Net impairment charges dropped by 20.4% at the end of the third quarter and that moderated the impact of rising interest expenses on the bottom line.

Interest cost is the only major cost area the bank has to contend with in the current year. Rising interest cost is claiming an increasing proportion of revenue. Compared with a decline in 2013 and a marginal increase in 2014, interest expenses rose by over 50% at the end of the third quarter – more than two and half times as fast as interest income. This constrained net interest income, as revenues saved from reduced impairment charges were largely claimed by increased interest expenses.

There was a slip in customer deposits during the period and the bank had to depend more on expensive liabilities to maintain earning assets. Rising cost of funds is a general trend in the banking sector as well as the larger economy.

Interest income grew by 19.3% to N66.64 billion year-on-year at the end of the third quarter, which was accounted for exclusively by earnings from loans and advances. A decline of 9.9% in investment securities affected interest income from that line of activity. This is however more than compensated by a rise of 15.6% in loans and advances, which provided the strength for an 8.9% increase in the size of the balance sheet.

With a gross income of N84.72 billion, the bank isn’t showing sufficient strength to match the revenue of N135.80 billion it reported at the end of 2014. Based on the third quarter growth rate, full year revenue is projected at N115 billion for Union Bank at the end of 2015. This will be a drop of over 15% unless there is accelerated growth in earnings in the final quarter.

Operating cost is under a firm control with a flat growth of 1.1% at the end of the third quarter. With that, the bank reduced its operating cost margin from 55.5% in the same period last year to 51.6% at the end of September. This remains well above the average banking industry ratio of 44.6%.

The moderation of operating cost and the drop in loan loss expenses enabled the bank to improve profit capacity relative to the corresponding period last year. Net profit margin is up from 10.2% to 11% over the review period. This enabled the bank to grow after tax profit ahead of revenue at 15% compared to 6.4%.

In terms of the full year outlook however, the cost-income ratio of the bank has titled to the side of cost this year and the bank’s profit prospects have weakened.  Net profit margin has dropped from about 20% at the end of last year and with revenue weakness, the bank isn’t expected to come anywhere close to the after tax profit of N26.82 billion it earned at the end of 2014.

A good part of the profit of last year was earned in the final quarter. Unless a final quarter windfall happens again this year, profit is headed for a major drop. Based on the third quarter growth rate, the bank is expected to close the 2015 financial year with an after tax profit of N13 billion, a likely drop of over 50%.

The bank earned 55 kobo per share at the end of the third quarter, improving from 44 kobo in the same period last year. It is expected to earn 76 kobo per share at full year. This will be a sharp drop from earnings per share of N1.52 at the end of 2014. Cash dividend isn’t expected until the bank is able to wipe off accumulated losses, which still towers to about N250 billion at the end of September.