OREANDA-NEWS. S&P Global Ratings today affirmed its 'B/B' long - and short-term counterparty credit ratings on Nigeria-based First City Monument Bank (FCMB). The outlook is negative.

At the same time, we affirmed our 'ngBBB-' long-term and 'ngA-3' short-term Nigeria national scale ratings on the bank.

The affirmation reflects our view of FCMB's ability to contain the deterioration in its risk metrics amid challenging operating conditions characterized by heightened credit risks and reduced capitalization among banks. Nigeria's economic prospects are constrained by its dependence on a weakened hydrocarbons sector, which is facing international oil price volatility and production shocks. Consequently, this has placed significant pressure on the country's foreign currency reserves. Additionally, in June 2016, the Central Bank of Nigeria took actions to liberalize the exchange rateregime, which has led to a sharp depreciation in the value of the naira. Foreign currency liquidity in the economy remains tight and economic growth iscontracting.

Despite these headwinds, FCMB has managed to contain deterioration in the quality of its loan book better than some of its domestic peers, although its profitability and earnings capacity is subdued. Over the next 12 months, we expect the bank will focus less on expansion and more on maximizing efficiencies and promoting greater retail transactions through electronic channels.

The bank's regulatory capital adequacy ratio fell sharply in 2015 to 16.9% from 19.3% in 2014 compared with a statutory minimum of 15%. This is largely attributed to the transition to Basel II and pressure on internal capital generation throughout the year. There is some fungibility of capital within the FCMB group, which would benefit the bank, as the group's core subsidiary, in case of need. At the same time, while the bank has some headroom to raise Tier 2 capital, we think its appetite to do so is limited given its aim to manage down its high cost of funding and limited lending opportunities.

We project FCMB's risk-adjusted capital (RAC) ratio will weaken to about 4.8%-5.0% over the next 12-18 months from 5.8% at year-end 2015. Our projections take into account slow balance sheet growth, high operating costs, pressure on net interest margins given the bank's above-average funding costs, and devaluation risks given the high proportion of foreign currency assets on the balance sheet. For 2016, we expect cost of risk will worsen to about 3%, anonperforming loans ratio of about 5%, and minimal dividend distribution. We think that the bank's below-average loan loss reserve coverage (excluding regulatory risk reserves) of about 65% is a weakness, which could materialize in unexpected losses and capital pressure.

In addition, FCMB's loan book is vulnerable due to significant credit concentrations by sector, single-obligor, and foreign currency. At year-end 2015, 29% of gross loans was to retail and general commerce, 24% oil and gas, and 11% real estate, while its top-20 obligors and foreign currency loanseach accounted for approximately 42% of gross loans. In general, we think that FCMB's management of its foreign currency balance sheet is sound, with only a small, negative net open position in the banking book, which is less than 5% of shareholders' funds in 2015, and the bank has high levels of cash coverage over short-term liabilities denominated in foreign currencies. However, its foreign currency borrowing headroom is tight when compared to the regulatory ceiling of 75% of shareholders' funds, and currency devaluation may trigger a breach of this limit. Similar to peers', the bank's funding profile is contractually short term, with a high, albeit reducing, concentration of institutional and corporate depositors, which we consider to be confidence sensitive. Positively, FCMB maintains a sizable liquid asset portfolio mainly comprised of Nigerian sovereign bonds and treasury bills.

The negative outlook on FCMB reflects our negative view on the Nigerian banking sector and the rising economic risks in the country, which could result in weaker asset quality and pressure on capital and earnings. We could lower FCMB's ratings if asset quality weakens beyond our expectations over thenext 12 months, resulting in negative profitability and diminished capital buffers compared to the regulatory minimum threshold. We could also take a similar rating action if FCMB’s liquidity coverage metrics fall below the statutory minimum or if its foreign currency liquidity position deteriorates markedly and heighten refinancing risks within the next 12 months. We could also lower the ratings if we lower the banking industry country risk assessment score of Nigeria, which is the starting point for rating banks operating in Nigeria.

We would revise the outlook to stable if we witness an improving trend in credit losses and loan loss reserve coverage to levels comparable with similarly rated peers', underpinned by strong credit underwriting and risk governance standards, and adequate earnings buffers, all other rating factors remaining unchanged.