Here is Afrinvest’s response to the recently announce CBN policy changes. I think a substantial part of their analysis is spot on.  Some of the main points are:

1. Limited scope for a manjor price appreciation of the commercial bank sotcks
2. Banks have already indicated their intentions to slow down lending volumes to close to zero. So the benefits of these changes and reductions in lending rates are relatively ineffective
3. A near zero real exchange rate in an economy with an uncertain inflation outlook does not lend itself to medium term currency stability
4. The Naira is expected to come under substantial pressure
5. Commercial banks are rated as Underweight
6. Recommends diversification into non-Naira assets, preferably US$ denominated assets in the short to medium term. Non-financials (particularly Breweries, Beverages and Consumer-related products) continue to offer some scope for value appreciation, despite worsening business/market conditions.

Dear All -

CBN announced yesterday new regulations on deposits and loan pricing at Nigerian banks, effectively fixing money market prices in the country till December 2009. On this basis, we expect that much of the assumptions surrounding banking sector operating performance in 2009/2010 will now be up for significant revision, potentially limiting the scope for a major price appreciation on commercial bank stock prices.

Credit Volumes Will Thin-Out Further
In summary, CBN and the banks have agreed to fix lending rates at a maximum of 24.0% (all in, including fees), and deposit rates at 15.0%. We note that there are no indications as to whether these limits are retroactive (will they apply to loans and deposits already in issue), and if so, what would be the contractual implications of these changes. We also note that most Nigerian banks have already indicated that due to macroeconomic weaknesses and uncertain market conditions, they intend to slow-down lending volumes to close to zero (at least for new loans) in 2009/2010. We expect that mandatory loan pricing reductions (from the current levels of 28.0% – 29.0% all in) will further ensure that only the highest quality borrowers (government and the largest corporates) will be able to substantially access new bank credit this year.

Money Market Dynamics Likely to be Altered
Further, there are no indications as to whether these fixed deposit rates also apply to short-term (typically overnight) inter-bank deposits, the pricing of which typically fluctuates with market liquidity conditions and various banks’ credit standings. In the event that it does, we expect that there will be a near shut-down in lending volumes to any banks with major credit concerns (many of whom have borrowed overnight at 18.0% to 24.0% levels in the past few months). In the absence of any risk-reward spreads for depositing with banks perceived to be less credit-worthy, we also anticipate challenges with those banks accessing market-based liquidity from wholesale private sources. We expect that the CBN will increasingly become the major counterparty for such banks to deal with.

Dire Implications for US$/Naira Exchange Rate Levels
With the fundamental outlook on US$ supply levels remaining challenging (due to lower crude oil prices), a fixed exchange rate regime reduces Nigerian banks’ ability to compete for short-term foreign currency funding. Given that most recent inflation numbers came out at 14.6% (with the future outlook still uncertain), a 15.0% fixed deposit rate would imply a net positive real (excluding inflation) exchange rate of 0.4%. On this basis, we expect to see major Nigerian and offshore depositors actively weigh their options for currencies in which to place short-term money. US$ denominated deposits would yield higher real exchange rates, while limiting exchange loss risk levels. Overall, a near zero real exchange rate in an economy with an uncertain inflation outlook does not lend itself to medium term currency stability. Barring changes to the fundamental outlook on fiscal and current account balances (i.e. in the absence of a positive oil price shock), we expect the Naira to come under further pressure as a result of this fixed interest rate regime, as large ticket depositors begin to reassess their options for short-term placements.

Going Forward, We Reiterate: Underweight Banks; Overweight Non-Naira Assets; Overweight Non-Financials
We reiterate our views from the Afrinvest 2009 Outlook Report. Regarding equities exposure, we remain cautious on the market as a whole. We are Underweight commercial banks as a group, and continue to recommend diversification into non-naira assets, preferably US$ denominated assets in the short to medium term. Non-financials (particularly Breweries, Beverages and Consumer-related products) continue to offer some scope for value appreciation, despite worsening business/market conditions. We will continue to observe money market developments and trading reactions to the new pricing regime, and give feedback as to emerging dynamics.

Regards,

Research Department