8 Final Rating Report · BankÕs WACF was the highest amongst the selected peers and the merchant...

FBNQ MB Funding SPV Plc Series 1 ₦5 billion 3-year 10.5% Fixed Rate Senior Unsecured Bond

Final Rating Report

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2018 Bond Rating: FBN Quest MB Funding SPV Plc

FBNQ MB Funding SPV Plc Series 1 ₦5 billion 3-Year Fixed Rate Senior Unsecured Bond

FBNQ MB Funding SPV Plc Series 1 ₦5 billion 3-year 10.5% Fixed Rate Senior Unsecured Bond under the ₦50 billion Debt Issue Programme

Rating Assigned:

A RATING RATIONALE Agusto & Co. hereby affirms the ‘A’ rating assigned to FBNQ MB Funding SPV Plc’s (‘the Issuer’) Series 1 ₦5 billion 3-year 10.5% Fixed Rate Senior Unsecured Bond (‘the Issue’, ‘Series 1 Bond’ or ‘the Bond’) due in 2023. The Bond is guaranteed by FBNQuest Merchant Bank Limited (‘FBNQ MB’, ‘the Sponsor’ or ‘the Bank’) and mirrors the standalone rating of the Sponsor. FBNQuest Merchant Bank Limited is rated ‘A’ by Agusto & Co reflecting its adequate capitalisation, good liquidity profile, strong ability to refinance upheld by membership of the FBN Holding Group and its experienced management team. However, the rating is constrained by the lingering obligor and sector concentration in the loan book and the Bank’s subpar profitability. The adverse economic impact of the COVID-19 pandemic and tight regulations are also considered. FBNQ MB grew its loan portfolio by a marked 30.6% to ₦48 billion as at FYE 2019. As at the same date, the Sponsor’s impaired loan ratio of 3% was lower than the 5% regulatory threshold. However, the vulnerability of the loan book remains high, owing to the concentration to the volatile oil and gas sector. Supported by loan workouts permitted by the CBN, we expect the quality of the loan book to remain satisfactory. Capitalisation also remains adequate for the current level of business risks, with the computed capital adequacy ratio of 17.7%, well above the prescribed minimum of 10% for merchant banks operating in Nigeria. The proposed Series 2 bond under the ₦50 billion debt issuance programme scheduled for Q3 2020 is expected to qualify as tier 2 capital and provide additional capital buffers. Profitability was sustained by a 10.5% increase in non-interest income and a 440-basis points reduction in the Bank’s cost-to-income ratio to 71.9%. Profit before tax grew by 22.5% to ₦2.8 billion during the financial year end 2019, while pre-tax ROA and ROE improved to 1.9% (FY 2018: 1.6%) and 10.3% (FY 2018: 21.6%) respectively. Despite the improvement, profitability ratios remained below the industry average and its selected peers. Although we expect near-term performance to be impacted by the pandemic and unfavourable regulations, we believe the Bank’s strong treasury function, honed from its discount house antecedence and the heritage of FBN Capital Limited will sustain its near-term performance.

Outlook: Stable Issue Date: 22 July 2020 Expiry Date: 30 June 2021 The rating is valid throughout the life of the instrument but will be subject to periodic monitoring and review.

Bond Tenor: 3 years Industry: Banking Analysts: Mariam Dabiri, CFA [email protected] Ayokunle Olubunmi, CFA [email protected] Agusto & Co. Limited UBA House (5th Floor) 57, Marina Lagos Nigeria www.agusto.com

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2020 Bond Rating FBNQ MB Funding SPV Plc Series 1 ₦5 billion 3-Year Fixed Rate Senior Unsecured Bond

Based on our expectations that asset quality will remain acceptable, profitability will be sustained by ancillary income and capitalisation will remain adequate despite elevated macro-economic risks, a ‘stable’ outlook is hereby attached to the rating of the Sponsor and the Issue. The outlook and rating will be closely monitored for material changes elicited by the pandemic that could impact the performance of FBNQuest Merchant Bank Limited in the near-term.

Table 1: Background Information

• Affiliation with the FBN Group with strong brand equity• Experienced and stable management• Good liquidity profile• Adequate capitalisation

Strengths

• Obligor and sectoral concentration in the loan book• Subpar profitability relative to peers and industry average• Funding profile mismatches

Weaknesses

• The impact of the COVID-19 pandemic on the performance of the obligors of the Bank

• Heightened economic risk• Tight regulatory policies

Challenges

31 December 2018 31 December 2019 31 May 2020* Total assets & contingents ₦142.6 billion ₦155.5 billion ₦190.7 billion Net earnings ₦9.6 billion ₦9.9 billion ₦5.3 billion Pre-tax return on average assets & contingents (ROA)

1.6% 1.9% 3.7%**

Pre-tax return on average equity (ROE) 8.7% 10.3% 21.6%** *Unaudited **Annualised

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PROFILE FBNQ MB Funding SPV Plc (“the Issuer”) was incorporated under the laws of the Federal Republic of Nigeria as a vessel for debt issuance programmes and FBNQuest Merchant Bank Limited listed as the Sponsor. FBNQuest Merchant Bank Limited (“FBNQ MB”, “the Sponsor” or “the Bank”) is a wholly-owned subsidiary of FBN Holdings Plc (“the HoldCo”), one of the largest financial institutions in Nigeria. FBNQ MB, formerly called Kakawa Discount House Limited was initially incorporated in Nigeria as a private limited liability company on 14 February 1995. It was granted a license to carry on discount house activities on 31 October 1995 and commenced operations on 16 November 1995. In May 2015, a merchant banking licence was granted by the Central Bank of Nigeria and related activities commenced on 02 November 2015 as FBN Merchant Bank Limited. In August 2017, the Bank received approval to adopt the “FBNQuest” prefix for entities under the merchant banking & asset management group within the HoldCo Group, and thus became FBNQuest Merchant Bank Limited. Subsequently, FBNQ MB acquired 100% interest in two entities (FBNQuest Securities Limited and FBNQuest Asset Management Limited) to form the FBNQuest Merchant Bank Group. FBNQuest Merchant Bank Limited is one of the five merchant banks operating in Nigeria. The principal activity of the Bank is the provision of finance and credit facilities to non-retail customers, treasury management services, financial and advisory services, issuing house activities and the coordination of the securities issuance. FBNQ MB’s services also include debt and equity capital markets as well as wealth management. The Bank’s liability generation strategy focuses on high net worth individuals, corporates and financial institutions while asset creation targets industrial and mid-tier corporates, public sector entities, banks and non-bank financial institutions. FBNQ MB operates from the Head office, situated at 10 Keffi Street, Off Awolowo Road, South-West Ikoyi, Lagos, along with two business offices in Abuja and Port-Harcourt. The Bank had a staff strength of 174 as at December 2019. FBNQ MB Funding SPV PLC’s registered address is 30 Marina, Lagos.

Business Structure FBNQ MB’s principal activities include providing finance and credit facilities in local and foreign currency, proprietary securities trading, foreign exchange trading, investment banking, treasury and asset and portfolio management services. The Sponsor also provides debt and equity capital market advisory services and other bespoke services to top tier and medium-sized businesses. FBNQ MB’s liability generation strategy focuses on high net worth individuals, corporates and financial institutions. The Bank’s asset creation targets industrial and mid-tier corporates, value chain corporates, public sector entities, banks and non-bank financial institutions. The Sponsor’s core banking business is carried out through four business divisions: § Coverage & corporate banking division: overseeing risk asset creation and liability generation from

financial institutions and corporates

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§ Investment banking division: comprising debt solutions (arranging and structuring), equity and debt capital markets as well as financial advisory services

§ Fixed income, currencies & treasury division: overseeing fixed-income trading, foreign exchange and treasury activities.

§ Sales division: responsible for liability generation and distribution of the Bank’s products and services. The corporate services, operations and technology divisions provide support to the aforementioned business divisions.

Subsidiaries & Affiliates FBNQMB currently has two wholly-owned subsidiaries: FBNQuest Asset Management Limited and FBNQuest Securities Limited, both acquired in 2017. FBNQuest Asset Management Limited provides asset, portfolio and wealth management services and had assets under management (AUM) in excess of ₦400 billion as at 30 June 2020. FBNQuest Securities Limited offers investment securities trading services. The Sponsor’s 100% equity stake in the two subsidiaries stood at ₦1.3 billion as at FYE 2019. In addition, FBNQuest Trustees is an affiliate company of FBNQ MB, being a part of the FBN Holdings Plc (‘HoldCo’).

Governance FBNQuest Merchant Bank Limited is governed by a nine-member Board of Directors comprising two Executive Directors and seven Non-Executive Directors (including two Independent Non-Executive Directors). The Board is chaired by Mr. Bello Maccido and operates through four standing committees: Board Credit Committee, Board Audit Committee, Board Risk Management and Board Governance Committee. In September 2019, Mrs. Oyinkansola Adewale was appointed as an Independent Non-Executive Director. Mr. Kayode Akinkugbe serves as the Managing Director and Chief Executive Officer (CEO) of FBNQ MB and is supported by the Deputy Managing Director; Mr. Taiwo Okeowo and six other management staff.

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THE ISSUE The Issue is a ₦5 billion 3-year 10.5% Fixed Rate Senior Unsecured Bond due in 2023 (‘the Issue’, ‘Series 1 Bond’ or ‘the Bond’) and it represents the first tranche of a ₦50 billion FBNQ MB Funding SPV Plc Bond Issuance Programme registered in 2019. The Bond is a direct, unconditional, senior unsubordinated obligation of the Issuer and ranks pari passu among other existing and future senior unsecured obligations. Coupons are payable semi-annually while the principal will be repaid as a bullet payment at maturity in 2023. Purpose of the Issue Net proceeds of the Issue have been channelled to the Bank’s lending activities in the different sectors of the economy. The Bond also funded activities in the Sponsor’s investment securities portfolio. Furthermore, the Issue augmented the Bank’s asset and liability mismatches by providing longer-tenured funding for some long-term loans.

Terms and Source of Repayment The repayment of the coupon and principal are fully supported by the Sponsor’s operating cash flows. The principal amount will be repaid at par, with any outstanding interest accrued thereon as a single and complete repayment at the maturity date. Interest (coupon) payments are due and payable on fifth day in February and August of each year up to the maturity date.

Covenants & Guarantees The negative pledge in place stipulates that as long as the Bond is outstanding, the Issuer and the Sponsor shall not create (without the written consent of the Joint Trustees, acting on behalf of bondholders) any mortgage, charge, lien or encumbrance on the whole of part of its present and future undertaking, business assets or revenue to secure any indebtedness unless the Bond obligations are secured equally in such a way not to be materially less beneficial to the bondholders. The Sponsor is further not permitted to secure any present or future indebtedness or incur any financial indebtedness that makes obligations on the Issue subordinate. Similarly, FBNQuest MB Funding SPV Plc is not to issue any other bond or debt instrument with the ability to be listed on any exchange without the consent of the Joint Trustees. Performance report from the Trustees as at June 2020 indicates that no covenants by the Sponsor or Issuer were breached during the period. The first bi-annual coupon payment is expected on 5 August 2020.

Trustees to the Issue FBNQuest Trustees Limited, ARM Trustees Limited, United Capital Trustees Limited and UTL Trust Management Services Limited are the Joint Trustees to the Issue. The Joint Trustees have the mandate to manage the bond payment account and ensure compliance with the terms of the Trust Deed, which includes confirming that debt service obligations are met as and when due.

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FBNQuest Trustees Limited is a wholly-owned subsidiary of FBN Holdings Plc, one of the largest financial services groups in Nigeria. FBNQuest Trustees Limited is registered by the Securities and Exchange Commission (SEC) and offers private trust, public trust, corporate trust and agency services. The registered office is located at 10 Keffi Street, Off Awolowo Road, Ikoyi, Lagos. ARM Trustees Limited is a wholly-owned subsidiary of ARM Traditional Asset Management Company Limited and registered with SEC. ARM Trustees Limited in almost two decades of existence offers a bouquet of services including private trust, estate planning and commercial trust services. The registered office is located at 1, Mekunwen Road, Off Onikan Abayomi Drive, Ikoyi, Lagos. United Capital Trustees Limited was incorporated in 1964 and registered with SEC. Services offered by United Capital Trustees Limited include investor protection, bond trusteeship, portfolio and asset management, real estate investment trusts, estate planning and investment trusts. The registered office is located at 4th Floor, Afriland Towers, 97/101 Broad Street, Lagos. UTL Trust Management Services Limited was incorporated in 1966 as Barclays (Nig) Nominees Limited. UTL Trust is registered with SEC and offers services such as portfolio and fund management, trust of consortium finance, property management and family trust, nominee services, estate and will administration, custodian trusteeship and corporate trusteeship for debt instruments. The registered office is located at 47 Marina, Lagos. In line with the Trustee Investment Act of 1962, trust assets held are duly separated from the accounts of the Trustees such that trust continues to exist even if the Trustee goes into liquidation. The Securities and Exchange Commission is also empowered to periodically monitor the activities of FBNQuest Trustees Limited, ARM Trustees Limited United Capital Trustees Limited, and UTL Trust Management Services Limited, hence providing an independent check on these entities.

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REVIEW OF FINANCIAL CONDITION Asset structure

As at 31 December 2019, FBNQuest Merchant Bank Limited’s asset base (including contingents) stood at ₦155.5 billion, reflecting a year-on-year increase of 9%. The growth in the asset base was most prominent in restricted funds (cash reserves) with the Central Bank of Nigeria (CBN), which jumped by 106.2% to stand at ₦8 billion and accounted for 5.1% of total assets and contingents. The restricted funds, which are sterile and not available for daily banking operations, have been a drag on the Sponsor’s performance, given the Bank’s primarily dependence on purchased funds, similar to other merchant banks. The Sponsor’s restricted funds spiked by 505.2% to ₦48.4 billion as at 31 May 2020 as the applicable cash reserve ratio (CRR) for merchant banks increased to 27.5% from 2% amidst additional debits by the CBN for breaches in complying with the minimum loan-to-deposit ratio. We anticipate a further increase in the Bank’s restricted funds in the near-term as the CBN continues the discretionary debits in line with managing liquidity in the system.

The growth in the asset base was also prominent in the loan book, which increased by 30.6% year-on-year to stand at ₦48 billion as at FYE 2019. As at the same date, FBNQ MB’s gross loans and advances accounted for 30.9% of total assets and contingents. Notwithstanding a 12.2% decline in the liquid assets to ₦54.9 billion as at the same date, it accounted for 35.3% of the Bank’s asset base, reflecting its core treasury function honed by its discount house antecedence and the heritage of FBN Capital Limited. We do not expect a material change in the asset structure in the near term. Breakdown of the loan book by sector

FBNQ MB’s risk asset creation strategy focuses on providing lending solutions to corporates operating within various economic sectors. In 2019, the target market which hitherto was restricted to the top-tier segment was expanded to include mid-tier corporates as part of initiatives to improve profitability. The Sponsor’s loans are predominantly short-dated facilities for multiple cycle trade and working capital needs, except for a few term loans. As at FYE 2019, 28% of the loan book was denominated in foreign currency, which we expect will increase by end of 2020 on account of further devaluation of the domestic currency. Typical of merchant banks in Nigeria, the top 20 accounted for 98% of the loan book as at FYE 2019 signifying a high degree of concentration risk. This increases the vulnerability of the loan book to a deterioration in the financial condition of the major obligors. We are concerned that a single obligor operating in the volatile oil and gas industry accounted for 14.8% of gross loans and 25.2% of shareholders’ funds. The facility was granted to the obligor to acquire participating interests in two oil prospecting licences and also for refinancing purposes. Unfortunately, the obligor is contending with some governance issues, which has negatively impacted its performance. The exposure, which is foreign currency denominated, is expected to be restructured in view of current market realities.

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Figure 1: Breakdown of the Loan Portfolio (FYE 2019)

The Bank significantly grew loans to the trade, real estate, information and technology, manufacturing and power and energy sectors during the review period. Owing to this, the contribution of oil and gas loans declined but remained significant at 33% as at FYE 2019 from approximately 40% in the prior year. Loans to upstream operators accounted for a significant 55% of oil and gas exposures, natural gas operators and downstream oil and gas businesses represented 31% and 14% respectively. The COVID-19 pandemic has translated to a lull in economic activities and a depressed global crude oil market. Therefore, the cash flows of oil and gas operators in the upstream segment have weakened. In the downstream segment, FX illiquidity and lower demand have adversely impacted the performance of operators. Thus, we expect some strain in the Sponsor’s oil and gas loans. FBNQ MB’s exposure to the manufacturing sector spiked by 806.6% and accounted for 19% of gross loans as at FYE 2019. We are concerned by the impact of the naira devaluation and supply chain interferences occasioned by the pandemic on the manufacturing sector. Nevertheless, our asset quality concerns are moderated by the forbearance granted by the CBN to provide loan workouts to businesses severely impacted the pandemic. Owing to the prevailing macroeconomic headwinds, the Bank intends to maintain a cautious approach to lending and projects a comparably low 7% loan growth for FYE 2020. Subsequent to year-end, as at 31 May 2020, the loan book had shrunk by about 3.2%, despite the 5.3% naira devaluation in March 2020. The quality of the loan book remains within the acceptable standard

As at FYE 2019, FBNQ MB’s stage 1 loans (credit facilities with the lowest default risk) accounted for 86.8% of gross loans down from 96% in the prior year. This was due to a restructured oil and gas facility reclassified under the stage 2 category. As a result, the proportion of stage 2 loans increased to 10.2% (FYE 2018: 0.4%). As at FYE 2019, stage 3 loans (impaired loans) to gross loans stood at 3% (FYE 2018: 3.6%), below the prescribed guidance of 5%. FBNQ MB’s impaired loan ratio was lower than that of one of the selected peers: FSDH Merchant Bank Limited’s (FSDH MB) 4.8% but higher than the second selected peer, Coronation Merchant Bank Limited (Coronation MB) nil impaired loans ratio as at the same date. FBNQ MB’s loan loss provisioning to stage 2 loans stood very low at 2%. However, the provisioning for stage 3 loans stood better at 90%.

Agriculture 12%

Construction 4%

General 2%

Public Sector 5%

Information & Communication 9%

Manufacturing 19%

Oil and Gas 33%

Power and Energy 1%

Real Estate 11%

Transport and Storage 3% Trade 1%

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Subsequent to the year-end, as at 31 May 2020, FBNQ MB’s stage 3 to gross loans stood at 3.2%, a negligible change from the 2019 year-end largely due to the contraction of the loan book. In line with the CBN’s forbearance, in June 2020, the Bank was granted regulatory approvals to restructure loans amounting to ₦17.8 billion. This includes loans granted to obligors in the oil and gas, manufacturing, transport and storage sectors. Owing to this, we anticipate a spike in stage 2 loans in the near-term. Supported by the loan workouts approved by the CBN, we expect the impaired loans ratio to remain within the regulatory threshold. We consider the asset quality of FBNQuest Merchant Bank Limited to be satisfactory. Figure 2: Stage 3 Loans to Gross Loans (FYE 2018 – May 2020)

Net interest spread suppressed by relatively low loan yields

During the 2019 financial year, FBNQ MB made efforts to moderate the impact of relatively high competition within the top-end corporate lending space by diversifying its focus to mid-tier corporates. However, due to a low Interest rate regime, income from the loan portfolio declined by 21.7% to ₦4.9 billion in 2019, despite the 30.6% loan growth in that period. The Bank’s interest income from investment securities also declined albeit marginal by 5.5% to ₦8.2 billion due to the low interest rate environment in the latter part of the year.

Supported by a marked 19.9% reduction in tenured deposits, interest expense declined by 11.9% to ₦10.9 billion. However, stifled by relatively low interest income, FBNQ MB’s net interest spread (NIS) reduced by 100 basis points to 23.7% in 2019. The Sponsor’s NIS for FY 2019 was the lowest since its transition to merchant banking in 2016. FBNQ MB’s NIS was also lower than FSDH MB’s 33.3% but higher than 17.6% recorded by Coronation MB during FY 2019. We expect NIS to be further constrained by the muted growth in lending activities elicited by the pandemic, low Interest rate regime and the adverse impact of a higher cash reserve ratio (CRR). Our outlook for NIS is also hinged on the anticipated increase in funding costs from the Series 1 Bond the planned Series 2 issuance. Nevertheless, we believe the lingering low interest rate environment, coupled with the 100-basis points reduction in the Monetary Policy Rate (MPR) will provide some benefits as deposits are typically repriced faster than loans. FBNQ MB’s impairment charge declined by 74.6% to ₦119.8 million in FY 2019 and accounted for less than 1% of interest income, at par with Coronation MB but lower than FSDH MB’s 2.4%. The decline in the Sponsor’s impairment charge was due to write-backs recorded on provisions made for some financial assets during the

3.6%3.0% 3.2%

FYE 2018 FYE 2019 May 2020

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year. Owing to the naira devaluation and heightened macroeconomic risk, we expect the Bank’s impairment charge to increase in the near-term. Figure 3: Net Interest Spread (FY 2017 – FY 2019)

Non-interest income maintains support to the Sponsor’s earnings profile

During the 2019 financial year, FBNQuest Merchant Bank Limited’s non-interest income increased by 10.5% to ₦6.6 billion and accounted for a significant 67.1% (FY 2018: 62.7%) of net earnings. Ancillary earnings were bolstered by fixed income gains of ₦1.8 billion, a year-on-year marked increase of 53.9%, reflecting the Bank’s discount house antecedence. Supporting non-interest income was the 29.7% increase in fees and commission to ₦4.5 billion. This was largely from a boost in credit-related transactions as brokerage and restructuring fees declined. Nevertheless, fees from this business line remained a significant contributor to fees and commissions, accounting for a significant 55% during the year under review, reflecting capabilities honed by the heritage of FBN Capital Limited. Foreign exchange income dipped by 51.6% to ₦323.2 million while the Bank did not receive dividends from its subsidiaries in comparison to the prior year’s dividend of ₦655.3 million. Owing to the downward review of fees by the CBN effective January 2020 and lower transactional volumes due to the pandemic, we expect some fees and commission lines to decline in the near-term. However, we believe prevailing macroeconomic headwinds will increase avenue for financial advisory transactions and thus, boost the brokerage and restructuring fees. We also expect fixed income trading gains, especially given the relatively low interest rate environment to sustain non-interest income in the near-term. Moderate improvements in operational efficiencies

During the year under review, FBNQ MB introduced cost optimisation initiatives to promote operational efficiencies. However, these initiatives were muted as a result of the adoption of IFRS 16 and the resultant increase in depreciation expense. Consequently, the Bank’s operating expenses (OPEX) declined marginally by 2.8% to ₦7.1 billion. Nonetheless, FBNQ MB made cost savings off some expense lines including fuelling, business entertainment, travelling and training. As a result, the cost-to-income ratio (CIR) declined to 71.9% (FY 2018: 76.3%) but higher than Coronation MB’s 51.6%, FSDH MB’s 49.3% and the banking industry average of 64.3% in 2019. Subsequent to year-end, in the five months to 31 May 2020, CIR improved to 49.7%, upheld

36.2%

24.7% 23.7%

34.1%

28.8%

17.6%

34.9%31.6% 33.3%

2 0 1 7 2 0 1 8 2 0 1 9

FBNQ MB Coronation MB FSDH

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by further improvements in operational efficiencies and earnings growth. In the near term, prevailing inflationary pressures and the naira devaluation is expected to exert pressure on the Bank’s cost profile. However, with the remote work arrangements and other efficiencies elicited by the pandemic, we believe CIR will decline marginally in FY 2020 though will still be higher than its peers. Profitability improved but lagged peers

Upheld by non-interest income and moderate cost savings, FBNQ MB’s profit before taxes increased by 22.5% to ₦2.8 billion in FY 2019. As a result, profitability indicators improved, with pre-tax return on average assets and contingents (ROA) of 1.9% (FY 2018: 1.6%) and pre-tax return on average equity (ROE) of 10.3% (FY 2018: 8.7%). However, the Bank’s ROE was lower the two selected peers – Coronation MB (15.4%) and FSDH MB (18.5%). The Sponsor’s ROE was also lower than the banking industry average of 24.3% and the 13.9% average return on 364-day treasury certificates during the year under review. In our opinion, FBNQ MB’s profitability is subpar.

Subsequent to year-end, in the five months of 2020, annualised ROA and ROE improved to 3.7% and 21.6% respectively. In the near term, we expect unfavourable regulations, particularly in terms of bank charges and CRR debits amidst the adversities elicited by the pandemic to impact profitability. Nevertheless, we believe the Bank’s strong treasury function and anticipated cost savings should sustain performance in the near-term. Figure 4: Profitability Ratios (FY 2019)

Capitalisation is adequate for current business risks

As at FYE 2019, FBNQ MB’s core capital stood at ₦28.3 billion, a year-on-year increase of 10.3% and funded 7.4% of the Bank’s total assets and contingents. The growth in core capital was upheld by the suspension of dividend payments, which boosted revenue reserves by 10.3% to ₦11.3 billion as at the same date. At this level, the Sponsor’s core capital stood significantly higher than the regulatory minimum of ₦15 billion for merchant banks operating in Nigeria. The Bank’s capital adequacy ratio (CAR), computed in line with Basel II accords increased to 17.7% from 12.2% in the prior year. FBNQ MB’s CAR was significantly higher than the regulatory minimum 10% for merchant banks but was the lowest amongst its peers: Coronation MB (19.2%) and FSDH MB (30.7%). In our opinion, the Bank’s capitalisation is adequate for the current level of business risks. The Sponsor intends to issue a medium-term bond in 2020, which will qualify as tier 2 capital. If successful, this will boost capitalisation ratios.

71.9%

1.9%10.3%

51.6%

1.7%

15.4%

49.3%

3.3%

18.5%

C I R P r e - t a x R O A P r e - t a x R O E

FBNQ MB Coronation MB FSDH

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Figure 5: Core Capital and Capital Adequacy Ratio (FYE 2017 – FYE 2019)

The mix of local currency deposits improved albeit marginal

FBNQ MB is funded by deposit liabilities generated from customers, the inter-bank market, commercial papers and borrowings. The Bank also leverages its subsidiaries and affiliation with the FBN Group for the generation of liabilities. However, merchant banks are limited to deposits of ₦50 million per tranche and typically rely on purchased funds. Largely due to the tight regulatory environment, the Bank increased its reliance on funding excluded from the CRR computation. As a result, local currency deposits (excluding inter-bank takings) declined by 9.6% to stand at ₦67.4 billion and funded 43.4% of total assets and contingents as at FYE 2019. The drop was due to a 20% reduction in call and time deposits (purchased or high-cost funds). Consequently, the deposit mix improved, with the proportion of low-cost deposits increasing to 36% from 27% in the prior year. Given limitations in growing low-cost deposits, we do not expect a material improvement in the deposit mix in the near-term. Subsequent to year-end, as at 31 May 2020, the proportion of low-cost deposits declined to 16%. Given the increase in the applicable CRR for merchant banks, we expect the reliance on customer deposits to decline in the near-term. As at FYE 2019, FBNQ MB’s inter-bank takings spiked by 245.4% to ₦27.6 billion and funded 17.8% (FYE 2018: 5.6%) of total assets and contingents. Foreign currency (FCY) deposits dropped by 47.8% to ₦8.5 billion as at the same date and funded only 64.7% of FCY loans. However, this improved subsequent to year-end, as at 31 May 2020, to 98.3%, owing to a 54.4% jump in FCY deposits. In our opinion, we believe speculative activities in the foreign exchange market due to the naira devaluation to sustain the Bank’s FCY deposits in the near-term.

26.3

25.6

28.3

13.5%

12.2%

17.7%

10%

12%

14%

16%

18%

20%

23

24

25

26

27

28

29

FYE 2017 FYE 2018 FYE 2019

billi

ons

of n

aira

Core Capital Capital Adequacy Ratio

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Figure 6: Local Currency Deposit Liabilities (Excluding Inter-bank Takings): (FYE 2017 – May 2020)

The Sponsor’s weighted average cost of funds declined

Notwithstanding the relatively high proportion of high-cost deposits, the low-interest rate environment fostered a 1.5% decline in FBNQ MB’s weighted average cost of funds (WACF) to 10.5% in 2019. However, the Bank’s WACF was the highest amongst the selected peers and the merchant banking average of 9.2% during the same period. In the five months ended 31 May 2020, the WACF reduced further to 5.2% on the back of the lingering low-interest rate environment. Owing to this, we expect funding costs to remain in the single-digit territory in the near-term, notwithstanding higher funding costs from the Series 1 and Series 2 bonds. Figure 7: Weighted Average Cost of Funds (2019)

The liquidity position remains good while mismatches in the funding profile linger

The Bank’s liquid assets, which largely comprised investments in government securities, stood at ₦54.9 billion as at FYE 2019, a year-on-year decline of 12.2%. This translated to a liquid asset to local currency deposits (liquidity ratio) of 42.6%, significantly higher than the regulatory minimum of 20% for merchant banks operating in Nigeria. In our opinion, the FBNQuest Merchant Bank Limited’s liquidity position is good. As at 31 December, there were mismatches in the loan and deposit maturity profile of the Bank, except for the ‘below 90 days’ bucket. This is typically managed through inter-bank takings and commercial papers. However,

20.5 24.1 14.5

82.3 54.1 43.3

77.8

FYE 2017 FYE 2018 FYE 2019 May-20

Low-cost deposits High-cost deposits

10.5%9.9%

8.6%9.2%

FBNQ MB Coronat ion MB FSDH Merchant Bank ing Average

14



the Issue has reduced the mismatches to an extent and the Series 2 bond, scheduled to be issued before FYE 2020, will further bridge the gaps in the maturity profile. The Bank’s staff productivity indicator is below the merchant banking segment average

During the 2019 financial year, FBNQ MB’s average staff strength stood flat at 174 persons (FY 2018: 173 persons). Given the improved performance recorded during the year under review, net earnings attributable to each employee increased slightly by 2.5% to ₦56.9 million. Staff productivity, measured by net earnings per staff to average staff cost, stood at 4 times, slightly higher than the prior year’s 3.7 times but lower than the merchant banking peer average of 5.3 times. In our opinion, staff productivity is satisfactory.

OUTLOOK Despite difficulties within the regulatory terrain, FBNQuest Merchant Bank Limited’s performance improved in the 2019 financial year. The Bank attained higher capitalisation levels; some operational efficiencies were recorded while a strong ancillary income base was upheld by its discount house antecedence. FBNQ MB Bank expects to maintain this trajectory in the near term, through a strategic focus on three core areas:

§ Growing top-line significantly, supported by already initiated cost optimisation measures. § Partnerships and collaborations, especially in unlocking opportunities within subsidiaries and

affiliates § Improvement in staff productivity

Considering the impact of COVID-19 pandemic on all economic sectors, including the business of banking, FBNQ MB intends to adopt a more cautious approach to risk asset creation. However, due to heightened competition in the top-tier corporate segment, the Bank plans to diversify to the mid-tier category in a bid to optimising loan yields. We note that business risk is much higher in the mid-tier category and therefore the Bank's risk management must be proactive. With prevailing inflationary pressures and the incessant devaluation of the naira, the Sponsor’s cost profile will be impacted. However, due to remote work arrangements activated to contain the coronavirus outbreak, coupled with other efficiencies elicited by the pandemic, a considerable level of cost savings is expected in the near-term. The current state of the economy also presents opportunities for the financial advisory and restructuring business lines. Overall, we believe profitability will be sustained by ancillary income while capitalisation will remain acceptable. Despite the increasing level of arbitrary cash reserve deductions by the CBN, we believe the Bank’s liquidity position will remain good. Based on the aforementioned, Agusto & Co. assigns a stable outlook to the Sponsor’s rating and FBNQ MB SPV Funding Plc’s Series 1 ₦5 billion 3-Year Fixed Rate Senior Unsecured Bond. We shall continue to closely monitor the operating terrain for material changes that could impact FBNQuest Merchant Bank Limited.

15



FINANCIAL SUMMARY

FBNQUEST MERCHANT BANK LIMITEDBALANCE SHEET AS AT 31-Dec-2019 31-Dec-2018 31-Dec-2017

₦'000 ₦'000 ₦'000ASSETS

1 Cash & equivalents 3,515 0.0% 2,249 0.0% 1,908 0.0%

2 Government securities 52,869,784 34.0% 52,587,640 36.9% 53,961,271 38.9%

3 AMCON Securities 2,000,466 1.3% 9,900,496 6.9% 6,000,479 4.3%

4 Quoted investments

5 Placements with discount houses

6 LIQUID ASSETS 54,873,765 35.3% 62,490,385 43.8% 59,963,658 43.2%

7 BALANCES WITH NIGERIAN BANKS 1,488,911 1.0% 3,678,982 2.6% 1,925,509 1.4%

8 BALANCES WITH BANKS OUTSIDE NIGERIA 1,047,043 0.7% 1,412,550 1.0% 6,993,120 5.0%

9 Direct loans and advances - Gross 48,005,509 30.9% 36,770,767 25.8% 39,585,410 28.5%

10 Less: Cumulative loan loss provision (1,615,056) -1.0% (1,427,942) -1.0% (432,177) -0.3%

11 Direct loans & advances - net 46,390,453 29.8% 35,342,825 24.8% 39,153,233 28.2%

12 Advances under finance leases - net

13 TOTAL LOANS & LEASES - NET 46,390,453 29.8% 35,342,825 24.8% 39,153,233 28.2%

14 INTEREST RECEIVABLE

15 OTHER ASSETS 8,517,527 5.5% 6,151,414 4.3% 3,993,045 2.9%

16 DEFERRED LOSSES 9,113,548 5.9% 9,113,548 6.4% 9,113,547 6.6%

17 RESTRICTED FUNDS 8,000,335 5.1% 3,879,865 2.7% 2,172,798 1.6%

18 UNCONSOLIDATED SUBSIDIARIES & ASSOCIATES 1,313,329 0.8% 1,381,773 1.0% 1,737,106 1.3%

19 OTHER LONG-TERM INVESTMENTS 8,445,447 5.4% 4,902,151 3.4% 9,005,703 6.5%

20 FIXED ASSETS & INTANGIBLES 2,310,991 1.5% 3,441,472 2.4% 4,631,534 3.3%

21 TOTAL ASSETS 141,501,349 91.0% 131,794,965 92.5% 138,689,253 100.0%

22 TOTAL CONTINGENT ASSETS 13,952,856 9.0% 10,761,510 7.5%

23 TOTAL ASSETS & CONTINGENTS 155,454,205 100% 142,556,475 100% 138,689,253 100%

CAPITAL & LIABILITIES

24 TIER 1 CAPITAL (CORE CAPITAL) 28,266,254 18.2% 25,626,030 18.0% 26,339,624 19.0%

25 TIER 2 CAPITAL (315,728) -0.2% (2,086,380) -1.5%

26 LONG-TERM FOREIGN BORROWINGS

27 Demand deposits 24,143,910 15.5% 20,512,253 14.4%

28 Savings deposits

29 Time deposits 43,330,080 27.9% 54,096,141 37.9% 82,321,467 59.4%

30 Inter-bank takings 27,648,648 17.8% 8,003,945 5.6% 11,639,548 8.4%

31 TOTAL DEPOSIT LIABILITIES - LCY 95,122,638 61.2% 82,612,339 58.0% 93,961,015 67.7%

32 Customers' foreign currency balances 8,547,458 5.5% 16,368,975 11.5% 5,169,517 3.7%

33 TOTAL DEPOSIT LIABILITIES 103,670,096 66.7% 98,981,314 69.4% 99,130,532 71.5%

34 INTEREST PAYABLE

35 OTHER LIABILITIES 9,880,727 6.4% 9,274,001 6.5% 13,219,097 9.5%

36 TOTAL CAPITAL & LIABILITIES 141,501,349 91.0% 131,794,965 92.5% 138,689,253 100.0%

37 TOTAL CONTINGENT LIABILITIES 13,952,856 9.0% 10,761,510 7.5%

38 TOTAL CAPITAL, LIABILITIES & CONTINGENTS 155,454,205 100% 142,556,475 100% 138,689,253 100%

Proof

BREAKDOWN OF CONTINGENTS39 Acceptances & direct credit substitutes 10,310,436 6.6% 8,172,760 5.7%

40 Guarantees, bonds etc.. 3,642,420 2.3% 2,588,750 1.8%

41 Short-term self liquidating contingencies

16



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RATING DEFINITIONS

The first four categories of ratings are investment grade while the last four ratings are speculative grade. The ratings from Aa to C may be modified by the addition of a plus or minus sign to show relative standing within the category.

Aaa Bonds rated ‘Aaa’ are judged to offer highest safety of timely payment of interest and principal. Though the circumstances providing this degree of safety are likely to change, such changes as can be envisaged are most unlikely to affect adversely the fundamentally strong position of such issues.

Aa Bonds rated ‘Aa’ are judged to offer high safety of timely payment of interest and principal. They differ in safety from ‘Aaa’ issues only marginally.

A Bonds rated ‘A’ are judged to offer adequate safety of timely payment of interest and principal; however, changes in circumstances can adversely affect such issues more than those in the higher rated categories.

Bbb Bonds rated ‘Bbb’ are judged to offer sufficient safety of timely payment of interest and principal for the present; however, changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal than for bonds in higher rated categories.

Bb Bonds rated ‘Bb’ are judged to carry inadequate safety of timely payment of interest and principal; while they are less susceptible to default than other speculative grade bonds in the immediate future, the uncertainties that the issuer faces could lead to in adequate capacity to make timely interest and principal payments.

B Bonds rated ‘B’ are judged to have greater susceptibility to default; while currently interest and principal payments are met, adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal.

C Bonds rated ‘C’ are judged to have factors present that make them vulnerable to default; timely payment of interest and principal is possible only if favourable circumstances continue.

D Bonds rated ‘D’ are in default and in arrears of interest and principal payments or are expected to default on maturity. Such bonds are extremely speculative and returns from these bonds may be realized only on reorganization or liquidation.

www.agusto.com

© Agusto&Co.

UBA House (5th Floor)

57 Marina Lagos

Nigeria.

P.O Box 56136 Ikoyi

+234 (1) 2707222-4

+234 (1) 2713808

Fax: 234 (1) 2643576

Email: [email protected]

8 Final Rating Report · BankÕs WACF was the highest amongst the selected peers and the merchant...

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