In this interview with journalists, the Chief Executive Officer, DataPro Group, an indigenous credit rating agency, Abimbola Adeseyoju, speaks on relevance of credit ratings on organisations NIKE POPOOLA was there

As the country’s economy recovers, what impact might the positive trend in output have on credit ratings of Nigerian corporates and the broader risk environment?

Recovery of the economy is generally rating positive but we will also continue to monitor the uneven recovery across sectors and sub-sectors to effectively integrate the impact of recovery or otherwise of each industry on the prospect of the corporates within the sector and implications for their credit ratings and broader credibility. Beyond the general expectation, the impact on companies is often uneven, as different companies have varying vulnerabilities and response rate to changing macros. While some corporates have built relative resistance to macro volatilities, putting in place proactive measures to manage shocks and effectively exploit new opportunities, others are rather reactive. Hence, we do not use a single brush on all corporates. Rather, we drill down to the real fundamentals of each company, taking cognisance of the pros and cons of the macro events.

Nigeria recorded a Gross Domestic Product growth of 5.01 per cent in the second quarter of the year, the highest output growth since 2014. What further impact could this make on the economy?

First, I will like to say the Nigerian economy is relatively resilient. But it is pertinent to put the five per cent growth in context. Notably, the growth partly reflects the low base effect of the 2020, Q2 Gross Domestic Product numbers when the economy shrunk 6.1 per cent. As you may observe, the nominal size of economic output in the second quarter of this year stood at N39.6tn and that is still below the size of the economy in the first quarter when nominal GDP stood at N40.5tn, and worse still, it is far below the size of the economy in the second quarter of 2019.

So, it is good to be excited at this growth feat which marks the third consecutive positive quarterly growth, hence reinforcing the recovery from recession.

Oil production is down to 1.2 million barrels per day from about 1.6 million barrels per day production we had in the second quarter, even as concerns are rising that prices may take a breather at current levels.

While oil sector represents less than eight per cent of the GDP, it may be a drag. Trade and manufacturing took positive turns in the second quarter but increasing foreign currency volatility, precisely at the parallel market may undermine the sustainability of that growth, given impact of relative scarcity of foreign currency for import.

With the Central Bank of Nigeria and the fiscal authority providing support to agriculture, hopefully the sector remains resilient. Likewise, ICT should remain strong, as the telecommunications gear up for new investments in 5G technology, in expectation of NCC receipt of the spectrum and subsequent auction of 5G licences.

How sustainable is this feat, which beat the projected 2.5 per cent GDP growth target of the government?

While I am constructive in my expectation of sustaining the positive growth trajectory, I am conservative on the ability of the economy to sustain the strong five per cent growth posted in the second quarter, given constraints on aggregate demand at all levels, as all the three economic agents are going through patches of income pressure – household income is not growing, thus undermine corporate earnings prospect and of course government revenue trails budget, hence undermining spending capacity, especially with the debt service burden, which represents 42 per cent of 2021 budget but over three-quarter of actual revenue.

This is why we need revolutionary reforms across all major sectors, from oil & gas to agriculture, manufacturing to finance and indeed infrastructure.

We need big push reforms and strong political will to catalyse deserving growth momentum that can change the narratives.

While some aspects of the Petroleum Industry Act remain controversial, it is important to leverage this long-awaited legislation in opening up and revolutionising the sector, with the objective of ensuring increased domestic private sector participation and enhanced benefits to the country.

Considering the impact of the COVID-19 pandemic on corporate cashflows and credibility, what should be the focus of institutional investors holding or seeking to invest in debt instruments at this time?

Institutional investors need to focus on key fundamentals defining the sustainability of businesses. Major shifts in cashflow patterns are oftentimes lagged effects of a few leading indicators, such as the strength of demand for the offerings of a corporate and its competitiveness, major changes in supply chains, cost profile, production margins and profitability.

In addition, the quality of management, corporate governance, regulatory compliance, innovation and softer issues are increasingly important as early signals of business sustainability.

All of these and many salient fundamentals of the operating environment are what credit ratings try to summarise. While a credit rating is neither an assurance nor investment report, it thus provides a foundation for counterparty assessment and investment analysis, being the output of a thorough independent assessment of the credibility of the entity or issuer of a debt instrument.

So, investors and other users of credit rating reports should pay attention to the trend and details of credit ratings, which provides context to the rating.

The Nigerian government had to get Fitch and S&P to assign ratings on its Eurobonds to ensure the international investors bought into the securities both at primary market offering and also in the secondary market. However, FGN raises bonds in the local market every month, without the instruments being rated. Why are the FGN bonds not rated?

Yes, for naira-denominated instruments issued by the Nigerian government, they implicitly carry the highest credit rating possible, being “AAA”, as the full faith and credit of the Federal Government of Nigeria indicates the presumably “risk-free” premium on those instruments, as the Federal Government of Nigeria has full authority to print naira as a way of repayment of the debt, in the extreme situation that it is not able to generate revenue to redeem the bonds. While this should not be the case, as there are consequences for printing money, the fact that the government is the issuer of naira provides comfort on its ability to redeem all Naira obligations.

However, it is different for foreign currency denominated debts, as investors would need the credit rating as a basis of evaluating the capacity of the Federal Government of Nigeria to generate foreign currency revenues to redeem its obligations under such debt programme.

You recently released reports on the rating reviews of some financial institutions. What does this mean for the market?

Credit rating is an independent thorough assessment of the credibility of an entity and its ability to meet obligations over a period of time. In our case, our ratings are valid for 12 calendar months. Even so, we monitor and change the ratings either upward or downward, as may be required, during the rating validity period.

Each rating has its full meaning, and we ensure to define the meaning of this rating constructs in our report. For instance, the “AA-” rating of Zenith Bank, which is two notches below the Sovereign rating of “AAA” indicates that Zenith Bank has a low risk, highlighting its strong financial strength, operating performance, governance, and capitalisation among other factors which suggest its ability to meet obligations as and when due over the next 12 months validity period of the rating.

The rating of course reflects our independent and thorough assessment of the bank, with focus on local currency capacity over the next 12months. While it is neither a solicitation of business or investment for Zenith Bank, it is a summary review report that can guide different stakeholders in appraising the institution. Indeed, it is also a very useful self-assessment report for the management and board, as the rating exercise involves comprehensive engagement with management, and provides salient guidance on how to sustain and improve on the fundamentals of the bank.

What are the key fundamentals that inform your assignment of credit ratings and how do you navigate the risks of subjective factors and conflict of interest of analysts?

Credit ratings are a blend of quantitative and qualitative metrics across different constructs, and it is important to state early in this conversation that the assessment is more forward-looking, even as we leverage on the historical performance in dimensioning the prospect of the business.

Thus, we look at issues ranging from financial performance, competitive positioning, management capacity, governance and regulatory compliance to issues bordering on the capital level and ability to generate both internal and external capital as may be required, operational excellence including risk management practices, and control systems that may expose the business to operational risks.

So, while we have a robust framework that helps to objectively access various components of the risk elements and ensure its closeness to science as much as possible, there is a faint blend of judgement that may arise from the qualitative factors, albeit we moderate this judgement with the rating process controls, including the fact that the rating on any entity or instrument is the decision of a thorough review of the rating committee and not an individual analyst.

This is in addition to ensuring that we mitigate all probable conflict of interest, in line with the ethics and global standards of our profession.

As pseudo umpires in the system, we adhere to the highest level of ethical standards, as we need to set benchmarks and lead the way on governance practices, hence we place the highest premium on our independence, integrity and ensure we prevent all forms of bias that may intervene in our work. Sometimes, clients feel we are paranoid set of people, but it is a reflection of the high ethical standards we must adhere to.

Most smaller institutions, including microfinance banks, which also take deposits or other form of funds from Nigerian retail and institutional clients do not have credit ratings. Why is this so and what are rating agencies doing to change this narrative?

 It is not an elite service, but I presume the low level of education, low enforcement and affordability of the small and medium scale enterprises have limited the penetration of credit ratings.

At DataPro, we are working on a number of initiatives to deepen the credit rating market and make the service accessible to MSMEs, as it may help to catalyse enhanced governance and increased access to credit and broader capital for the MSME players.

One of the initiatives is our upcoming virtual conference, which we are running in partnership with the Association of Issuing Houses of Nigeria, as we aim to further educate the market on the imperatives of credit rating for a post-COVID-19 economic recovery and how best to deepen our market and stimulate capital flows within the Nigerian economy.

Have you had cause to downgrade the ratings of institutions under your coverage and when such happens what is the expected reaction of the market?

Yes, we have many times downgraded the ratings of some of the entities under our coverage for different reasons, including macro, industry and company-specific factors.

When we have such rating action on an entity, it often weakens the ability of the entity to raise capital, as it is a caveat for investors to take caution on such entity, given that a rating downgrade is an indication of deterioration in the fundamentals of the entity.

This does not mean that the entity cannot meet obligation; rather, it shows weakness in its ability. For instance a downgrade from “A-“Rating to “BBB+” does not mean investors cannot invest in the securities issued by the entity, as “BBB+” is still a good investment grade rating but it only signals weakness in the strength of the institution.

Such rating downgrade may mean that investors should demand higher interest rate when lending to such entity, as against when it had a higher credit rating of “A-“.

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