Written by MOODY’S
On 5 March, Bank of Uganda (BOU), the central bank, published its quarterly financial stability review showing that banks’ restructured loan balance declined 38% to UGX4.8 trillion (about $1.3 billion) as of 31 December 2020, from UGX7.7 trillion in April. Restructured loans accounted for 29% of total loans at year end, down from 45% in April, indicating normal performance of some pandemic-related problem loans, a credit positive.
Stanbic Bank Uganda Limited (B1 stable, b21), the only Moody’s-rated Ugandan bank, reported that restructured loans are about 14% of its loan book as of June, and we expect the ratio fell to around 10% by year-end 2020.
Despite this decline in restructured loans, asset risk remains elevated for Ugandan banks. We expect the banks’ nonperforming loans (NPLs) to rise because of their still-large stock of restructured loans, large exposures to pandemic-vulnerable sectors and high volume of foreign-currency loans. The banks’ ratio of NPLs to gross loans rose to 5.3% as of year-end 2020 from 4.9% at year-end 2019. The relatively modest increase in the 2020 ratio reflects the restructuring of 29% of all loans because of pandemic-related adverse effects, and a 12% increase in loan originations that increased the NPL ratio’s denominator.
The remaining stock of restructured loans is vulnerable to slower economic activity (we expect Uganda’s real GDP to grow by 3.0% this year compared to average GDP growth of 5.4% from 2015-19). And, loans that needed a second restructuring to avoid becoming nonperforming more than doubled to UGX606.2 billion at year-end 2020, from UGX264.1 billion in August 2020. Restructured loans that are past due by at least one installment increased more than 5x to UGX764.5 billion over the same period.
We estimate that if banks classify 12.5% (the proportion of loans that were restructured twice) of their outstanding restructured loans as NPLs, the NPL stock would increase to UGX1.49 trillion, about 8.9% of gross loans. The increase would reduce the banks’ specific provision coverage to 27% from 45%, exposing banks to capital erosion if loan losses were to materialise.
Banks’ exposures to pandemic-vulnerable sectors are also high. Loans to the trade sector accounted for 16.6% of system loans in 2020, despite contracting 4% during the year. Personal and household loans, which tend to be unsecured, increased 9% in 2020, and were 17.4% of total loans. Loans to the transport sector increased 12% in 2020 because of strong growth in the road and rail subsector although they account for only 2% of total loans (6% when telecommunication loans are added). Lending to the agricultural sector comprised 12% of total loans, leaving banks exposed to uncertain crop yields.
Ugandan banks have high sectoral concentrations to pandemic-vulnerable sectors
Systemwide loans exposure by sector, as of December 2020
Building, Mortgage, Construction and Real Estate 20%
Personal Loans and Household Loans 17%
Community, Social & Other Services 8%
Transport and Communication 6%
Other sectors 8%
Sources: Bank of Uganda and Moody’s Investors Service
Ugandan banks also have large single-name concentrations, exposing banks to the risk of a default by one or a few borrowers. According to BOU, the proportion of large exposures to capital was 111% at year-end 2020. The proportion of large exposures increased to 43% of total loans in 2020, from an average of 39% in 2010-19.
Ugandan banks are also exposed to a depreciation of the local currency as they have 37% of total loans in foreign-currency at yearend 2020, exposing banks to a higher probability of corporate defaults in the event of a significant Ugandan shilling depreciation. We believe some foreign-currency loan borrowers earn revenue in shillings, and a substantially weaker shilling would require higher shilling cash flow for them to meet foreign-currency loan repayments.
However, Ugandan banks tightened lending practices during the coronavirus pandemic, which will likely limit NPL formation in 2020 vintage loans. Ugandan banks’ solvency also benefits from its solid capital adequacy ratio. As of year-end 2020, the systemwide ratio of regulatory capital to risk-weighted assets was 22.2%.
Peter Mushangwe, CFA, Analyst
Moody’s Investors Service
Antonello Aquino, Associate Managing Director
Moody’s Investors Service