Credit Risk Management

1. Overview
2. Authority and responsibility
3. Credit philosophy
4. Responsibilities and functions of key stakeholders in the credit process
5. Internal ratings scale
6. Risk limit control and mitigation policies
7. Classification and provisioning policy
8. Portfolio ratios
9. Margin trading facilities/loans secured by shares
10. Credit risk management outlook

1 Overview

Credit risk management verifies and manages the credit process from origination to collection. In designing credit policies, due consideration is given to the Bank's commitment to:

1. create, monitor and manage credit risk in a manner that complies with all applicable laws and regulations;
2. identify credit risk in each investment, loan or other activity of the Bank;
3. utilise appropriate, accurate and timely tools to measure credit risk;
4. set acceptable risk parameters;
5. maintain acceptable levels of credit risk for existing individual credit exposures;
6. maintain acceptable levels of overall credit risk for the Bank's portfolio;
7. coordinate credit risk management and other risks inherent in the Bank's business activities; and
8. set remedial and recovery actions.

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2 Authority and responsibility

Final authority and responsibility for all activities that expose the Bank to credit risk rests with the Board of Directors. The Board, however, may delegate this authority to the Board Credit Committee, the Executive Committee (Credit), the CRO or other officers with credit risk management responsibilities.

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3 Credit philosophy

The following principles guide credit risk management across the Bank. The Bank shall:

1. deliberately manage its risk asset portfolio to ensure that the risk of excessive concentration to any industry, sector or individual customer is minimised, as well as ensure portfolio flexibility and liquidity;
2. ensure that exposures to any industry or customer are determined by the regulatory guidelines, clearly defined internal policies, debt service capability and balance sheet management guidelines;
3. extend credit to only suitable and well-identified customers and never where there is any doubt as to their ethical standards and record;
4. never extend credit where the source of repayment is unknown or speculative nor where the purpose/ destination of funds is undisclosed;
5. never take a credit risk where ability of the customer to meet obligations is based on the most optimistic forecast of events. Risk considerations shall have priority over business and profit considerations;
6. ensure that the primary source of repayment for each credit is from an identifiable cash flow from the counterparty's normal business operations or other financial arrangements. The realisation of security remains a fall-back option;
7. adopt a pricing model that reflects variation in the risk profile of various exposures to ensure that higher risks are compensated by higher returns;
8. ensure that products to be sold in the retail market are backed by approved product programmes;
9. ensure that the quantum of exposure and quality and value of collateral required are determined based on the risk profile of the counterparty;
10. avoid all conflict of interest situations and report all insider-related credits to appropriate bodies; and
11. ensure that there are consequences for non-compliance with the Bank's credit policies.

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4 Responsibilities and functions of key stakeholders in the credit process

Credit Analysis and Processing (CAP) is responsible for the appraisal of credit requests and processing through to final decision.

Specialised Lending Department (SLD) was set up to take advantage of growing opportunities in project financing of all types and real estate developments across various sectors of the economy. This is in order to build capacity in the understanding and assessment of credit proposals in these areas.

Apart from project finance, SLD is also responsible for the appraisal and processing of credits such as credit programmes in conjunction with Products and Channels Division, credits to financial institutions, restructuring of impaired assets (sub-standard or doubtful) and public sector transactions (excluding cooperative societies of civil servants).

Credit Risk Management (CRM) is responsible for the planning of the credit portfolio, the monitoring of loans on an obligor and portfolio basis as well as the reporting of these to Management and the Board. It is also responsible for controlling and ensuring that conditions set out for obligors are met before disbursement of funds. CRM has ownership of all rating systems/scorecards and recommends and monitors the credit risk appetite for the year and reports periodically to the Board and the Management. CRM also manages the Retail Collections Unit responsible for calling retail customers with past due obligations of 1–59 days to promptly correct irregularities detected on these category of accounts.

Classified Assets Management (CAM) is responsible for the recovery of classified loans that are 360 days past due and the provision of strong support to recovery units with the business development officers recovery teams on other accounts.

The above structure ensures the separation of policy, monitoring, reporting and control functions from credit processing functions, thus ensuring sound credit governance.

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5 Internal ratings scale

In measuring credit risk of loan and advances to customers and to banks at a counterparty level, the Group reflects the following components: (i) the character and capacity to pay of the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and its likely future development; (iii) credit history of the counterparty; and (iv) the likely recovery ratio in case of default obligations – value of collateral and other ways out.

The Group's rating scale, which is shown below, reflects the range of default probabilities defined for each rating class. This means that, in principle, exposures migrate between classes as the assessment of their probability of default changes. The rating tools are reviewed and upgraded when necessary. The Group regularly validates the performance of the rating and their predictive power with regard to default events.

5.1 Obligor Risk Rating (ORR) system

The obligor risk rating grids have a minimum of eight risk buckets to provide a pre-set, objective basis for making credit decisions.

Each risk bucket may be denoted alphabetically and range of scores as follows:

5.2 Collateral Risk Rating (CRR)/Facility Risk Rating (FRR)

• The Bank does not lend to speculative grade obligors, on an unsecured basis. The Facility Risk Rating (FRR) is different from the Obligor Risk Rating (ORR) to the extent of the perceived value of enhancement provided.
• The Collateral Risk Rating grid indicates the acceptable collateral types rated 1–8 from best to worst in order of liquidity.

Collateral Type	CRR
Cash/treasury bills	1
Marketable securities, guarantee/receivables of investment grade banks and corporates	2
Enforceable lien on fast-moving inventory in bonded warehouses	3
Legal mortgage on residential business real estate in prime locations A & B	4
Legal mortgage or debenture on business premises, factory assets or commercial real estates in locations A & B	5
Equitable mortgages on real estates in any location	6
Letters of comfort or awareness, guarantee of non-investment grade banks and corporates	7
Hypothecation, negative pledge, personal guarantee, clean	8

The Security Grouping Matrix places the ORR against the CRR, and indicates the level of approval that would be required for each mix.

The Facility Risk Rating (FRR) calculation is as follows:

• FRR (investment grade obligors):
  • – For all ORR 1 – 4, FRR = ORR.
  • – Except where CRR < ORR, FRR = CRR (e.g., if a 'BBB' rated obligor gives stocks, FRR will be 2 not 3). The rationale for this rule is to recognise the value of liquid collateral/enhancement, such as cash, marketable securities and receivables of investment grade banks/corporates.
• FRR (non-investment grade obligor, depending on collateral provided):
  • – For all ORR > 4 with CRR < = 2, the FRR = CRR (e.g., if 'BB' rated obligor gives cash, FRR will be 1, considering the value of collateral provided).
  • – For all ORR > 4 with CRR < 2, the FRR = (ORR + CRR) / 2 (e.g., if a 'B' rated obligor give a debenture over assets, FRR will be 5).

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6 Risk limit control and mitigation policies

The industry and portfolio limits are set by the Board of Directors on the recommendation of the ED/Chief Risk Officer. Credit Risk Management monitors compliance with approved limits.

6.1 Portfolio limits

The process of setting the limits is as follows:

• The Bank engages in a detailed portfolio plan annually. In drawing up the plan, the Bank reviews the macroeconomic factors, identifies the growth sectors of the economy and does a risk rating of the sectors to determine its acceptable target market industries and exception. The Bank's target loan portfolio is then distributed across acceptable target market industries, strategic business unit and approved product programmes.
• Aggregate large exposure limit of not more than 400% of Bank's shareholders' funds.
• Industry/economic sector limits are imposed on the Bank's lending portfolio, in line with the following policies:
  • – The Bank's target market are companies operating in industries rated 'BB' or better unless on an exception basis.
  • – The Bank would not have more than 20% of its portfolio in any group of positively correlated industries in terms of risk (e.g., oil exploration and oil service, tyre manufacturing and tyre distribution).
  • – The Bank would strive to limit its exposure to any single industry to not more than 15% of its loan portfolio and such industry must be rated 'BBB' or better.
  • – No more than 10% of the Bank's portfolio would be in any industry rated 'BB'.

6.2 Geographic limits

• Presently, the Bank does not have any exposure to counterparties domiciled outside Nigeria. Such exposures are taken by its subsidiary in the United Kingdom, which operates within country limits defined by its Board of Directors. However, the Bank has a fully developed country risk rating system, that could be employed, should the need arise. In such eventuality, limits will be graduated on country risk rating.

6.3 Single obligor limits

• Limits are imposed on loans to individual borrowers. The Bank as a matter of policy does not lend above its Regulatory Lending Limit, which is 20% of its shareholders' funds unimpaired by losses. The internal guidance limit is however set at 15% of SHF to create a prudent buffer.
• Also, the Bank will not ordinarily advance beyond 50% of customers' shareholders' fund/net worth in cases of loans offered under individual assessment.
• Product programmes contain guidelines on single obligor limits.
• Except with the approval of the Board of Directors, the Bank shall not lend more than
  • – 20% of the Bank's shareholder's funds to any company. Only companies rated 'A' or better may qualify for this level of exposure.
  • – No single retail loan should amount to more than 0.2% of total retail portfolio.
  • – No single retail loan should amount to more than 0.5% of the related retail product portfolio.

The Group also sets internal credit approval limits for various levels in the credit process and these are shown in the table below:

Approval limits are set by the Board of Directors and reviewed from time to time as the circumstances of the Group demand. Exposure to credit risk is also managed through regular analysis of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing these lending limits where appropriate.

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7 Classification and provisioning policy

Provision is made in accordance with the Prudential Guidelines for Licensed Banks issued by the Central Bank of Nigeria for each account that is not performing in accordance with the terms of the related facility as follows:

Classification	Past due obligation	Provision
Performing	<1–89 days	1%
Sub-standard	>90–179 days	10%
Doubtful	>180–359 days	50%
Lost	>360 days	100%

7.1 Write-off and recoveries

After full evaluation of a non-performing exposure, in the event that either one or all of the following conditions apply, such exposure shall be recommended for write-off:

• Continued contact with customer is impossible.
• Recovery cost is expected to be higher than the outstanding debt.
• Amount obtained from realisation of credit collateral security leaves a balance of the debt.
• It is reasonably determined that no further recovery on the facility is possible.

All credit facility write-offs shall require endorsement at the appropriate level as defined by the bank. Credit writeoff approval shall be documented in writing and properly initialled by the approving authority.

Whenever amounts are recovered on previously written-off credit exposures, such amount recovered is recognised as income on a cash basis only.

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8 Portfolio ratios

8.1 Asset quality ratios

Non-performing accounts have been recognised, classified and provisions made as appropriate in line with the prudential guidelines, giving a loan loss coverage of 67% (see chart below). Provisions required by Central Bank of Nigeria as a consequence of the special examination conducted in the year have also been recognised. Non-performing loans/total loans ratio for the period was 8.10%, mainly due to the recognition and classification of weak and impaired assets in the portfolio.

Non-performing exposures are defined as exposures with past due obligations >90 days. Loans move from performing status to sub-standard, doubtful and lost, depending on objective criteria based on the number of days past due as shown below.

	December 09 (N'MN)
Performing	1,019,936
Non-performing
– Sub-standard	15,144
– Doubtful	30,812
Lost	35,116
Interest in suspense	7,434
Total	1,108,442

Asset quality ratios (%)

8.2 Performing but past due loans

Loans and advances less than 90 days past due are considered performing, unless other information is available to indicate the contrary. Gross amount of loans and advances by class to customers that were past due but performing are as follows:

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9 Margin trading facilities/loans secured by shares

1. Exposure secured by shares (quoted and unquoted) stood at N53 billion, which represents 5% of total loan portfolio (TLP). However, exposure against quoted shares was N38 billion and accounts for 3% of total loan portfolio. There is a freeze on lending against shares and so new lines were not approved in the period under review.
2. As a result of a significant drop in prices of quoted stock in the year, total value of shares (quoted and unquoted) held as collateral on the total portfolio was N48.51 billion with portfolio coverage of 89.7%.
3. N17.60 billion or 32% of total exposure is secured by an unquoted stock with portfolio coverage of 119.32%. FirstBank exceptionally accepted the unquoted shares of a large telecommunications company as partial security for loans to investors in its private placement. Although the stock is not listed, liquidity risk is fair in over the counter (OTC) trading. All facilities have adequate margin coverage either in cash or quoted shares, and have not been affected by the drastic drop in prices of shares quoted on the Nigerian Stock Exchange.
4. Non-performing accounts have been classified in accordance with the Prudential Guidelines.
5. Remedial strategy on the portfolio is to recover past due obligations on non-performing accounts, restructure performing exposures against realistic cashflows, and pursue gradual workout.

9.1 Oil and gas facilities

1. Exposure to the oil and gas sector stood at N169 billion, representing 15% of total loan portfolio (TLP) with 96% of the portfolio performing.
2. This sector remains an area of growth for the Group, and transactions that meet our risk acceptance criteria will be consummated. We will, however, ensure that attendant risks are identified, mitigated and proactively monitored. Weak assets will also be recognised in line with the provisions of the prudential guidelines.

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10 Credit risk management outlook

The global economic crisis has translated into sharp declines in asset values/quality, economic activity, abrupt loss of liquidity, extreme volatility and instability throughout the financial system. Notwithstanding, we will continue to focus on the growth sectors of the economy through strategic portfolio planning, supported by sound risk identification, measurement, control, monitoring and reporting.

We will ensure that asset quality is not compromised through constant review of our risk appetite definitions and risk acceptance criteria. The level of risk asset growth is also expected to reduce relative to prior periods. Therefore credits will only be extended to suitable and well-identified customers.

The credit process will be enhanced to address prevailing challenges, while credit models will be subjected to periodic validation for the purpose of obtaining necessary assurances. Portfolio stress tests will be adopted as appropriate, to consider implications of scenarios that may seem relatively unlikely but could pose serious risks to the institution if they crystallise. The SAS risk management module and business analytics will be a useful tool in this regard to develop models and test and validate different business scenarios.

We will continue to strengthen specialised lending, credit analysis and credit monitoring through both internal and external trainings.

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