United States: A Special Report On The Nigerian Banking System: The Ripple Effects Of Lehman - A Tale Of Sin And Redemption?

Last Updated: December 8 2014
Article by Stephen Phillips and Alexander Janes

​This article focuses on the banking sector crisis which engulfed the Nigerian financial sector from 2008 to 2011, and the steps taken by the Central Bank of Nigeria (CBN) in restoring financial stability. We discuss the impact and the opportunities for international and domestic investors resulting from the crisis.

Introduction

In 2005, the CBN mandated all Nigerian banks to increase their capital base1 from ₦2 billion (c.US$12.5 million) to ₦25 billion (c. US$156.3 million) in order to improve their competitiveness on the international market and to increase profitability. Significant capital was raised and as a result, the banks were under pressure to realise greater profits and in turn, generate higher returns to shareholders. Nigerian banks became involved in securities trading, margin lending as well as huge oil and gas financings due to the increase in oil and gas prices at the time, thus fuelling a market bubble. When it hit in 2008, the global recession had a significant ripple effect on the Nigerian banking system. The result was that investors and traders in Nigeria had to liquidate their positions in profitable markets to fund their losses elsewhere. This led to huge exit of foreign investors from the Nigerian capital market and the attendant fall in share prices.

Outset of the Nigerian Banking Sector Crisis

Nigerian banks which had funded acquisitions of shares on the Nigerian stock exchange, found themselves with shares which were worthless and borrowers who were unable to service their loans. Liquidity problems arose for banks due to panic in the financial system and banks had to borrow from the CBN's expanded discount window, through which banks access short term borrowing from the CBN, as a lender of last resort. The CBN having observed the increased activity of a number of banks in the expanded discount window initiated an examination of all banks to ascertain their state of health. This examination revealed a disquieting state of affairs which if not addressed immediately, would have resulted in the systemic collapse of the Nigerian banking sector. The CBN took a number of steps aimed at ensuring the stability of the Nigerian financial system and also restoring public confidence in the banking sector. These steps included, (i) changing the management of the banks; (ii) injecting funds into ailing banks; (iii) providing a guarantee to cover exposure to correspondence and other international banks; (iv) establishing an asset management company to take the non-performing loan (NPLs) out of the Nigerian banking system; (v) recapitalising affected banks; (vi) adopting  a bridge bank model to avoid the liquidation of the ailing banks; (vii) reversing the universal banking model and imposing tighter regulations.

Special Examination of Nigerian Banks

In 2009, the CBN ordered that special examinations be carried out on all banks operating in Nigeria. This special examination carried out by officials of both the CBN and the NDIC2, was in exercise of the CBN's powers under the Banking and Other Financial Institutions Act, 2004 (BOFIA)3, to ascertain the wellbeing of the banks, with particular focus on liquidity, capital adequacy, risk management and corporate governance. The examination revealed that ten of the banks had huge non-performing loan portfolios and nine of the banks were in a grave situation due to deficiencies in capital adequacy. These banks were also found to have significant deficiencies in liquidity, risk management practices and corporate governance4.

The special examination revealed significant erosion of capital and extensive corporate governance malpractices driven by the huge surge of capital availability in banks at a time when corporate governance standards were weak. As banks grew in size and complexity, the growth in assets and the profits of the institutions lulled the management and board of the banks into a false sense of well-being and due to the lack of corporate governance, rules were broken and policies were not complied with. The market thus witnessed insider trading, share manipulation, improper granting of unsecured loans to friends, family and directors and creation of risky assets without any thoughts for the depositors. Disclosures in respect of accounts were falsified; certain banks reported false growth and also inflated their profits and capital. Some banks manipulated their books by colluding with other banks to artificially enhance financial positions and therefore stock prices. Practices such as converting NPLs into commercial paper and bank acceptances and setting up off-balance sheet special purpose vehicles to hide losses were prevalent5.

The examination reports were finalised and revealed that banks had sizable off-balance sheet instruments that concealed NPLs, while in other cases, NPLs were rolled over or otherwise classified as performing loans. Significant governance problems were also identified6. There were many cases of connected lending and undercapitalisation. As a result of the findings, the CBN had to take a number of steps to strengthen the banking industry and to protect depositors' funds. In addition, the CBN had to provide comfort to creditors including depositors and the international community in order to safeguard the integrity of the Nigerian banking system and to prevent a run on the banks. A number of the steps taken are discussed below.

The Reform

Statutory Intervention

Due to the extent of corporate governance weaknesses in the banks which appear to have played a big role in the erosion of the banks' capital, the CBN Governor in exercise of his statutory powers promptly removed the chief executive officers and the executive directors of eight Nigerian banks and appointed new managing and executive directors to serve on the boards of the banks in the interim period. In addition, all ten affected banks were mandated to shore up their capital within a stipulated time frame. The said eight affected banks7 (the Eight) however had to go through a managed/assisted process.

Maintaining Financial Stability through Bailout

The CBN in a bid to ensure that the banks were able to meet their day-to-day liquidity requirements, prevent a bank run and avoid a collapse of the banking sector (since most of the banks involved had large retail networks), injected fresh capital into totalling ₦620 billion (c. US$3.9 billion) as a stopgap. This capital was provided to the affected banks as Tier 2 capital8 in the form of unsecured subordinated convertible loans. In addition, the CBN provided a guarantee of all interbank lending transactions (expired end-December 2011), foreign credit lines, and pension deposits9.

Establishment of the Asset Management Corporation of Nigeria (AMCON)

Due to the enormous volume of NPLs found on the books of all Nigerian banks and especially on the books of the Eight, the CBN conceived the idea of creating an asset management company which would assist in cleaning the balance sheets of these banks and thus assist in restoring stability to the Nigerian financial system. In view of the nature of the role that the asset management corporation was intended to play and following the experience in Ireland and Thailand, it was considered important that such a body should have statutory backing. As a result, a bill for an Act to set up AMCON was sponsored by the CBN. Having passed through the various stages on the floor of the Nigerian National Assembly, the President of the Federal Republic of Nigeria gave his assent to the bill on 19 July, 2010, formally passing it into law10.

NPL Purchases and Bond Issuance

Upon its establishment, AMCON purchased the first set of non-performing loans in December 2010 in exchange for three-year zero-coupon bonds issued by AMCON and guaranteed by the Federal Government of Nigeria. The purchase of NPLs went on into 2012, by which time all the NPLs on the balance sheet of grave situation banks had been cleaned out and the NPLs on the books of all other banks were reduced to 5%. With AMCON's intervention, the banking industry ratio of non-performing loans to total credit was reduced from 34.4 per cent in November 2010 to 4.95 per cent by December 201111.

Recapitalisation – Managed Acquisitions

As part of the resolution of the banking crisis, the Eight were given timelines within which to raise their capital to the regulatory minimum. This process was supervised by the CBN to avoid a repeat of the previous era, where in some cases, capital was fictitiously purported to have been raised. This process involved a number of bidders both international and local, including banks, private equity funds and investor groups. As a result, 5 of the Eight, Intercontinental Bank Plc, Oceanic Bank Plc, Union Bank Plc, Equitorial Trust Bank Plc, and Finbank Plc, were able to find committed investors. However, due to the huge capital deficit within the banks, AMCON had to inject capital into the Eight in order to restore to zero their net asset value, while the capital raised them above the regulatory requirement. In consideration for the capital injection, AMCON was issued equity in these banks12.

The Bridge Banks

Despite the prescribed ultimatum of September 30, 2011 for the recapitalisation of the Eight, three of the Eight (the Three) were unable to secure investors. As a result of this development, in the interest of depositors and in a bid to avoid the costly process of liquidating the banks, which would have been the option available to the NDIC, in view of the negative net asset value of the banks, the NDIC invoked its statutory powers and for the first time since it was established, adopted the Bridge Bank resolution process.

A bridge bank is a temporary national bank organised by the deposit insurance corporation, to takeover and maintain, banking services for the customers of a failed bank. It is designed to "bridge" the gap between the failure of a bank and the time when the deposit insurance corporation can implement a satisfactory acquisition by a third party. Bridge banks are designed to aid in the resolution of complicated, large failing banks and provide the time the deposit insurance corporation needs to take control of a failing bank's business, stabilise the situation, effectively market the bank's franchise, and determine an appropriate resolution. This option which has been adopted a number of times by the FDIC13 in the US is known to assist in resolving complex and large bank failings14. A similar mechanic is available under the European Bank Recovery and Resolution Directive15.

In adopting this measure, the NDIC after due consultation with the CBN as required by law, incorporated three entities which were duly licenced to carry on banking business by the CBN. These bridge banks which had NDIC nominees as shareholders thereafter acquired certain assets and assumed certain liabilities of the Three, pursuant to a purchase and assumption agreement. Under the terms of this agreement, the three bridge banks, namely, Mainstreet Bank Limited, Keystone Bank Limited and Enterprise Bank Limited each acquired all the deposit liabilities and certain other liabilities and the assets of Afribank Nigeria Plc, Bank PHB Plc and Spring Bank Plc respectively. By the provisions of the NDIC Act, Bridge banks are to exist for a maximum period of two years unless otherwise extended by the NDIC. However, the bridge bank status of these banks did not last for two years as AMCON stepped in again to acquire substantial equity holdings in the banks and thereby brought their capital to the required minimum levels.

This step ensured that there was no disruption in banking business, avoided the potential run on the banks and restored public confidence. The bridge banks acquired the assets and liabilities on a Friday and opened their doors to customers of the erstwhile banks on Monday under the bridge banks' names and licences. As a result, the employees of the Three who wanted to continue with the bridge banks were employed whilst those who wanted to leave were allowed to. This process thus not only saved depositors' funds, it also ensured that a lot of jobs were saved.

Prosecutions

Whilst the resolution process was going on, the CBN and the office of the Attorney General of the Federation of Nigeria initiated both criminal actions against the board members of the Eight, who had been implicated in the course of investigations by the Economic and Financial Crimes commission (EFCC). The EFCC had been called in to carry out further investigations following the outcome of forensic audits carried out on the institutions further to the special examinations. As a result, the managing director of one of the banks was convicted further to a plea bargain and was sentenced to prison for her role in the failure of the bank.

AMCON's Mandate

As mentioned earlier, AMCON was established as a stabilisation tool to revive the Nigerian financial system through the efficient resolution of the non-performing loan assets of Nigerian banks. This mandate has been followed through by AMCON through the purchase of Eligible Bank Assets16 at a fair value in accordance with the valuation methodology prescribed in the AMCON Guidelines17. The assets acquired by AMCON are thereafter put to economic use to ensure the realisation of the best achievable financial returns on the assets having regards, to the need to protect or otherwise enhance the long-term economic value of the assets, the cost of acquiring the assets, AMCON's cost of capital and other costs as well as guidelines and directives issued by the CBN18.

In furtherance of this mandate, AMCON acquired about 12,537 NPLs across various sectors, including oil and gas, general commerce, capital markets, manufacturing, finance and insurance19. As consideration for the NPLs purchased by AMCON and capital acquired in the Eight, it has issued bonds to Nigerian banks, worth about ₦5.6 trillion (c. US$35 billion). Some of these bonds have become due and have been repaid, however a large portion of the instruments were refinanced by the CBN in December, 2013. As part of the purchase of NPLs, AMCON has also acquired a significant number of underlying assets which were collaterals for the loans. These assets include, shares in various companies, real estate, bonds and other debt instruments, and other assets. Though most of the NPLs are secured in one form or the other, about 27% of the NPLs are unsecured, leaving AMCON to pursue recovery or restructuring.

In realising its objectives, AMCON has adopted different approaches including restructuring of the loan assets, loan workouts, instituting actions for debt recovery, conversion of debt to equity in order to secure control of the debtor company ahead of a planned divestment, forbearances, etc.

Banking sector sinking fund

One rationale behind establishing AMCON was to achieve a resolution of the banking crisis with minimal impact on depositors, other creditors of the banks, and taxpayers. As a result, the capital of AMCON was a contribution from the CBN and the Ministry of Finance. In addition, it is expected that AMCON would be able to generate enough funds from the loan recoveries as well as realisation of underlying assets to enable it pay off its obligations to bondholders. However, in recognition of the fact that it would require some time to do this, most of the bonds were issued as zero-coupon bonds with a bullet payment at maturity, thus giving AMCON time to work the assets ahead of the maturity of its obligations. In addition, in realisation of the challenge with distressed assets and the average rate of recovery, the CBN together with all Nigerian banks agreed to establish a sinking fund, tagged the Banking Sector Resolution Cost Fund. This sinking fund is to act as a credit enhancement and a form of security in the event that AMCON is unable to generate enough returns from the loan assets to meet its obligations. As a further security and assurance to the bondholders, the bonds are statutorily required to be backed by the full faith and credit of the Federal Government of Nigeria.

The Opportunities

In furtherance of its mandate, AMCON has acquired assets spanning different sectors of the Nigerian economy, including oil and gas, general commerce, capital markets, manufacturing, finance and insurance. Having being in operation for about four years, it has commenced the divestment of its interests in some of these assets with a view to achieving the best realisable financial returns on the assets. These interests include equity interests in companies, including banks, manufacturing companies, etc. In addition, it has plans to divest its interests in physical assets which are part of its asset portfolio.

These assets have generated a lot of interest from both the local and the foreign markets as seen by the number of bids submitted for the purchase of the erstwhile bridge banks, two of which were put on the market further to the request for expressions of interest by AMCON. This process has resulted in Heritage Bank acquiring AMCON's interest in Enterprise Bank Ltd and Skye Bank being named as the preferred bidder for the sale of AMCON's interest in Mainstreet Bank Ltd.  

In addition to the above assets, AMCON recently concluded transactions with Qatar National Bank resulting in the acquisition of AMCON's 12.5% interest in Ecobank Transnational Incorporated and Atlas Mara resulting in its acquisition of 20.9% of Union Bank Plc (formerly Barclays). If these transactions are anything to go by, it is without doubt that the next few years would see a lot of divestments by AMCON from its holdings in various companies and possibly a transfer of the loan assets it has acquired.

Another resolution in the offing

Recent reports20 have alluded to the fact that the Nigerian banking sector may be in need of a rescue soon following the huge exposure of the banks to the Nigerian power sector, further to the privatisation of Nigeria's power sector amounting to about US$1.6bn and the current challenges being faced by the investors in the power assets in servicing their loans. Although AMCON is of the view that its job of acquiring NPLs of Nigerian banks is complete, there may be a requirement for the banks to find a way to clean the NPLs off their balance sheets by selling to AMCON or to other entities.

Conclusion

Resolving the Nigerian banking sector crisis has not been without its hitches and challenges. The CBN, in a bid to avoid a repeat of the banking crisis, instituted tighter regulations and supervisory practices and encouraged healthier cooperation between the various regulators. In addition, the universal banking model was revoked and banks can only carry out the business of banking as envisaged under the BOFIA. This led to a few banks transforming into bank holding companies and others divesting their interests in their non-banking subsidiaries.

A number of court actions were instituted to challenge the bridge bank process as well as the banking reform. AMCON has also faced significant challenges in the performance of its obligations as there has been significant resistance from debtors in relation to AMCON's ability to realise the debts or transfer the underlying assets. A number of hurdles have been overcome by AMCON. In a bid to assist in paving a smoother path for AMCON to carry out its remaining tasks, a draft amendment bill is currently pending before the National Assembly to address some of the challenges being experienced and to make clearer the ambit of AMCON's powers. 

Footnotes

1. Paid up capital and reserves unimpaired by losses

2. Nigeria Deposit Insurance Corporation

3. Section 33, Cap B3 Laws of the Federation of Nigeria, 2004

4. Sanusi Lamido Sanusi, Consolidating the Gains of the Banking Sector Reforms, Lecture delivered at the Sylvester Monye Foundation lecture series on 9 July, 2010. See also CBN Public Statement on the Recapitalisation of Eight Nigerian Banks date 9 June, 2011 available at http://www.cenbank.org/out/2011/pressrelease/gvd/press%20statement%20-%20gov.pdf  

5. See Sanusi L. Sanisu "The Nigerian Banking Industry: what went wrong and the way forward", a paper delivered at the Bayero University, Kano on 26 February, 2010

6. IMF Financial Sector Assessment Program Nigeria – Crisis Management and Crisis Preparedness Frameworks Technical Note May 2013 available on http://www.imf.org/external/pubs/ft/scr/2013/cr13143.pdf 

7. Oceanic Bank International Nigeria Plc, Intercontinental Bank Plc: Equitorial Trust Bank Ltd, Union Bank of Nigeria Plc, Spring Bank Plc, Finbank Plc, Afribank Nigeria Plc, and Bank PHB Plc 

8. Press release issued by the NDIC on 5 August, 2011

9. IMF Country Report No.13/143, May 2013

10. Asset Management Corporation of Nigeria Act, No.29, 2010, hereinafter referred to as AMCON Act

11. Sanusi Lamido Sanusi, Banking Reform and its Impact on the Nigerian Economy, a paper delivered at the University of Warwick's Economic Summit, 17 February 2012, available at http://www.cenbank.org/OUT/SPEECHES/2012/GOV_WARWICK_150211.PDF

12. It should be noted that due to the transaction structures adopted by some of the banks, AMCON's equity was in the acquiring entity and not the target bank.

13. Federal Deposit Insurance Corporation

14. https://www.fdic.gov/bank/historical/managing/history1-06.pdf

15. 2014/59/EU 

16. S.61 of the AMCON Act defined by Eligible Bank Assets as those assets of a bank specified by the governor as being eligible for acquisition by AMCON in accordance with the provision of the Act

17. Issued by the Governor of the CBN further to powers conferred under the AMCON Act

18. Section 4, AMCON Act

19. See www.amcon.com.ng

20. http://allafrica.com/stories/201409220314.html

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