Tuesday, August 11, 2009

Finally Tackling the Nigerian Banking Sector

Finally! The average Nigerian might just get to reap the benefits of another overhaul of the banking sector. The business model of Nigerian banks never ceases to amaze me - from faulty investments in areas they know nothing about (e.g. Oceanic Bank creating an HMO!) to aggressive short-term business lending that ends up constraining rather than stimulating SME growth. New CBN governor, Lamido Sanusi, certainly has his work cut out for him, but I'm hopeful that he will indeed be able to quell the vested interests that have run the industry for so long.

The Magic of Margin Lending - Ayuli Jemide, This Day

The new Central Bank Governor Lamido Sanusi has come into office with a bang. First, he questions the ambitious audacity of the President’s 7-point agenda, next he insists that banks should declare fully in their books the exposure on margin lending. With the second one, he has touched a very sore spot.

About Margin Lending
Margin lending in this context refers to investment loans that Nigerian banks give to customers to enable them invest in shares purchased on the Nigerian Stock Exchange. In most cases, the approved shares, became security for the loan. These types of loans are no longer available as you will see shortly.
I recall a conversation i had with a very entreprenueral former classmate of mine about two years ago. At that time it was the fashion to borrow money from the bank to buy shares and when i told him i could never take a loan from the bank to buy shares, he said he has met people who have a low apetite for risk, but never met someone like me who has “no” apetite for risk.
These were my points as we had this heated debate:
My argument was that the capital market was so risky in Nigeria, and as i heard stories of “quick spin” return on investment of 100-300 % in months, i thought it was getting even riskier. Why? Because in many cases the business fundamentals of the company whose shares just went up did not match their growth. A company share price on the floor of the stock exchange triples (300%) in 6 months but the company itself has not grown 20% in that period. Some “dead” companies were trading on the stock exchange with such high returns whilst their factories had not produced a stitch in 3 years.
I posited futher that from a bankers perspective i wondered how a bank could finance such an investment using the shares as collateral. I was made to understand that investment gurus have said time without number that you should buy shares with money you can afford to lose. Was it not evident that anything could happen on the stock market and that the shares held as security may become worthless if the not very unlikely worse does happen?
It is usually a lending tradition to ask a customer to make a contribution to a business venture while the bank advances a counterpart funding. Not so with majority of margin loans – bankers apetite for risk had risen so high that they could fund a share purchase 100%. Then I came to the conclusion that bankers being the “wise” men that they are must know something about the Nigerian stock market that many of us are oblivious about. This genre of thinking crystallised when i heard that Bank Managing Directors had crossed lent to each other millions of Naira in margin loans. Surely there is a diamond in this rough that only a “discerning investor” can see? And indeed many creamed home to the bank and got out just in time for Christmas.

The crux
Today, it is estimated that Nigerian banks are being owed about 1.4 trillion Naira by customers who took margin loans. This is about 13% of total commercial banking assets as at 2007. Whats more? Now that the share prices (value of the share certificates) held as Security have dropped (or become more realistic?), the customers have said to the banks – go ahead and sell the shares to recover your money. Many can be therefore aptly be classified as bad or doubtful debts, or partially so if they can sell some of the shares at today’s value in a bearish market.
Given this situation the Central Bank believes that a non disclosure of these margin loans in the annual reports of the banks would have the effect of painting the banks in better light than the actual. Which in itself is deceptive to customers and shareholders. The Central Bank therefore demands a full disclosure and herein is the crux of the matter.

What next?
Several trends are bound to follow:
Firstly, there is a likelihood that many banks will suffer an even greater drop in their share price when (or if?) they actually disclose the true state of their margin loan portfolios. The demand for their shares may drop invariably!
Secondly, it is very unlikely that banks will declare huge dividends and bonuses in this season to its shareholders.
Thirdly, it is already happening that banks are calling in more of their credits and there is a credit squeeze in the market because the banks need to beef up their liquidity to cover the deep gash margin loans have left in their books.

One newspaper article concluded that “The thirst to make quick and easy money drove margin lending”. Many banks will in the days to come rework their approach to banking - moving away from the quick to the sustainable - heading back to the traditional banking culture which has a medium to long term view founded on the tradition of customer service.