Nigeria debate: Nigeria leads the continent
Capital markets and financial services have advanced dramatically in the past few years across Africa. In this debate, Nigerian bankers and informed foreign peers discuss the achievements and the upcoming challenges.
• Africa has begun to appeal to a much broader range of investors than just emerging market frontier specialists
• However, in such vanguard countries as Kenya and Nigeria, much of capital market development is domestically driven
• Capital market development and general economic buoyancy in such countries as Nigeria have been built on increasingly sound macroeconomic policies in the past few years
• The Nigerian economy is benefiting from its large scale, its regulatory openness to foreign investors and the return home of large numbers of skilled expatriates
• The Nigerian government needs to develop infrastructure more aggressively but with close attention to strategic imperatives
• Bank consolidation in Nigeria has vastly improved and broadened financial services provision
Delegate biographies: Learn more about the panelists
SB, Euromoney Before we look at Nigeria, let’s paint the broader picture and think about Africa. John, what has changed to make more investors look seriously at the continent?
JP, Morgan Stanley The things that have helped drive the story – aside from oil – are increased stability, corporate earnings growth, greater transparency and, maybe most importantly, a strong local stock market with an established equity culture. The analogy I use is India in the middle of the 1990s, where there was an established equity culture – both retail and an evolving institutional environment – as you have in some countries in Africa, notably Nigeria and Kenya – whereas a number of other emerging markets are still nascent in this regard. In Nigeria, the strength of the banking sector, as well as the energy story, has been of particular interest to investors.
Investment in sub-Saharan Africa has only just started spreading out. A year ago, the list of investors we would go to internationally would have been pretty small. Now it’s growing very fast. It’s not just a hard core of people in London with a couple here and there in Europe, the interest in these markets is a lot broader now; and there’s interest from the Middle East, emerging Europe and east Asia now.
There’s a group of investors who have been investing in Africa for a very long time, and they don’t need any education on the Africa story. And then there’s a new group emerging of investors who are starting to look at the market. Now pretty much every major investor either has, or is looking at, developing an Africa strategy.
But the strength really comes from the domestic markets. If you look at the Safaricom IPO in Kenya in which we were involved, the foreign tranche was six times oversubscribed because investors saw value in the economic fundamentals of the country, the strength of the domestic market and a terrific company. The real blowout stat for me, however, is that there were over 750,000 retail applications from the domestic market, substantial oversubscription of the institutional portion from accounts across East Africa – and from a markets perspective there’s something fundamentally very healthy about the fact that international investment has been something of a sideshow, rather than driving it. This is really about these markets emerging from within, rather than outside influences coming in and showing them how to do it.
If you carve up Africa into its broad legacy of colonial constituents, the anglophone regions that seem to be consistent with Anglo-Saxon trans-Atlantic markets, and in particular Nigeria, Ghana and Kenya and of course South Africa, seem to be stalwarts. Then interestingly, the lusophone regions – Angola, Mozambique – are really coming into their own in a way that you, again, wouldn’t have expected. Yet we would all probably have expected francophone Africa to be much more prevalent.
Nigeria – the big picture
SB, Euromoney That’s the continental story. Let’s turn to Nigeria and look first at the macro story. Ladi, perhaps you could start?
LB, FCMB The first thing that Nigeria offers is scale. Investors who wish to invest in the Africa story are able to make investments of significant size and exit them with relative ease in Nigeria. One of the other factors that one has to say about Nigeria is that it’s a very open economy. Most industries welcome foreign investors – look at the average of $15 billion in FDI and portfolio flows in the last two years, according to the Central Bank of Nigeria annual report 2007 – and that is quite different from a number of other emerging markets in which there is an unwillingness to allow foreign investors to have majority stakes in certain sectors. The rate of growth in Nigeria has been among the fastest in the continent, and when you consider that it is a fairly large economy, to be able to achieve that level of growth as well as having size is unique. Clearly, there is an oil component to the economy but Nigeria also presents huge demand-side opportunities. With a population of around 140 million, we now have more than 50 million GSM subscribers, and across the economy there are a number of sectors that are as yet untapped. Just one example: we have significant infrastructure challenges – estimated at $510 billion over the next 15 years – and as capital comes into the market to help fix those infrastructure challenges, GDP will pick up even further and be sustained in the double digits.
BS, Helios I’m Nigerian, so I am probably biased! But I think right now, there are two perspectives. One is that Nigeria the country is going through the phenomenal changes that Ladi mentioned. The return of the diaspora is crucial in creating the mindset as well as the management for the economy. The macroeconomic situation is very strong and there are minimal constraints and regulation on the private sector. And you have very liquid domestic markets, which means that virtually any credible opportunity gets financed. Some investors may feel that valuations, vis-à-vis other countries in Africa, are a bit competitive. But that ignores the fact that there are a vast number of untapped business opportunities. Look at telecoms – there’s still just 30% penetration; look at banking and only 15% of people have bank accounts. So across the country, no matter what sector you look at, it’s at a very, very early stage.
SB, Euromoney What you’ve all focused on so far is the openness and transparency of the private sector. What about the governmental side of things?
JP, Morgan Stanley I think credit improvement and strength of the central bank have been a key factor: $30 billion owing to the Paris Club to BB– credit rating in less than 18 months. The speed at which foreign reserves have built up. The policies and actions of the central bank and the commitment of the government to stick to reforms have clearly been good for the credit story of the country.
SB, Euromoney There’s been some friction between the central bank and the executive – is that positive or negative?
LB, FCMB I think that’s a positive. I recall a couple of years ago that when the minister of finance who led the Paris Club debt negotiation was relieved of her duties, a lot of people felt that would spell the end of macroeconomic policy discipline. In fact, the economy has gotten even stronger, and most people who look at our credit outlook today feel that it’s even more positive than it was in that era, as supported by the recent Fitch rating upgrade. What you’re seeing in Nigeria is a young democracy – one in which various agents within that democracy are willing to challenge each other and build what will be a more robust system. That is a positive development, which will lead to stronger institutions. One of the things you’d have to credit the current administration and the president for is that they are great sticklers for the rule of law, and as far as institution-building is concerned, I think that is a great positive. On the other side, the central bank has achieved things that many countries and economies could not have achieved, such as the banking consolidation; and making that kind of dramatic change has sometimes required moving at a very fast pace. In this process of improvement you are likely to see some friction but it’s certainly not something that would destabilize the country in any way.
BS, Helios I’m not sure the parallel holds. If there is inflation now there should be inflation in Nigeria, but in Nigeria inflation is coming down.
SA, CBC One significant difference is oil. For every dollar rise in oil, India’s import bill goes up a billion dollars.
BS, Helios I think the key point is that we have gone from a past in which there was reckless budgetary discipline; where you had rampant inflation, currency shot to pieces and ‘drunken-sailor’ expenditure by government, to a period right now where you see very clear discipline from the government. So to us Nigerians who’ve seen the cycle over many years, I think it’s as good as actually it’s ever been.
QZ, Merrill Lynch To add to what Baba was saying, one underplayed attraction of Africa is its lower correlation to the rest of the world. And if you want African diversification, then Nigeria is the broadest and deepest market in which to obtain it. Over the last 18 months Merrill Lynch arranged over $1 billion financing in Nigeria, and diversification was one of the themes international investors expressed.
AS, FCMB I feel Nigeria has skipped a few generations. The diaspora lets the country leap an educational generation. We have leapt technological generations – we have more mobile phones in Nigeria than in South Africa, and our banking technology is second to none. In political terms, we have leapt a generation because in a young democracy, challenges typically happen after a second or third term. Here, in the first phase of democracy, institutions are challenging each other in a very pragmatic way. The president has said he has no friction with the central bank, but just wants proper process. Clearly there are going to be challenges and the question is, is Nigeria ready to manage them? Part of the answer to that is we have professionals, both in the public and private sector, capable of meeting them.
BS, Helios Remember that more than 50% of the population in most countries in Africa is under the age of 18. So in the next few years we’re going to have half of our population join the workforce and consuming. The impact of that change is going to be phenomenal.
MK, CBC Again comparing with India, Nigeria has a number of challenges. First it needs not simply to focus on urban growth but also to look at the rural economy, which has been a problem in India. Here the private sector and micro-finance are important. Second, mass migration from rural areas to the cities creates problems if the cities cannot cope. Bombay is creaking. In Lagos the traffic is appalling. The third area is upskilling. Nigeria has to make sure that people coming out of its schools and universities are up to joining the formal economy. If Nigeria gets these things right it will be way ahead of other emerging markets.
The infrastructure challenge
SB, Euromoney A key problem in many emerging markets is infrastructure, to the point where the lack of it ruins the growth story. How will Nigeria avoid this?
SA, CBC Very pertinent point. First, the state governments must be brought closer to the federal government. Second, governments must avoid a transaction-by-transaction approach to infrastructure development. Governments need to take a more strategic approach that not only solves today’s problems, but also takes tomorrow’s growth into account. So build seven airports at once; not one by one because that would take much too long. This also reduces costs. This means close co-operation with state governments, using PPP structures and so on.
LB, FCMB The infrastructure challenge in Nigeria boils down to power and transport. The power challenge is the biggest and is a national issue. Candidly, I think we got that wrong in the last administration and so that leaves the question: ‘Will we get it right this time?’ In transport there are a number of initiatives, from proposed rail projects to toll bridges and roads. Over the next five years we will see a marked difference in Nigeria, but we need quality sponsors.
BS, Helios It’s a combination of fixing what you have right now and trying to do what you can to limit urbanization, because what you fix today becomes a problem in five years’ time if migration to the cities doubles their population. The president has announced an initiative to create a number of new towns in different non-urban centres but we need to do more to limit urbanization.
QZ, Merrill Lynch From an offshore financing perspective, we want to see the Nigerian government being more aggressive on infrastructure. These kinds of projects have long lead times and the deal sizes are very substantial. To get this, capital investors have to be able to see a bankable project with the details and structure in place. Yes, there are projects on the table but they are not at a stage where foreign investors will get involved. Right now the projects are being developed, but if you’re standing on the outside with cash, you don’t have specific deals into which you can invest.
SC, Exotix Obviously there is a huge need for infrastructure but there are different categories of infrastructure project. There are those the government must take responsibility for because they will not be viable or sufficiently attractive for the private sector but serve a critical public function. And they cannot be held back while the system is debating concession frameworks and operator tenders and so on – they have to happen. Then you have the self-contained projects the private sector tends to find attractive, which are the lower-hanging fruit, and it is these new developments with self-contained mall and residential and office complexes, sanitation, power and water, that are springing up from Luanda to Lagos. It’s these projects that are attracting developers and appear to be bankable with foreign investors, in addition to high-traffic roads and bridges, power plants, water treatment facilities, etc. We also need to look at the fact that last year the central bank issued a 10-year bond, so we’ve got a domestic yield curve that goes 10 years, but infrastructure projects on the sovereign side will need to go further than that using public funds. And I do think capital is still an issue for the government. It still has to spend far more than it may have available for all these projects and will have to prioritize what will be funded by the public sector and what will be left to the private sector and the markets.
The banking sector
SB, Euromoney Nigeria has gone through one of the most rapid and profound banking consolidations of any emerging market. What is the situation now?
LB, FCMB Well, in 2004, before the consolidation policy was announced, there were 89 banks with an average capital base of about $6 million. The largest bank in the country at the time had about $150 million of capital, and banks had a hand-to-mouth strategy. They were not involved in financing many of the strategic sectors of the economy – the oil and gas sector was totally outside of the realms of domestic banks, as was infrastructure financing. Even heavy industry, to a large extent, relied on offshore financing. Development finance institutions like the IFC, the African Development Bank and the like were providing much of the long-term financing that was required for the economy. Also, the skills base of the local banks was very low, simply because they did not have the revenue to be able to afford the highly skilled staff that would make a significant impact in the financial services industry. In addition to that, interest rates were typically in the late 20%s to early 30%s, and every dozen years or so there would be a round of bank failures, in which up to 30% of the banks would collapse.
In July 2004, the central bank governor announced the consolidation programme, which was really part of a broader set of policy objectives designed to make Nigeria one of the world’s top-20 economies by the year 2020, and to make it the leading financial centre for the region. This includes a number of policies concerning the convertibility of the naira and liberalizing the foreign exchange market as a whole, as well as banking reform; and when it was announced a lot of people thought it couldn’t be done and there was a lot of resistance. But people realized that the governor was serious and that he had the full backing of the president. Even the international banks, who were initially very sceptical – some even threatening to pull out of the country – raised the capital to meet the requirements.
That reduced the number of banks from 89 to 25 within 18 months by December 2005. Every international bank in the country raised capital, in some cases bringing in up to $160 million to meet that requirement.
Some people argued that this would be too much capital for the banking industry of Nigeria. But two-and-a-half years down the line, even including the international banks who have relatively small balance sheets, there is no bank whose return on equity is below 20% today on the capital they raised then, although there have been further rounds of capital-raising. And I think this showed that when you cross that threshold from being a banking industry that’s focused on the mid-tier corporates in Nigeria, yes, $200 million of capital seems too much, but when you start to play at the same level as the international banks and engage with some of the major corporates and infrastructure opportunities in the country, then even that $200 million very quickly becomes inadequate. That is why in 2007 a number of banks went back into the markets to raise more money. We ourselves raised over $800 million during that period. And today there are around 12 banks with tier-1 capital in excess of a billion dollars, with the largest having tier-1 capital in excess of $2 billion.
That’s the background. Has it been successful? Are banks really stable? Yes. Profitability is good and is increasing; balance sheets have been growing, and the increased revenue base has allowed the banks to attract foreign talent.
However, there are still areas of challenge. One has to be careful that with all this capital that is being brought in, banks are under pressure to deliver revenue, and therefore asset growth has been very fast. However, Nigerian banks are very liquid, maintaining liquidity ratios in excess of 50%. That notwithstanding, I think the asset growth is likely to lead to an increase in the level of non-performing loans in the industry as an average, although, as the larger banks tend to play at the higher end of the corporate market, then you will see the quality of credit generally improving.
SB, Euromoney What about the non-Nigerian view, John?
JP, Morgan Stanley There are clearly a number of very high quality and dynamic players emerging that have benefited from that history and background – such as FCMB, GT Bank, Diamond Bank, for example. And although there has been a lot of capital-raising – around 20 common stock offerings for $15 billion by Nigerian banks in the last 18 months or so. To put that in perspective, there’s been $65 billion raised in Europe for balance sheet repair in the first six months of this year as opposed to that new capital, which is all for growth. And another important qualifier is that out of that $15 billion, around 85% got taken up in the domestic market. Firstly, that emphasizes the amount of liquidity and demand domestically, which is a very big differentiator versus a lot of other emerging markets. Secondly, the $2 billion or so which has been invested by international investors is probably now worth between $3 billion and $4 billion; people have made money in a tough environment for banks worldwide and that, combined with the fact that Nigeria is only just getting on the radar of the mainstream institutional universe, means there is appetite for more.
AS, FCMB The situation is transformed. We have capital; we have robust technology; we have a strict regulatory framework; we have banks focusing on good governance and risk management processes. For the first time we are able to attract the best international talent – Nigerians and others who are relocating to Nigeria.
The challenge now is for Nigerian banks to move into niches like investment banking and consumer banking – there is a huge wealth management opportunity. Nigeria is one of the least insured countries in the world. And only about 10% of the population has a bank account. So the opportunities are enormous.
FW, FCMB We’ve talked about growth in the fundamental economy of Nigeria trending northwards. When you look at the other countries that can be described as similar to Nigeria, economies like Kazakhstan or Russia and so forth, would you say that, given we talk about $10 billion to $15 billion of equity raised for Nigerian banks last year, there’s that same quantum of sub-debt or something in between customer deposits and equity that contributes to the liability side of bank balance sheets that investors can look forward to being issued out of Nigeria?
JP, Morgan Stanley Absolutely. I think one of the next logical steps is capital structure evolution, in which you see a lower tier-2 market developing. European banks have about half the amount of tier 1 in lower tier 2. So yes, we will see more hybrid products, and actually the equity-linked product is specifically appropriate for Nigeria for newcomers.
QZ, Merrill Lynch Interestingly, investors are now beginning to differentiate among the banks. They are looking at business strategy, management quality reporting standards and governance. The top 12 are now viewed very differently from the rest, for example.
FW, FCMB To the point about banks moving into new areas, I think that the rapid acceleration of assets under management in the pension fund sector (it’s thought to be about $7.5 billion and growing) will put downward pressure on domestic interest rates, because many of those assets get allocated to government securities. This will allow people to borrow at lower double digits, and even single digits, where historically anything in the upper double digits kept corporates, and certainly individuals, out of the market and allowed the government to crowd them out, leaving nothing else for banks to do than to put their funds into government certificates.
Combine that with the growth of the private sector as a proportion of GDP, and opportunities for banks to grow their assets will increase very quickly, and I think that’s what you will see going forward.
From FCMB’s perspective on the investment banking side, we’re always looking to sell assets off the bank’s books into the markets, and I think that growing pool of assets under management will present a natural opportunity for us to sell assets domestically. That will differentiate us from some of our competitors.
SC, Exotix I think the proof will be in the deployment of the capital that the banking sector has raised in the past year.
The fixed-income markets
SB, Euromoney Moving to the debt markets, how liquid is the domestic government market and how well has the government managed its yield curve?
QZ, Merrill Lynch The government has created a relatively long yield curve but we see very little appetite from the local players to raise money en masse. Part of the problem is liquidity, with the pension fund market still evolving and local savings limited. So both the banks and the government need to focus on developing the local capital markets and reducing reliance on offshore financing. On the international side, the government hasn’t set a benchmark, which creates a pricing issue for other Nigerian borrowers in the offshore markets. If the government did issue, that would go a long way to developing that side of the debt capital markets.
JP, Morgan Stanley I agree with that. There is a default swap market in five-year for Nigeria, but no benchmark. A sovereign bond would be a big event and a great benchmark.
LB, FCMB I think the reality is the government issues local-currency bonds that range up to 10 years in maturity and the auction process works well. They’re sitting on $65 billion of reserves and they really don’t need foreign-currency debt, especially when we’ve had a fairly negative experience of that in the past. I think the main reason for them going out to do that, as Quinton said, is that it would help some of the private sector issuers have a more transparent benchmark from which to price their own bonds.
SB, Euromoney And is the local fixed-income market accessible to foreign investors?
SC, Exotix Foreign investors aren’t allowed to invest in treasuries with maturities less than one year, but aside from that the market is very accessible. However, we’ve found there’s a bit of a disconnect between the price that the borrowers are currently willing to pay and the price at which the lenders are willing to part with their money. Last year, Nigerian borrowers had a wonderful year but foreign investors now want better terms in a widening credit spread environment. Some borrowers have not yet caught up with that and believe that there’s enough demand in the local market at the lower prices. We have seen a few deals being completed by domestic banks and investors at lower spreads than international investors were able to offer.
QZ, Merrill Lynch Investors have other choices and if you look at the spreads available in comparable emerging markets, they are often better than Nigeria. So I think the challenge is to diversify the investor base into Nigerian debt instruments from the higher-yielding requirement funds, ie, hedge funds, to broader, real money accounts that want to invest for the long haul, because they may take a lot more longer-term view on the pricing.
AS, FCMB And of course the naira is expected to continue appreciating, which is attractive. The foreign-currency bond market is something of a distraction as it would really only benefit a few large corporates and some of the banks – and the latter do not need that help in any case. As far as ease of investor access is concerned, the process of entry and exit is remarkably straightforward in both the equity and debt markets and I think the government has done a good job there.
SB, Euromoney And are there structured vehicles that let investors dip their toes into the market in a more user-friendly way than going straight to the domestic market?
JP, Morgan StanleyYes, but I think there is much more of that to come. We will see rapid development of the public and private debt markets, corporate bonds, bond funds, structured vehicles that enable participation in other credit exposures, project finance, project finance vehicles and so on.
SC, Exotix I’d agree with John. It’s phenomenal over the last six months, let alone 18, how many new funds – Africa funds, sub-Saharan funds, agri-funds, special situations, private equity, etc – are raising money and asking us for deals to invest in. In terms of structured vehicles, some of our investors are set up to participate directly and some invest through an issuance vehicle that allows them to participate through an offshore structure. In terms of the market, I think there’s a lot more to happen. Within Nigeria itself clearly there is much more to do – there is no real repo market, no liquid derivatives markets. So there are great opportunities.
JP, Morgan Stanley And remember, Nigeria is still rated BB–. Based on the fundamentals, if you look three years forward there is a credible argument for investment grade, and if that trajectory is realized, then again the investment opportunities and the markets can expand substantially.
QZ, Merrill Lynch I do think that there has to be more done to extend the tenors of debt available in the market. The infrastructure projects we were talking about need 20- or 30-year financing and you can’t lend that long unless there is decent longer-term funding. The government and private sector have to work together to structure longer-dated instruments to be able to move the debt markets to the next level.
FW, FCMB I think over the past 10 years we’ve seen a dramatic shift in the investor base. Ten years ago in these markets, those investors were very credit-driven, long-only, real money, emerging markets asset managers, cash-driven. Today that group has grown to include cross-over hedge funds, absolute return funds, funds less sensitive to credit ratings per se. I think this provides an opportunity for insurance companies to be creating long-term collateralized instruments, even before the Nigerian government issues a long-term benchmark. I believe that we will see a lot more structured products coming into this market, sooner rather than later, and that that may create the longer-tenor securities Quinton was talking about.
SB, Euromoney Turning to the equity markets, valuations are quite steep relative to other emerging markets and the market is heavily weighted towards banking. How should investors look at Nigerian stocks?
SC, Exotix I think that the banking sector is about 65% of total market capitalization in Nigeria. And I believe it’s also true that P/E ratios are quite high. However, the market has done very well and, as we mentioned before, the increasing tendency of investors to differentiate bank from bank has meant that some stocks have performed very well indeed. What investors will watch closely is how each bank deploys the debt and equity it has raised and how it manages its capital
The market is going through a gradual correction now but we saw good earnings last year and prospective earnings for this year also look healthy. The real challenge for the equities market is to get the corporates/non-banking companies to list on the stock exchange and reduce the relative weighting of the banking sector. With regard to the banking sector, we have heard talk of a possible second round of consolidations between the smaller banks.
JP, Morgan Stanley The concentration on banking is not too big a problem. Although investors would like to get exposure to all aspects of the economy, the banks give you an indirect play on most other sectors. On the valuation side, people focus on short-term metrics when, on an ’09 basis, you can make some pretty compelling arguments.
LB, FCMB And the mix in the market is already changing. In the last nine months alone we’ve had over $5 billion of private placements done in the Nigerian market. Now, if we assume that most people, having issued a private placement, will IPO at a size of at least twice their private placement listing, then we can expect within the next year or so that, just from those private placements now going on to list on the exchange, somewhere between $5 billion and $10 billion of new issues will emerge. In addition, looking at the direct-to-IPO route, we hope to be involved in the first upstream oil and gas IPO that will happen on the Nigerian stock exchange this year; there’s going to be the first telecoms listing on the exchange, and the largest cement concern in the country – which will be worth more than 10% of today’s total market cap – will probably be within the next 12 months. So you will see diversification away from the banking industry.
On valuations, as John says, they may seem quite high but earnings are growing very fast. We as bankers see the quarterly numbers of most of our customers, a number of them being listed, and we’re fairly confident that that earnings growth is representative of the whole economy. Yes, the forward P/E ratio is quite high relative to other African markets or markets that investors would consider similar to Nigeria, but if you take a two-, three-year forward, it’s a dramatically different picture. People have to remember that a lot of companies are growing at 20%, 30%, 40% year-on-year earnings growth, so from that perspective then the valuations are pretty well supported.
SB, Euromoney How easy is it to get reliable information about companies that foreign investors will take seriously and think is credible?
JP, Morgan StanleyCertainly the research industry is at a very early stage and needs to develop as the new groups of investors we’ve talked about come into the market. As far as how companies provide information, I think it’s very case by case at the moment and there’s a big variance.
QZ, Merrill Lynch This is clearly an opportunity for the Nigerian banks, because they’re closer to the action. And we all have a long way to go, not just with disclosure, but with things like reconciling Nigerian GAAP to IFRS, which is not easy. But if Nigerian companies want to attract more mainstream foreign investors, then disclosure will need to improve.
SC, Exotix This is actually driving a huge demand for accountants in Nigeria, in addition to bankers!
AS, FCMB We specifically identified that as a gap in the market so we have invested heavily in research, in order to provide a world-class product for this local market.