By Adesina Odedina
By all accounts, 2011 is shaping up to be a watershed year for financial markets in Nigeria, with many stakeholders betting a return to loan book stability on the activities of the Asset Management Company of Nigeria (AMCON). Similar to the Troubled Asset Relief Programme (TARP) in the US, AMCON’s aim is to recapitalize banks by buying up distressed loans on their balance sheets; as a consequence, it also shares the same moral hazard concerns that have worried many critics of the TARP.
However, while the jury is still out on the success of the TARP, I fear that prospects for AMCON may be bleaker than is being popularly speculated. Like most Nigerians, I constantly applaud the use of modern solutions to deal with critical capital market issues; however, in this particular situation I feel that the country does not have the market infrastructure necessary to successfully implement AMCON’s stated goals.
Firstly, to fund this toxic debt purchase, AMCON issued 2.5 trillion naira worth of three year, zero coupon bonds on December 31st 2010; with an additional 500 million issuance expected before the end of the quarter. , The plan is for troubled banks to acquire these bonds in exchange for their bad debts, and then sell them in the secondary market to recapitalise and create liquidity. However, with all the political risk inherent in emerging market investing, there can be no reliable indications as to the state of Nigerian secondary bond markets over the next three years, and as a result international bond investors will largely stay away.
But because these securities are largely in competition with sovereign bonds, they will likely be streaky; with domestic interest coinciding with times of sovereign crises. This makes their sale worryingly predictable. It is my fear that banks – being keenly aware of the prospects of these AMCON bonds – will attempt to sell in the secondary markets at the same time. And this increased supply will raise effective interest rates on the bonds, with cascading effects on the rates of rest of the Nigerian economy. The US TARP avoided these problems by being directly tax payer funded; a much simpler proposition, and one which ensures substantial recapitalisation – the paramount concern of both programmes.
Secondly, and most importantly, the method being used for valuing these troubled assets seems uncomfortably simplistic. For example, margin loans backed by shares in listed companies (which account for 40% of the total distressed loan purchase) will be valued across the board at a premium of 60% over the 60 day average share price of relevant listed company. While the merits of taking into account recent under-valuations in the Nigerian stock market are laudable, the proper valuing of distressed assets typically involves a significant degree of quantitative monte carlo simulation modelling. And while this basic valuation method has been attributed to transparency concerns, the fact of the matter is that distressed assets are, by nature, not meant to be transparent . That is precisely why they are so hard to value, and any attempt to pretend otherwise creates more problems than it solves.
And so here’s the picture: the economy is exchanging bonds of uncertain value for potentially mispriced toxic assets. Reliance on the capital markets for solving its own problems is an admirable trait, but in the end, AMCON is owned by both the Central Bank and the Ministry of Finance. Thus, any losses from this scheme will still be borne indirectly by tax payers.
Image via NSE