Presented at the NDFF 2012 Conference, Guoman Tower Hotel St. Katharine's Way, London, 24 May 2012 Asset Valuation and Residual Risks to the Nigerian Financial System After the Banking Crisis Resolution Mohammed Garuba Partner, CardinalStone Partners Limited

3 Introduction Economic Overview  The Nigerian economy is the 30 th largest economy in the world and the 2 nd largest in Sub-Sahara Africa with GDP of US$413 billion in 2011, only after South Africa with GDP of US$555 billion in the same year. Agriculture accounts for about 40% of Nigeria’s GDP, though crude oil is the country’s major foreign exchange earner  Crude oil output has been on the increase since 2009 due to reduced militants’ activities in the Niger Delta region -Nigeria is the largest oil producer in Africa, with average crude oil production output of mbpd in 2011 (2008: mbpd)  With a population of about 167 million people, about 61.5 million (2011 est.) constitutes the country’s labor force  It is expected that the reforms currently undertaken by the Jonathan administration will be completed by 2015  Key reforms in the economy include: - Privatization of the power generation and distribution companies to solve the lingering power problems currently faced by the country - Deregulation of the downstream petroleum industry to free up more funds for infrastructural and social development Key Highlights Source: World Bank Economic Indicator

5 What lead to asset valuation bubble  Increase in the minimum capital for banking license from N2 billion to N25 billion announced in July 2004 which was effective December 2005 lead to industry consolidation resulting in the decrease of banks from 89 to 25  Nigerian banks raised about N2.0 trillion between 2004 and 2008  Universal banking and its antecedent risks lead to unmanageable growth and poor corporate governance.  Excess liquidity in the financial system and a rapid increase in credit lead to excessive consumption and bad loans  Due to lack of innovativeness for high return products, banks had limited opportunities to create quality risk assets  Accumulation of huge unsecured risk assets in banks portfolio and high leverage to the stock market and real estate sectors  Huge inflows of foreign portfolio investments into Nigeria and other frontier markets

6 What lead to asset valuation bubble (cont.)  Poor or even non-existent risk management oversight in most Nigerian banks led to the concentration of assets in certain risky areas  The significant exposure of the banks to the capital market via margin loans and direct equity investment threatened banking sector stability, as some banks had their capital fully eroded.  Deplorable internal control processes in banks and lax regulatory oversight influenced poor corporate governance and ethical value system  Liquidity drove the proliferation of financial products which were not well tested or fully understood and this allowed for professionally concealed frauds and high level manipulation of financial activities  Lack of coordination between regulators in the financial market – CBN, NSE and SEC.  Poor regulatory oversight in the capital market lead to price manipulation, over trading and unsupervised capital raising

What lead to asset valuation bubble (cont.) Trend in the Equity Market 7 All-Share Index Performance in 12 years of Democracy Source: Nigerian Stock Exchange

8 Intervention & Reforms The Nigerian Economy  The Central Bank of Nigeria together with the Federal Ministry of Finance in making sure there was stability in the financial system after the burst of the asset bubble set up the Asset Management Corporation of Nigeria (AMCON).  AMCON was set up for the purpose of efficiently resolving the non-performing assets of Nigerian banks thereby helping to achieve equilibrium pricing across most asset classes.  AMCON as a resolution vehicle absorbed the toxic assets of intervened banks and provided liquidity to facilitate the re-capitalization of the banks.  AMCON adopted a fair and transparent valuation basis for the acquisition of margin loans, non- performing loans and bad loans which lead to timely execution for each tranche asset acquisition.

9 Intervention & Reforms AMCON has acquired significant Eligible Bank Assets (EBAs) Source: AMCON’s website, April 2012 DECEMBER 31, 2010 APRIL 6, 2011 DECEMBER 28, 2011 EBA Value Purchased N2.46 trillionN885.3 billionN675.2 billion AMCON Purchase Price – N866.2 billionPrice – N515.2 billionPrice – N377.8 billion All Banking Sector Margin Loans Non-Margin NPLs acquired Systemically important Loans All NPLs of Intervened Banksfrom 22 Nigerian DMBs Repricing of acquired EBAs AMCON purchased total EBAs worth N4.02 trillion at a price of N1.76 trillion

10 Post AMCON intervention Source: CardinalStone Research  The Central Bank of Nigeria (“CBN”) will embark on another round of stress test to reduce systemic risk. CBN to embark on further stress testing and this will help achieve more confidence for the general public.  Regulators requesting forbearance of loans of 95 stockbrokers amounting to N91 billion and foreclose on the collateral.  AMCON, in its bid to support the capital market reforms, is in discussions with various service providers with a view towards creating new products such as ETFs, unit trusts, etc. from its AUM  Rapid pace of financial innovations to help stabilize the market.  AMCON will embark on additional NPL purchase over time in line with the CBN mandate of capping banking industry NPLs at 5%.

Performance of Nigerian Equities versus regional & global peers 11 OverviewNSEASI/African Markets African Currencies/USDNSEASI/Developed markets  NSEASI has lagged African peers in the recovery from the global financial crises despite significant improvement in the profitability of quoted companies. This has resulted cheaper market valuations relative to peers  The Nigerian stock market is not immune to events in the global economy and markets. Recent trends show significant correlation between the NSEASI and global market indices  Less volatile currency (in the last 12 months) relative to peers like the South African rand and the Kenyan Shilling Source: CardinalStone Research

12 Risk Considerations Inherent risk  An Economic downturn  Foreign Investor risk  Foreign Exchange Risk  Regulatory and accounting changes  Infrastructure risk  Interest Rate Risk  Operational Risk

13 Concluding Remarks Source: CardinalStone Research  Banking sector reforms adopted in Nigeria in response to the financial crisis have so far yielded positive results as the reforms were carried out without depositors losing their money  All the Nigerian banks have been fully recapitalized and relative stability has been restored to the financial system  It was very good that no bank was allowed to fail  AMCON will be judged by the level of its impact on the economy and its antecedent cost to the economy  Regulators will need to work together to create a balance in the financial market.  Research has shown that periods of high international capital mobility have repeatedly produced international banking crises, especially if there’s inadequate regulation and supervision at the time of deregulation.  The savings and investment culture amongst local investors in Nigeria needs to improve.

14 Thank you for your attention