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Thursday, 25 September 2014
Nigeria: Eurobonds to the rescue of Nigerian banks
After the 2009 Nigerian banking crisis, the Central Bank of Nigeria (CBN) opted for a risk-based supervision approach in the banking sector to address the inherent systemic risks occasioned by the failure in corporate governance, inadequate disclosure and exposure about financial positions, gaps in the regulatory framework, and uneven supervision and enforcement. Emerging themes in the global economy including the United States’ quantitative easing programme, Eurozone contagion issues and international conflicts in Iraqi, Syria, Ukraine, and Gaza juxtaposed with the whirlwind of domestic reforms has contributed in no small measure to increasing costs and a profitability squeeze in the Nigerian banking sector.
Also, regulatory headwinds such as: the sterilization of public and private sector funds through the hike in cash reserve requirement to 75% and 15% for public and private sector funds respectively; the increased capital adequacy requirements and liquidity ratios for financial institutions designated systemically important banks; and the preparation for the adoption of Basel ll/lll regulatory standards; compelled many banks to adjust their business models and access the international debt capital market as a last resort for augmenting funding gaps and meeting regulatory requirements.
Finally, the growing demand for dollar denominated loans amidst lower interest rates in developed economies increased the frequency of Eurobond issuance by Nigerian banks with circa US$3.9 billion raised as tier ll capital by Nigerian banks from the Eurobond market since 2011 and over US$1.9 billion raised in 2014 alone.
A. Underlying Rationales
The “Too Big to Fail”
In a bid to avoid the systemic contagion effect of the 2009 banking crisis, the regulator identified and classified eight institutions as Systemically Important Banks (SIB). According to the regulator, the banks that made the list were determined by assessing four criteria: size, interconnectedness, substitutability, and complexity. The SIBs currently account for over 70 percent of the banking industry’s total assets. The consequence of this designation is that a SIB irrespective of its status is expected to have a minimum regulatory Capital Adequacy Ratio (CAR) of 16%, hold more liquid assets and meet a liquidity ratio of 5 percent above the minimum requirement currently set at 30%. In terms of capital split, tier ll capital can comprise up to 50 per cent of total qualifying capital hence the resort to Eurobonds as an option to shoring up capital.
Quarantined Public Sector Funds
The sterilization of public sector funds as a fiscal policy initiative of the regulator was to address the following issues: curb “the perverse incentive structure” under which Nigerian banks source huge amounts of public sector deposits at 0% and lend same to the government at 12-14%; promote the financial inclusion strategy of the regulator; mop up excess liquidity in the system that was not being deployed to the real sector; defend the currency and prevent exchange rate volatility as a result of strong foreign exchange demand pressures coming domestically, not necessarily linked to an increase in the import of goods; and also contain inflation risks.
While the jury is still out on whether the quarantining of public sector funds is an albatross or a palliative, the reality is that it has blocked a cheap source of domestic funding and exerted pressure on Nigerian banks to opt for alternative sources of funding such as Eurobonds, Rights Issue, Hybrid Instruments, and Subordinated debt.
Increasing Appetite for Risk Assets
The privatisation of the power sector, divestment of oil & gas assets by the international E&P companies and high-end real estate market continue to sustain the push for dollar denominated loans and these opportunities have significantly contributed to the growth in risk assets by Nigerian banks. In the past five years, US$15billion in asset acquisition deals have occurred in Nigeria’s oil & gas and power sectors with 80% of them done with debt and with the recent rebasing of the economy it is obvious there is still a lot of more appetite. It is therefore not surprising that Nigerian banks ‘have pressed on in a quest to raise more debt funding from the Eurobond market in order to optimize borrowing costs, hedge currency risk and still maximize shareholders wealth’.
Race towards Implementation of Basel II/III
On December 10, 2013, the regulator issued guidelines for the regulatory capital measurement and management for the Nigerian banking system. The guidelines specifies approaches for quantifying the risk weighted assets for credit risk, market risk and operational risk for the purpose of determining regulatory capital; and is meant to be adopted by end of September, 2014. Thus, when the banks release full year 2014 results, they will be reporting Basel II/III-compliant ratios for the very first time. In response to regulatory requirement and in a bid to beat the deadline, Nigerian banks have perfected strategies to raising additional tier I/II capital to meet these regulatory requirements hence resort to Eurobonds, Rights Issue, Hybrid Instruments, and Subordinated debt.
B. Key Legal Issues in Eurobond Issuance Programmes
The following key legal issues should be considered from inception of the issuance programme and in our view are integral to a successful closing of an Eurobond issue particularly from a local law perspective.
Due diligence process
Given the international dimension of the issuance and the statements to be made in the offering circular regarding the Issuer, the due diligence exercise is of integral significance in the issuance process. The diligence process ensures that the proper disclosure statements and representations are made in the offering circular hence reducing the risk that incorrect information is given about the Issuer, the issuance or of the economic, political or financial position of Nigeria.
This is an important consideration particularly for international investors as the international bond market operates on the basis that payments of principal and interest by issuers to bondholders are made gross and not net. In order to incentivise debt programmes, the Federal Government of Nigeria issued the Companies Income Tax (Exemption of Bonds and Short Term Securities) Order 2011 which exempts bonds issued by Nigerian corporate bodies and interest payments thereon from companies’ income tax for a period of ten years from the date of the order. In addition, the Personal Income Tax Act 2004 also exempts from taxation any income earned from bonds issued by corporate bodies.
Unlike most international jurisdictions, stamp duty tax has not been abolished and is still payable in Nigeria on instruments. Based on Sec 22(4) of the Stamp Duties Act (Cap S8, LFN 2004) (SDA), any document executed in Nigeria, or relating, wheresoever executed, to any property situate or to any matter or thing done or to be done in Nigeria must be duly stamped. Consequently, the Trust Deed, Subscription Agreement and Agency Agreement are liable to stamp duty under the SDA. Given the high stamp duty rates in Nigeria, it is advisable that these documents are executed abroad in order to benefit from the provision of the SDA which recognizes that execution of documents can take place offshore provided that such documents be stamped within 30 days after the document has been first received in Nigeria. Therefore payment of duty can be deferred and penalties avoided by executing the document outside Nigeria and then stamping it within 30 days if it ever needs to be produced in Nigeria.
Exchange Control Issues
Exchange controls have been effectively abolished in Nigeria by virtue of the Foreign Exchange (Monitoring and Miscellaneous) Provisions Act, which introduced regulatory monitoring provisions on foreign exchange and allows effective repatriation of foreign exchange legally inflowed into Nigeria through an authorised dealer. This ensures the unqualified remittance of payments of the coupon to the different bondholders in various jurisdictions.
Enforcement of foreign judgement
The governing law and jurisdiction of the transaction documents will be foreign law and foreign courts hence the ability to enforce any judgement secured in international courts in Nigeria will be of significant importance to international investors. There are two regimes for enforcement of foreign judgment in Nigeria and these are: Reciprocal Enforcement of Judgement Ordinance (1958) and the Foreign Judgment (Reciprocal Enforcement) Act (2004). Subject to certain restrictions in the Reciprocal Enforcement of Judgment Ordinance, foreign judgments against the issuer are registrable and enforceable in Nigeria if such judgments are obtained in the High Courts of England, Ireland, Scotland or in any other territory under Her Majesty’s protection to which the Reciprocal Enforcement Ordinance is extended by proclamation.
C. Peculiar Risk Considerations
As with any investment, certain considerations need to be factored by a noteholder when purchasing Eurobonds issued by a Nigerian institution and the key risk considerations in our view are:
Potential Toxic Assets
A significant portion of the approximately US$9billion acquisition funds utilised by investors in acquiring power assets from the Federal Government was raised through debt funding from local banks. Due to the inherent challenges in the gas supply and tariff structure, these assets are operating below capacity and yielding significantly lower than expected cashflows hence there is an urgent need to restructure the credit exposure of the banks. It is expected that most of the Eurobond issuances by Nigerian banks will be targeted at restructuring these loans or providing additional debt capital to turnaround the assets. There is however a growing concern that if these risk assets are not carefully handled it could potential lead to emergence of another era of toxic assets. In recognition of these risks, the Federal Government and industry players have been actively engaging each other on policy palliatives and incentives to mitigate these risks.
Insecurity and Political Instability
The spate of sectarian violence and insurgency plaguing the northern part of Nigeria remains a source of great concern both locally and internationally and continues to have a significant impact of economic activities. Additionally, the success or otherwise of the impending 2015 elections is considered the litmus paper test for the continued ethno-political cooperation in Nigeria. It is however noteworthy that the Government’s recent counter terrorism strategies is yielding fruit and recent performances of electoral commission in Ekiti and Osun gubernatorial elections indicates the innate capacity of the umpire to conduct free and fair elections.
Pressure on Currency/ Currency Mismatch
Payment of coupon will require the greenback biannually to fulfil the Issuer’s obligations to the Eurobond noteholder and with cashflows in local currency; the need for the greenback may exert pressure on local currency and also brings up the issue of currency mismatch.
Given the economic opportunities, significant margins in ROI for potential investors and regulatory headwinds, it is expected that more Nigerian banks will access the international debt capital market in order to bridge the funding gap and meet the local demand for dollar denominated facilities.
An article written in The Euromoney International Debt Capital Market Handbook 2014/2014 by Abayomi Adebanjo Head, Banking, Finance & Infrastructure Practice, Jackson Etti & Edu.