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Rejoinder to Kemi Adeosun: Walking into a debt crisis by @nonso2

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If you have been observer of the Nigerian economy in the past few years you must have read about the pending debt crisis. The story has been brought to the front burner again recently with the request by the federal government to sell $5.5bn worth of Eurobonds. The question on every observer’s lips is “Will this be the decision that finally tips the government into bankruptcy?”, or is this just yet another false alarm by doomsday conspiracy theorists. To address the fears the minister of finance published an Op-ed, trying to deconstruct the reality of the debt situation. So, should we be worried?

First a bit of background on the debt strategy of this government. Since the oil price crash of 2014 the revenues collected by the federal government have been significantly below expectations. In response to this revenue shortfall, the federal government decided on a strategy of increasing spending, to boost economic output, financing this increased spending by issuing new domestic and foreign debt. On the face of it the strategy makes sense. Increase debt when there are revenue problems and decrease debt during the boom years when revenues exceed expectations. Taking that into account, issuing new debt when view in isolation made sense.

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Theory unfortunately is always different from reality. Nigeria had raised new debt during the boom years. The debt stock increased from N5.3tn in 2010 to N9.5tn in 2014, despite record high oil prices. As the famous saying went, “we were borrowing to pay salaries” in-spite of record high oil prices. The minister rightly points to this as the backdrop of the current debt problem. The previous government did not follow the responsible debt rule of limiting debt expansion during boom years.

However, this information has been common knowledge since 2015. Everyone knew we were borrowing to pay salaries. Everyone knew our spending was out of control and that it was unsustainable. Everyone knew something was wrong. Trying to pin the blame on the not so good debt behaviour of the previous regime is akin to taking control of a car that is heading towards a cliff and saying, “oh well, the previous driver did not drive so well anyway”.

The reality is that, despite the knowledge of the debt situation, the federal government has gone one a debt binge not seen since the years before the 1980s crisis. Between the middle of 2015 and the last official debt statistic, the federal governments debts have increased from N10.4tn to N16.6tn, a 60 percent increase in just two years. The increase cannot be blamed on the devaluation either as much of the debt is domestic debt and the external debt stock has also increased from $10.3bn to $15bn, an almost 50 percent increase. To put this into our analogy, “the driver not only got into a car heading for the cliff, but put the foot on the accelerator”.

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Of course, the minister recognizes this, defending that position by saying according to their forecasts “in the short term, there would be an acceleration in the accumulation of debt and an increase in debt servicing costs”. The hopes on resolving this are pinned on increasing tax revenue. As the plan goes, an improved economy would lead to increased tax revenues and that should, according to the minister, help get the debt under control. The thing is, as everyone also knows, the fortunes of the Nigerian economy are not really connected to the tax collection efforts of the federal government.

A stronger economy does not imply that tax revenues will increase. The data also continues to support that view with non-oil tax revenue looking as flat as the Jos plateau. Could tax revenue miraculously increase in the next few years? Maybe. But Maybe not. I know where I’d place my bets but more importantly for the minister, what happens if tax revenues don’t significantly increase? The reality of the government’s fiscal position now is that 60 percent of revenue is used just to service existing debts, at least if the last budget implementation report is anything to go by.

My advice to the minster is this: rather than try to point fingers at the previous administration, and yes they have to take some of the blame, address the reality of the debt situation and let it be clear to all parties, that if something does not change soon we are really going to have a bankrupt government.

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Spoiler alert: the major “something” that needs to change is the government’s spending habits. If government spending does not slow quickly then they might as well check into bankruptcy court right now. Ironically, the minister hit the nail on the head on the real challenges to slowing spending and preventing a debt crisis: POLITICS. In her words,

“Politically, it offended the principles of the All Progressive Congress” and that is all that needs to be said.

 

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Nonso Obikili is an economist currently roaming somewhere between Nigeria and South. The opinions expressed in this article are the author’s and do not reflect the views of his employers.

 

Patricia
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Why Insurance firms are selling off their PFAs

It has not been uncommon over the years to have insurance companies with pension subsidiaries.

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Why Insurance firms are selling off their PFAs

The idea of mitigating risks and curtailing losses at the bare minimum begins from the insurance industry and only crosses into the pension space with the need for retirement planning. For this reason, it has not been uncommon over the years to have insurance companies with pension subsidiaries. However, controlling the wealth of people is no easy feat – and crossover companies are beginning to think it might not be worth it competing with the big guns; that is, the pension fund administrators (PFAs) that already cater to the majority of Nigerians.

A few months ago, AXA Mansard Insurance Plc announced that its shareholders have approved the company’s plan to sell its pension management subsidiary, AXA Mansard Pensions Ltd, as well as a few undisclosed real estate investments. It did not provide any reason for the divestment. More recently, AIICO Insurance Plc also let go of majority ownership in its pension arm, AIICO Pension Managers Ltd. FCMB Pensions Ltd announced its plans to acquire 70% stakes in the pension company, while also acquiring an additional 26% stake held by other shareholders, ultimately bringing the proposed acquisition to a 96% stake in AIICO Pension. The reason for the sell-off by AIICO does not also appear to be attributed to poor performance as the group’s profit in 2019 had soared by 88% driven by growth across all lines of business within the group.

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 So why are they selling them off? 

Pension Fund Administration is, no doubt, a competitive landscape. Asides the wealth of the over N10 trillion industry, there is also the overarching advantage that pension contributors do not change PFAs regularly. Therefore, making it hard to compete against the big names and industry leaders that have been in the game for decades – the kinds of Stanbic IBTC, ARM, Premium Pension, Sigma, and FCMB. Of course, the fact that PFAs also make their money through fees means the bigger the size, the more money you make. With pressure to capitalize mounting, insurance firms will most likely spin off as they just don’t have the right focus, skills, and talents to compete.

The recent occurrence of PENCOM giving contributors the opportunity to switch from one PFA to another might have seemed like the perfect opportunity for the smaller pension companies to increase their market shares by offering better returns. More so, with the introduction of more aggrieved portfolios in the multi-fund structure comprising of RSA funds 1, 2, & 3, PFAs can invest in riskier securities and enhance their returns. However, the reality of things is that the smaller PFAs don’t have what it takes to effectively market to that effect. With the gains being made from the sector not particularly extraordinary, it is easier for them to employ their available resources into expanding their core business. There is also the fact that their focus now rests on meeting the new capital requirements laced by NAICOM. Like Monopoly, the next smart move is to sell underperforming assets just to keep their head above water.

READ MORE: AIICO seeks NSE’s approval for conducting Rights Issue

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Olasiji Omotayo, Head of Risk in a leading pension fund administrator, explained that “Most insurance businesses selling their pension subsidiaries may be doing so to raise funds. Recapitalization is a major challenge now for the insurance sector and the Nigerian Capital Market may not welcome any public offer at the moment. Consequently, selling their pension business may be their lifeline at the moment. Also, some may be selling for strategic reasons as it’s a business of scale. You have a lot of fixed costs due to regulatory requirements and you need a good size to be profitable. If you can’t scale up, you can also sell if you get a good offer.”

What the future holds

With the smaller PFAs spinning off, the Pension industry is about to witness the birth of an oligopoly like the Tier 1 players in the Banking sector. Interestingly, the same will also happen with Insurance. The only real issue is that we will now have limited choices. In truth, we don’t necessarily need many of them as long all firms remain competitive. But there is the risk that the companies just get comfortable with their population growth-induced expansion while simply focusing on low-yielding investments. The existence of the pandemic as well as the really low rates in the fixed-income market is, however, expected to propel companies to seek out creative ways to at least keep up with the constantly rising rate of inflation.

 

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Patricia
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Nigerian Banks expected to write off 12% of its loans in 2020 

The Nigerian banking system has been through two major asset quality crisis.

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Nigerian Banks expected to write off 12% of its loans in 2020 

The Nigerian Banking Sector has witnessed a number of asset management challenges owing largely to macroeconomic shocks and, sometimes, its operational inefficiencies in how loans are disbursedRising default rates over time have led to periodic spikes in the non-performing loans (NPLs) of these institutions and it is in an attempt to curtail these challenges that changes have been made in the acceptable Loan to Deposit (LDR) ratios, amongst others, by the apex regulatory body, CBN. 

Projections by EFG Hermes in a recent research report reveal that as a result of the current economic challenges as well as what it calls “CBN’s erratic and unorthodox policies over the past five years,” banks are expected to write off around 12.3% of their loan books in constant currency terms between 2020 and 2022the highest of all the previous NPL crisis faced by financial institutions within the nation.  

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Note that Access Bank, FBN Holdings, Guaranty Trust Bank, Stanbic IBTC, United Bank for Africa and Zenith Bank were used to form the universe of Nigerian banks by EFG Hermes.  

READ MORE: What banks might do to avoid getting crushed by Oil & Gas Loans

Background  

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Over the past twelve years, the Nigerian banking system has been through two major asset quality crisisThe first is the 2009 to 2012 margin loan crisis and the other is the 2014 to 2018 oil price crash crisis 

The 2008-2012 margin loan crisis was born out of the lending institutions giving out cheap and readily-available credit for investments, focusing on probable compensation incentives over prudent credit underwriting strategies and stern risk management systems. The result had been a spike in NPL ratio from 6.3% in 2008 to 27.6% in 2009. The same crash in NPL ratio was witnessed in 2014 as well as a result of the oil price crash of the period which had crashed the Naira and sent investors packing. The oil price crash had resulted in the NPL ratio spiking from 2.3% in 2014 to 14.0% in 2016.  

Using its universe of banks, the NPL ratio spiked from an average of 6.1% in 2008 to 10.8% in 2009 and from 2.6% in 2014 to 9.1% in 2016. During both cycles, EFG Hermes estimated that the banks wrote-off between 10-12% of their loan book in constant currency terms.  

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 READ MORE: Ratings firm explains why bank non-performing loans could be worse than expected

The current situation 

Given the potential macro-economic shock with real GDP expected to contract by 4%, the Naira-Dollar exchange rate expected to devalue to a range of 420-450, oil export revenue expected to drop by as much as 50% in 2020 and the weak balance sheet positions of the regulator and AMCON, the risk of another significant NPL cycle is high. In order to effectively assess the impact of these on financial institutions, EFG Hermes modelled three different asset-quality scenarios for the banks all of which have their different implications for banks’ capital adequacy, growth rates and profitability.  These cases are the base case, lower case, and upper case. 

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Base Case: The company’s base case scenario, which they assigned a 55% probability, the average NPL ratio and cost of risk was projected to increase from an average of 6.4% and 1.0% in 2019 to 7.6% and 5.3% in 2020 and 6.4% and 4.7% in 20201, before declining to 4.9% and 1.0% in 2024, respectively. Based on its assumptions, they expect banks to write-off around 12.3% of their loan books in constant currency terms between 2020 and 2022a rate that is marginally higher than the average of 11.3% written-off during the previous two NPL cycles. Under this scenario, estimated ROE is expected to plunge from an average of 21.8% in 2019 to 7.9% in 2020 and 7.7% in 2021 before recovering to 18.1% in 2024.  

Lower or Pessimistic Case: In its pessimistic scenario which has a 40% chance of occurrencethe company projects that the average NPL ratio will rise from 6.4% in 2019 to 11.8% in 2020 and 10.0% in 2021 before moderating to 4.9% by 2024It also estimates that the average cost of risk for its banks will peak at 10% in 2020 and 2021, fall to 5.0% in 2022, before moderating from 2023 onwards. Under this scenario, banks are expected to write off around as much as 26.6% of their loan books in constant currency terms over the next three years. Average ROE of the banks here is expected to drop to -8.8% in 2020, -21.4% in 2021 and -2.9% in 2022, before increasing to 19.7% in 2024.   

Upper or optimistic case: In a situation where the pandemic ebbs away and macro-economic activity rebounds quicklythe optimistic or upper case will hold. This, however, has just a 5% chance of occurrence. In this scenario, the company assumes that the average NPL ratio of the banks would increase from 6.4% in 2019 to 6.8% in 2020 and moderate to 4.8% by 2024Average cost of risk will also spike to 4.2% in 2020 before easing to 2.4% in 2021 and average 0.9% thereafter through the rest of our forecast period. Finally, average ROE will drop to 11.6% in 2020 before recovering to 14.4% in 2021 and 19.0% in 2024. 

With the highest probabilities ascribed to both the base case and the pessimistic scenario, the company has gone ahead to downgrade the rating of the entire sector to ‘Neutral’ with a probability-weighted average ROE (market cap-weighted) of 13.7% 2020 and 2024. The implication of the reduced earnings and the new losses from written-off loans could impact the short to medium term growth or value of banking stocks. However, in the long term, the sector will revert to the norm as they always do.   

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Even with a 939% jump in H1 Profit, Neimeth still needs to build consistency

Neimeth has been one of the better performers in the stock market in the last one year. 

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Even with a 939% jump in H1 profit, Neimeth still needs to build consistency 

Neimeth’s profit after tax for H1 2020 might have jumped by 939% from H1 2019, but there’s still so much the company needs to do to remain in the game. 

For the first time in years, Pharmaceutical companies across the globe are in the spotlight for a good reason.  As the COVID-19 pandemic rages on, the world waits patiently for this industry to produce a vaccine that can once again lead us back to the lives we all missed. Nigeria is also not an exception, it seems. One of Nigeria’s oldest pharmaceutical companies, Neimeth, has been one of the better performers in the stock market in the last one year. However, there is still so much the company needs to do to earn profits consistently. 

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READ MORE: Covid-19: List of pharmaceutical firms that will receive grants from the CBN

Neimeth’s recently released H1 2020 results show a jump of 19.4% in revenue from 976 million earned in H1 2019 to 1.165 billion in H1 2020. While this is impressive, its comparative Q2 results (Jan-March ‘ 20) show a drop in revenue of 25.4% from 748.8 million earned in Q2 2019, to the 568.7 million revenue in Q2 2020. In similar vein, while its profit-after-tax soared by 939% from 5.447 million in H1 2019 to 56.596 million in H1 2020, its quarter-by-quarter results show a drop of 118%. While there is a truth that some months are better performers than others, Neimeth’s extreme profit jump in the half-year results juxtaposed with the more-than-100% drop in the first quarter of this year, reveal wide-gap volatility in its earning potential. Its revenue breakdown attributes the quarter-by-quarter drop in revenue to a comparative drop in its ‘Animal Health’ product line by a whopping 897.42%. The ‘Pharmaceuticals’ line also only experienced a marginal jump of 2.57%. 

Full report here. 

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READ MORE: Nigeria records debt service to revenue ratio of 99% in first quarter of 2020.

Current & Post-Covid-19 Opportunities  

A 2017 PWC report had revealed that by 2020 the pharmaceutical market is expected to “more than double to $1.3 trillion. Mckinsey had also predicted that come 2026, Nigeria’s pharma market could reach $4 billion. The positive outlook of the industry is even more so, following the disclosure by the CBN to support critical sectors of the economy with 1.1 trillion intervention fund.  

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The CBN governor, Godwin Emefiele, had stated that about 1trillion of the fund would be used to support the local manufacturing sector while also boosting import substitution while the balance of 100 billion would be used to support the health authorities towards ensuring that laboratories, researchers and innovators are provided with the resources required to patent and produce vaccines and test kits in Nigeria. 

READ MORE: Airtel to acquire additional spectrum for $70 million 

While manufacturing a vaccine for the Covid-19 pandemic might be nothing short of wishful, the pandemic presents a global challenge that businesses in the healthcare industry could leverage. Through strategic R&D, it could uncover a range of solutions, particularly those that involve the infusion of locally-sourced raw materials.  

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In order for the company to attain sustainable growth, it needs to come up with structures and systems that are dependable, while also tightening loose ends. One of such loose ends is its exposure to credit risk. It’s Q2 2020 reports reveal value for lost trade receivables of N693.6 million carried forward from 2019. To this end, it notes that while its operations expose it to a number of financial risks, it has put in place a risk management programme to protect the company against the potential adverse effects of these financial risks. 

At the company’s last annual general meeting (AGM), the managing director, Matthew Azoji, had also spoken on the company’s efforts to gain a larger market share through its initiation of bold and gradual expansion strategies.  

The total revenue growth and profitability of the half-year period undoubtedly signals a potential in the company. However, we might have to wait for the company’s strategies to crystalize and attain a level of consistency for an extended period before reassessing the long-term lucrativeness of its stock or otherwise. That said, it certainly should be on your watchlist.  

Patricia
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