Securitization: Implications for Economic Development in Nigeria

Securitization is chief among the many financial terms which have gain notoriety and new found (negative) meanings in light of the current global financial crisis, so it will seem very ambitious and even foolhardy to prescribe securitization as one of the tools and policies needed to drive Nigeria’s economic development.

Securitization in its most basic form involves the creation of securities from real assets, i.e. the process of turning real assets into tradeable securities. I believe the genesis of modern securitization is traceable to the pioneering work done on Wall Street to widen accessibility to mortgages by broadening the investor/creditor base for the mortgage markets. Prior to the creation of Mortgage Backed Securities (e.g. Pass through Securities and Collateralized Mortgage Obligations), lenders in the United States were constrained in their mortgage origination efforts by the size of their balance sheet as a result of this the mortgage business was largely a local business. This led to significant imbalances in the borrowing-lending dynamics, with regions of high savings and high growth not always colliding, i.e. there were regions with high savings rate (with large deposits in its lenders’ coffers) that did not have a high housing growth rate and as a result they had few mortgage lending originating opportunities. For a number of high growth regions the reverse was the case, the savings and deposit base was insufficient to fully utilize the mortgage lending opportunities. So there was a scarcity of mortgage lending opportunities in some regions, while there was a glut of mortgage lending opportunities in some other regions.

What securitization achieved was to create a system, whereby mortgage lenders in high growth areas could serve as “loan originators”, they originate mortgages which they repackage as securities which are then sold to investors from all over the world (particularly those from high savings regions such as the Far east). It is such a powerful tool because it creates a system whereby people savings can generate decent rates of return by funding growth opportunities in emerging/high opportunity markets. Through mortgage securitization, a pension fund or High Networth Individual in Norway or China can help finance the acquisition of a house or a car by someone living in the United States or United Kingdom.

Securitization is needed particularly for the Nigerian Housing industry to grow and for us to broaden home ownership in the country, it has been estimated that we may be a shortfall of about 12 Million housing units in the country presently. A conservative cost estimate of N3 Million naira per housing unit will imply that about N36 Trillion (roughly US$257 Billion) is needed to fix our housing deficiency. When this figure is juxtaposed with the 2009 Federal Budget of N2.87 Trillion (roughly US$20.5 Billion) and our current GDP of US$ 166 Billion, one quickly realizes that we are not dealing with small numbers. As the housing market stands, Primary Mortgage Institutions (PMI) who have the primary responsibility for housing finance are woefully under-capitalized (no PMI currently has total assets in excess of US$500 Million)and as such they are severely constrained in their mortgage underwriting efforts by the size of their balance sheets. This situation has led to a regime of a severely under-funded mortage market with full equity payments being the order of the day. In order to truly tap the opportunities inherent in the housing markets, we must broaden access to finance and apply the tools of the Capital Markets.

The Nigerian Capital Markets (i.e. both Equity and Debt Markets) are rapidly developing, with over N1 trillion (US$7 Billion) of Federal Government Bonds Outstanding and a Stock Market Capitalization in excess of US$48 Billion. Futhermore, Total Pension Assets are currently in excess of N1 Trillion (US$7 Billion) and is being projected to double within the next two years. A good way for the housing industry to grow is to develop a secondary market framework for the mortgages which are being created, this will allow the growing domestic and international investor base participate in the financing and development of this sector. If this Secondary Market framework is perfected, PMIs will be less constrained by the size of their asset base in originating mortgage loans. As they will be able to repackage the loans (which meet a certain underwriting standard) for on-selling on the secondary market to raise money for originating a new set of loans. This system will also provide investors (particularly Pension funds) with long term assets to invest their funds, these houses will then serve as a store of wealth whose equity can be tapped into by the homeowners for other productive ventures.

Although Securitization is now associated with unbridled greed and risk taking because of the role securities backed by sub-prime mortgage loans have played in this current economic crisis, it is still a very powerful and useful tool which can help harness savings potential in a country to aid its economic development.

Main Street and Wall Street: The $700 Billion Bailout "Saga"

It is no longer news that the United States Congress has passed the $700 Billion financial sector bailout bill, probably the biggest bailout of the private sector in America. What is noteworthy in the whole episode is the reaction from "Main Street" towards a government bailout of Wall Street Institutions, a reaction so fervent that it most probably led to the first defeat of the bill in the House of Representatives.

There is a tendency for "ordinary folks" and small business owners to dismiss the measures proposed by the Fed and Treasury as nothing more than a bailout of fat cats who ought to be made to suffer for their greed and excessive risk taking. While everybody (including myself) may feel entitled to some feeling of Schadenfraude towards traders who threw all caution to the wind in the urge to deliver record breaking profits and as a result reap obscene bonuses which are beyond the imagination of millions of honest hardworking people. To decide to allow the financial markets collapse in the pursuit of punishing a few thousand traders is tantamount to "cutting off the nose to spite the face" and can only lead to large scale self destruction.

So why should the "ordinary man" care about turbulent financial markets, since they may not even own stocks, not to talk of Collaterised Debt Obligations (CDOs) and other financial "jargons" which have proven to be as opaque and toxic as they sound?. The answer is that the average man should care and he should care a great deal about what is goind on, even though he may not own shares directly the odds are that he may be exposed to the financial markets indirectly either through a mutual fund, a pension plan, his insurance policy etc.

The world's financial markets have grown so interconnected that the phrase "no man is an island unto himself" is probably truer now than ever in global history. People's life insurance policies, college savings plans, mortgages, car loans, credit cards etc are all part of the global financial maze and decisions on Wall Street have real life implications for everyday people. The world has become increasinly dependent on the capacity and ability to securitise all kinds of things from mortgages to car and credit card loans and then trade them in a market. If the securitisation markets dry up completely as it is tending to do, people find that their ability to purchase a house will become severely constrained as mortgage lenders will become severely hampered in their origination efforts due to the absence of a secondary market in which it can sell mortgages to.

Even car ownership will also suffer, automobile manufacturers are very dependent on the ability to finance car purchases by consumers, as most consumers do not pay fully (i.e. 100%) of the car value, hence most manufactures now have fully well developed finance arms, which they have come to depend on in order to boost sales. These finance arms are in turn heavily dependendent on the Asset Backed Securities (ABS) market, in which they repackage the car loans they have originated into securities and sell to investors on wall street, they in tuirn use the proceeds of such sales to originate many more car loans which in turn boosts revenues, corporate profits and job creation efforts. If the ABS markets freeze totally, which might happen if the government bailout doesnt happen, car companies will also be severely constrained in their ability to originate new car loans.

A dearth of new car loans, will lead to a steep reduction in the number of cars sold which will in turn lead to the piling up of unsold inventory. Unsold invesntory coupled with a bleak sales outlook will inevitably lead to plant closures and the attendant loss of jobs by "ordinary people" worlwide who are very dependent on the automobile industry (i.e. auto companies, tyre companies, auto component manufacturers etc). In essence, while the man on the street may feel he has no business being concerned about the markets for "esoteric" ABS instruments on wall street, the truth is that his livelihood and the security of his unionised job (with benefits) may depend on it.

Although I believe that people should not be sheltered from the effects of their own folly, I believe that the government has a greater obligation to maintaining the stability and soundness of the markets than in seeing a couple of wall street execs suffer. I believe the US government should not just throw money at these firms, the government's bailout of the firms should come at a cost to these firms and their excesses should be curtailed and the environment which encouraged the excessive risk taking by these firms needs to be re-examined and rejigged to prevent insurance companies like AIG from acting like highly leveraged hedge funds in the future.

However, in the meantime the US Government should come to the rescue of the Financial Services Sector before it spreads contagion and economic depression to the rest of the world, even though it may seem that Wall Street just got a "get out of jail free" card.

Recent Turmoil in American Financial Markets: Implications for Investment Banking in Nigeria

158 year Old Lehman Brother's recent financial difficulties and eventual bankruptcy filing is a shocking testament to the adverse effects of untamed risk. The firm, one of the Oldest and largest companies, in Wall Street was forced to declare bankruptcy after unsuccessful attempts at getting a buyer for itself failed (due partly to the unwillingness of the US Treasury and Federal Reserve to protect potential buyers against all or some of the risk inherent in a purchase of the company).

Lehman Brothers, with total assets exceeding $630 Billion, represents the largest bankruptcy in US Corporate history and is estimated to be more than 10 times larger than the Enron Bankruptcy. The fact that a firm with less than 30,000 employees and only a couple of offices worldwide was able to generate over $630 Billion in assets, says a lot about its frenzied accumulation of assets and reckless embrace of risk. Lehman brothers, which is the 4th Largest pure play investment bank in America, had experienced rapid growth over the last few years and declared two consecutive full record profits in 2005 and 2006 and Q1 2007. In a bid to boost profitability and generate assets in order to play catch up with much larger rivals such as Goldman Sachs and Morgan Stanley, the company readily originated, underwrote and invested in increasingly opaque and illiquid mortgage instruments with highly questionable credit quality. As defaults from subprime borrowers rose, Lehman became particularly vulnerable as it was highly exposed to the mortgage markets and had invested heavily in the riskiest of these securities in order to boost profits, to cap it all the company was also highly leveraged. Highly Leveraged investments in illiquid securities that was supported by borrowings from subprime borrowers, must sure qualify as a perfect recipe for disaster.

The lessons for the Nigerian markets are quite significant, as the Lehman woes have come at a time when the Nigerian Equity Capital Markets are experiencing a market downturn. The most important lesson from Lehman's bankruptcy episode, is the need to balance revenue and profit growth with appropriate risk management and controls. If appropriate risk management had been deployed by the firm, it will not have invested highly leveraged funds in some of those mortgage securities, which turned out be its nemesis and ultimate undoing. Nigerian investment and securities firms will need to realise that abnormal profits from the stock market are an exception rather than the norm and they must learn to balance the urge for supernormal profits with the need to ensure that the company does not go bust. It is instructive that as late as April last year, Lehman Brothers had just declared the largest quarterly profit in its corporate history, and less than eighteen months later (September, 2008) it was already filing for bankruptcy.


Nigerian securities must start to build appropriate risk controls to manage their exposure to the capital markets, they must be able to have an idea of what their Value At Risk (VAR) is with certain percentage declines in the stock indices. Furthermore, investment and trading committees should include Risk Managers, as it is done in Goldman Sachs where traders and Risk Managers sit together on the trading floor and traders and risk managers are rotated together in positions. Furthermore, John Thain current CEO of Merrill Lynch, had served as both the Head of Mortgage trading and chief financial officer (with responsibility for risk management) at Goldman Sachs before he was appointed as President (number two man) at the investment banking. He therefore had a good grasp of both risk generation, through his trading career, and risk management (through his stint as Chief Financial Officer).

I believe this widespread difficulties being experienced by investment banks across the US should make Nigerian firms (particularly those with active trading operations) reflect on their own operations, strategies and investment policies. How many Nigerian firms know what their Value At Risk is at the end of every trading session or week?. How many of them have risk managers and are these risk managers an integral part of the investment decision process and what is their level of input to investment decision making? Does the firm balance the impulse to generate profits with the need to manage liquidity and ensure quality of risk assets. Are arguments for and against an investment opportunity presented at investment decision meetings? Are the potential upsides and downsides of an investment analyzed and argued before investment decisions are made (this was not done at Lehman brothers as the risk managers were relegated to the background and the traders took over all decision making and characteristically saw only the potential upsides in investing in the ultimately toxic securities)?

Every Nigerian investment house needs to ask itself these questions and answer them in the affirmative if it is to survive in the long term. The devastating effects of untamed risk has been proved by the fact that in April 2007, Lehman Brothers declared the highest quarterly profits in its 158 year history and eighteen months later (September 2008) the company is already in the bankruptcy courts fighting for its survival while talks of liquidation keeps going round.

Virgin Nigeria - "Relocation with Immediate Effect"! : Recent Lesson in Managing Foreign Investors

There has been a lot said and analysed on the recent disagreements between the Federal Government and Virgin Nigeria (a subsidiary of the United Kingdom's Virgin Atlantic Airways). The rift was centered on the initial unwillingness of Virgin Nigeria to move from the Murtala Mohammed Airport's International Airport to the newly Built Domestic wing of the Airport, which was built by a Private Developer under a Build, Operate and Transfer (BOT) agreement with the Federal Government of Nigeria.

The stance of Virgin Atlantic and its chairman, the British serial entrepreneur: Richard Branson, was that the agreement they had with the government at the point of investing in Nigeria stipulated that Virgin Nigeria will always operate from the International wing, while the new Federal Administration continued to insist that the airline move its domestic flight operations from the international wing to the new domestic terminal despite the agreements signed by both Virgin Nigeria and the previous administration of Chief Olusegun Obasanjo.

What I find particuarly disturbing in the entire episode, or should I say Saga, is the manner in which the Federal Government ensured Virgin Nigeria's compliance with its directive. The Federal Government, using security operatives, physically "stormed" the company's offices and grounded its operations. As a result of this, the company had to relocate to the new domestic terminal in order to continue its operations. I believe the government was very wrong in grounding the airline's operations in order to ensure its compliance. Most, if not all, agreements have arbitration clauses which stipulate modalities for resolving disputes and/or disagreements which may arise during the course of the relationship between the parties.

The government should have sought other legal means, including arbitration and litigation, to ensure that Virgin Nigeria complies with its directive. This government has set a bad precedent through its actions, as many foreign investors will be skeptical about investing in Nigeria as they will be unsure of what course of action the government might take in the event of a business dispute or disagreement after they have made their initial investment. In my view, I think it is very important that the Yar'Adua administration tread very softly in dealing with foreign investors, as we do not want to be viewed as being unfriendly to investors. Nigeria needs a lot of
foreign money and technical expertise to drive our economy and we will not advance our

developmental aspirations/plans and our drive for higher Foreign Direct Investments (FDI) by alienating the foreign investors that are already in our economy (as evidenced by indications that Virgin Atlantic may be seeking a buyer for its stake in Virgin Nigeria)

The rule of Law and the democtratic/judicial process may appear slow and inconvenient when we seek quick results, but it is still the fairest and most equitable for resolving business disputes. The earlier we embrace dialogue, eschew unilateral action and institute investment friendly laws and investments, the qucker we wil realise our developmental goals.

Recent Stock Price Declines and Implications for Capital Raising

The recent decline in prices of stocks listed on the Nigerian Stock Exchange has significant implications for capital raising activities. Though few market watchers expect a full blown credit crunch or drying of the capital markets as witnessed in the US and Europe in the last twelve (12) months, it is widely believed that the markets will be a little more discriminating about the quality of the issues that will get financed. What this means is that while high quality companies with well-priced and well packaged issues will still be able to raise equity
capital, it will be more difficult for poorly run companies with questionable valuations to raise capital from the Nigerian Equity Capital Markets.

I believe a relative scarcity of capital is a good thing, as access to capital should be a reward for competent management, clear vision and efficient execution. A number of poorly run companies have been able to raise capital easily in the last one (1) year through Private Placements that were many times over-subscribed as investors sought to take a position in the company pending the eventual listing, and almost certain price appreciation, of the company's ordinary shares. This mentality copupled with ever rising stock prices, led people to invest in companies
they did not particularly undertstand as long as the companies were going to list on the Stock Exchange and scarcity effect was going to push up its share price.

The end result of this over-optimism was that little or no due-dilligence was done by prospective investors and many poorly run or ill-prepared companies were able to raise large sums of money from investors. I believe this situation has grave consequences for corporate performance and the Nigerian Economy as a whole as companies without the structures or operations to deliver good returns on capital employed were raising large sums of money. I believe one of the hallmarks of capitalism is "creative destruction" or the ability to "shoot the mortally wounded"
situations through which companies with crumbling operations and incompetent management are denied funding and allowed to die (to make room for new and innovative companies) instead of being propped up with infusions of capital that will be eroded through bad results.Giving
huge sums of money, in form of equity subscription, to poorly performing companies with questionable strategy and incompetent managements who do not feel the pressure or obligation to deliver value to shareholders is like giving an M16 Assault Rifle to a child soldier and will eventually lead to destruction of shareholder value and long term negative return on capital invested.

The difficulties that I believe poor performing companies will have in raising capital in the near future will have practical implications for the development of Private Equity industry in Nigeria. The ease with which companies have been able to raise money, has placed Private Equity funds in an uncomfortable position as promoters of many small, struggling companies have not been willing to work with such funds. Many promoters and managers of private companies, if given the choice, will opt for private placements rather than receive funds from a Private Equity
Investor. This is because capital raised through Private Placements or Public Offers comes with fewer strings attached to it than Capital raised from Private Equity investors. This is mainly because Private Equity funds usually have higher due dilligence requirements and take a more hands-on approach in monitoring the performance of companies in which they invest and this may not sit down well with company promoters and management that may not want to share control of their companies with a PE investor.

However if struggling companies become constrained in raising capital, they may have to turn to one or more of the new Private Equity funds that have been launched in the last 18-36 months. Private Equity investments can be mutually beneficial to both the PE firms and company promoters and management. This is because PE funds tend to be hands-on investors with significant financial, strategic and operations competencies and are in a position to add some value, apart from capital infusions, to companies in which they invest. The increased levels of monitoring by PE firms, through board memberships and direct executive appointments, will put management "on their toes" and is likely to lead to more disciplined management with the resultant improvements to corporate performance and shareholder value.

Policy Pronouncements and the Recent Performance of Nigerian Equity Capital Markets

Equity Capital Markets in Nigeria have been under considerable strain in the last three (3) months with week after week of sustained price declines and losses. The All Share Index (ASI), the major stock index in Nigeria has witnessed a Year-to-date return of 13% as at Friday, 25th July. The recent deeps in the capital markets have demonstrated the potential downside in investing in equities, as many Nigerian investors have only experienced the upside potentials of the market.

The ever appreciating stock prices had pushed valuations to astronomical heights and led to a capital raising frenzy in the country and many investors and market analysts have been talking of an imminent market correction. In my view the bearish run witnessed on the Stock Exchange was not due to a market correction and return to fundamentals-based investing. I believe the market correction is yet to take place, as the bearish run was precipitated by tightening of credit brought about by policy changes.

The first policy change to hit the markets was the restriction placed on banks from extending margin facilities to Stockbroking firms and from operating margin accounts. Since a large portion of the gains in the markets over the past few months has been due to the activities of leveraged investors with easy access to credit which could be rolled over or paid off from gains from capital appreciation. Hence, a tightening of bank credit, as a matter of policy, will prevent investors from rolling over their margin facilities hence they will have to resort to selling their shares to repay the facilities. This widespread, sustained selling of equities placed an enormous downward pressure on equity prices and led to a freefall of the All Share Index.

The second major policy shift that contributed to the decline was the directive from the CBN that all Nigerian Banks harmonise their financial calendar by having a uniform financial year end pegged at 31st December. Considering the fierce competition in the Nigerian Banking sector and the urge of the various bank managers to be seen as having the largest asset base, it was clear that they will all engage in an all out battle for deposits. Nigerian banks have always engaged in the practice of obtaining huge funds from the Interbank market to beef up their balance sheets towards the end of their Financial years. The uniform year end directive from the CBN led to a near freezing of the Interbank market as banks became reluctant to lend to other banks.

The banks' reluctance to lend coupled with a clear willingness to to attract deposits to boost their balance sheets led to a spike in interest rates and a boom in Money Market activities. When rising deposit and money market rates are viewed in the light of declining stock prices it becomes clear that a good number of investors will move their funds from the stock markets into fixed deposits and money market instruments. This move into money markets resulted in more selling activity on the stock markets with attendant declines in share prices. These policy shifts coupled with already high market valuations led the All Share Index into a negative 11.7% year return.

However, the markets have rebounded in the last one week in the aftermath of the CBN's postponement of the implementation of the Uniform Year End directive to December 2008 to December 2009. This policy shift reduced the pressure on Nigerian banks to engage in aggressive deposit seeking, hence leading to lower fixed deposit and money market rates. The downward pressure on money market rates coupled with the willingness of banks to engage in Margin lending on the stock markets has made more people willing to invest once again in the stockmarket. The sharp increase in Buying activity has resulted in daily gains on the Nigerian Stock Exchange.

I think the overall lesson from this episode of "crashing" prices is the fact that the general investing public now knows that the markets can swing both ways and policymakers will become more aware of the fact that their policy pronouncements can have far reaching consequences and may have a direct, quick and measurable impact on the Financial markets as demonstrated by the CBN pronouncements and the performance of the Nigerian Stock Exchange

Private Equity Investment in Nigeria: Investing in Infrastructure the Best Bet

With Private Equity deals in the US and much of Europe going bust over inability of banks to syndicate the huge loans necessary to fund "the mega buyouts" that became the norm over the past few years and the slowing down of stockmarkets in the same markets, somepeople have written off the ability of the private equity industry to generate alpha returns to its investors.

However, I believe the hope for the Industry lies in exploring uncharted terrritories and extracting more value from their portfolio companies by working with management to improve the performance of such companies. In exploring uncharted territories, few terrains are as unchartered, in Private Equity terms, as Nigeria. There exist substantial opportunities for principal investors in the Nigerian economy to generate higher returns than may be obtainable in Europe or America.

In exploring PE opportunities in Nigeria, there are basically two options available to investors, these are: 1) Investments in Privately Held companies and 2) Investments in Infrastructure projects/deals. Although a number of PE firms, eg Helios, have made some investments in certain quoted companies such as FCMB, I believe this model will not generate superior returns to PE investors, once the Nigerian stock markets "cool down"and normalize. On the privately held company option, a major impediment will be the poor level of financial disclosure by priate companies in Nigeria. This coupled with their often weak corporate governance standards make investing in privately held companies in Nigeria a much more difficult exercise than is the norm in many parts of the world.

Investing in Infrastructure presents a very good investment opportunity, as Nigeria has extremely underdeveloped infrastructure and big rewards await those who can provide it. For instance, electricity supply in Nigeria falls far short of demand and as such most factories rely on "diesel guzzling" generators. There are a number of opportunities for PE firms to invest in Captive power plants that will generate electricity for sale to companies in a restricted area such as the Agbara Industrial area, Ikeja Industrial Estate etc. Furthermore, a company that can get a sustainable business model for providing a good transportation system for transporting large numbers of people in an efficient and comfortable manner.

An example of the gains from investing in Infrastructure is MTN Communications Nigeria, at the time of its creation in the year 2001, the country had less than 500,000 lines. In only Six years of operation, the company is probably the most important member of the MTN Group. The wide gap between the number of lines available and the effective demand for them, led to massive sales and very lucrative margins. Furthermore, PE firms can enter into Public-Private Partnerships to provide certain services to the populace. A very good example will be the concessioning of toll roads, a business model that has been perfected all over the world by Australia's Macquarie Bank, Airports, Sea ports etc. It is clear that Nigeria is on a path of sustained growth and it is clearer still that existing infrastructure in the country cannot keep up with the expected pace of growth. A good strategy may be to invest directly in infrastructure projects or to invest in companies, such as energy companies, port operators etc, with a high exposure to basic infrastructure.

There are profits to be made from investing in infrastructure and though it is not for the faint of heart, the likely gains compensate for the risks involved.