Investment Banking Pay Structures: What are shareholders paying for?

It is a well known fact that Investment Bankers, traders and salesmen are some of the most highly paid professionals on God's green earth. Even the near collapse of the global financial and economic system has not succeeded in burying multi year guaranteed contracts or multimillion dollar paychecks.

One question that I seem not to have answer to is: why are investment bankers and traders so highly paid? Yes the hours are crap and job security should be described more in the lack of it. But do investment bankers work harder than Resident Doctors, I really don't think so. Is the job security any worse than that of military or police officers, whose careers - and indeed lives - can be easily terminated by a posting to a war zone or a chance encounter with a trigger happy bandit. So we cannot justify the outsized pay by citing job insecurity or hazard, so what drives investment banker pay?

Another often cited rationale for astronomical pay is that traders often make so much money for the company that they are guaranteed a cut of the profits - sometimes as much as 50% - as compensation. However, a bigger question that needs to be answered is who made the money in the 1st place, the trader or the Bank?. Will the same trader have been able to make as much money if he had been working for a lesser name, without access to teams of research analysts, structurers, systems people and access to real time trading flows?. Will Andrew Hall - the Citi energy trader to whom a $100 Million paycheck is due - have made so much money if he had been working for some nameless XYZ securities firm?. I seriously doubt it!. A lot of his success can be attributed to the stellar cast that Citi has been able to amass to support his efforts. He has access to the best systems, the best analysts, a far-reaching and global informal information gathering network and a whole lot of other things. So if a lot of an investment bank's success is attributable to teams of people working in concert, why are individuals then as richly rewarded as they currently are in Wall Street and the City of London?.

Let me clear, I believe that the capital markets play a very central role in ensuring the proper functioning of the world's economy. Without capital markets and the work being done by the often maligned bankers and traders, we would all still be economic cavemen. Without bankers and traders, excess capital will accumulate in one region of the world or country while other opportunity-rich regions remain starved of capital. That being said, the skills/knowledge required to be a successful investment banker/trader are neither exceptional nor scarce. Though some bankers/traders invented options, swaps and other mind bending derivatives, the truth is that the bulk of investment bankers - including many that earn million dollar bonuses - just originate and process deals. The mental aptitude required for investment banking is not on the same page as that required to be a world class poet, a Nobel prize winning physicist, brain surgeon or a Fields medal winning mathematician. Investment banking does not require or demand "out of this world" skills and as the British City Minister said "Derivatives traders and others are not footballers and should not be paid as if they are". Well said!

Although I don't support explicit pay caps for bankers, because I believe it is an example of an externality that can impair markets and unduly stifle innovation. However, the current global downturn should not be allowed to go to waste, shareholders and chief executives have a chance to force through tough pay reform measures while the financial jobs market is still soft and this has to start from the bulge bracket investment banks. Bulge bracket investment banks - such as Goldman Sachs, Morgan Stanley etc - should actually pay out the least bonuses rather than be industry leaders in terms of compensation packages. They need to develop compensation models and systems that strip out the portion of their firms' revenues and profits that are franchise/reputation driven and those that are employee initiative driven. The truth is that if Goldman Sachs pitches for 10 capital raising mandates, it would get at least 2 or 3 due to its market reputation and global coverage, even if the banker(s) making the pitch(es) is(are) near completely clueless!. It is therefore not very smart to reward a banker for free-riding on the bank's reputation in this manner.

I think bankers' compensation are business decisions that are best handled by shareholders and not by governments. However, shareholders need to be aware that the current compensation models need not be cast in stone and like any discerning buyer they must demand to know exactly what value/"alpha" they are getting from the bonuses they are paying the bankers and traders that work for them.

Much Ado about Islamic Banking

A lot of hot air has been blowing over the recent pronouncements of the CBN regarding Islamic Banking in Nigeria. With many commentators and analysts - who should know better - mentioning it as evidence of a sinister religious and/or northern agenda at play in the ongoing banking sector reforms. Although it is commonly said that there is no smoke without fire, I am convinced trhat that there is no fire in the smoky discussions - or much better: allegations, surrounding the CBN Governor's pronouncemnets on Islamic Banking.

First of all, the CBN is not trying to "introduce" islamic banking into Nigeria, as this form of banking has already been introduced and tested in Nigeria decades ago. Habib Bank (now part of Bank PHB) was licensed to carry out Islamic Banking activities- among other things - in Nigeria in 1981. Furthermore, Jaiz Bank International Plc has already obtained the greenlight - conditional upon meeting the minimum capital requirements - from the CBN to operate non-interest banking in Nigeria since 2004. That the go-ahead was obtained in 2004, under the stewardship of Joseph Sanusi - a Southern Christian - should allay the fears of cynics who view slamic Banking through the biased lenses of tribal and religious sentiments.

Secondly, an important characteristic of democracy is the opportunity it gives various segments of a pluralistic society - such as ours - to express themselves. A large number of Nigerians are muslim and many of them are desiropus of financial products, systems and institutions that are compliant with the dictates of their religion. To deny them of this opportunity - because some people are uncomfortable with the sound of the name - is not only undemocratic it is condescending and near paternalistic. Islamic Banking is one of the fastest growing fields of modern finance, with conservative estimates of assets in the field now exceeding US$ 500 Billion. Shariah-compliant financial products now cut across Investment Banking (i.e. Sukuk Bonds), non-interest bearing deposits and asset management products. Matter of fact, a Shariah compliant equity fund has been offered in Nigeria since 2008 and is even listed on the Nigerian Stock Exchange.

Lastly, one thing is clear: the decision to offer (or not offer) Islamic Banking is a business decision. For an Islamic Bank to kick off - or even raise private capital - a legitimate business need must exist for it and this legitimacy cannot be legislated into existence by lawmakers or the regulators. If there is no consumer base for Islamic Banking in Nigeria to justify its practice, then it will fail. That is the simple law of the business jungle!. Islamic Banking has been growing the world over, because it has found a ready customer base and it is serving legitimate business needs. Even non-Islamic issuers - such as the very German state of Saxony-Anhault - have found Sukuk Bonds to be an attractive and cost-effective financing tool.

I think the tribal and religious sentiments being whipped up in the wake of the Nigerian Banking sector is despicable and indicative of a worrying trend towards abondoning logical arguments in favour of sensationalism. I agree that this trend is not specific to Nigeria, even American critcics of Barack Obama's reform agenda have accused him of wanting to "Kill Grandma!". A discussion outside of the facts of the case is wrong and the people who should know better but keep on whipping these dark sentiments are doing the entire nation a disservice.

This argument should not be about a "northern agenda" or an "islamic agenda" or an attempt to "snatch the banking system from southerners". What is material to this discussion is whether or not certain executives at the helm of our financial institutions have acted in contravention of established laws or regulation and by so doing earned their day in court. It should be about whether or not certain executives at the helm of our financial system have acted in ways that put the Nation's financial at serious risk. I don't have answers to these questions and I think the accused people should be assumed innocent until proven guilty. However, I am certian that painting the CBN governor's action in a sinister and sectarian manner does everybody a lot of harm. Let's have an enlightened discussion please!

Corporate Debt Markets in Nigeria: Emergence of Green Shoots?

True to their typical bandwagon form, Nigerian Corporates (particularly the Banks) have been falling over one another to announce one multi-billion naira bond issuance programme or the other over the last few weeks. These programmes are designed to cover potential multiple bond issuances across various maturities and structures over the next 2 years (which is the typical life of a Shelf filing in Nigeria). Some of the deals announced include: GTBank Plc - N200 Billion (US$ 1.4 Billion), First Bank Plc - N500 Billion (US$ 3.5 Billion) and UBA Plc - N500 Billion (US$ 3.5 Billion). Many more of such deal announcements are expected in the coming weeks.

Though I am very skeptical of the chances of success of these Jumbo Bond programmes and slightly disgusted at the "follow follow" nature of their potential issuers, I am generally pleased with their implications for the financial markets and economy. Corporate Debt has been, and remains, an underinvested asset class in Nigeria with the last publicly issued corporate bond being Access Bank's Convertible Bond issued in 2006. Since its redemption, the number of corporate bonds in issue in Nigeria amounts to a grand total of" ZERO!.

Despite the flurry of announcements, the building blocks of a decent corporate bond market are largely non-existent in Nigeria. There is no network of corporate bond dealers willing to make markets, settlement platforms for bond trading are largely non-existent while skilled and experienced hands in bond structuring are few and far between. Furthermore, the Stamp Duty and other related charges on primary debt issues make bond issuances a very expensive proposition for would be issuers.

Despite this, the story is not all gloomy. The considerable success of the Federal Government of Nigeria (FGN) Bond market and its network of Primary Dealers/Market Makers (PDMMs) may be leveraged on in corporate bonds. FGN Bonds are so liquid and highly traded that annual volume of trades last year exceeded that of the Nigerian Stock Exchange (NSE) handsomely. The banks and Discount Houses serving as PDMMs can scale up their activities to include making markets in corporate bonds. The active trading of these bonds has also created - for the first time in Nigeria - a risk free yield curve (extending to 20 years) from which corporate bond issues of various maturities can be priced.

The demand side also gives much to cheer about. The advent of Pension Fund Administrators (PFA) has resulted in serious latent and unmet demand for corporate bonds. All PFAs are currently grossly underweight in this asset class as they are permitted to invest up to 30% of their assets in corporate bond instruments. Many of them are likey to be enthusiastic buyers in the near future as they seek to build up their corporate bond portfolios from a near zero basis. The supply side of the equation is also going to get deeper as the effects of the banking sector sector crisis and subsequent cleanup cause banking loan portfolios and appetites to shrink across board and lead to seriously compromised financial intermediation capabilities. Many highly rated corporates may decide to approach the debt markets directly for financing rather than be at the mercy of banks that are probably in a weaker financial position than they are.

On the regulatory side, the stars also seem to have aligned very nicely in favour of corporate bond market development. The CBN Governor has - from his first press briefing - always reiterated his support for a virile corporate debt market to reduce pressure on the banking sector. The current Finance Minister: Mansur Muhtar served as a Director General of the Debt Management Office (DMO) and it was under him that many innovative measures - such as the PDMM framework - were introduced into the FGN Bond Market. Debt Market proponents are very likely to get a receptive hearing from him. In addition to these people, the recently nominated Director General of the Securities and Exchange Commission (SEC), Arunma Oteh, was a past treasurer of the African Development Bank (ADB) and has spent most of her career working in Supranational and Sovereign Debt Capital Markets and funding. I dare say that Nigeria has never had a trio of people so conversant with, and supportive of, Debt Capital Markets as we currently do, this chance must not be wasted but seized upon to bring lasting development to the Corporate Debt marketplace.

Storm in the Banking Teacup: Interesting and depressing times ahead

That the Central Bank unceremoniously fired the CEOs and Executive Management of five (5) banks in Nigeria on Friday, August 14th will only be news to either those just let off the kidnapping hook of the gentlemen from MEND or illiterate Nigerians on the fringes of civilisation. The Central Bank in what is now being termed as “Black Friday” has done the undoable and touched the supposed untouchables of the Nigerian business sector. To say that fear of the CBN has now become the beginning of banking wisdom in Nigeria is to be stating the bloody obvious. While the decision and the Gestapo like efficiency of its execution is interesting in itself, I believe the greater interesting points lie in the wider implications of the decision for the banking sector and the Nigerian business environment in general.

The sack of these executives and the emergence of “kings who do not know Joseph” in the form of interim management teams appointed by the CBN to steady the affected banks and recoup the Central Bank’s investments has serious implications for the Banks’ creditors. Various loans which have now gone bad were granted to either related companies of the ousted executives; longstanding customers of the affected banks and/or close personal/business associates of the executives. The interim executives – who are mainly retired folk – would most likely swing towards loan recovery if the choice came to either recovering loans through asset sales or maintaining the existing business and personal relationships of the ousted executives. As a result, we are very likely to see a huge rise in forced sales of various collateral assets in the coming months and something tells me that in light of the prominence given to downstream Oil and Gas loans we are likely to see a preponderance of tank farm and Oil Tanker sales in the coming months. The next few months will be very appealing for companies and individuals seeking to acquire downstream Oil and Gas assets as banks seek to recover whatever they can. Same goes for relatively under occupied high end real estate assets in Lagos and shares of companies listed on the Stock Exchange. The NSE’s All Share Index is likely to dip further as considerable selling pressure will be on the affected Bank’s shares which constitute a very significant portion of the index, this selling pressure may yet spread to other banking and non-banking stocks as banks recover whatever they can of the margin loans they have given out.

Beyond the expected pressure on asset prices across board in the coming months, the actions of Mr. Lamido Sanusi is very likely to result in changes to the ownership structure of the affected banks with shareholders of these banks likely to find themselves left out in the cold. To put this in perspective, the CBN Governor stated that one of the affected banks had a Capital Adequacy Ratio (CAR) of only 1.01% as against the minimum regulatory requirement of 10% (this implies that the said bank has only N1 in capital for each N100 in Risk Weighted Assets). The CBN is injecting fresh funds – in the form of hybrid Tier 2 capital – to bring the CAR to the 10% minimum, what this means is that the CBN is going to inject – into the bank over this weekend – new capital amounting to 9 Times! the current capital of the bank. Needless to say, current shareholders of that particular bank are practically wiped out as their current shareholding will amount to only 10% of the capital of the bank post bailout!. While the CBN has signified its intention to recoup its investment in the banks as soon as practicable through capital raising exercises that the interim managers are expected to conduct in the near future. It is clear that given the near comatose state of the Nigerian Equity Capital Markets, a normal public offer of securities will be very unlikely to succeed. As a result, the guys who will be supplying the funds – to ensure the CBN’s exit – will be deep pocketed strategic investors and not the thundering herd of gullible, over leveraged retail investors that have typified our markets. This will provide a very good opportunity for the foreign banks - whose incursions have been very effectively blocked by Prof. Soludo - to finally enter the banking sector. I will be very surprised if at least one or two of the affected banks do not fall into the hands of foreign banks in the next 12-24 months.

Finally, we are likely to see a big change in the competitive structure of the Banking industry with each of the affected banks losing market share over the next few months as: interim managers focus on fighting fires rather than growing the business; depositors grow increasingly wary of the Banks’ survival chances and competitors swoop on them like vultures. I believe a number of big ticket accounts may flee those banks for the refuge of supposedly more stable banks such as GTBank, First Bank and UBA with the affected banks losing the marketing and business generation edge provided by their very charismatic and highly connected CEOS.

The next few months are likely to be interesting and depressing in equal parts with losers and winners being thrown up by the current crisis, we can only keep our minds attuned towards seeking opportunities in the crisis!

Recent Developments in the Nigerian Banking Sector: A defence of Fair Value Accounting

There have been much debate and outcry over the recent statements of the new Governor of the Central Bank of Nigeria: Sanusi Lamido Sanusi regarding the health of Nigerian banks and the need for full disclosure of asset quality. This new line has prompted a number of hitherto unprecedented write downs by Nigerian Banks in their latest results: Ecobank Nigeria has written off N12 Billion; First Bank - N25 Billion and to the mother of all writedowns: Oceanic Bank - N42 Billion. These write downs have primarily been in their margin and other equity collateralised loan portfolios and are meant to reflect the steep losses witnessed in the Equity Capital Markets over the last 15-18 Months. Many analysts have sought to paint this new found penchant for fair value accounting on the part of the regulator as being ill-advised and a misguided adoption of western standards. I however beg to differ, I believe the dual and complementary emphasis on detailed disclosure and adoption of fair value accounting are two of the best initiatives in the Nigerian Banking Industry.

A bank’s – and indeed any company’s – balance sheet should be a reflection of value and its stated asset valuations should reflect the monetary value that can be obtained as consideration for the sale of such assets (there is no point listing an asset that can only fetch N40 Billion in an arms length sale as being worth N100 Billion in any balance sheet). This principle should apply to banks as well, for example I don’t think a N5 Billion loan - wholly and solely collateralised by equity securities of an equal value - advanced by a bank to a brokerage firm in 2007 is worth the same in 2009 when the basket of underlying securities serving as collateral has declined in value by over 50%. The truth is that the bank will be lucky to get N2 Billion if it recalls the loan by seizing the underlying collateral and selling it off in the market. To then account for this loan at the initial value of N5 Billion - even if a token and often reduced interest is still being paid - is unrealistic at the very best and downright fraudulent at the worst.

Fair value accounting also helps bankers and portfolio managers make the tough decisions necessary for the functioning of markets. Many bankers and portfolio managers will remain reluctant to exit losing investments under a cost or historical value accounting system, since they would not have to book the losses until they actually sell the investments. Fair value accounting helps them out by making decision making more straightforward: they would have to recognise the losses whether or not they sell the securities , so they might as well recoup whatever is left of shareholders’ or investors’ capital. Furthermore, marking down the loan books will make the Asset Management Company being proposed by the CBN more effective, without the writedowns most banks would have been seeking to sell their margin loan books to the Company at historical values.

Although I am aware that Fair Value accounting is not without its drawbacks and that it often results in volatile Balance Sheets, if given a choice between Fair Value and Voodoo accounting, I will choose Fair Value accounting over and over again!

Michael Jackson – Le Roi est mort, vive le Roi!

Anybody for whom the death of Michael Jackson is still news must either be: living under a rock or just waking up from a very deep coma. The news of his death put so much stress on – and sometimes crashed – Google search; Tweeter; numerous SMS platforms and TMZ.com. To say that he was a superstar is to underestimate the scale of his achievements, he was the superstar and it is by him that superstardom will come to be measured and defined. His music transcended race; religion etc and made a mockery of geographic boundaries, he was as accepted in Western Europe as he was in America, Africa and the Far East and he came to be accepted as the first true global icon. I can remember that growing up in a little corner in Nigeria, my elder brother had a full Michael Jackson outfit complete with sequined glove; black loafers and white socks.

He is sure to add – in death - many more record sales to the estimated 750 Million that he was reported to have sold during his lifetime. He went from prodigy to superstar then on to megastar and finally – in the last 2 decades of his life – to Wacko Jacko (the crazy uncle in the attic!). In his five (5) decades on earth he achieved more success and attracted much more controversy to last a couple of lifetimes, a friend of mine described him as a bicentennial man who experienced near universal acclaim and hero worship in the first century of his life and then endured near universal gossiping; ridicule and oftentimes disgust in the final century.

In the sheer significance of his life – whether in fame or infamy – lies the true lessons to be learnt from the death of Michael Jackson, the King of Pop. He lived for only 50 years but he will be remembered for centuries and will join a small group of men who lived relatively short lives but whose memories have endured in the minds of generations to come. His death made me remember a sermon I heard many years ago in Secondary School, the preacher recited the whole of Genesis Chapter 5 (which by the way is a litany of XXX begetting Methuselah, who then begat XXX who in turn begat XXX and so forth). However two things were striking: each of the guys in the passage must have lived for at least 900 years and they were each allocated just one sentence in a Bible that must contain millions of sentences. Then contrast this with another man (Jesus Christ) who lived for only 33 years but had five entire gospels devoted to chronicling his short life and whose death led to the creation of a sect of Judaism whose devotees were named in reference to him: Christians. This “sect” – initially regarded as a body of people on the fringes of society – has become the biggest religion in the world and a source of hope; pride and moral anchor for billions on planet earth.

Alexander the Great also died at 33, yet he had conquered the entire known world before his death and turned a group of bickering city-sates into a nation called: Greece. Joan of Arc died at age 19 but had managed – despite being unschooled in millitary affairs – to lead French armies to victory over an imperious England; and succeeded in uniting her country (in the process earning the epithet: Maid of Heaven). John F. Kennedy died at just 46 but only after he had succeeded: in winning election as President of the United States; in instituting a new policital order (which came to be regarded as the Age of Camelot) and in establishing the concept of the celebrity politician (of which Barack Obama is just the latest incarnation).

There is one inalienable truth: we will all die, but when we die will we just be accorded a sentence and quickly forgotten by men? Or will we leave our indelible footprints on the sands of time? Are we going to have a life of impact or just one preoccupied with subsistence; survival and the accumulation of wealth?. The King is dead but he lives on: in the hearts of his numerous fans; in the pages of the countless tabloids and biographies that will each attempt to put a new spin on his life and death. Above all, he will live on in the minds of generations yet unborn who will download “Billy Jean” and think its the coolest song ever or attempt to borrow a few lines from the lyrics of “Speechless” to convince some teenage girl to go out with him on a first date.

Buying to the Sounds of Cannons

Reading about the jumbo 1.5 Billion Pound profit made by the Abu Dhabi based International Petroleum Investment Company ("IPIC") under the leadership of Sheikh Mansour Bin Zayed Al Nahyan (pictured on the left) on an investment made in Barclays Bank Plc in October 2008, I was reminded of a rather apt quote. Nathan Rothschild (one of the founding sons of the illustrious Rothschild banking family and a notable financier and speculator) was said to have remarked that his investment strategy was to “buy to the sound of cannons and sell to the sound of trumpets”.

Nathan Rothschild must have been referring to the various wars that plagued European kingdoms during his day and the tendency for shares and bonds to crash deeply during wartime and rise spectacularly in times of peace and prosperity. While nation states are less prone to war in this age than they were during Nathan Rothschild’s lifetime, the modern age has its own parallels to the “sound of cannons” of the 19th Century in the form of stock market failures and credit crises. While Nathan Rothschild bought British Consols (i.e. a Government Bond variant) which had become undervalued and oversold during the battle of Waterloo by a skeptical (some might even say paranoid!) investing public and later made a killing from his position when victory was attained and investors’ fears turned out to be unfounded. So also Sheikh Al Nahyan has made a ton of money, after only 9 months, as a result of having the wisdom (and above all the guts) to invest in Barclays Bank when most other investors thought that the sky was falling; the global financial system was headed towards oblivion and that we would abandon modern finance and go back to trade by barter. The IPIC has sold its nearly 12% stake in the bank to, largely, the same class of investors who would not invest in the Bank at less than half the price about nine months earlier.

History has so often taught us that the best opportunities present themselves at times of great danger and uncertainty and that those investors who are willing to take calculated risks are likely to make huge gains. These scenarios also play out in investment opportunities related to Nigerian companies and investment opportunities, with Guaranty Trust Bank Eurobonds being a case in point. In the aftermath of the Lehman collapse (around November last year) GT Bank Eurobonds were trading at Yields To Maturities of between 27-28% on the international markets after being issued at Yield to Maturity of about 8.5% less than 2 years before. That the yields on the debt of a bank that was in no grave danger would widen by such a margin is quite ridiculous, especially when viewed against the fact that the Bank had minimal exposure to margin loans; next to zero exposure to complex derivative products and has maintained a conservative lending policy and healthy Net Interest Margins. A really smart investor would have bought the bonds at those yields (at an implied price of about 60 Cents per US$1 of face value) with a very high probability of being made whole at maturity, as the fundamentals of the bank remain unchanged and are more likely to be enhanced by the recent minor shakeup in the Nigerian Banking industry. As at the time of my writing this post, the Yield to Maturity for the bonds had narrowed to 17% and market value increased to about 81 Cents per US$1 of face value.

The Nigerian equities market also tell a similar tale, the Nigerian Stock Exchange’s All Share Index shed 30% of its value in January of 2009 alone and by the end of March the Index was down by 37%, prompting investors to dump their shares and leave the market in huge numbers. However, with the benefit of hindsight, these periods presented wonderful buying opportunities and were in essence our own “sounds of cannons” and should have been a cue for savvy investors. Since the trough of the Index on the 26th of March, the All Share Index has gained about 50%!. While the markets are essentially flat on a year-to date basis, many investors with the foresight (and I must say: courage!) to invest during the first quarter of the year have achieved returns (in certain stocks) of between 50-100% and have started to unload their shares at a profit during the recent rally (i.e. “sound of trumpets”!).

"The King is Dead, Long live the King" - My wish list for the next Governor of the CBN

It is becoming increasingly likely that Prof. Chukwuma Soludo, the Governor of the Central Bank of Nigeria (CBN), will not be getting a second 5-Year term in office. His replacement or, unlikely, renomination is due to take place on Friday, 29th May when President Yar'Adua is expected to forward the name of the nominee to head the apex Bank to the Senate for confirmation.

Although Prof. Soludo has received some knocks in the recent past over some of his recent actions, such as the poor handling of the recent naira devaluation and hurried closure of the Interbank Fx Markets, most market participants are of the opinion that he has performed creditably. The consolidation programme embarked upon during his first few months in office has been widely hailed as a success and has led to the emergence of 24, relatively, strong banks from an unwieldy bunch of 89 banks that could hardly finance projects or transactions of any significance.

Without the consolidation process, the disappointments and setbacks witnessed in the last one year in the Nigerian Financial markets will probably have degenerated into a full scale crisis. In addition, the stealthy and effective use of the Expanded Discounted Window offered by the CBN ensured continuous liquidity in the banking industry and prevented the collapse of any bank, an event which may have resulted in an acceptably high risk of systemic failure. To further assure the stability of the system the CBN, under Prof. Soludo, gave its tacit approval and encouragement to the acquisition of certain perceived weaker banks by other banks deemed to be stronger and capable of absorbing potential losses.

I believe the skills needed in the next CBN Governor are those of a consolidator; effective regulator and technical specialist not necessarily that of a grand strategist in the mould of Prof. Soludo. The Nigerian banking industry is entering a new era in which the gains made in the last 5 years will need to be consolidated; bigger and more systematically important financial institutions more closely monitored and the foundations of a more effective and modern financial sector laid.

Strategy for the industry should be left to the industry players to decide and not be suggested to them by a regulator (I see no reason why every bank should seek Shareholders' Funds of at least US$ 1 Billion, as they should not all have the same strategic focus and capital requirements). I do not think every one of the 24 banks in Nigeria ought to have an Investment Banking/Capital Markets subsidiary or branches across Africa and Europe, some banks may position themselves as wholesale banks while some others can emphasise retail/consumer lending activities.

While the average central banker wears two (2) hats: that of a regulator of a country's banks and that of its macroeconomic manager, the focus of central bankers for such a long time in Nigeria has been on the regulatory aspect to the detriment of the macro economy. The next CBN Governor should strengthen the linkages between the banking sector and the broader economy to ensure that profits and activities in the Banking Sector reflect the health and performance of the real sector. The health of the national economy must be reflected in the profits/performance of the financial industry (as US President Barack Obama said: "we can't have a thriving Wall Street while Main Street suffers").

In addition to the above, the Central Bank needs to broaden its scope and appropriate the role of national economic manager and guardian of systemic risks. The scope of the next Governor should go beyond the Money Markets and the familiar economic management tools such as Open Market Operations ("OMO") and others. The CBN must take an active interest in the evolving Debt Markets and even the Equity Markets to ensure that potentially destabilizing
bubbles are not been built in areas it has been overlooking, for example Banks' exposures to the Stock Markets have to be actively monitored by the CBN and limits placed from time to time on their activities. These exposure measures have to be reasonably broad, with limits set not only on the level of margin loans that may be granted by a bank but also on the level of loans that may be collateralised by equity instruments. This exposure monitoring should not be limited to only the equity markets, exposures to Real Estate markets need to be monitored and curtailed when necessary as well. The real estate sector is as prone to disaster causing bubbles as any market in the world (the entire world probably has the American real estate market to thank for the problem we are all in!).

Finally, and somewhat contradictorily to my earlier points, the new CBN Governor should champion financial innovation both in products and service delivery. Because derivatives and securitization have been blamed as the main causes of the current global economic crisis, it is easy to forget the very important roles they have played in broadening access to financial markets; reducing financing costs and generally supporting the upward march of civilisation and innovation. It is shameful and unacceptable that structures have not been put in place to ensure that credit worthy people in Nigeria have access to mortgage loans, this is largely a consequence of the absence of a secondary market for mortgage trading in Nigeria. Swap lines are largely non-existent for transforming fixed rate loans into floating rate and vice-versa. Nigerian corporates can hardly hedge their foreign currency transaction risks as our banks are severely curtailed in their ability and capacity to deal in Foreign Exchange Futures and Forwards, thereby making our largely import dependent companies have highly volatile earnings (case in Point: Starcomms Plc declared a loss of 8 Billion Naira (the worst in Nigerian Corporate history)largely as a result of foreign currency translation losses). Even Automated Teller Machines ("ATM") only became widespread in Nigeria in the last 5 or so years!!, and Naira Credit Cards are about a year old. Ultimately, I believe the next CBN Governor should be judged not only by how well he manages to avoid financial disasters but by how much he succeeds in laying the foundations of a banking and financial system that supports Nigeria's economic aspirations and empowers our companies and citizens in their quest for increased prosperity and a better life.

"Investors from the vasty deep" - Nigeria and the quest for new Oil and Gas Investors

Reading the news report in the Tuesday papers that the Special Adviser to the President on Energy: Dr Emmanuel Eghogah was seriously lobbying for new investors at the Offshore Technology Conference ("OTC") holding at Houston and assuring them of the security of their investments in the nation's Oil & Gas Sector, I was reminded of a dialogue in one of William Shakespeare's plays: Henry IV.

In Part 1 of the Play, two characters (and bitter rivals): Hotspur and Glendower had this very interesting conversation:

Glendower (boasting):
I can call spirits from the vasty deep.

Hotspur (responding):
Why, so can I, or so can any man;
But will they come when you do call for them?

The moral of the dialogue is that anyone can wish upon or command anything he desires, the critical thing is whether the desired outcome/wish will occur. This dialogue seems all the more relevant, when one considers the fact that the Nigerian government is currently seeking new foreign investors for the upstream Oil and Gas sector while the deep-seated investment-inhibiting issues plaguing the sector remain unresolved.

The security situation in the Niger Delta, which was alluded to in Dr. Egbogah's statement at the conference, is abysmal and has led to a situation of near anarchy with various "packages" (i.e. human beings, preferably Caucasian) being kidnapped at will and huge ransoms being demanded and, almost invariably, paid to secure their release. A kidnap and ransom industry has blossomed to complement the already established bunkering industry in the Delta, culminating in the emergence of large numbers of young men with criminal careers that are so lucrative, and near risk free, as to make the pursuit of any legitimate career or trade unrewarding and unreasonable in comparison. All this happens despite the launching of various "expeditions"(with often scary names) by the police and armed forces which seem not to make a dent in the seemingly impenetrable armour of militants motivated by quick riches. To solve the Niger Delta crisis, we need to go beyond sloganeering and begin to tackle the structural issues which have made lawlessness second nature to the youths of the region. The problem at hand has gone beyond that of ensuring a nice and friendly neighborhood, it has become a matter of national economic survival. The activities of these "restive youths" have led to severe losses in Crude Oil production (Nigeria's lifeblood), reducing our current average daily production rate to about 1.78 million barrels as against 2.6 million in 2006 and a 2009 budget benchmark rate of 2.29 million. Yet no end seems in sight to this crisis as our politicians seem incapable and/or unwilling to make the tough choices and concessions necessary to maintain our collective security and prosperity.

The security situation in the Niger Delta is by no means the sole militating factor against foreign investment in our Oil and Gas industry, equally troubling is the incoherent and often volatile policy regime of the current administration. In the last 2 years, various companies have watched their concessions and/or contracts being revoked, with the Korean National Oil Corporation (KNOC) being the latest company to join the "revocation club". KNOC is currently contesting the revocation of its Oil Prospecting Leases (OPL) in the federal courts and if the antecedents of our justice system are anything to go by, the company faces a long, hard and tortuous road to justice. The government cites the non-payment of US$ 231 million out of the US$ 323 Million required for the leases as the reason for its revocation order, while KNOC maintains that the US$ 231 million balance being cited by the government had already been written off by the immediate past administration in return for the construction of much needed infrastructure (such as a power plant and gas pipelines) by the Company. This incidence just adds to the string of policy somersaults and reversals that have plagued our country in the recent past, how can we begin to think seriously about attracting investments into the country when companies can't be sure that agreements survive the transition into another government of the same political party!. I don't want to sound unduly alarmist, but it is increasingly beginning to seem as if agreements in this country are not worth the paper on which they are written.

Until we begin to adopt investor friendly policies; strengthen our judicial and other independent institutions and improve the security of lives and property, we may struggle to attract serious investors with long term investment horizons. And like Glendower, we may continue to boast of the ability to call "investors from the vasty deep" but it is far from assured that they will come!

Pirates Ahoy!: Lessons from the rising scourge of Somali Piracy

It is no longer news that piracy around the Horn of Africa has been on a steady, near meteoric, rise. Neither is it newsworthy to state that the same pirates have given "brazen" a new definition, almost no week goes by without another news of them hijacking another vessel surfaces. Their targets are varied: they have attacked vessels ranging from trawlers; to Container ships; luxury yachts and even crude-laden supertankers. The condemnation from the international community has been strident and concerted, over 15 warships belonging to superpowers such as the United Kingdom and the United States, and Emerging powers (such as China and India) now patrol the waters. What is particularly galling is that despite the open display of naval might and superiority by the world powers, the Somali pirates - often armed with light machine guns and moving with speedboats - have continued to hijack vessels with reckless impunity.

I believe the lessons to be learnt from this scourge lies in understanding why these pirates took up piracy in the first instance and why they are such potent adversaries despite their obvious firepower disadvantage. Somalia, the native country and base of the pirates, has witnessed decades of civil war and sectarian fighting which has resulted in the complete breakdown of law and order. The country has practically been a "no man's land" for upwards of 2 decades and the last semblance of a government in the country - the militant Islamic Courts Union - was kicked out of power by Ethiopia. This state of anarchy has given rise to total economic breakdown; deprivation and hopelessness therefore ensuring that there are next to no opportunities in Somalia for attaining any level of prosperity through legitimate means. For many of the pirates, piracy, and other acts of brigandage, is nothing more than an occupation that may lead to some material prosperity in a lawless land where might is inevitably right.

Then why are they such a potent force despite the overwhelming military might of the superpowers? The answer is simple: the world is against an enemy who has nothing to lose and whose everyday existence is little better than death. It is clear that no navy can totally protect the high seas or completely secure every inch of water, the bulk of the benefits from the display of naval power is the deterrence that it provides to potential "disturbers of the peace" (i.e. pirates, sovereign aggressors etc). The key challenge in this case is: how do you deter a non-state aggressor who is neither afraid nor unwilling to die?. It is instructive to note that the bulk of these pirates are in their late teens and early to mid twenties, therefore they have come of age during a period of constant warfare, starvation and epidemics. These are young men who have watched parents, friends and relatives die from either bombs, bullets, disease or starvation and as such they place little value on their own lives or those of others. They have nothing to lose, if they do not die in the course of a pirate raid they may as well die on their beds from hunger; from a mortar shell or even from disease. They are particularly formidable because they cannot be threatened; reasoned with; bribed or even negotiated with. In their view the world offers nothing and they might as well see it burn. If ten pirates are shot dead, there will probably be another ten recruits willing to take the place of each of the dead pirates.

So is the situation beyond redemption? Is there a possible solution lurking somewhere?. I believe - like every other challenge facing the world - this scourge has a solution, I only doubt whether the solution is a military one. The Somali piracy problem has made very clear to the world the devastating effects of poverty; sectarian violence and poor economic expectations. Also made evident is the fact that rich and poor countries alike will suffer, either directly or indirectly, from these effects. While hunger may be far from the streets of Houston, Riyadh or London, the Somali pirates (products of the circumstances mentioned above) can hijack crude oil supertankers originating from from these cities; endanger the lives of their citizens and increase the cost of doing business for their corporations ( either by increasing the cost of shipping insurance or by increasing freight costs as a result of longer routes taken to avoid the pirates!). The rest of the world has to take very seriously the problems in Somalia and realise that the scourge of piracy cannot stop until Somalia is stabilized; a legitimate government established and economic rehabilitation and reconstruction embarked upon. This same situation applies to various impoverished and/or devastated regions of the world which are dangerously close to violence. International development needs to be redefined from being a "nice" thing championed by "bleeding heart" celebrities such as U2's Bono and Bob Geldoff. International development should be championed henceforth by calculating, hard-nosed strategists in developed nations as a matter of national security and self preservation. Nobody can be safe from large groups of people who have so little to look forward to in life that they cannot be scared of death.

Fair trade practices; responsible African leaders and private sector investments must be actively encouraged by world leaders in order to reverse the twin scourges of despondency and poverty that often lead people down the path of violence and recklessness. A "Marshall Plan for Africa" should be designed in consultation with responsible African governments, to ensure that the people who Prof. Collier of Oxford University has so aptly named the "Bottom Billion" can have a stake in the world to prevent them from being so inclined to destroying it. New generation of African businessmen and political leaders must be encouraged to emerge; policies to improve the capacity of African financial markets instituted and fair trade policies to ensure that African farmers have a short at profiting from the global commodities trade also put in place. Roads have to be built to ensure that crops do not rot on farms; hospitals stocked with vaccines to reduce alarming rates of child mortality and resource rich but despotic governments discouraged from plundering their country's treasuries and murdering its citizens.

The Somali pirates can (and must) be defeated, but they will not be defeated at sea or by naval worships. They will only be defeated when they have something to hope for in life to prevent them from being so fearless about death and unmindful of the value of human life. This can only happen when the whole world (including other African leaders) get serious about bringing lasting peace, development and prosperity into the region.

Dead Aid: Another entrant in the Trade Vs. Aid Debate in Africa

It is a well known fact that the African continent is increasingly attracting more vocal supporters - within the Continent, in the Diaspora and even among former colonial masters- for its development. What is less well known is that many of these supporters passionately advance either of the following viewpoints: 1.) Africa needs aid and the rest of the world should be shamed into providing more aid and grants to Africans; 2.) Aid is practically useless and in fact encourages corruption in African Leaders as it doesn't promote the sort of monitoring and accountability that the financial markets and taxpayers dictate; and 3.) the middle of the road people, who think Africa needs a little of both to develop. I am happy to report that I fall into the 3rd Category, I am a passionate member of the "Middle Roaders club"!. I believe that Africa needs a combination of both free-market liberalism and plain old-fashioned handouts (the Politically Correct synonyms are Aid and Grants!) to develop in the short to medium term.

The newest entrant - and a loud one at that - is a new book titled "Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa" written by a former economist covering Sub-Saharan Africa at Goldman Sachs: Dambisa Moyo. A quite comprehensive and really critical summary of the book is given in the here. I am yet to get a copy of the book, but the summaries and commentaries which I have read indicate that the book was quite strident in its criticism of western aid in Africa. The crux of the book - from the summaries I have read - is that aid tends to make governments and political leaders corrupt; fund white elephant projects and avoids the sort of accountability which funding through taxation or through international debt markets demands from governments and politicians. She (i.e. the Author) has identified 3rd world countries which have been able to raise financing from international capital markets for their developmental projects and who have, as a result of improved macro-economic management, been able to improve their credit ratings. Which has in turn has led to lower borrowing costs on such bonds and the attention of a wider investor universe.

On the whole, while I believe that the whole "Trade not Aid" movement has many significant merits, I believe the efforts of celebrity "do-gooders" such as U2's Bono and Bob Geldof in increasing aid assistance to Africa is also not without some merits. I believe aid has a large role to play in the re-emergence of post-conflict states such as Liberia, Rwanda etc. I doubt that many purely profit motivated investors will be inclined to invest in such countries or buy bonds issued by them in the international capital markets. These countries can hardly be expected to get back on their feet without some assistance (i.e. Aid!) from the international community. In these sorts of situations, it will be quite difficult to make an informed argument against the provision of western aid.

However, providing aid to more established, mineral-rich and relatively stable countries such as Nigeria is a totally different matter. I believe a country like Nigeria does not deserve foreign aid, given our rich resource base; relatively developed domestic financial markets and large population. Foreign aid is only likely to compound our governance problems as it will only provide another "accountability-lite" source of funding for our already corrupt politicians. We need to subject ourselves to the disciplines of the international debt markets and the associated credit rating process which places considerable pressure on governments to pursue sound macro-economic policies. In the alternative, our government can seek to better finance itself by broadening the tax base, which will in turn constrain it to pursue sound economic policies which will improve citizen "wealth being" and subject politicians to the anger of taxpayers who would not like to see their hard earned money squandered or downright stolen.

I think the most strident view of the book was provided by a columnist writing in the Washington Post. However, the Oxford Don: Paul Collier (author of the book: "The Bottom Billion" and a well known Africa expert) gives a much more balanced view of the book and the "Trade Vs. Aid" debate which I am more inclined to align with.

CBN caps on Lending and Deposit Interest Rates: An exercise in futility?

Yesterday the Governor of the Central Bank of Nigeria (CBN): Professor Charles Soludo announced that interest rates on deposit and loans in Nigerian Banks are now subject to a maximum of 15% and 22% respectively.

While I am not unmindful of the destabilizing effects of rising interest rates and I fully appreciate the need to put in place measures to stem the trend, I am convinced that this particular measure is an exercise in futility. I believe that one of the lessons the current market crisis has thought us is that bankers can hardly be forced into doing anything, America's Congress has not been able to get banks to increase lending despite the fact that the American Taxpayers are basically responsible for the continued existence.

Nigerian Bankers, and bankers everywhere, are quite famous for acting in their perceived self-interest and for being able to creatively work around regulations that have potentials to reduce their profits. I am sure that by now, each bank will have worked out its strategy of beating the 22% maximum lending rate restriction. What we are likely to see is that each bank will obey the restriction in theory, but will resort to filling their credit offer letters with all sorts of hidden and open charges that will ensure that their lending rates inch up to the rates they will like to lend at (and not what the CBN wants them to lend at!).

Furthermore, the maximum deposit rates of 15% can also be easily breached in practice as banks desperate to attract sizable deposits from their competitors will devise new products that will ensure that they can offer depositors interest rates in excess of 15% and still not breach the letter of the law. For example, instead of offering 180-day fixed deposit products, a bank may simply issue a 180-Day Commercial paper yielding say 18% to a potential depositor. This commercial paper, though technically not a deposit, has the same effect liquidity-wise on a bank. It may even be more attractive to a potential investor since they are discount instruments which do not attract interest payments (which are subject to withholding tax), the implied interest is capitalised and is realised through the capital gains at redemption. Since capital gains are not taxable in Nigeria, the depositor (because that's what he effectively is) will have received tax-free "interest" from the bank and the bank will also have "stolen" depositors from other banks (maintaining 15% deposit rate limits).

In addition to this, the cap will also limit credit creation in the industry, which is a situation we really cannot afford in a slowing economy. For instance, there are quite a number of companies who can still access financing from banks, but they can only do that at high interest rates such as 25-26% in view of the risks perceived by the banks. Setting an interest rate cap (of 22%) may result in banks cutting off credit to these categories of borrowers who may then reduce operations or lay off workers.

In conclusion, I believe reactionary measures such as the one currently being proposed by the CBN will not solve the crisis in the banking sector but only create avenues for "black markets" and rule dodging. Since market forces have pushed up interest rates in our banking system, we need to also find a market-based approach to solving the interest rate crisis not just wish them to stay at a rate through fiat!!.

Book Review : Outliers- The Story of Success

I just finished reading (over the extended weekend) Outliers: The Story of Success, written by the writer - and the world's favourite "drugstore sociologist" - Malcolm Gladwell, author of bestselling works: Tipping point and Blink. The core essence of the book is the idea that men of great abilities and achievements did not get there by only their own efforts but that many of the ingredients and determinants of success are often beyond the control of most people and highly dependent on the opportunities presented by society and cultural legacies.

The author weaves together anecdotes and case-studies of various successful businessmen, academics, scientists and lawyers to support his assertion that successful people are not necessarily outliers with indecipherable secret formulas, but products of a complex interplay of personal effort (e.g. the 10,000 hour rule), unique opportunities (a 13 year Old Bill Gates was fortunate to attend a private school with a more powerful computer than many universities at that time) and enduring cultural legacies (Asians are generally smarter than most other people due to their increadible work ethics, which is in turn necessitated by the demanding nature of the primary occupation of their ancestors: rice cultivation).

The first part of the book: Opportunity describes the unique advantages enjoyed by many successful people, which ensured that they had a deeper and more meaningful preparation - than most of their competitors - for the careers and/or goals that they later embarked upon. He stated that Bill Gates probably had logged in over 10,000 hours of programming time before he was 19 at a time when most people his age had never even being within a 10 meter radius of a computer in their entire lives. To illustrate the importance of opportunity in developing successful people, he mentions a case of a man with an IQ of 190 (Albert Einstein's was a mere 150!) who spends his time on a horse farm, lacks a college degree and has spent his entire adult life doing a string of low-income jobs such as ranch hand, bouncer etc. The answer is simple: Einstein had access to people, systems and institutions that provided him with a platform to develop and display his talents, while the 190 IQ man had nothing in his life or background to help him develop and display his abilities. As the author wrote about the man: "He had to make his way alone, and no one — not rock stars, not professional athletes, not software billionaires, and not even geniuses — ever makes it alone."

The second part deals with the effect of history or cultural legacies on our abilities to achieve great things and he asks a simple question: why do Asians (particularly Chinese) seem to beat almost everyone else at Mathematics and Science?. Is it because they are smarter than everyone else?, the author's simple answer is simple: Cultural Legacy. The Chinese were primarily rice farmers for much of their history and rice cultivation is an infinitely more demanding activity (which requires a mastery of various sophisticated value-addng tasks) than wheat cultivation which was the norm in Europe (or yam, Cocoa and cassava cultivation in West Africa!!). This has resulted in Chinese and Japanese people being more comfortable with having highly demanding work schedules and School Calendars that last more days in the year than most people in the world!

Overall, it was a very enjoyable book as it makes a good attempt at explaining the sources and characteristics of success and successful people. According to the author: Success "is not exceptional or mysterious. It is grounded in a web of advantages and inheritances, some deserved, some not, some earned, some just plain lucky"

Beyond the ICRC - Infrastructure Concessions and Investing in Nigeria

It is longer news that the Federal Government has appointed a high powered board (under the chairmanship of former Head of State: Chief Ernest Shonekan) to oversee the Infrastructure Concession Regulatory Commission (ICRC). The ICRC, established in 2005, is charged with creating and managing a framework for regulation of Public Private Partnerships (PPP) in Infrastructure Development in Nigeria. While the fact that we must - as a country - make significant investments to improve our dilapidated infrastructure is not in doubt, what remains to be substantiated is the level of our preparedness to embrace Infrastructure Concessions and investing in this country.Infrastructure concessions have become an increasingly important activity the world over, with infrastructure rapidly attaining the status of an asset class in which specialised firms such as Macquarie and Babcock & Brown (both Australian companies) have built time-tested profitable business models. Infrastructure concessions cut across a wide cross-section, ranging from: Toll roads, to airports & seaports to electricity projects and even waste management. Despite this broad spectrum of activities which may be classified as infrastructure investing, most successful infrastructure regimes share similar characteristics (which I attempt to describe below).

Infrastructure concessions are highly dependent on strong contractual, and stable political, frameworks, this is due to their capital intensive nature and standard lengths of concession (not usually less than 30 years, often extending to 90 years or more). Concessionaires not only need to enter into binding contractual agreements with the relevant authorities, they must also be confident in the ability of the concessions they have received to withstand changes in governments and political alignments. Nigeria's recent history of reversed privatisations and concessions (the Abuja Airport transaction is a good case study!) is very discouraging and doesnt signify the willingness and/or enthusiasm with honouring agreements (contractual or gentlemanly) which may have been entered into between investors and previous governments. Therefore, for us to begin to contemplate raising serious money for our PPP initiatives , the government has to display a greater willingness to honour and abide with convenants already agreed to and prove its commitment to a stable polity.

An equally important "ingredient" for successful Infrastructure Concessions is the depth and sophistication of domestic financial markets. Infrastructure projects (such as Toll roads, power plants and rail lines) are capital intensive projects with long gestation periods and as such they depend on access to long-dated financing arrangements. Most of the infrastructure projects originated by Macquarie Bank (probabaly the biggest firm in the infrastructure asset class) are sold and passed on to dedicated infrastructure funds (both listed and unlisted) that it manages. Furthermore, the firm routinely has access to long term bank financing with various lenders advancing loans with tenors up to 30 years to augment its equity contribution. In the case of Nigeria, two (2) quick questions come to mind: 1. Do we have investors with the competence, capacity and appetite to invest equity in infrastructure projects?; and 2. where are the sources of long term debt financing which will enable project sponsors complete their deals. The longest-dated bank financing in Nigeria - at least that I have heard of - is the 12-Year term loan given to the Lekki Concession Company - developer and operator of the Lekki Toll Road, the first toll road in Nigeria - by First Bank and UBA. A 12-Year term loan is a significant development in Nigeria (at least given where we are coming from) but it will be barely scratching the surface if bigger projects such as the Port Harcourt-Maiduguri rail line and the Lagos-Ibadan expressway are to be developed by the Private Sector. It is clear that for Infrastructure Concessions to take off and become serious business in Nigeria, we must begin to put structures in place to mobilise private capital (in the form of debt and equity) for executing various infrastructure projects.

Despite the obvious limitations cited above, I am of the opinion that - once proper structures are put in place - infrastructure investing has a bright future in Nigeria. The opportunities are so great (to the point of being limitless) due to our very low development base. The electricity situation in Nigeria is so bad and demand so far outstrips supply that almost any business model
for generating and/or distributing electric has a high chance of returning a profit to its sponsors. The same idea applies to investing in urban transportation, the proposed Red and Blue lines up for concession by the Lagos State Government will serve such an obvious need that I wonder how concessionaires operating these railway lines will lose money. If the Government backs up its talk with action and the proper incentives, infrastructure concessioning may turn out to be the "silver bullet" (if any exists!) which we have been seeking to our currently dreadful infrastructure situation.

Proposed Deregulation of the Downstream Petroleum Industry - Good riddiance to an unsustainable system

The Federal Government of Nigeria announced its intentions to deregulate the downstream petroleum industry by discontinuing the current government subsidy on petroleum product pump prices and privatising the Country's refineries. I believe this announcement has potentially beneficial implications for the growth of the sector and for the encouragement of private sector participation in building refining and distribution capacity in the Country.

Although, a cross-section of Nigerians and organised labour are up in arms against the proposed discontinuance of the subsidy and have described it as being insensitive I believe the policy has the potential of modernising the industry, encouraging private sector investments and strongly mitigating the cronyism and patronage for which the sector has achieved notoriety (even in corruption riddled Nigeria!). I cannot help but wonder how much of the 1.6 Trillion Naira (about USD 11 Billion) in Government subsidies was spent in supporting the inefficiencies and corruption in the system and not on actually alleviating the burden of high Crude Oil prices on Nigerians. For example, what warped logic dictates that imported petroleum products which are offloaded in Lagos should sell for the same price in Maiduguri which is hundereds of kilometres in the hinterland, despite the considerable costs involved in trucking these product over hundreds of kilometres from Lagos to the far north.

The current industry structure and the monopoly enjoyed by the PPMC (downstream arm of the NNPC) reminds me of the pre-2001 regulatory regime in the Nigerian telecommunications industry when NITEL was "lord and master" over all. A not so distant era during which NITEL officials had to begged, bribed and paid homage to before we could get overly expensive telephone lines which broke down for more days than they worked. The liberalisation of the telecoms industry and the advent of the various Mobile and Fixed Wireless Access (FWA) operators filled the deep void created by NITEL, rendering it practically irrevelant in the scheme of things with the Nigerian subscriber being the better for it. I am sure that a liberalised downstream petroleum sector will be ultimately beneficial to Nigerians, as it will lead to increased transparency engendered by competitive tension, reduced inefficiencies and greater mobilisation of private resources in building capacity.

Furthermore, the deregulation will help mobilise private investments in developing and improving the Country's refining capacities. All the refineries in Nigeria (which are currently under government ownership and control) are either moribund, grossly underutilised or both, this is in spite of the hundreds of millions of US Dollars which have been spent on various Turn Around Maintenance (TAM) contracts. The best option is for us to privatise the nation's entire refining capacity, so they can quit constituting a drain on the public treasury and a conduit for lining politicians' pockets.

An often cited reason for the inability of private refineries to kick off in Nigeria is the difficulty in securing financing for the projects. This lack of investor appetite is directly attributable to the current pricing regime, as we will be hard pressed to find a rationale investor who will be willing to spend hundreds of millions of US Dollars in developing an immovable asset (i.e. a refinery) to produce goods (petroleum products) over which he will not have pricing control. As someone else (the all knowing Federal Government of Nigeria of course!) will dictate their pump price all over the country and will almost certainly prevent him from exporting to other markets if he is uncomfortable with the prices the Government dictates in the domestic markets. Even if such an investor can be found, I am sure that he/she will not be able to get a bank that will be willing to provide financing for such a venture.

On the whole, I believe the deregulation of the downstream petroleum sector is one of President Yar'Adua's better decisions since taking office. Although the effects may sometimes be difficult for Nigerians to bear, we will all eventually be the better for it.

Book Review: Cold Steel

Just finished reading the tale of Mittal Steel's takeover of Arcelor in 2006, as told in the book "Cold Steel" written by Tim Bouquet and Byron Ousey. The book describes the transaction through the "eyes" and activities of the major players in the deal (both on the Mittal and Arcelor sides), a method popularised by the granddaddy of business epics: "Barbarians At the Gate" (a narrative on the groundbreaking (and ultimately disastrous) buyout of RJR Nabisco by KKR, which was published in the late 1980s by two WSJ Journalists).

The book gives a good background on Lakshmi Mittal's rise from operating Steel Mills in his native India and then Indonesia, to becoming the undisputed global King of Steel. The book vividly describes the various behind the scenes moves and machinations of the two "warring parties" (as represented by Guy Dolle, CEO of Arcelor and Lakshmi Mittal of Mittal Steel). The book was definitely written with the casual follower of finance and business in mind, so hard core finance "junkies" may be a little disappointed with the authors' refusal to dig deep into the mechanisms of valuations and/or deal structuring.

On the whole, I enjoyed reading the book and I learnt two (2) key lessons about the modern day international business environment. The first is: the amazing rise of globalisation: although Lakshmi Mittal was born and raised in India, his business empire spanned the whole globe (from former Soviet Republics, to Trinidad & Tobago and the United States) with no significant presence in his native country of India. At the time of the deal he was resident in London, while his business' head office was located in the Netherlands, while his first son (& heir apparent) graduated from an American University.

The second (somewhat contradictory) lesson I got from the book is the big role nationalism, ethnic pride and local politics continue to play in this fast moving globalised business world of the 21st Century. To get the deal done, Mittal had to appeal to, and appease, various politicians in Arcelor's operating countries (i.e. France, Luxembourg and Spain) even though Arcelor was at that time a publicly listed company with a diverse shareholder base who shoul Tacit racial slurs and insults were hurled at him from time to time, with Mittal Steel being severally referred to as: "a bunch of Indians", "that Indian Company" even though it was registered in Europe and did little or no business in India. Not to be outdone, the Indian government filed a complaint and its Prime Minister came out strongly in support of Mittal's bid (even threatening retaliations) even though Mittal Steel was technically an European company with practically no business operations in India.

The book is really good and I will recommend it to anyone interested in international business, finance or just desirous of a good read.

2009 and the Challenge of Recovery

2008 has come and has (thankfully!!) gone, yet the scars and fears inflicted on us by 2008 are still clear and present.

In 2008, seizures hit the Global financial systems as a result of a Credit Crunch more severe than any the world has seen since the great depression of the early 1930s. If early 2008 marked the height of the global financial crisis, I believe 2009 may be the start of the recovery, starting with Financial Markets and then filtering into the Real Economy.

My belief in the resurgence of the Global and Nigerian Financial Markets are premised on two (2) main points: (1) assets may have been oversold and prices may reflect a worse situation than may be the case and (2) profit seeking investors (who still have access to funds) still need to make money and earn a decent return on their funds (this applies more for Global Markets than Nigerian markets though).

The crises witnessed in global credit and stock markets have led to unprecedented levels of risk aversion on the part of investors which has inevitably led to massive selling of securities with any hint of riskiness which is then followed by a swift flight to safety. A clear testament to this was the ever widening TED spread (difference between yields on 90-Day Treasuries and those on 90-Day LIBOR) and in Nigeria, the 46% decline in the NSE's ALl Share Index, spiking NIBOR rates and the practical collapse of the Nigerian Interbank Market. A further testament to the extreme risk aversion prevalent was the 29.1% Yield To Maturity on GTB's Eurobond (a yield reflecting an unrealistically high probability of default) and the low to mid single digit Price to Earnings (PE) multiples at which Nigerian Banks and Corporates are trading (which i also believe reflects unusually low estimates of growth prospects). The resulting effect of these activities have been a propensity for investors to hold cash or short term government securities which has made 90-Day US Treasury Bills to be priced at yields close to zero (in effect the US government is borrowing from the world at no cost!!) and FGN Bonds in Nigeria witnessing hitherto unprecedented levels of activity.

The fact that there has been such a high degree of "flight to safety" gives me the greatest belief in the resurgence of the Equity and Credit Markets. Many institutional investors always have access to liquidity even in the bleakest of times due to constant inflow of investible funds. Such investors include Pension Plan Funds (with constant monthly inflows from plan participants) and Insurance Companies (who receive periodic premium payments from policy holders irrespective of the states of the markets). These investors have been placing the bulk of their new inflows in short term government securities, which as discussed above are yielding next to nothing due to the heavy demand for them. I believe that the time is not far from now when such investors will realise that handing out all new inflows for free (i.e. at 0% yield) to governments which in turn invests these (costless) money into the same banks and corporates that the investors are avoiding like plaque, may not be the best allocation of their funds and may be stretching risk aversion to a near breaking point. This idea has started to gain some ground in the new year with the burst of activity witnessed in international debt markets prompting many analysts to speculate that January 2009 may be one of the most active months (in terms of new issues) in recent debt markets history. This "mini resurgence" has been due to the willingness of big institutional investors (e.g. Central Banks, Pension Funds and Insurance Companies) to buy the credit of high grade, blue chip companies, a situation which is a significant reversal from Q3 2008 when practically nobody could borrow without a sovereign (i.e. government) guarantee.

The problem with the application of the idea discussed in the preceding paragraph in Nigeria is the unrealistically high rates of interests which banks are willing to pay on term deposits. There are rumours that some banks are offering depositors (annualized) interest rates of up to 20% on 90 and 180 day deposits. An assured 20% return on a term deposit may incentivize people to stay out of the stocks, thus further delaying the recovery of the Stock Market

I believe that once gains occur in Financial Markets, the Real Economy will also pick up (as a result of the multiplicative effect of the financial industry's activities on the wider economy). However, improvements in the global economy may lag those in global financial markets and may make people wonder why the "stupid financiers" who put everybody in this "economic mess" have suddenly began to smile while the
general populace (which the financiers of course dragged into the mess) is still in teeth gnashing mode.

Book Review: Niall Ferguson's "The Ascent of Money"

I just finished reading this book during the New Year and Christmas holidays and i was very impressed by its depth, historical basis and contemporary relevance.

I was initially put off by the book's sub-title: "A financial history of the world", my initial thoughts were that writing a financial history of the world is such a major undertaking that whoever attempts to do so will fail and that the book will not live up to its promise. However, the book's author (Niall Ferguson, one of the most renowned economic historians in the world) has delivered on the promise of the book in a way that only an history professor who grew up in scotland, went to school in England and Germany and holds concurrent academic appointments in Oxford University, Stanford University, Harvard University and the Harvard Business School can.

Not only did he give an exacting historical background to the important role that money, financial instruments and financial markets have played and continue to play in modern societies, he delivered it in such an engaging way as to make the book simply "unputdownable"!.

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  The various sections of the book, include:
  
  Dreams of Avarice (basically an introduction to the rise of modern banking in medici-era Florence (in modern day Italy);
  Of Human Bondage (a chronicle of the rise and importance of Bond Markets and instruments);
  Blowing Bubbles (history of investment in stocks and behaviour of stock markets);
  The Return of Risk (history of the Insurance Industry and the concept of the "social safety net" (i.e. Social Security, National Pension Schemes etc))
  Safe as houses (description of mortgages and the housing finance industry)
  From empire to chimerica (overview of "emerging market" and cross border investments over the centuries and the unique role currently being played by America & China in the global economy); and
  The Descent of Money (sort of an epilogue to the whole book).

I really enjoyed reading the book as it reinforces my views (as an unashamedly ardent capitalist) that financial markets and innovation are the main contributors to the improvements witnessed in incomes, standards of living, longevity and even the rise of democratic systems in the modern world.

Above all, i recommend the book to the legion of "doomsdayists" currently predicting (or is it "prophesying"?) the ruin of financial markets. They will quickly learn from reading the book that crises are an integral part of Financial markets and that financial markets have (just in the space of the last 100 years) survived two world wars (one of which was tagged "the war to end all wars"), a great depression (during which unemployment rate crept to almost a third of the adult population), many recessions, earthquakes and other natural disasters, numerous sovereign bond defaults, widespread hyperinflation and even thieving dictators and strongmen.

There is no reason why international trade and finance should not recover, and even emerge stronger and better, from this current financial crisis. The world has witnessed and survived worse situations than this!!!!

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.