AMCON and the Confusion of the Nigerian Investor
The Asset Management Company of Nigeria (AMCON) was set up by the laws of the Federal Republic of Nigeria with a mandate to take up non performing loans from the books of all the banks in Nigeria in order to restore liquidity and grow credits. This is a welcome development for the third fastest growing economy in the world according to IMF. The valuation methodology that will be used to take up the bad loans are listed below:
a) For non-performing loans (NPLs) backed by shares of listed companies, AMCON will value the loans at an implied premium of approximately 60% on the 60-day average of recent prices ending November 15th 2010. The underlying assumption is that a fair value to ascribe for the purposes of buying the NPLs would be two times book value and this premium approximates that value. It should be noted that this valuation is solely for the purpose of buying the NPLs and not for recapitalisation of the banks.
b) For non-performing loans (NPLs) backed by other perfected collateral, AMCON will accept the most current estimate of the loan value supplied by the institution. The estimate must be based on current market analysis of the collateral and a written guarantee of good faith by the institution. Additionally, there must be a post-transaction adjustment agreement that allows AMCON to independently value the loan as of the transaction date of November 15th 2010.
c) All unsecured loans or loans with ineligible collateral will be valued by AMCON at 5% of the principal value.
I watched with horror as retail investors on the Nigerian Stock Exchange lost all sense of fundamental and technical valuations and bid up stocks of the rescued banks far above their fair values. The fire was further stoked by analysts interviewed by Business Day, a Nigerian daily, who did not fully comprehend how the AMCON business will affect stock prices.
According to Business Day:
In the same vein, Tope Fasua, a Dubai, United Arab Emirates based investment management specialist, said taking over bank assets that were secured with equities at 60 percent of original value will, in reality, be more than what those shares are currently worth, considering that the value of most of the distress loans secured with shares declined by over 90 percent.
Quoting Renaissance Capital, Tope said: “Valuing such loans at 60 percent is, therefore, quite magnanimous. The capital market is likely to receive that most favourably, because such shares would naturally buy banks shares at much above their current values,” he said.
This is a sheer misinterpretation of the modus operandi of AMCON as listed above. The loans backed by shares out of the total non performing loans of N2.2 trillion is about N0.99 trillion, while unsecured loans used for the purchase of shares is about N0.11 trillion. This is according to Mustafa Chike-Obi, the AMCON MD, on CNBC Africa. These loans valued at N0.99 trillion backed by shares that the Dubai based analyst mis-analyzed and stated that the banks will get back N594 billion, when he said the loans will be valued at 60% of original value. He got it wrong; this is misleading and totally unacceptable. Investors will lose money based on this and confidence will be shattered. It is clearly stated in the AMCON valuation guide that the loans will be valued based on an implied premium of approximately 60% on the 60-day average of recent prices ending November 15th 2010 and NOT the magnanimous valuation of loans at 60% of face value.
As I type this, Oceanic bank is up by 4.70% at N3.12, which is far above the price that AMCON will pay for the loans. Let me illustrate with a quick example. Alhaji Ahmed took a loan from UBA worth N100 million and backed it with Oceanic bank shares worth N120 million. During the boom Oceanic bank traded between N32 - N38 but I will assume the bank was worth N30 per share at that time, meaning Alhaji used 4 million units of Oceanic bank as collateral. As at yesterday's closing price, Oceanic bank had a 56-day average price of N1.646; assuming Oceanic bank gains 5% per day till November 15, 2010, the 60-day average price will be N1.760. AMCON will pay a 60% premium on this which means it will take up the loan at N2.82 per Oceanic bank share. Therefore, AMCON will pay a total of N11.280 million for a loan with a face value of N100 million backed by Oceanic bank shares that were worth N120 million. If I am UBA, I'd rather sell these shares into the market at N3.12 than give it to AMCON. Investors in the true sense of the word, are beginning to make money for AMCON long before it starts operations. This means that loans backed by Oceanic bank shares will be replaced with bonds with face value of about 12% of initial loan. That is not the end of the story, I will get there later.
First bank is probably the most margined stock on the exchange. Let's see the effect on the books of the banks after AMCON has taken up the bad loans. First bank closed at N12.76 yesterday and is currently by 3.45% at N13.20 (why am I not surprised that it is not up by full 5%?). Assuming the stock gains full 5% for the next 4 days, the 60-day average will be N12.35 per share and with a 60% premium, AMCON will pay N19.76 per First bank share. During the boom, First bank sold between N38 - N46. This is 52% of initial loan and short of 60%.
Nestle is perhaps a better story but with an average price of about N230 during the boom and with less than 3% of market cap as at then, its effect is close to negligible on AMCON activities as the banks would rather sell the collateral themselves at prevailing market prices.
Now to the little twist in the story. AMCON is going to issue a 7-year bond that will be backed against default by the full faith of the Federal Government of Nigeria. These bonds will be given to the banks in exchange for the bad loans. When the banks approach the secondary market to offload the bonds for cash we know what will happen to the price of the bond. I foresee an imminent negative butterfly twist in the yield curve when it happens. The bonds will end up being priced at a discount to the face value that the banks will receive. That means there is another inherent unknown further discount that should be applied to the values that banks will receive from AMCON.
AMCON MD has not told the world what percentage of the other loans is unsecured but for sure we know that the N30 billion loan to the Super Nanny is one of them.