AMCON and Toxic Assets of Nigeria’s Banks

Several countries in the past ventured into rescuing ailing banks with bailout. Nigeria experienced a near US scenario last year when she pumped a whooping N600 Billions of tax payers’ money (or is it oil money?) to save the “Big Banks” from collapse and unveiling the dodgy practice that almost drive the economy into a ditch. Those practices have caused enormous suffering, and much of the damage has fallen on ordinary Nigerians and small-business owners. This is fundamentally unfair, and Nigerians are justifiably angry and frustrated. The Nigerian economy and much of the world now face extraordinary challenges, and confronting these challenges will continue to require extraordinary actions; one of such is the intention to give a value to “toxic assets” in the banking sector, or calling for a buy or investment into banks’ “waste”. Simpler as it may sound from the realm of the Central Bank of Nigeria (CBN), no crisis like this has a simple or single cause; as a nation, we borrowed too much and let our financial system take on irresponsible levels of risk.
In US, over $500 billion was ushered into the banking sector, with the Treasury Department buying as much as $1 trillion in troubled mortgages and related assets from financial institutions. The plan is likely to offer generous subsidies, in the form of low-interest loans, to persuade investors to form partnerships with the government to buy toxic assets (waste) from banks. Now, it’s all about selling something called “Waste”, or “Toxic Assets” as the economists put it. It seems to me that the problem is based in two simple-to-understand areas: How much money is N600 billion; and, how to put a certain value on so-called "Toxic Assets". These had sidelined the proper financial role of the taxpayer (if there is provision for one). In practice, the government is highly likely to provide cheap financing for the private investors, combined with guarantees of the floor values of the assets, with a minimal emphasis on co-investing by directly purchasing toxic assets.
The CBN, in a quest to curtail the crisis of toxic assets in the banking sector is floating the Asset Management Corporation of Nigeria (AMCON), perhaps in public/private partnership, to manage or buy or induce the public to invest in “toxic assets” from banks. If the idea is to move as many of the toxic assets as possible off the books of the banks, where they have been wreaking havoc by creating massive uncertainty as to the solvency of those banks, where does the CBN deems fit to place such “assets” with imaginary values and expects it to contribute positively to the financial sector and the economy at large? What the lay investor knows about waste is something that does not have a value, left alone an economic value that would be expected to generate a future return on investments.
First let’s get a grip on Toxic Assets. What are Toxic Assets? The economists and financial analysts made us understood it doesn’t mean what it sounds like. Toxic Assets, they say, are not a rock band (although that would be a good name for one), but things that may not be worth what the price tag says. What they mean by "Putting a value on Toxic Assets" is "How to put a value on something that no one wants to buy?" Now, do you see? It’s simple. Come to think about this; who do you think will buy something no one wants to buy? This answer is consistent with the preference to minimize the potential for losses to the taxpayers from toxic assets, even when this means giving up potential gains, but there is no “right” public policy answer here. The correct solution depends heavily on the risk preferences of the government, and ultimately the taxpayers. It starts with an explanation of the likely financial structure of the public/private partnership and then shows how the risk/return tradeoffs vary between this and an alternative approach centred around government purchases of the toxic assets.
Is purchasing billions of toxic assets the best way to recapitalize the financial system? No. It is rather a disgrace and rip-off benefitting only the shareholders and unsecured creditors of banks. It has been stressed severally that whenever there is a systemic banking crisis there is a need to recapitalize the banking/financial system to avoid an excessive and destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system. Such recapitalization – through the use of public resources – can occur in a number of ways: purchase of bad assets/loans; government injection of preferred shares; government injection of common shares; government purchase of subordinated debt; government issuance of government bonds to be placed on the banks’ balance sheet; government injection of cash; government credit lines extended to the banks; and government assumption of government liabilities.
Even in cases where bad assets were purchased, as in Chile, dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course in most cases multiple forms of government recapitalization of banks were used. But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases where the recapitalization of banks occurred via the government purchase of bad assets, such recapitalization was a combination of purchase of bad assets together with other forms of recapitalization (such as government purchase of preferred shares or subordinated debt). In the Scandinavian banking crises (Sweden, Norway, and Finland), which are a model of how a banking crisis should be resolved, there was not government purchase of bad assets. Most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead – in most cases in which it was used – made the fiscal cost of the crisis much higher and expensive (as in Japan and Mexico).
Although the purchase of toxic assets might have an advantage in the sense that it actually moves the assets off the balance sheets, freeing up lending capacity, and might even make the value of these assets more attractive than before, the Stock Market may not be a realistic yardstick for trading such toxic securities in the first phase of the crisis; else, the “bad” securities could pull down the market and destroy national wealth. The best two options left are government’s taken up the assets or putting more capital in (the banks), and that is de facto nationalization. After all, we don’t expect foreign investors to buy into our troubled or trying banks and take up the risks of controlling our significant arm of the economy at the long run when these assets are expected to yield a plausible return on investments.
Nigeria is on the threshold of putting some economic theories into practice with the hope of salvaging the banking industry, the fate of the ordinary investor whose funds is expected to buy up “valueless” assets could have a negative impact on their savings, and ultimately on consumption. What the picture really depicts here is: AMCON will manage the banks’ toxic assets by giving a value to a valueless stock. How? That AMCON buys over toxic assets at their original cost to the banks; in this case, the banks will only suffer the loss of interest charges and other fees accrued on the facilities while their principal/capital will be restored. Better still, AMCON takes over nonperforming loans at either the book value or at a fair value by applying any of the available options of assets pricing such as, forced sale value, realisable value, or intrinsic value. However, in a distress and illiquidity situations, there could be a high tendency for the “failing” banks to dispose precious or valuable assets at their forced sales value to enhance cash inflows to abate illiquidity.
The CBN has the option, as provided by the existing legal framework, to liquidate the banks in the event of the failure of the above options. When this happens, where then lies any assurance to the investment on “wastes” by shareholders and the general investing public? Alternatively and in a bid to protect investors in the short run, investment into bank toxic should be solely AMCON involvement. In this case, AMCON should rather buy the toxic assets from the affected banks at prices equivalent to the capital amounts disbursed by the banks for the underlying loans, adding that in virtually all the cases of toxic assets, the market value of the underlying assets or collateral is less than the principal amount disbursed by the banks. But for a long run consideration, it is worthwhile to induce the general public into investing in banks’ toxic assets now. Some might argue that this is a means of the rich scamming the system, but is it? While the previous investment loss as a result of the crash in the capital market would stop many from ever investing again, it would encourage some to learn more about investing. After all, someone made money on the deal, right? Meanwhile, it costs nothing to hold onto the worthless stock, but there can be some gain later on.
Meanwhile some economists opined that the best way to value assets is through an open market bidding process. If that process doesn’t exist, it is through appraisals, as those in the real estate. However there could be some unavoidable inherent risks as to the decisions of shareholders to decide on the best buy option. Prospective investors need not worry over their investments in banks “wastes” because, AMCON, when established will be funded through sale of 10 year bonds that will be guaranteed by the government. It is expected to start with a take-off grant of N20 billion minimum to be funded by both Federal Ministry of Finance and CBN, which will invest N250 billion and N450 billion respectively. Let’s put ourselves in the mindset of the quick thinkers and let’s see if we can’t figure this thing out. It means: we have the privilege buying into stocks that would be guaranteed for 10 long years. We also have the assurance that the Apex, through the AMCON, will ensure proper management, regulation and supervision of the banks’ assets to ensure growth and return in shareholders’ funds, improve Nigeria’s credit and risk ratings, restore confidence in Nigeria’s capital market and prevent continued job losses in the country’s banking industry.
Now that we know there is a guarantee for our investment, are we willing to take this advantage and invest into toxic assets? Part of the reasons private investors may invest in toxic assets, however, are the government’s assurances. The trick is figuring out what they are worth, because high-risk mortgages will be bundled together with safer loans. However, knowing that toxic assets are worth nothing, and cannot fall below their current price, any marginal increase of their values in the future will mean a profit. What is more? The CBN in an effort to fix the nation’s ailing banks have initiated a competent company who have billions in assets and technical know-how in managing waste. It is time to invest, and an investment in bad bank’s “waste” could be a worthy spend.
Salim Salihu Muhammed

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