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Memo To AMCON: Nigerian Tax Payers are not Responsible for Repayment of Bad Debt

Debtors & Recovery	3480 VIEWS
Debtors & Recovery
3480 VIEWS

Thursday, 23 July 2020 / 13:57PM / Adesola Borokinni and Adaeze Nwachukwu, Proshare Research / Header Image Credit: Ecographics

Recent statements by the Central Bank of Nigeria's (CBN's) asset resolution company, AMCON, and in particular, the Managing Director (MD) on the matter/in regards to the likelihood of public sector resources being used to clean-up N5trn in toxic banking sector loan assets. Analysts have noted that AMCON's conjecture may have been propped by a mistaken premise.

Specifically, we refer to the pronouncement documented in the PointNG news story titled - Nigerian tax payers may bear burden of unrecovered N5tn debt, AMCON warns of July 19, 2020.

Coming after our release of the May 13, 2020 Debtors Africa Report on debtors and NPL's in banks, and the extensive work done thereafter; it was another example of misinformation that needed to be addressed, especially one from the regulator.

The resolution company created in 2010 at the height of the asset delinquency challenges faced by banks at the time raised N1.7trn by way of a bond issue to the CBN to buy off toxic assets from banks and reinject fresh funds to support systemic liquidity and protect depositor liabilities. The arithmetic of the current situation suggests that so far AMCON has recovered N1.1trn which represents 65% of the amount committed by the company to the protection of domestic deposit liabilities and systemic stability.

The N5trn alluded to by, Mr Ahmad Kuru, the incumbent chief executive of AMCON, refers to the face value of the toxic loans outstanding.

A number of clarifications need be set as follows:

AMCON is obliged to recover the money that it raised from the CBN by way of a bond and therefore is required to recover the N1.7trn.
The face value of outstanding toxic loans is being written down by a banking sector sinking fund designed to pay off the bad loans from a deduction of 0.5% of the systems total assets. Not immediately verifiable data suggest that the sinking fund was N139.13bn in 2017, N154.98bn in 2018 and N167.90bn in 2019.
No supposed 'sunset clause' will wind up AMCON in ten years (or by 2020) as presumed in the reported AMCON statement on the use of public funds to cover N5trn of delinquent loans. The initial ten (10) year-target was based on the assumption of an average growth rate of total bank assets of 15% annually at a time annual bank asset growth was about 22%. In the event that banking sector asset growth slowed down the resolution company]s shelf life became naturally extended. More recently bank-wide asset growth has been between 5 and 6%.
Loan recovery is less complicated than it may appear at first. Only 350 Nigerians are responsible for 80% of the N5trn in toxic assets outstanding. The narrow spread of delinquent borrowers means that AMCON's recovery efforts should stay focused on the recovery of N4trn in toxic asset face value. A recovery of 70% of this amount should be seen as a clear win as even the best recovery rates of bad loans in countries like Malaysia is around 58%.
A noticeable proportion of toxic assets have been recovered by way of seizure of landed property, machinery and buildings, but the problem is that in an environment of low liquidity and slow economic growth monetizing these recovered assets has become a high hurdle.

At its inception, AMCON identified 10 banks with systemic credit challenges and subsequently injected N736bn liquidity to buy up the toxic assets. With the structured repayment plan under a sinking fund arrangement the suggestion that public funds would be needed to cover the indebtedness of the banking sector is odd.

The evidence available indicates that with expansion in bank-wide total assets as the economy picks up will lead to accretions to the sinking fund which in turn would write-off toxic asset size over time. Furthermore, the growth in the domestic economy would increase asset values and make the local investment market more attractive resulting in fresh funds flowing into the real estate business as foreign direct investors buy into the economy in search of superior market yields, enabling AMCON sell off stranded assets at tidy profits , thereby paying down the N5trn delinquent loans on the resolution company's balance sheet.

Understanding the State of Play

Since its inception AMCON has acquired over 12,000 non-performing loans worth N3.7trn from 22 commercial banks and injected over N22trn as financial accommodation to 10 banks. AMCON has been able to recover over N1.1trn while its total obligation to the central bank of Nigeria was over N5trn. In a recent presentation by Mr. Aliyu Kalgo on behalf of AMCON's boss, Mr. Ahmed Kuru, Kalgo noted that AMCON was unable to recover its outstanding debt of over N5trn and noted that the debt burden would become the debt of the federal government and local taxpayers.

The statement, though well-meaning, wrongly interprets the financial accommodation principle guiding the establishment of AMCON. The financial accommodation meant that AMCON was to recover what it paid for toxic loans. The bank's sinking funds were expected to pay for the majority of the liabilities of the banks. The difference between the bank's loan purchase amount and the balance with AMCON was referred to as 'financial accommodation'. Therefore, financial accommodation was not AMCON's responsibility to recover but that of the banking system through a sinking fund.

According to the guiding principle of its establishments, the taxpayers should not be a party in the debt recovery process. Major parties to credit recovery include AMCON itself, the CBN, Deposit Money Banks (DMBs), Credit Bureaus, NDIC, and delinquent debtors. Therefore, recoveries by AMCON, note financial analysts, cannot be used as a fiscal cushion to help plug budgetary gaps of the federal government and neither should the debt burden resulting from an inability to recover toxic loans be shifted to taxpayers. Therefore, as far as corporate finance professionals are concerned, AMCON at no time had the legal right or fiscal responsibility to give the federal government money for whatever purpose neither does it have the right to transfer burdens of debt.

A grey area that is yet to be properly clarified is the role of NDIC. NDIC was saddled with the role of charging insurance premiums on the deposits of distressed institutions. The insurance premiums charged were supposed to insulate depositor's funds in the case of the collapse of a bank. Therefore, NDIC's role was faulted as there was no reason for NDIC to collect insurance premiums during bank failures when AMCON was covering the cost.

But the NDIC has collected premiums from banks which were beneficiaries of AMCON intervention meaning that AMCON was paying money to the federal government through NDIC. According to ChikeObi, "if the adjustments for NDIC payments to the federal government by way of premium payments on deposits are added to the taxes paid to the government by now profitable banks the money made available to the federal government by AMCON would be in the region of N2trn."

The New Grail

To validate Proshare's position, a discussion with Mr. Mustapha Chike-obi, erstwhile chief executive of AMCON, gave some confirmation of the evidence-based arguments. According to Chike-Obi, all AMCON needs to recover is what it paid for the loans. The recovery of the balance of the face value of loans outstanding on the asset resolution company's books was to be amortized and recovered by a sinking fund created for the industry's toxic assets. The bank's loan purchase amount was about N1.7trn, the balance of N4trn was what AMCON called, 'financial accommodation'. The accommodation was supposed to be paid back by the sinking fund, and represents what the banks at the time had lost. Based on this playbook, Chike-Obi believed that it was incorrect to say that AMCON bought loans of N6trn.

The sum of N6trn represents the face value of the loans outstanding at the time of intervention but did not represent the amount that AMCON paid. The N6trn was made up of N1.7trn that AMCON paid for eligible loans (EBLs) and N4.7trn represented the money that AMCON gave to the banks as financial accommodation to ensure that depositors were protected from loss. The financial accommodation was not AMCON's responsibility to recover but that of the banking system through the sinking fund.

According to Chike-Obi, "Sanusi and I discussed mentioning the face value of the loans, and Sanusi prevailed that we should make the face value of the loans public in line with policy transparency and adherence to proper corporate governance standards. Sanusi felt this would give the loan resolution body greater flexibility in pursuit of recovery"

"If a borrower was in a hole for N1bn, AMCON only needed to go for recovery of between N300m and N400m, but Sanusi felt that the agency should go for the full face value of the loan thereby putting a lesser burden on the systems sinking fund".

Chike-Obi also noted that the highest recovery rate globally, occurred in Malaysia which was about 58%. AMCON's target was 70% asset loss recovery. So, of the N1.7trn the agency paid for bank loans, its actual target was 70% of that or what came to roughly N1.2trn. AMCON presently has recovered about N1.1trn according to the current Chief Executive of AMCON, Ahmed Kuru. The N1.1trn recovery represents 92% of the debt resolution company's target of 70% recovery of its N1.7trn paid to banks. Based on these numbers, Chike-Obi may be correct in stating that the agency has done a good job of meeting its initial debt resolution mandate. Chike-Obi's position may be at variance with the frustration of the agency's asset management partners (AMPs) who have expressed concern over the style and strategy of the agency in recovering delinquent debt, but premised on targets set by the CBN for the body, AMCON appears to have delivered on the original agency target.

An interestingly compelling point that Chike-Obi equally makes concerning the recently mentioned N5trn face value of AMCON debts is that no bank would sell for 40kobo on every 100kobo face value an asset it strongly believed was worth at least 60kobo on the naira. Besides, Chike-Obi also noted that a number of the banks had already made certain provisions for the diminution in loan asset values on their profit and loss (P&L) accounts.

So how does CBN come in on the issue of bad bank loans? Chike-Obi argues that CBN has nothing to do with bad bank loans. In his words, "CBN bought AMCON bonds worth N5trn, the question is whether CBN can recover the N5trn invested in AMCON bonds? From AMCON's model, the CBN is getting N400bn a year from the sinking fund. The CBN should get its money back if not in 10 years then in 15 years. So, what the CBN has on its books is AMCON bonds". The bond is being serviced by the sinking fund and AMCON. CBN has nothing on its books on AMCON other than the bond investment.

A tricky area of AMCON's playbook is a situation where the agency recovers more than was required by the recovery formula, suppose a N1bn debt AMCON was required to recover N300m (30kobo on a naira). Suppose AMCON recovers N500m, does the additional N200m go to the sinking fund? No, it does not.

Chike-Obi agreed that one of the most profitable aspect of the AMCON delinquent debt was the loans without collateral that were purchased at 5%. Many of these debts, according to Chike-Obi, "were recovered 100%". The excess of money recovered over and above that required by the AMCON recovery target goes into a pool of recovered loans. The former AMCON boss reiterated that all AMCON can ever do with recovered money is to pay down its debt.

Fighting the Tyranny of Debtors

The problem of chronic debtors in the banking sector has been a perennial concern for some years. One of the major challenges of the local lending cycle in Nigeria is that lenders which are the banks have become victims of the tyranny of bad and delinquent debtors.

Some of these bank debtors are high profile individuals and people with political influence, therefore, worsening banks' ability to recover delinquent loans. CBN has adopted various policies to reduce the incidence of bad loans in Nigeria. In 2015, CBN issued a directive titled "Recovery of Delinquent Credit Facilities" to all Nigerian banks and discount houses, to give delinquent debtors a three-month grace failure by these debtors to make recompense within the grace period will lead to the names of these debtors being published in three (3) national dailies which is expected to be quarterly.

However, the question arises whether the "name and shame" strategy and blacklisting of the defaulting creditors constitute the right approaches to dealing with credit defaulters. These strategies may be viewed as severe and beg the question how banks can avoid delinquent loans in the first place.

The latest strategy adopted by CBN is the GSI (Global Standing Instruction) guidelines issued by banking sector regulator. The GSI contains notable provisions on the obligations of a borrower to execute a GSI mandate permitting a creditor bank to debit any of its bank accounts in Nigeria, in repayment of the loan facility availed the borrower. As previously noted, the GSI was prompted by the need to reduce the incidence of delinquent loans in the financial sector.

The New Approach

With opportunities for better debtor profiling before loans are granted, a report written by Proshare Nigeria but commissioned by Debtors Africa earlier in the year noted that the domestic loan process can be de-risked by improved borrower knowledge and monitoring. The Debtors Africa report noted that the use of digital registers of borrower's activity across the financial service sector provides a loan marker which enables new lenders insight into the character of the borrower. The new approach would embed a customer's borrowing journey into a digital framework that can be reviewed by lending institutions. The digital register differs from a credit bureau; while a credit bureau provides a scoring system to determine whether a borrower is a fit and proper person to take a loan, the digital register is a dynamic record of strictly delinquent and hardcore borrowers. The record looks at the amount outstanding, the customer address and business, and details of directors if the customer is a company. The register replaces the old perishable "name" and "shame" approach tried by AMCON and Access Bank Plc. The "perishability" of hard copy print list of delinquent customers makes its effectiveness limited. However, a digital list of bank customers that are delinquent or unwilling to pay debts is more permanent and overcomes the psychological impact of "saliency" and "recency".

Illustration 1: Lending Cycle

Proshare Nigeria Pvt. Ltd.

The online digital register is a quick recourse for base rate references on a prospective borrower's existing credit position. The lender can screen the borrower while also assessing the character of the corporation or individual concerning recent and past loans received. The register could serve as a pre-emptive tool at the point of loan appraisal, a digital monitor at the point of loan administration, and a loan recovery tool at the point of loan repayment.

Illustration 2: Debt recovery/Management new indicative paradigm

Proshare Nigeria Pvt. Ltd.

Going Forward

AMCON must evolve and reset its internal and external engagements to ensure better monitoring of loans outstanding and providing clarity of context of the face values of delinquent loans outstanding, the balance on the amount outstanding with respect to an early bird intervention of N1.7trn into the banking system and the status of banking sector sinking fund accumulation. AMCON may also need to resolve with the NDIC issues over premiums collected by the depositor's protection agency on depositor funds that were protected by AMCON at the point of banking system intervention in 2010.

AMCON needs to disabuse itself of the unusual notion that taxpayers' funds could be used to write-off outstanding delinquent banking sector loan assets. The notion of the use of public funds to resolve private sector financial indebtedness contradicts all known concepts of efficient financial markets. The fiscal treasury is not a reserve of last resort for financial buccaneers. Markets must take care of their own mess.