Friday, August 17, 2018 04:00 PM / Proshare Research
Business Cycle and Policy Response
The history of economies is best captured by business cycle. It reflects the grim reality that the seed of every burst is sown in its bubble. Every prosperity leads to an uptick in asset prices, and with time moral hazards are piled up.
Though, monetarist over the years have consistently harped on the notion that prosperity must be effectively managed to avoid being caught up in a hard landing scenario.
Recently, tilting towards a more forward-looking approach, Central Banks all over the world have come to terms. In their own way, they are creating mechanisms on how best to combat the next bubble that have become especially in a period of boom.
The grim reality is that bubbles have become a grim reality. Stunningly, both spleen of economics and finance have come to terms that such bubbles turn out to be a necessary correction to asset prices.
Recently, the cycle of bubbles and burst has become shorter. In reality, financial stability has become more cumbersome in the long run. No doubt, this tale brings back the memories of the 2008 banking crisis coupled with the policy response in reaction to the systemic shock.
Therefore, this edition of Proshare Confidential takes an in-depth study on the systemic shock that led to the formation of an Asset Management Company (AMC). The kind of AMC, Nigerian at this point, is practicing and the grey areas patterning the eclipse of the going concern of the AMC.
However, policy response at that time was intended to avoid an inflammation in the downturn which could result in short term problems becoming a long term one.
Such response gave birth to an Asset Management Company, which was named as the Asset Management Company of Nigeria (AMCON). Certainly, like all asset management company, AMCON is also a child of consequence, one born with the intent to detoxify the system.
AMCON was poised with the responsibility of taking away bad loans out of the system. Such action calm nerves around the standing lending facility corridor. In a follow up, the overnight rate was tampered down a bit as the AMC untangled the existing liquidity crunch.
In addition, AMCON was given the responsibility to restructuring through re- discounting capital base of bank to nil. Thus, AMC acted as a leg room for the economy by bolstering credit to the private sector, eventually ensuring that money not dented by the shock.
The intermediate objective of averting wider contagion by increasing money supply and providing a breather for pro-cyclical lending which allowed the GDP to grow by 7.2% a year after the creation of the AMC.
The AMCON Act 2010 was established and empowered with the ability to tap into money market. Therefore, AMCON raised a N2.3 trillion bond, which was to be refinanced at a rate of 12%. Such amount raised was referred to as a sinking bond, thus putting the corporation in a position of substantial financial leverage. The Federal Government and the Central Bank injected N10 billion and N500 billion respectively
Even though such act further encouraged supply following finance after the bond was raised. Although, it was not fully guaranteed by the Federal Government which in return also increased the total Public Debt to GDP.
Sinking Fund Explained
The sinking fund was tied with the margin of growth in the asset base of the Deposit Money Banks (DMBs) modelled around a historically growth pattern of 20% over the years, however the thin growth in GDP has slimmed down the growth in the asset of banks.
More importantly, the super-normal growth level experienced have largely faded off thus threatening the ability to fill the sinking fund. One thing was certain that the model failed to take into account the diminishing marginal return to scale.
Fig 1: Bank Assets from 2010 to 2017 (N’trillion)
Certainly, the marginal growth levels of banks will dip at some point and diminishing returns will play out. Ignoring revenue in the model, no doubt, made the sinking fund a quick sand scenario.
What is even more disturbing is that the model failed to consider macro imbalances and structural break-out. According to our estimates, our optimistic position based on the purported model showed that it will take 18 years to fill the hole.
No doubt this model highlighted the limitation of asset-based model. The prompt repayment of such loan in accordance with the given framework is obviously blurred; there is a need to redeem such loan by the Apex Bank in tranches.
Thereby, levying it on the profit of the Deposit Money Banks in piecemeal provides headroom for the AMC balance sheet. With the exhaustion of asset for sale and rising debt issuance, financial leverage has shot up to 80%.
Deposit Money Banks are institution entrusted with the hope and fate of ordinary folks. They are regarded as the trustee of their hard-earned income and sweat, there is no greater honour than that.
Thus, the transfer of financial institutions must go beyond the highest bidder. Besides they are not durable items or luxury items like paints works. Obviously, they are not bought for fancy, but to save guard deposits, maximize existing shareholders’ wealth, create fresh wealth and deepen financial inclusion.
In reality, they are livid columns of any economy. Therefore, it is pertinent that the transfer of banks must go beyond the bidding prices. It must include the micro prudential, capacity and track record of the buyer.
Sometimes, price could be a smoke screen, which leaves the financial system in a more delicate position than it was. Our inability to allow a balanced approach that involves both quantitative and qualitative indicators have created a scenario whereby dead wood still persist.
Truth be told, the cobwebs still hang in our financial system. In addition, there is need to strengthen the Nigerian Deposit Insurance Corporation (NDIC) Act as the banking system have gone through substantial evolution since 1991. After all, empowering the NDIC in the first place would have reduced the occurrence of grey areas or avoid committing the phenomenon of the original sin in the first place.
One wonders if a law that empowers the Nigerian Deposit Insurance Corporation (NDIC) allows it to give a bridge bank licence. Why can’t the Nigeria Deposit Insurance Corporation wean the bank? By doing so we can limit the room for multiplicity and accumulated losses being witnessed.
In climes like Turkey where the savings deposit fund played a big role in averting deposit runs and also stabilizing the economy. Certainly, having an NDIC that can live up to such billing will be in the best interest of the economy.
The huge leverage position of the firm has continued to put net income of the corporation under severe pressure, thereby resulting into a negative net interest position . The limited fee due to diminishing scale, macro imbalances and the tight monetary policy has made the gulf between interest free and interest expense inevitable.
The AMCON scenario clearly point out the damage of huge leverage position coupled with high cost of debt and transferred macro imbalances on net interest income.
Although other income is a major source of income, given its wide mandate. The buffering in net trading, accretion in fair gain value and bolstering net gain, crystallized a departure from the norm of net operating loss.
Therefore, recording N26 billion in net operating profit. However, the surge in operating expenses triggering a N56.2 billion negative Earnings before Income and Taxes (EBIT) reflective of a 33% dip in loss. However, the disposal gain of N46 billion depresses the headline loss to N16.4 billion.
The firms cost of equity according to the net income approach puts it at 0.26% and a negative weighted cost of capital at -0.1%. Even though the corporation recorded positive net operating profit, the high financial dragged down WAAC.
Although, the corporation has served as a macro stabilizer, but the opportunity cost to the firm has been raising losses. It also shows that for an AMC birthed to detoxify the financial system, there is a very dim possibility of the corporation having positive Economic Value Added (EVA).
Therefore, the Economic Value Added so far has been negative. Certainly, the corporation is dwindling it balance sheet and reducing its losses. However, a more aggressive approach so as to diverge from the usual trend accumulating loss. More importantly, it has to dilute its leverage, it’s not healthy for the earnings, especially when current asset meant for disposal is not.
Conclusion: White Noise of Eclipse
In fairness, there is no 10 years eclipse in the AMCON Act, rather such perception is drawn from the National Asset Management Agency (NAMA) of Ireland which has a 10 year lifeline. AMCON is similar to NAMA, besides they were birthed around the same time. While we do admit the reality of business cycles, with the revolving door scenario and the existing macro imbalances, more than ever, there is a need for an AMC.
However, a two-case scenario, the tail scenario is one whereby the value of the AMCON ends up been an arm of NDIC. Just like Resolution Trust Corporation which later became a division of the Federal Deposit Insurance Corporation. The head scenario revolves round the corporation becoming more independent and winding down its balance-sheet. Moreover, rather than reward moral hazard, it must restructure its capital and be more profit oriented. Anything less will be self-injurious in the long term.
Previous Proshare Confidential Report (s)
1. Poverty Tracker and Nigeria: Raising The Red Flag – Jun 2018
2. POCKET Economics: Addressing Income Inequality – May 2018
4. Judging IMF’s Position on Development Indices – Mar 2018
5. Money Market: The Folk Road – Feb 2018
9. States and the Rising Weight of Debt – Oct 2017
10. Money Supply: Reeling from Policy Response – Sep 2017
12. Too Big Government: The Hysteria of Developmental Quagmire – Jul 2017
14. Article IV vs. ERGP - The Third Way – May 2017
15. Lifting The Veil off The Financial Sector – Apr 2017
Related Materials / References
53. AMCON Had a Duty to Act – Mustapha Chike-Obi - - Proshare Aug 27, 2011
80.Buhari Appoints Banire as AMCON Chairman Jul 18, 2018