The proposed Asset Management Corporation of Nigeria (AMCON) represents Nigeria’s response to the problem of troubled assets or non-performing assets within our financial institutions (mostly commercial banks).

According to the Central Bank of Nigeria CBN), 10 of the 24 commercial banks that failed a joint stress and risk examination conducted by the CBN and the Nigerian Deposit Insurance Corporation (NDIC), have a negative N1.5 trillion capital in their books, mostly in bad debts or debts that are unserviceable.

With the passage of the AMCON Bill by the National Assembly and the signing of the bill into law by the President, the new government agency is now a reality and every investor in our economy who wishes to be successful better take notice of the emerging scenarios that will for decades change the financial landscape of the Nigerian capital markets.

The CBN’s idea or case for AMCON is based on the principle that these banks are too big to fail in the first place. As “non-government” financial institutions, though government supervised and regulated, they have made bad business deals in the form of loans that have now become unserviceable, in other words, the banks cannot collect on these loans, those who borrowed money cannot pay, and such assets or collaterals involved in these deals in most cases are now less than the amounts owed on them.

It is further an implied assumption that our courts are incapable of addressing the legal tangles involved in these contractual relationships between the lenders and the borrowers. These bad business deals are weighing on the balance sheets of these banks and have impacted on their abilities to be effective financial intermediaries, hence, the commercial bankers’ inability to lend funds to consumers and the business communities.

According to the CBN, AMCON is in line with what has been taking place in several other countries, in the wake of the global financial crisis that began in 2007. AMCON as a government owned asset management firm will pool several “toxic” assets from the financial institutions and manage such “market grade” assets in attempts to turn them around and may attempt to make them profitable. A 10 year initial run is envisaged for AMCON and nothing in the books or thinking of the CBN says that it must be shut down within that period. AMCON’s mission may be extended.

The Concept of Government Rescue for Bad Bank Debts The idea and principle of assisting monetary intermediaries and or banks to deal with market failures in the financial sector is not new.  Over the last two decades for example, the most famous was the 1989 United States Financial Institutions Reform Recovery and Enforcement Act (FIRREA), which was subsequently overhauled in 1991. FIRREA gave birth to the Resolution Trust Corporation (RTC). The then US President George Bush, Senior, appointed L. William Seidman as head of the RTC with a mandate to liquidate assets, mostly real estate assets and mortgage loans that were made by failed or insolvent Savings and Loans Thrift Institutions in the United States.

The failed Savings and Loans Institutions of the 1980s in the United States were not full commercial banks that were under the direct supervision of the US Federal Reserve Bank (the US Central Bank) and the US Federal Deposit Insurance Corporation (FDIC).  Rather, they were loose thrift institutions poorly regulated by the Office of Thrift Supervision and the consequence of that failed regulatory regime was the engagement of these thrifts in various sharp financial market practices, including making mortgage backed loans using convoluted asset valuation methodologies.

To clean up the financial mess caused by these thrifts, several of them were shut down, the directors of some of these thrifts faced rigorous prosecutions and restitutions, and the surviving thrifts were folded into the direct supervision of the Savings Association Insurance Fund (SAIF) of the FDIC. At its height, the RTC had more than 20,000 employees, with an army of lawyers, several of them direct employees and others contracted.

In 1995, when Mr. Seidman shut  down the RTC, it had dealt with nearly 750 thrifts with assets in excess of $400 billion.

The most important attribute of the RTC and why to date it represents a land mark in any government attempt to assist or intervene with the problems of troubled assets or bad business deals in the financial markets is its use of the concept of Multiple Equity Partnerships. For one thing, RTC was an institution with a Czar, L. William Seidman, who was prepared to learn fast, shift the goal post, and was on a mission to complete the assignment and claim the associated fame.

When he found out that bulk sales of asset portfolios in the possession of the RTC were cumbersome because of valuation and pricing difficulties, him and his army of experts opted for the Multiple Equity Partnership approach, where the RTC brought in private equity partners, gave the private operators interests in a pool of assets, including management controls. Upon sale of the assets, the private equity partner will make payments and distributions to the RTC in proportion to the RTC’s interest in the asset pool.

The Multiple Equity Partnership approach did not eliminate the army of crooks and financial market gamers and predators (most of them having honed their art within the failed Savings and Loan institutions), however, it did reduce government reliance on them. Private Equity Partners were better prepared to deal with the problem, and in due cause enabled the RTC to maintain an upbeat posture and better performance.

The financial crisis of 2007, again led the US to establish the Troubled Assets Relief Program (TARP).  When the TARP became law on October 3, 2008, it empowered the US Treasury Department (The Ministry of Finance), to purchase up to $700 billion in mortgage backed securities (MBS) across the country in attempts to create liquidity within the financial institutions.

It is important to note that the US mortgage market is perhaps one of the world’s most fluid and robust. Several mortgages are insured, especially those for first time home buyers. Mortgages are marketable securities that can be traded among financial institutions. Several hedge funds also buy into mortgage backed security instruments. In other words, a mortgage origination company may sell the mortgage within months after the initial closing to a second party, who then continues to service the portfolio. Several commercial banks in the United States acquire mortgage portfolios through this method, i.e. in the secondary market.

Financial institutions who acquire baskets of mortgage portfolios in the secondary market do not reappraise the individual real estate assets in such portfolios. While commercial banks, due to regulatory and supervisory requirements may apply strict due diligence when acting as origination bankers for mortgages, several mortgage companies, especially those licensed by the various states, do not follow such strict requirements because of lax or non-existence of regulatory mechanisms for them. The consequences included the near reckless making of loans based on poor evaluation criteria and loans made to consumers with little or no ability to pay.

When market and economic dynamics caught up with these sharp practices, commercial banks who had bought into these assets were basically carrying loan portfolios that are almost impossible to service. In September 2008 major financial institutions such as Lehman Brothers, Fannie Mae, Freddie Mac, American International Group, etc. went bankrupt because of the weight of mortgage portfolios within their asset base. In a coordinated attempt to prevent further collapses, investor bankers Goldman Sachs and Morgan Stanley, were given commercial bank charters in attempts to stabilize their capital positions.

Using TARP funds, the Bush administration invested in top American banks, either as direct equity owners or loans and in some cases provided guarantees for corporate bonds. One key component of regulation and supervision of financial institutions, especially commercial banks is the ability to close down those that are no longer viable, within the ambit of the law. The United States bank regulatory authorities shut down nearly 12 dozen commercial banks in 2009 and in 2010, several banks that are considered week or incapable of being rescued have been shut down.

In 2005, the Olusegun Obasanjo administration carried out one of Nigeria’s most sweeping banking reform and consolidation regimes to date. It compelled the nearly 89 banking outfits and financial beautiques in Nigeria then to raise their capital base to N25 billion, arguing that such institutions will be better prepared to meet the commercial banking needs and challenges of a market driven Nigerian economy.

In pursuit of that regulatory mandate, several Nigerian investors and bankers realigned and at the end of the exercise 25 commercial banks emerged. Those who could not raise the requisite funds required for their new capitalization requirements were shut down, including some of Nigeria’s premier banking names.

AMCON and the Concept of Distressed AssetsFinancial institutions in Nigeria are private businesses. From a purely business standpoint, these commercial banks are not different from any well organized eatery. Both provide services that the public patronize, except that government has a heightened interest in the well being of these financial institutions.  If a multi-chain eatery engages in expensive real estate acquisition for its locations, most likely it will be forced to charge more for its fried chicken than other competitors, a conduct that will lead to its patrons going to other providers. The consequence will eventually lead to the eatery going out of business or make it vulnerable to acquisition by other businesses.

The concept that a commercial bank with bad managers should be protected through financial engineering while other sectors are allowed to weather through the consequences of market forces is nothing but voodoo economics. It is an ill conceived financial market concoction that defies rational economic thought.
For investors, it is important to understand what the consequence of bailing out distressed assets from bank balance sheets portends. Some examples are important.

Bank A made a N4 billion loan to company X, using company X’s property located in Maitaima, Abuja, “valued” at N5 billion as collateral. The collateral could be a private residential property or even a commercial property that does not realize N5 billion in rent income any given year. Three years into the life of the 15 year loan, company X stopped paying the monthly installments on the loan. The bank proceeds to foreclose on company X and have taken the property into its books. However, the collateral upon proper appraisal is only worth N1.5 million, not the N5 billion that it was valued at three years ago. In the mean time, the N4 billion loan is not performing and the interest calculation at an annual rate of 15 percent has now turned the loan into a N7 billion debt.

The bank is now distressed and the CBN says it is distressed and pumps in N3 billion to keep the bank afloat. The Asset Management Corporation of Nigeria, AMCON, will acquire these kinds of assets across the banking terrain and attempt to management them “profitably.” According to the CBN, there is nearly N1.5 trillion worth of these kinds of assets in bank books across Nigeria. The reason for this is because these banks are important financial intermediaries that cannot be allowed to fail.

The first question in the mind of any rational economist, invest, market man or woman is how did bank A arrive at a residential property in Maitama having a value of N5 billion. This will be followed by others. What kind of work does the owner of the property and those in his community do that shut the value of their house to N5 billion. Is Maitama in Nigeria or is it in some foreign country where everyone in such a country is a multi billionaire? Why are we not suing the company that provided the appraisal of the property and seeking damages against them, including the bank manager who signed off on such valuation?
The reality is that most of the properties that AMCON when fully functional will acquire have convoluted values.

Irrespective of the financial gymnastics and double speak that is applied, AMCON is a bonanza to shareholders of these banks at taxpayers’ expense. The fraudster who took the loan, company X, the manager who made the loan, and the appraiser who carried out the valuation of the property directly or indirectly participated in the fraud.

The rational economic approach
would be for bank regulatory authorities, if they know what they are doing and are sincere, to approach the banks and expressly make demands for them to shore up their capital base, excluding the bloated real estate or asset portfolios. Where the shareholders cannot meet the demand, nothing stops the regulator from applying the exact replica of the 2005 consolidation scheme, i.e. meet up or go out of businesses.

For one thing, this seems to be very fair on its face and protects the Nigerian tax payer from the follies of businessmen and women who hire poorly equipped and ill prepared managers to run the affairs of their corporate interests.

AMCON, the way it is being envisaged will start with a negative asset base of N1.5 trillion. Beyond this, it is going to become a massive government bureaucracy with hundreds if not thousands of employees, who will have to deal with a myriad of experts in law and financial analysis, majority of them coming from the financial institutions that have been at the forefront of the very mess that AMCON is supposed to clean out.
AMCON assets are of enormous magnitude, involving financially skewed mortgage backed instruments with valuations so byzantine in their structure that the best brains from the most quantitative business schools on earth will ponder and wonder, how did we get here?

Assets in the corporation’s portfolio will be managed by private equity operatives and secretive fund managers who will in most cases be serving their own self interests. Initial employees of AMCON definitely will be faced with the problem of managing the nuts and bolts matters from day one, of policing fraud, overseeing an army of contractors, and many of them will become political scapegoats.

The banks that lost these properties know them very well and several of these banks and their operatives will most likely set up straw companies and invest to buy these assets at bargain prices, delivering a double punch to the tax payer.

If we are serious about these distressed properties, it is important to strictly follow due diligence in their acquisition from their owners. Make conscious efforts to dispose them and fold up AMCON to avoid rescuing the rescuer down the road.