Nigeria has taken the first strategic step to creating an active distressed debt market locally. This is a significant move in the light of the build-up of non-performing loans (NPLs) in Nigeria’s banking industry. NPLs in Nigeria’s banking sector have now crossed the N2 trillion mark and are still on an upward trajectory. The International Monetary Fund reports that NPLs in Nigeria’s banking sector has increased by more than double since 2015. In June 2017, the Central Bank of Nigeria (CBN) released an Exposure Draft of the Framework for Licensing, Regulation and the Supervision of Private Asset Management Companies in Nigeria. (The Guidelines). What the Guidelines do specifically is to require the universe of promoters and investor seeking to play in Nigeria’s distressed debt market to register with the CBN as a Private Asset Management Company (PAMCs) and to comply with fairly standard, capital, reporting and operational requirements. It is useful to note that the Guidelines also provide for the sale and purchase of performing loans.
Although the market for distressed debts is still relatively, an early market and there are yet no distressed debt funds locally, we think that the issuance of the Guidelines provides an opportunity for alternative asset investors to establish an early foothold in the local distressed debt market as the long term outlook for private credit in Nigeria remains strong. There is also some comfort in the ongoing review of the legal framework around insolvency law and practice and on this basis, we expect that existing legal hurdles will ease up.
One of our key concerns with the Guidelines is that the Guidelines do not contain provisions that can incentivize and or drive the disposal of NPLs by financial institutions. We say this because the recurring issue we see with negotiations for NPL purchases locally, is the gaping discrepancy between the price at which banks are prepared to sell the NPLs and the price buyers are willing to pay. The provisions on pricing in the Guidelines merely require that the pricing and transfer of assets must be transparent, reasonable and at arm’s length. We think this provisioning may be inadequate. Investors have a fairly different economic perspective and apply diverse methodologies for the appraisal of NPLs. On this basis, we think it is important for the Guidelines to be structured in such a way as to strategically enable the NPL disposal process by preserving provisions that address NPL pricing gaps issues without restricting the freedom of parties to contract.
We think that NPL pricing gaps will continue to be a challenge. Thus, it will be useful for the CBN to consider stricter supervisory approaches, in terms clarifying time limits for NPL disposal or write-offs , setting NPL resolution targets and generally strengthening provisioning practices. In the same vein, we think that the CBN should also consider a review of the extant accounting and tax regime around NPL disposals with a view to making them more favourable to NPL disposal and with the objective of incentivising NPL sales. It certainly wouldn’t be out of the CBN’s remit to initiate discussions with Federal Inland Revenue Service to consider a review of its priority status within the context of corporate insolvency under Nigerian law. We also think that the Guidelines should also as far as is possible, creatively address the information asymmetry issues, which was a major challenge for the government-owned asset management company, AMCON, during the initial acquisition process of NPLs from local banks.
Overall, it is instructive to note that the CBN is keen on using private capital to mop up the NPL overhang in the country. On this basis, we expect that there will be additional market-sensitive interventions in the short term that will be aimed that further deepening activity in the local distressed debt market.
In this Client Industry Update, we focus on some of the more important provisions of the Guidelines which investors should bear in mind in thinking around investing in the local distressed debt market in Nigeria.
Please note that the following is not intended to constitute legal advice. If you require a copy of the Guidelines for comment purposes or legal support or assistance with respect to the procurement of a PAMC license or investment in a PAMC or raising foreign equity or loan capital for obtaining a PAMC License, we kindly ask that you speak to your Balogun Harold contact or reach us on email@example.com.
A. Which Assets Are Up for Sale and Purchase?
The assets eligible for sale and purchase based on the provisions of the Guidelines include:
1. The Secured and Unsecured Non-Performing Loans (NPLs) of Eligible Financial institutions (EFI) which are substandard, doubtful or lost.
2. Loans whether classified or not, owed to EFIs, whose license has been revoked by the CBN.
3. Assets acquired by an EFI in the course of satisfaction of any debt whether or not the underlying debt remains outstanding.
4. Any loan which possess significant financial risk to an EFI.
B. Which Financial Institutions Are Eligible to Sell NPLs?
The financial institutions eligible to sell NPLs include Deposit Money Banks, Microfinance Banks, Non-interest Banks, Development Finance Banks, PAMCs and banks-in-liquidation
C. Which Activities are Prohibited for PAMCs?
PAMCS are prohibited from (i) providing credit to its customers (ii) accepting deposits (iii) obtaining loans from banks or other PAMCs (iv) providing fund management activities to third parties (v) engaging in the sale and buyback of eligible assets with selling banks and other PAMCs (vi) issuing securities; and (vii) providing guarantee for loans. It is important to note that as part of the NPL acquisition process, PAMCs are required to enter into security agreements with counterparties in an NPL sale transaction.
D. Which Activities Can a PAMC legitimately Carry On?
PAMCs are permitted to (i) acquire, hold, manage, realise and dispose of the eligible assets (and underlying collaterals) of banks and other financial institutions (ii) acquire performing loans of banks and other financial institutions, undertake debt factoring and asset securitization (iii) purchase or sell other receivables of banks and other financial institutions (iv) provide consultancy and advisory services to banks and other financial institutions for the purpose of restructuring receivables and any other assets, including the sale of such assets to third parties (v) own subsidiaries and issue /invest in securities (vi) purchase and or sell eligible assets to other PAMCs.
E. What Are the Regulatory Capital, Shareholding and Directorship Requirements for PAMCs?
PAMCs are required to have a minimum paid up share capital of N10, 000,000,000 (Ten Billion Naira) and pay a non-refundable application fee of 500,000 (Five Hundred Thousand Naira) and a non-refundable licensing of N2, 000,000. (Two Million Naira). It is useful to note that a PAMC license is granted for an indefinite period and non-transferable.
There are also some provisions on directorship and shareholding that investors and promoters should be aware of. For instance, Nigerian banks, financial holding companies, other financial institutions and their subsidiaries are precluded from investing in PAMCs. Also, no board member of any Nigerian banks, financial holding companies, other financial institutions and their subsidiaries can serve on the board of a PAMC. There are no restrictions on foreign shareholdership, however CBN approval for such foreign ownership will be required. There are standard corporate governance, risk management and accounting standards that PAMCs must comply with.
F. Supervision and Reporting Obligations
The CBN reserves the general powers to conduct on-site examinations and off-site surveillance of the activities of a PAMC. In this regard, the CBN will have unrestricted access to the records of a PAMC. PAMCs are also required to comply with International Financial Reporting Standards. It is instructive to not that a PAMC license is revocable by the CBN where a PAMC fails to comply with the terms of its license and condition of operations after a 3-month notice period from the CBN to address any regulatory concerns.
Our Final Thoughts
We think the big winners in the evolving market, will be the investors who are willing to complement their fundamental credit and risk control knowledge and valuation discipline with the discipline and patience to adopt enhanced due diligencing approaches and to understand the cultural and legal differences in frontier markets like Nigeria and the intricacies of the local insolvency and security enforcement framework.