In an industry circular dated October 22, 2018, the CBN announced an increase in the regulatory share capital requirement of microfinance banks (MFBs) in Nigeria, across unit, state and national license categories. With this requirement, the CBN intends to drive a further consolidation of the MFB sub-sector of Nigeria’s financial services industry through mergers & acquisitions and direct injection of funds. In the same quarter, prior to the issuance of the latest circular, the CBN revoked the operating licenses of 154 MFBs out of the 1000 plus, licensed MFBs, operating in Nigeria and also issued a new code of corporate governance for MFBs. Amongst others, the new code bears provisions which aims to protect MFB shareholders, discourage government direct and indirect shareholding in MFBs and imposes extensive disclosure, transparency and risk management obligations on MFBs and their boards. If one considers the rapid succession of the latest regulatory interventions, CBN’s signaling to the MFB sub-sector becomes very clear, to wit, MFBs with sub-optimal models and methods of operation will suffer some form of voluntary euthanasia if they do not find opportunities to recapitalize and align their operations with best practices.
We think that it is commendable that the Regulation allows an 18-month grace period within which MFBs in Nigeria are expected to finalize mergers and/or acquisitions, or direct injection of funds. It would appear that regulators increasingly recognize the level of diligence, detail and complexity that is typical of financial sector M&As, especially in frontier economies. In reality, it may take up to 2 years to initiate and finalize discussions around a decision to merge and to implement a planned merger. Going forward, we expect to see more depth from regulators, across board, especially in terms of how they take market factors and investor sensitivities into consideration in what comes out to the market as a regulatory decision.
We think that mergers and acquisitions will be good for the MFB industry. Amongst others, mergers and acquisitions -if executed right- can potentially create market leaders with a clear and tangible value proposition. At least, this is the evidence from jurisdictions with relatively similar demographics like Nigeria. However, the critical question to ask is whether, the industry is investible in its current state or whether the underlying fundamentals will allow investors to favorably consider an opportunity to invest.
We encourage promoters of unit and state MFBs to seriously consider merger possibilities. As a general rule, the resulting entity following a merger will most likely be better placed to attract foreign direct investment. Merging parties should definitely consider a vendor due diligence with a view to properly positioning the resulting entity for a financing event. Other than been able to accurately estimate the amount and timing of cash flows, the investment community will react favorably to scale and to enterprises with financial reporting/ control and corporate governance procedures in place. We expect that the better performing national/state MFBs would also take the opportunity to consider expansion financing with a view to acquiring unit MFBs in new states or possibly taking equity positions in fintechs that currently play in the MFB space. Depending on the objective of the merging parties, any of these strategies can be achieved using cash for equity or equity for equity deal structures.
Discussions around mergers and acquisitions are by no means easy. Promoters may have to consider the possibility of losing their identity, autonomy, and decision-making authority. With particular regard to merger discussions, merging entities may have achieved varying degrees of sustainability, and the more profitable one may be concerned about been burdened by less profitable operations or the implications of less-performing parties having substantial input into management decisions. These are not easy conversations, however, win-win scenarios are very possible and it’s important to engage professionals from the get-go.
Timing is a peculiar transaction variable in this clime. Although it is possible to meet timelines, parties are better advised to start discussions early and leave an allowance gap for extensions. Although, we would not expect CBN to frustrate deals that are already at an advanced stage by the cut-off date.
Overall, potential market leaders in the MFB space, will need to deepen their leverage on new technology in regard to product development, operations and credit profiling as tech-driven improvements in this areas will definitely have an impact on portfolio quality and, ultimately, profitability. Fintechs are increasingly an existential threat to particularly MFBs. We expect that post-consolidation, MFBs will be as nimble and innovative as fintechs in how they innovate around local challenges.
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