Investor Beware! A Preview of the Nigerian Capital Market in 2009

Capital market drivers. The prosperity of the capital market depends on the prosperity of the economy. Thus the capacity of the market to successfully provide long-term funds and a good platform to trade in the accompanying securities will depend on the strength of macroeconomic productivity. A productive economy is invariably one in which economic agents create value and earn correspondingly meaningful income. Because economic agents generally subscribe to primary offers of either debt or equity or purchase stocks at the secondary market if they have income it is only consistent to argue that vibrant markets are ones where the economies create positive economic value added.

There are, however, other reasons investments can be made. These other factors are usually considered if the budget constraint has been satisfied. Thus no matter how appealing the market prospects of a security is, in the absence of income there will be no transaction overtures from the demand side. The reverse cannot be the case because even badly performing securities can be deliberately purchased once there are the funds depending on the kind of strategy that is being pursued by the investor largely because these strategies ultimately aim at making profits or returns.

So when an investor consciously transacts on the securities of an obviously dead company, such decisions though in the short-run, can be with a long-term focus of acquiring, restructuring and turning around the stock’s underlying business operations for better performance. A good example is the acquisition game between bank PHB and some Springbank investors.

Similarly some old persons, for instance, may forgo the fat capital gains of stocks of companies which are still at the early stages in industry life cycle and consistently go for the moderate returns of stocks of companies at matured stages in the industry growth cycle. Although in this case, returns are fundamental, risk perceptions are considered. This risk consideration is not strictly of the stocks but on the perceptions of the impact of the business environment on such firm’s prosperity.

Overall, three important considerations for flourishing capital market existence are the income levels of the investors; investor evaluation of current and potential performance of company as well as the risk perceptions of the investor. These forces cover the supply and demand sides of the market but not of the market umpires. What of the umpires: those who ensure that the rules of the game are complied with? The importance or unpopularity of market umpires have become more critical because from recent experiences their unwarranted interference with the market process created more problems than solutions. So a fourth factor can as well be added as the role of market umpires and regulators.

Behaviour of market drivers in 2009 In order to predict the performance of the capital market in 2009, we have to examine how these four forces are likely to fare during the year. While it is possible to make some informed guesses about the likely behaviours of the first three, it is difficult to predict how the regulators are likely to behave during same period. So for the umpires, we can at best advise on what they should or should not do in order to ensure that the market performs better.

We start with individual incomes. The incomes of individuals are tied to the prosperity of firms who in turn pay them wages in return for the services offered. Possible exceptions here are the government employees may continue to earn their wages irrespective of whether government’s finances are doing well or not.

Although it is equally possible for government to respond to macroeconomic conditions and reduce the number of persons in its payroll, oftentimes such decisions are mired in serious political considerations and are oftentimes wrongly targeted so that those who lose their jobs may not necessarily be the people who should. Historical experience in this country also has not supported wage cuts in the public sector. So we concentrate on the private firms who are more flexible in responding to changes in the environment of business.

The factors which therefore determine the profitable performance of firms in Nigeria are: infrastructure adequacy, monetary stability, fiscal equilibrium, efficient justice system and ease of taxes.

The presence of these factors ensure that firms face minimal macroeconomic uncertainty and also much more able to compete more efficiently. How are these determinants likely to fare in 2009? Infrastructure inadequacy has been unresolved and cannot be resolved in 12 calendar months. On average, partially substantial resolution of Nigeria’s infrastructure problems given its current state – should last longer than 18 months. Power supply has remained the most problematic of the entire infrastructure nightmare which was seemingly, but in futility, addressed over the eight year reign of the past administration.

What of monetary stability? It is going to be a scarce commodity in 2009. The scale of the budget deficit and the pressure on the naira exchange rate following the depressed earnings from crude oil are good pointers to what should be expected in these regards. Such huge deficits will be financed with equally huge expansions in money supply. At present, some of the areas that the budget had specified as its financing sources are being contested by some other stakeholders in the federation account particularly state governments.

With such sustained pressure, the Federal Government and the Central Bank, will come up with more ingenious ways of creating money out of nothing. This has started with the deliberate allowance of the naira exchange rate to fall from N116.00/US$1.00 to N138.00/US$1.00 in less than 60 days which enabled the transfer of naira earnings from actively struggling and value-creating economic agents to the government and its monetary authorities.

More straightforwardly, by deciding not to defend the naira as it statutorily claims with the community fund (foreign exchange reserves) and allowing the naira to fall at such scale with such speed,

(a) the CBN has saved and will continue to save as long as the naira value falls that portion of the foreign exchange reserves that will have been used for such interventions. These savings can be monetized for direct use by the government (depending on the understanding and arrangement) and; (b) all government’s proposed dollar earnings in 2009 would have become higher in naira terms which in a way may plug the holes to be created

(1) should the Federal Government lose the contested revenue sources and

(2) should it have to re-do the clearly unrealistic assumptions that underscored the revenue side of the budget proposal.

Government’s expenditure plans far outweigh its earnings prospects. In the past, the deleterious consequences of this historically traditional policy indiscretion have been cushioned by good oil prices. Government is not an investor and in a highly corrupt environment such as ours and particularly now that it appears that the fight against public sector economic and financial crimes are seriously waning, most of these proposed deficit spending will definitely find their ways straight into the pockets of some powerful predators.

So having lost the opportunity to successfully execute the projects for which the funds are meant, we shall in turn suffer the inflationary and other economic-price consequences of these actions. Who feels the brunt? The firms continue to suffer lack of competiveness in the face of the inclement operating environment where basic infrastructure remains inadequate, firms will equally not able to effectively plan over a longer time horizon because of the heavy degrees of uncertainty injected by policy-induced inflation, distortion of relative prices and inevitably rising interest rates. Firms will equally suffer demand losses because of the reduction in the real worth of incomes in the hands of households (private consumers).

Take for instance, the issue of naira devaluation. Who benefits? Who suffers? More than 70 per cent of all intermediate input into industrial production that take place in this country are imported: raw materials, machinery even technical expertise, etc. With massive naira devaluation, how competitive can these entrepreneurs be? Yet the Central Bank has pitched the reason for naira devaluation on mercantilist premise: to promote exports? Which exports? Unfortunately the export industry in this country has as well been destroyed by exactly the same reasons which we have provided above.

What has happened in the devaluation game in effect therefore is the deliberate sacrifice of the economic well-being of majority of Nigerians and Nigerian businesses in order to meet a pre-determined motivation of government’s short-term financial objectives: a consequence of many years of deliberately neglecting to put in place policies and processes that will make the economy prosper along a natural path with minimal fruitful interventions.

What of the other factors that equally contribute to the prosperity of the economy such as efficient justice system and ease of taxes. We are definitely far from these. This administration which started off with a great promise on the pursuit of the rule of law appears to be pursuing a contrary objective. In recent times we were witnesses to the executive threats meted out in the name of justice to clearly guilty government thieves. Some received N3.5 million as fine for practically wrecking their states.

Some of the accused’s files are already joining the archives of the forgotten documents without even being called up after baton change at the EFCC. For genuine vanguards of the campaign to rid the country of this mess, his reward is bouts of inglorious dishonour culminating in an ultimate sack from the service.

On the area of taxes, my suspicion is that mid-way into 2009, the government will likely invoke the dropped raise in the value-added tax rate. It is my sincere wish that this does not happen. But what can possibly prevent its occurrence is the rebound of good oil prices. The Federal Government has already recognized the massive effects that taxes from non-oil sources can play in its finances in 2009. Thus if oil prices do not stabilize at more than US$45 per barrel, the government are most likely to raise the rate of VAT as it earlier intended.

The current desperation which resulted in the sudden devaluation of the naira justifies this position. Unfortunately, VAT if well implemented and at a higher rate has even more devastating consequences on businesses. Whereas corporate profit taxes are imposed on businesses that have already made profit, there is no such discrimination with VAT and thus firms are forced to internalize in part or full – the additional costs imposed by VAT rather than allowing its transfer to the customer in order to remain competitive in a tough operating environment. In effect many firms may have to give way in 2009 and many more will proceed to the fringe of extinction.

In all these, government still intends to use the capital market to finance some of its deficits. Because the returns on government bonds are much more certain than those that can be expected from firms in a highly uncertain environment of business – as the one we expect in 2009, – entrepreneurial activities will be massively crowded out.

With many foreign investors already gone; with many investors badly hurt in 2008; with prospects for laundering of government funds in the capital market very bleak etc, the level of participation in the capital market will obviously decline. With declines in participation, the hitherto demand pressure that have led to rapid price appreciations will be absent. The crowding out effects of governments’ capital market bond participation will not only limit the capacity of businesses to access fresh funds but will equally raise bank interest rates. Can market makers change the prospects here?

Let us start with the primary market. Market makers cannot fundamentally alter the current trend in the primary market. There is a seeming cessation and poor outing in new issues segment primarily because of the overall lull in the capital market owing to

(a) recent previous massive losses,

(b) heightened market and macroeconomic uncertainty,

(c) massive investor withdrawals particularly foreign investors and short-term speculators.

Market makers, by restoring short-term demands for securities in the market place can trigger equally short-term speculations in the market. Barring any major shock in the market place, market makers can enable the market to coast albeit at a low level over a reasonably long period of time. In the absence of good company fundamentals and income which drive long term investment (following harsh macroeconomic environment of business), market making may have very limited impact on the market. If however, the market regulators over-use market making process and thus create herd reactions, the system will be temporarily ballooned and leave more participants much more hurt.

In summary, the outlook for the year 2009 is that of low productivity (and of course low income) and high macroeconomic uncertainty. These are not consistent with the forces that enable the market flourish which we enunciated at the beginning of this work.

Since the Nigerian economy is umbilically tied to crude oil, reduced earnings from it relative to governments spending plans equally means reduced spending of the Nigerian masses and businesses; majority of whose incomes are tied to such public consumption levels. The peculiarity of this year’s proposed spending is that the present administration must show strong and determined commitment to its promise on infrastructure for it to regain its fast crumbling reputation as non-performer.

If that is the case therefore, unless there is a deliberate policy to use Nigerian firms for the provision of these infrastructure with attendant high performance risks a good percentage of these expenditures will flow into the accounts of expatriate engineering firms. To quickly correct an impression, the high performance risk alluded to here does not refer to any perceived technical inferiority of Nigerians but the high levels of possible compromise due to corruption.

Let me quickly add that the Siemens case equally proves that such compromise is not limited to Nigerians alone. Our conclusion however is that; reduced government spending will affect private consumption levels with consequences for the demand for goods and services supplied by firms.

Similarly, there shall as already stated high uncertainty with implications for high inflation, interest rates and low naira value.

What should stakeholders brace up to? In rough seas, sailors can take a variety of options: abandon the ship altogether and escape on lowered boats, struggle to salvage the ship or do nothing. The present condition of the market approximates a rough sea situation and participants have variety of options which may approximate sailors’ actions in rough sea depending on their specific contexts. For instance, many investors have already abandoned the equities market following the relative shock levels that they experienced in 2008. On the other hand, many market operators together with the regulators are bent on salvaging the market. The question is: which options should various stakeholders take in approaching the capital market in 2009?

Investors as we know are in purposeful pursuit of profit. How much profit that satisfies an investor is subjective and depends on each individual investor. Consequently how much more risk an investor is prepared to take for more returns is equally subjective and depends on investor risk preferences. Thus investors with high return; high risk profiles who have a longer time operational dimension may find the capital market in 2009 worth it. But that is given the scenario that alternative opportunities/markets such as the markets for properties, currencies, solid minerals and other commodities do not offer better returns.

A proxy measure for the returns in the capital market is the expected yields on government bonds which many smart operators will aggressively leverage on to play on in the market place given the possible poor outing of the equities market. This area will be a tough battle ground in which only well funded and technically aware operators can achieve meaningful success. Few operators in the Nigerian capital market meet this desiderata.

Recall that government will be a major player in the 2009 market with the issuance of bonds to finance its huge deficits. If that is therefore the benchmark return expectation, it is my considered opinion that in the short-to-medium term speculating in many other alternative markets will offer better returns than the equities (or capital market) market which will make it clearly not very attractive for the short-term high risk-taking investors.

Another way to look at it is that those who were most hurt in the market last year were the high risk-taking cum short-term inclined investor groups. This is where most of us (over 90% of the investor-side participants in the stock market in the last two years) belong to. At the time it became obvious to many Nigerians that the equities market had become an ATM of some sort where you simply slot your card and draw money, millions threw caution to the wind concerning the associated market risks and ‘went for the money!’. Many more persons borrowed their lives and used it in the gamble. Consequently, when this supposed ATM machine got bad, they were the most badly hurt.

Now this category of short-term inclined and high-risk-taking groups are not going to gleefully run back to the equities market without serious meditation and sophisticated professional guidance. The reasons are many:

(a) their fingers have been burnt and they are yet to recover from it. The nasty experience is enough discouraging factor;

(b) they have lost their own past savings and are using their current incomes to pay the interest due on the margin facilities used to build the now decimated portfolios;

(c) even though they are high-risk taking, the global uncertainty and domestic macroeconomic outlook are very indicative of the need for serious caution;

(d) the outlook for the market is not consistent with the typical risk-return calculation. Thus the expected return by the end of the day, may not justify the attendant risk if they decide to take a chance once more. Perhaps, because this group constitutes the largest proportion of the investor-universe in Nigeria, their indisposition to the market is in fact the ‘market sentiments’.

Naturally, the short-term focused but risk averse investor groups have naturally retreated further into their shells.

The high pro-risk investors with long term focus may want to stay on and wait for a longer period of time to see if the market will rebound. Unfortunately this category of investors with strong waiting power constitutes not more than 2% of the entire investor-universe in Nigeria . Another side of that coin too is that if this category dominates the market, they scarcely engage in aggressive short-term price speculations – which create market ebullience. On the contrary they speculate with a focus on the long-term which equally implies that less of the tradeable instruments are brought to the market.

On the other hand, if many of the investors in the Nigerian market who are largely short-term inclined decide to move into alternative markets, the likely obstructions include poor development of these markets as well as limited technical expertise to profitably speculate in them. For instance the commodities and solid mineral markets may provide very good alternatives but these markets are not yet well developed in Nigeria and there are limited technical know-how as regards how to successfully operate such markets.

This therefore provides some kind of opportunity for the professionals and regulators of the capital market. The immediate development of the Nigerian commodities market has become indispensable as this can provide credible alternatives in situations such as this. The situation equally calls for increased attention to the bonds market. Since this has more guaranteed returns as well as generously involves government with high capacity to honour debt securities issued, many more investors that are relatively risk averse and many more high risk investors who want to diversify their portfolio holdings will find that outlet more reassuring.

It is evident from the market gloom that many operators in the Nigerian capital market will die within the next few months. At present, many of these firms are finding it difficult to pay the salaries of their members. This therefore calls for many likely initiatives. One of such is mergers and acquisitions as well as organizational refocusing and repositioning. For the former, the question is: what is there to acquire in many of these firms? Some of these firms are set up just to deliver dealing activities. And thus their expanse of skill availability ends with stock trading. Regrettably too, in most (up to 80% of all) instances, these firms are equally poorly capitalized.

Now with the recent calamity already wrought on proprietary portfolio of capital market operators such as in the described firm who are forced to repay margin facilities taken at about 33% while the portfolio value for which the facility is taken in the first instance is worth less than 40% of their cumulative purchase value because of rapidly dwindling prices, what strategic impact will the merger of firms in this category have? Very limited too! It could be a merger of liabilities! The funds are not there. The technical expertise that could enable the strategic navigation of these companies into alternative opportunities is equally lacking.

Inevitably therefore, many firms will be sold at much lower value to stay afloat while many lay-offs should be anticipated. Over the years the research and strategy capabilities of the firms in the market never exceeded the writing of reports and were not very much encouraged by the management. Today this works against many of the companies as they have to pay more dearly with non-existent funds in order to refocus and reposition.

Operators in the market who are well capitalized should begin a refocusing and broadening of their business areas outside of core capital market activities. Massive retraining of staff in what it takes to successfully operate in alternative markets is imperative. With a devalued naira for instance, the commodities export market will be a good option.

In Conclusion. The regulators have a critical role in the entire process as they can either aggravate or ameliorate the current crisis in the market. In an uncertain environment, the quality of monitoring and fine-tuning of the market rules and procedures shall go a long way in minimizing the risk exposure of majority of the participants.

I personally do not believe that market decisions based on the sole discretion of one man can produce such high quality. For instance, for quite a long time, the Nigerian equities market has been run at the discretion and whims of one person. Although there may be semblances of collective deliberation and output, closer examination of the decision making process reveals very much the contrary. Such monopoly needs to be broken.

Perhaps the establishment of more Exchanges may be an answer as it will engender necessary diversification and competition. It is equally very important that the market regulators cooperate among themselves so as to always minimize prejudiced decisions that usually fallout from their personality wrangling and disagreements. Whereas such disagreements are inevitable, it should at best be to further the cause of market development.

The regulators also need to generously seek as well as process the informed views and ideas of many stakeholders before arriving at their ultimate decisions. Patriotism should be the watchword here. For instance, decisions taken by the regulators should always be at the interest of the larger number of market participants and not to protect the sectional interest of few, which for instance may have rightly or otherwise been behind the initial decision of the NSE to put a wedge restricting downward movement of share prices by 1%.

To end this piece, what if things do not fall out as predicted? What if oil prices get back to about US$60 per barrel? That obviously is my prayer. Welcome to year 2009.

Martin Oluba, Ph.D., DBA, is the President/CEO of ValueFronteira Limited and an advisor to Proshare. He can be reached at martin@valuefronteira.com

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FINANCE MINISTER PETITIONED OVER CBN REVERSAL OF BANKS’ UNIFORM YEAR END

A corporate lawyer, Mr. Roy Bassey Ukoh and a forensic accountant, Mr. Ori Adeyemo, have, in a joint petition forwarded to the Minister of Finance, protested the reversal of the adoption of common year end by commercial banks as earlier directed by the Central Bank of Nigeria.

The two petitioners said they were compelled to write to the Minister in the overall interest of the banking public and asked for the reversal of the cancellation of the uniform accounting year end for banks in Nigeria which, according to them should have started in December 2008.

Describing the earlier directive contained in CBN Circular No. BSD/DIR/CIR/GEN/VOL2/008 issued on August 25, 2008, as laudable, the petitioners insisted the CBN Governor made an unpardonable somersault of his laudable policy of making December 31 of each year, the uniform accounting year end for each bank starting December 31, 2008.

Stating that such change of policy is not in the best interest of the general public but a compromised attempt to serve the parochial interest of the banking cabal, who are the Managing Directors of the 24 banks operating in Nigeria in other to cover their apparent lapses, the petitioners argued that CBN rationalizing the cancellation of the directive to the desperate mobilization of deposits and which led to the hiking of interest rates by banks, according to the two petitioners is not accepted and grossly untenable.

“We consider both excuses given by the CBN Governor as totally unacceptable and crassly untenable. It further goes to confirm our unassailable conviction that the Nigerian banking industry is not only weak, in dire state of distress but also desperately needing surgical operations to survive irrespective of the spurious splendid financial results that these fraudulent banks churn out from time to time (in active collaboration with the CBN) all in order to continually deceive the gullible unsuspecting Nigerians to invest their hard-earned money in the thrash shares of these sinking banks.” The petitioners reasoned.

Making further assertions on the impropriety of the cancellation of the common year end for banks, the petitioners asserted that: “It is a classic endorsement that the consolidation of the banking industry which the CBN carried out on December 31, 2005 has irredeemably failed if after telling Nigerians that it now has mega-banks; these same banks are still in hot pursuit of deposits at whatever costs not also minding the fact that these same banks had gone to the capital market times without number to mobilize funds. The question now is: what has happened to all the billion of Naira mopped up by Nigerians banks from the capital market from year 2004 to date? Nigerians need to know.”

“The CBN Governor has always been aware that Nigerian banks have been defrauding their customers through the passage of spurious and illegal bank charges into the accounts of innocent customers thereby leaving behind unpaid debts leading to the deceitful foreclosures of collaterised assets of the customers or the settlement of bogus debts at extremely high costs. For the unfortunate ones, it has always been a tale of woes leading to the collapse of businesses, ill-health and sometimes paying the ultimate price of untimely death. To worsen matters, whenever a report of the nefarious and illicit actions of the banks is brought to the attention of the CBN; an illegal referral is made by the CBN to the committee of Ethics & Professionalism which is a sub-committee of the Bankers’ Committee made up wholly and exclusively of bankers with nobody protecting the interest of bank customers thereby making banks judges in their own case.” The petitioner further asserted.

Making further allegations, the petitioned observed that: “Another very important point to deliver is the fact that the CBN Governor is in the knowledge that banks have surreptitiously been stealing Federal and State Governments funds through non-remittance of 10% Withholding Tax on declared dividend as well as interest on deposits, 5% Value-Added-Tax (VAT) as well Personal Income Tax yet have blatantly refused to call them to order knowing fully well that by virtue of Section 3.2.5 of the CBN Monetary, Credit, Foreign Trade & Exchange Policy Circular No. 37 of January 02, 2004, it is the responsibility of the CBN to collect these deductions from the banks for and on behalf of the Federal Government of Nigeria within seven days of collection. The various excess and spurious bank charges clandestinely laid into the accounts of both arms of government all in a bid to defraud in billions of Naira cannot also be wished away.”

“As investigative accounting consultants, we are in the knowledge that the books of these Nigerian banks have all along been cooked and spiced accordingly in order to present fake excellent performances. A veritable way of doing this is to aggressively mobilize deposits at the adopted scattered year ends and also to temporarily put a stop to lending when the accounting year end of banks is near.

“The banking cabal has also made it a point to be shifting deposits among themselves in order to help out each other and they are aware that a uniform accounting year-end will put a final stop to this unwholesome malpractice.

Alluding to one of the reasons the common year end would have done the banking industry some good the petitioners observed that: “Nigerians will recall that prior to the announcement of the uniform accounting year end for banks; every bank in Nigeria was always celebrating any achievement that they can think of from the mundane to the unimaginable. At that time, it was commonplace to find banks celebrating best bank with highest deposit base, the first bank to deploy certain banking software in Nigeria, the first bank to hit the trillion Naira asset base, the bank with the highest turnover and all what not. However, we note that with the announcement of the common accounting year-end, all this rubbish has stopped.

“We must not forget the so-called compromised ratings given to banks by the foreign rating agencies based on the falsified financials published, which these banks would then celebrate as if they have won the football world cup. It was either the banks were awarded A+++++ or AAAAA or some stupid figures by their collaborating foreign rating agencies without looking at facts behind the figures published.

“We wholly support this uniform accounting year-end for banks since it will enable Nigerians and the whole world to be able to separate the chaff from the grains but this laudable and well-thought-out policy by the CBN is being killed before it is born and therefore every attempt must be made to stop the unwarranted and self-serving shift or cancellation of the uniform account year-end.”

“It cannot be disputed that the capital market in Nigeria has lost over N3.5 trillion due to depression with the Nigerian banks accounting for over N2 trillion thereof. You will also admit that this was what led the CBN to issue a guideline allowing the banks to reschedule margin accounts by at least one year. We sadly note that even with this understanding, the CBN is yet to fully inform Nigerians as to the extent of the loss incurred by the banks as a result of their participation vide gambling with depositors and investors monies in the capital market.

“Our submission is that with the full implementation of this uniform accounting year-end policy by the CBN; Nigerians will be able to know the healthy banks from unhealthy or dead-woods because as things currently stand, the adopted scattered year-ends gives latitude for fraudulent and creative accounting manipulations, which undoubtedly amounts to corrupt malpractices which the CBN is now advocating and encouraging through the back door.

“It is an understatement to say that if you are allowed to have your way by shifting or out-rightly canceling the uniform accounting year-end of these banks, you would have succeeded in postponing the doomsday, which would eventually come considering the whole lots of unwholesome and unprofessional malpractices being daily perpetuated by these banks unrestrained.

“We cannot but state once again that the financial state of these banks is in sordid state and the earlier that the CBN and the banks come clean to tell Nigerians the truth the better.” The petitioners concluded.