Nigerian Banking Sector Update The Value of Disclosure August 2009

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1 A Member of the Nigerian Stock Excha nge Key Market Statistics NSE Index (Jan 2, 2009) 31, 357 NSE Index (Aug 21, 2009) 21, 974 NSE Market Cap (Jan 2, 2009) NSE Market Cap (Jan 2, 2009) NSE Market Cap (Aug 21, 2009) NSE Market Cap (Aug 21, 2009) US$46.9bn US$32.2bn YTD Index Decline -29.9% YTD Market Cap Decline -27.4% One week Market Decline (14-21 Aug, 2009) N6,936.7bn N5,037.1bn -9.3% Nigerian Banking Sector Update The Value of Disclosure August 2009 The Sanusi Tsunami Following an emergency meeting of the Banker s Committee held in Lagos on Friday, August 14, 2009, the Governor of the Central Bank of Nigeria (CBN), Sanusi Lamido Sanusi, announced the immediate sack of the executive management of five of Nigeria s Banks; Intercontinental Bank Plc, Bank Plc, FinBank Plc, Plc and Bank of Nigeria Plc. In a surprise move, which industry observers believe may yet turn out to be the most definitive step of his tenure, all five Managing Directors and their respective Executive Directors were relieved of their positions on account of poor corporate governance practices, a slew of reckless managerial decisions and unethical, insider related practices. These were the findings of a system-wide audit by the apex bank which found them to have breached their fiduciary responsibilities to stakeholders. Although speculation was rife that the outcome of the audit might be unpleasant, there was little to suggest the degree of exposure by the affected institutions. With N1.2tn in aggregate non-performing loans out of a total loan exposure of N2.4tn, the CBN was constrained to take drastic, decisive measures to mitigate the threat posed by these banks to the overall health of the financial system. By this singular action, the CBN made good its earlier threat to effectively sanction erring bank executives, sending a clear warning signal to other industry big wigs to either play by the rules or get axed. While some may disagree with the sudden removal of the bank chiefs, we will like to state that the timing of CBN s actions can not be faulted, in view of the circumstances culminating in its largely unprecedented response. Investment Research Victor Ndukauba Tel: ext 265 vndukauba@afrinvestwa.com Lamidun Laniyan Tel: ext 201 olaniyan@afrinvestwa.com aresearch@afrinvestwa.com IMPORTANT DISCLOSURES ARE INCLUDED AT THE END OF THIS NOTE 1

2 Banking Dangote Industry Flour Mills: Total Unique Assets Triple Play Opportunity September August 12, Chart 1: Nigerian Banks Total Assets (as at June 2008) Chart 2: Nigerian Banks Total Assets (as at December 2008) Chart 3: Nigerian Banks Total Assets (as at August 2009)

3 Our Dangote Perspective Flour Mills: on Recent Unique Events Triple Play Opportunity September August 12, In a flashback to our 2009 Banking Sector Report, we had observed that Nigeria s newly consolidated banks would be subjected to their first major test on account of the global financial crisis and its expected impact on Nigeria s economy. We had however noted that the banks appeared significantly better poised to weather the storm on the back of successive rounds of capital raising, than would have been the case prior to consolidation. The following excerpts capture some of our views as stated in the report:...rapid growth and easy access to domestic and international capital markets have fueled an expansionary period in risk asset creation that will now be tested under the most severe of market conditions. Further, we note in this report that risk management and corporate governance challenges that we anticipated would accompany growth in 2007/2008 have indeed emerged. Our assessment is that industry operational structure, regulatory oversight and accounting/financial disclosure levels have struggled to keep pace with overall growth in the size of banks. Overall, we argue that while Nigeria s banking system may be well positioned to manage through the operating environment, current statutory disclosure levels and other deficiencies with industry information structure make it difficult for that strong position to be credibly communicated to key stakeholders: in particular, investors, creditors and depositors. With respect to concerns about margin loans, we had observed that challenges with margin loan exposure reflected a mere symptom of a larger underlying problem. Specifically:...structural weaknesses that allow short-term funds flow from banks to other financial institutions for trading purposes, without appropriate disclosure and supporting mark-to-market accounting requirements. On this basis, we highlight our concerns with the significant lack of transparency surrounding banks money market placement activity and inter-bank trading in assets such as Guaranteed Commercial Paper (GCP) and Bankers Acceptances (BA). We note further that activities by the Central Bank of Nigeria (CBN) at its Expanded Discount Window, while rightfully being credited for averting a major banking crisis to date, may similarly be blamed for inducing a great degree of continued market uncertainty (given the opaque manner by which transactions have been executed at this window). Greater (and more frequent) disclosure surrounding every aspect of each bank s balance sheet (including loan book granularity and market visibility into short-term trading activities) will do more to help put an end to market concerns regarding Nigerian banks than any assurances of bank health from senior industry leaders and regulators. Our initial concerns regarding the quality and use of these money market instruments in a manner totally devoid of transparency have now proven to be prescient. On account of these metrics therefore, we expect to see 2 to 3 more banks run foul of the CBN audit of the remaining 14 banks. 3

4 Banking Dangote Industry Flour Mills: Shareholders Unique Triple Funds Play Opportunity September August 12, Chart 4: Nigerian Banks Shareholders Funds (as at June 2008) Chart 5: Nigerian Banks Shareholders Funds (as at December 2008) Chart 6: Nigerian Banks Shareholders Funds (as at August 2009), Adjusted for CBN Audit Report * Bank* Bank* * FinBank* * Assumes, FinBank, Intercontinental, and Banks Shareholders funds have, prior to August 14, 2009 been completely eroded and is equivalent only to the amount injected by the CBN. 4

5 Impact Dangote on the Flour Market: Mills: Unique Where Triple Do We Play Go Opportunity From Here? September August 12, In light of recent events, Afrinvest Research believes that the immediate impact on Nigeria s financial and capital markets will be severe and quite extensive. While this may exacerbate the current level of agitation in the sector, we believe that an appropriate, well timed combination of policy responses by regulators, aimed at addressing many of the underlying structural and credit concerns, should forestall a systemic crisis in the long term. There is but One Direction for the Equities Market South! However, this will come at great cost, given the need to restructure balance sheets, in line with significantly increased provisioning levels and substantial asset write downs. The adverse effect of these on earnings growth will ultimately lead to significant reductions in gross earnings, while potential losses may be incurred for another one to two years. We therefore expect to see a significant fall in the equities market over the next 2 to 4 weeks as the NSE All-Share Index seeks to test even newer lows than the 19,000 mark previously recorded in March, with banking stocks bearing the brunt. Using the Afrinvest Equities coverage as a proxy, the market is currently trading at 8.7x 2009 earnings. Specifically, our banking universe as a group is currently trading at 4.4x 2009 earnings, down from 5.4x earnings in March, We find this to be very much in line with market reaction to the dark clouds hanging over the sector given less than expected earnings announcements, on the back of significant increase in loan loss provisions. We estimate that P/E multiples will go even lower to about 3.0x earnings on the back of even lower earnings forecasts, and further write downs to assets and shareholders funds. Therefore, we expect the market to trade at 6.1x forward earnings, down 3% from current valuations by our estimates, seeing as the banking sector accounts for over 6% of the market capitalization. In the same vein, we expect to see even lower Price-to-Book (P/BV) ratios as most sector players will be priced for distress. Currently, Nigerian banks are trading at 1.1x book values based on shareholders funds, as reported in the most recent audited financial statements. This we expect to fall to between 0.5x to 0.7x book values, once banks adjust their balance sheets to accommodate write-offs for bad loans as well as the expected mark down in share prices in the market. 5

6 Nigerian Dangote Banking Flour Mills: Sector: Unique The Triple Value Play of Opportunity Disclosure September August 12, Chart 7: Afrinvest 2009 Banking Sector Comparable Valuation Statistics Banks Share Price (N) Total Shares (Bn) SHF (N, Bn) Current Market Cap. (N, bn) BV/ Share (N) LTM PAT (N, Bn) 2009E PAT (N, Bn) LTM EPS (N) 2009E EPS LTM P/E (x) 2009 P/E (x) P/BV Top Tier x 8.3x 1.0x Bank of Nigeria* x 4.6x 1.4x United Bank for Africa x 4.4x 0.9x x 4.9x 0.8x Intercontinental Bank* x 3.5x 0.7x x 6.8x 1.2x Bank* x 2.0x 0.5x Mean x 4.9x 0.9x Median x 4.6x 0.9x Middle Tier x 4.3x 0.7x x 6.4x 0.5x ** x 77.1x 5.8x Stanbic IBTC x 9.4x 1.9x x 3.2x 0.4x x 2.9x 0.5x x 3.6x 0.7x x 2.9x 0.5x * x 2.6x 1.6x x 2.9x 0.6x x 2.0x 0.8x Mean x 4.1x 1.3x Median x 3.6x 0.7x Source: Afrinvest, based on announced public market data as at August 20, 2009 *, Intercontinental Bank, Bank and Bank have been placed on technical suspension, following CBN s recent actions; ** The technical suspension on the shares of has yet to be lifted. We have excluded its ratios from this valuation as they significantly deviate from industry range. Chart 8: Nigerian Banks Composite vs. NSE Index (January to December 2008) Chart 9: Nigerian Banks Price Performance vs. NSE Index (January 2009 to date) Banking Sector Composite, Rebased NSE Index, Rebased Banking Sector Composite, Rebased NSE Index, Rebased Jan-08 2-Feb-08 2-Mar-08 2-Apr-08 2-May-08 2-Jun-08 2-Jul-08 2-Aug-08 2-Sep-08 2-Oct-08 2-Nov-08 2-Dec-08 2-Jan-09 2-Feb-09 2-Mar-09 2-Apr-09 2-May-09 2-Jun-09 2-Jul-09 2-Aug-09 6

7 WEST AFRICA Nigerian Dangote Banking Flour Mills: Sector: Unique The Triple Value Play of Opportunity Disclosure September August 12, Chart 10: Nigerian Banks Market Capitalization (as at June 30, 2008) Chart 11: Nigerian Banks Market Capitalization (as at December 31, 2008) Chart 12: Nigerian Banks Market Capitalization (as at August 20, 2009)

8 Nigerian Dangote Banking Flour Mills: Sector: Unique The Triple Value Play of Opportunity Disclosure September August 12, Macroeconomic Scenarios We anticipate further constriction in private sector lending as banks intensify debt recovery efforts and embark on a more frantic migration of balance sheets to more liquid assets. The drive for deposit growth will become even more aggressive with deposit rates expected to climb into the high teens as the December 2009 common year end deadline draws closer. This will expectedly exert an upward pressure on interbank rates, presently at a 6-month low of 4.5%, thus putting further strain on liquidity, despite the recent cash infusion by the CBN. Depressed Yields in Fixed Income The pressure on interbank money markets should exert an upward pressure on the short end of the yield curve for fixed income through a dearth of liquidity in the secondary market for bonds. Government may therefore decide to take advantage of cheaper borrowing costs to plug the widening fiscal deficit with more frequent forays into the bond markets. This may have a crowding out effect on the private sector which has just begun to mull the idea of corporate bond issuances as a means of diversifying their capital structure. Several Nigerian banks have already indicated plans to raise fresh capital via multi-billion Naira corporate debt issuance programs. Chart 13: FGN Yield Curve Actual vs. Forecast Yields Aug-08 Aug-09 Forecast Maturities 1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 8

9 Nigerian Dangote Banking Flour Mills: Sector: Unique The Triple Value Play of Opportunity Disclosure September August 12, This May Yet be A Silver Lining From an investor perspective, the current banking crisis presents a unique opportunity to consolidate holdings in selected good banks. We believe there would be significant upside potentials for the sector, once it rids itself of its pot of toxic assets. The banks would emerge, firmly repositioned to exploit opportunities that will definitely derive in the market place. The present reality is that there will be further challenges to GDP growth given the continued impact of increased production shut-ins on oil production and declining government revenues on spending. With total nonperforming loans estimated at well over N1.0tn, we believe that the total bail out package from government to the banking sector may potentially rise by an additional N600bn. We are therefore of the opinion that this would be the best opportunity for Nigeria to bite the bullet and painfully reboot her severely dislocated economy by effectively removing petroleum subsidies entirely. There will undoubtedly be unpleasant consequences to such an action, which may exacerbate an already precarious security situation, raise concerns on the effects of heightened inflation, worsen unemployment and lead to a further drop in productivity. However, if the Nigeria s ruling elite is able to muster the political will to follow through on such a drastic line of action, we expect to see a much more fundamental rebound in economic fortunes going forward. The funds previously channeled towards funding the gross inefficiencies in the economy will be redirected to the more productive sectors. The evident uptick in the global economy expected from 2010 should also impact Nigeria positively and lead to a resurgence in private capital flows into the local economy. The Nigerian Banking sector should be primed to benefit from this, given its strategic role as financial gate keeper to the nation, provided government maintains its track record of prudent macroeconomic management. Nigeria s fiscal and current account deficits would be also be reversed with the expected diversification of the economy while higher revenues would lead to increased government spending, notably in the area of infrastructure. We would also expect to see more benign economic growth while GDP growth estimates are reviewed upwards. Given such expansionary outlook for the economy, there would be upside risks to inflation though, which the CBN will do well to mitigate using effective monetary policies. In addition, net foreign currency inflows may help shore up the value of the currency and reflate our fast depleting foreign currency reserves. 9

10 Dangote Flour Mills: Unique Triple Play Opportunity September August 12, IMPORTANT DISCLOSURES AND DISCLAIMERS This report has been issued and approved by Afrinvest West Africa Limited ( Afrinvest ). This report is based on information from various sources that we believe are reliable; however, no representation is made that it is accurate or complete. While reasonable care has been taken in preparing this document no responsibility or liability is accepted for errors or fact or for any opinion expressed herein. This document is for information purposes only. It does not constitute any offer or solicitation to any person to enter into any trading transaction. Any investment discussed may not be suitable for all investors. This report is provided solely for the information of clients of Afrinvest who are expected to make their own investment decisions. Afrinvest conducts designated investment business with market counter parties and intermediate customers and this document is directed only at such persons. Other persons should not rely on this document. Afrinvest accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is for private circulation only. This report may not be reproduced, distributed or published by any recipient for any purpose without prior express consent of Afrinvest. Investments can fluctuate in price and value and the investor might get back less than was originally invested. Past performance is not necessarily a guide to future performance. It may be difficult for the investor to realize an investment. Afrinvest and/or a connected company may have a position in any of the instruments mentioned in this document. Afrinvest and/or a connected company may or may not have in the future a relationship with any of the entities mentioned in this document for which it has received or may receive in the future fees or other compensation. Afrinvest is a member of The Nigerian Stock Exchange and is regulated by the Securities and Exchange Commission to conduct investment business in Nigeria. AFRINVEST (WEST AFRICA) LIMITED. 11TH -12TH FLOORS, FORESHORE TOWERS, 2A OSBORNE ROAD, IKOYI, LAGOS, NIGERIA. PHONE NO: , , , , , Fax: ,