afrinvest nigeria banking report 2008[1]

8/9/2019 Afrinvest Nigeria Banking Report 2008[1]

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Nigerian Banking SectorMacro-economic play on Africas largest emerging market

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Nigerian Banking Report

Section 1

Section 2

Section 3

Section 4

Section 5

Section 6

Section 7

Executive Summary

Political and Socio-Economic Update

Elections Aftermath: Stability and Continuity 16

Continued Economic Growth 19

Key Risks: Infrastructure, Security, Corruption 20

Nigerian Banking Sector

2007: After Reforms, Growth 22

The Opportunity is Real 23

Size and Capital are becoming Key 25

Capital Markets have Helped 29

But there are Risks 31

Post-Consolidation Scenario

New Rules: Size is Imperative 34

New Entrants: Top Dollar, Tough Market 35Grand Ambitions: Expansion and Diversification 36

Bank Profile: Fifteen Banks

Operating and Valuation Statistics

Macro-economic and General Statistics 72

Financial Forecasts 74

Public Market Operating Comps, Part I 79

Public Market Operating Comps, Part II 80

Public Market Valuation Comps 81

Chart List 82

Contacts

Afrinvest (West Africa) Limited 86

Disclaimer 87

Table of Contents

3

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4


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Executive SummarySection 1

5

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Independent assessment of Nigerias macro-economic performance

continues to be favourable...

...And much of the local and international financial community have become

familiar with the compelling Nigeria story.

In many ways, Nigerias story mirrors a wider African renaissance.

In December 2006, the International Monetary Fund (IMF) published its second review

of Nigeria under a two year Policy Support Instrument (PSI). IMF endorsement had

been a key part of achieving the US$31bn 2006 Paris Club debt restructuring

agreement. The IMF made the following statements on Nigerias economic

performance, following on positive commentary from its previous review:

GDP growth and per capita income have doubled in the last five years

compared with the previous two decades. Headline inflation declined to

single digits in 2006 and the parallel and official exchange rates have

converged, reflecting the unification of the foreign exchange markets.

the authorities have maintained their commitment to the reform agenda;

nevertheless, the ongoing conflict in the Niger Delta poses a policy challenge.

Growth would benefit from significant infrastructure spending. This

spending reflects the governments efforts to address pressing infrastructure

needs.

Following years of tortuous reforms, and stability ensuing from over eightuninterrupted years of democratic governance, Nigeria has begun to exhibit macro-

economic characteristics that are more in line with the worlds leading emerging

market countries. Foreign portfolio investors have been quick to take advantage of

opportunities in the market. Amid the global quest for higher yields in 2006-2007,

Nigeria witnessed significant inflows into its sovereign debt and public/private equity

markets. Afrinvest Research estimates that, the banking sector (considered by many

to be an investment proxy for the larger economy) has attracted over US$5.0bn in

new foreign debt and equity investments, excluding direct equity portfolio

investments on the Nigeria Stock Exchange (NSE). The Nigeria story is essentially one

of a larger, yet faster growing version of commodities rich Africa. Just as

importantly, significant room continues to exist for growth, with per capita GDP

barely over the US$1,000 mark despite recent advancements (See Chart 1 and 2).

Key elements of the Nigeria macro story (GDP growth, declining inflation, improved

sovereign risk ratings and increased inward flow of Foreign Direct Investments) are

very much in line with emerging trends in many countries within the sub-Saharan

African region. A continuing global commodities boom has combined with significant

amounts of international interest in (and demand for) emerging market

opportunities, to spur a renaissance in many African markets. Many of these countries

are now enjoying the longest, sustained period of uninterrupted economic growth in

their post-colonial histories.

According to data from sovereign risk specialists Standard and Poors, Africas major

markets (a sample including South Africa, Nigeria, Egypt, Morocco, Tunisia, Kenya,

Executive Summary

Nigerias national leadership

continues to demonstrate

commitment to a private

sector driven reform agenda;

and to a secure, corruption

free country.

6

Independent observers attest

to a vastly improved

Nigerian macro-economic

environment in the last 3 to

5 years.

Foreign investors have been

quick to seize opportunities,

with local capital markets

benefiting from increased

levels of awareness and

inflow.

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Senegal and Ghana) are each seeing 5-year average output growth rates in the 5%

per annum region. Each is also seeing per capita GDP exceeding or approaching theUS$1,000 mark, with South Africa (US$5,516) and the North African countries

(averaging US$2,356) being well ahead of the rest of the continent. While these

indications of prosperity appear more pronounced in these more developed African

economies (South Africa and the Northern African countries) than in Nigeria, a closer

analysis reveals that there is indeed a higher, underlying level of per capita wealth

within the Nigerian economy.

There is evidence that a small proportion (estimated at 20%) of Nigerias 140 million

people account for up to 80% of the nations wealth. With a 2006 year end GDP of

US$140bn, our analysis indicates that while Nigeria may report a national per capita

GDP of merely US$1,000, there is actually a select, underlying market of up to 28

million people in the country; boasting a per capita GDP of US$4,000 (very nearly

comparable to South Africa, and well in excess of the North African average).

We believe that this select section of the population is responsible for much of the

underlying consumer market demand that is beginning to come to light in Nigeria.

Due to very high poverty rate, much of the analysis of the market opportunity has

failed to take cognisance of this latent consumer group, itself a substantial market,

and primary targets for immediate new business opportunities.

The wealthiest 20% of Nigerias population accounts for 80% of national

output; an estimated market of 28 million people with a per capita GDP of

US$4,000 per annum.


Population (millions) Per Capita GDP (US$) GDP Growth (2007E)

South Africa

Nigeria (Select)

Tunisia

Morocco

Egypt

Nigeria (Nationwide)

Chart 1: Underlying market demand in Nigeria

Source: Standard and Poors, Afrinvest Research

Executive Summary

7

47.1 5,516.0 4.58%

28.0 4,000.0 N/A

10.3 3,226.0 6.00%

33.8 2,264.0 4.31%

80.4 1,577.0 5.88%

140.0 1,000.0 7.58%

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Chart2:So

vereignRiskIndicators,NigeriaVersusAfricaI

Executive Summary

8

RSA

Morocco

Nigeria

Egyp

t

Tun

isia

K

enya

Senega

l

Ghana

2007Per

CapitaGDP,US$

5,5

16

2

,264

924

1,5

77

3,2

26

724

887

632

5-yearAv

erageGDPGrowth,

%

4.4

7

4.7

6

7.39

4.4

7

5.4

2

4.9

5

5.0

3

5.7

7

2007CPIAverage,

%

5.4

6

2.7

5

8.70

9.9

0

2.8

6

10

.00

2.6

0

9.5

0

2007Bud

getSurplus/(Deficit),

%

0.2

9

(2.4

0)

7.98

(7.4

8)

(3.4

0)

(3.9

7)

(5.5

0)

(3.9

2)

2007Gov

ernmentDebt,%

ofGDP

26

.02

42

.49

1.55

64

.72

48

.82

40

.93

29

.90

19

.99

Savings,%

ofGDP

13

.03

31

.88

30.05

21

.64

21

.23

15

.40

11

.68

24

.12

2007Inve

stment,%

ofGDP

20

.14

28

.85

23.76

19

.99

23

.12

20

.58

20

.28

27

.89

2007InvestmentGrowth,

%

9.2

7

7.0

6

11.5

7

14

.06

6.7

3

12

.83

10

.10

18

.00

2007Une

mployment,%

ofWorkforce

26

.60

10

.48

N/A

9.9

0

13

.60

N/A

N/A

11

.20

LongTermForeignCurrencyRating

BBB+

BB+

BB-

BB+

BBB

B+

B+

B+

Source:

Standardan

dPoors,

Afrinvest

Researc

h

Chart

2:

Sove

reign

RiskIndica

tors,

Nigeria

Versus

Afr

ica

I

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Democracy has come to stay in Nigeria...

and stability is spurring economic growth: a boom for banks.

Industry regulation is strong and forward-looking...

...and so the next round of consolidation has begun.

Economic growth remains robust; forecast at over 6% per annum for the

next 3 years..

The nation completed a historic political transition in May 2007, when President

Umaru Musa YarAdua was sworn into office; albeit amid widespread domestic and

international condemnation of the polls that brought him into power. Despite the

controversy, the successful transition has raised hopes that the momentum of

economic reforms of the outgoing government will be sustained. The previously

unknown and reclusive new president now seeks to step out of the shadows of

former President Obasanjo.

A combination of robust economic growth, an ambitious government initiative toposition Nigeria as a regional financial hub, and fierce competition among the

surviving 25 players has underpinned the rapid growth of the Nigerian banking sector.

Total assets have grown by 39% over the last year, an indication of the strength of

the underlying market. Banks continue to be successful in financing these assets from

various domestic and international sources. Retail deposit generation has been a

major imperative for the larger banks as they seek lower cost financing. Capital

raising was a major theme of 2007, following on the rounds of mergers and

acquisitions in 2005-2006. 2007 saw local and/or international capital market

transactions by at least 15 banks, with over US$15bn in new capital expected to have

been raised by the end of Q1 2008.

The central bank has stepped up surveillance of the industry, unveiling an ambitious

plan for an integrated transformation of the financial services landscape (the FSS

2020 plan). This integrated plan envisions a Nigeria that becomes one of the largest

economies in the world by the year 2020, propelled to those heights in large part by

its indigenous financial institutions.

A second round of consolidation has begun to gather momentum as the local players

compete to remain among the critical top 10 (out of 24). The strategic priorities for

the major banks include regional expansion, expanded retail banking, real estate

finance, project and infrastructure finance, mortgage banking, expanded consumer

lending, and corporate finance.

.

The Nigerian economy is experiencing its longest growth streak in over two decades.

High oil prices, combined with effective fiscal and monetary guidance by the Central

Bank of Nigeria (CBN) contributed to the 6% average annual GDP growth recorded

by the country since 2006. Non-oil GDP growth continues to outpace oil related

growth, as robust expansion in the agriculture, trading, building and construction,and services sectors compensate for the decline in the oil sector, where growth has

largely been stifled by disruption in production by local militants.

Executive Summary

After several decades of

successive military

governments, democracy

appears to have finally taken

root in Nigeria, albeit with

severe teething problems.

With political stability has

come macro-economic

growth, and Nigerias banks

appear to have been given a

new lease of life, achieving

significant expansion on the

back of a growing economy.

Active regulation, and a

forward looking national

financial services strategy is

helping banks become larger

and stronger, agents of

future national development.

9

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The international investment community has continued to endorse the emergence of

structural changes in the Nigerian economy on the back of a BB- sovereign rating,and investing billions of dollars in the debt and equity markets. In particular, the

banking, infrastructure, industrials, consumer goods and insurance sectors have

attracted significant interest from international institutional investors, including

private equity and hedge funds from as far away as Europe, Asia, and the Americas.

Several international banks have also upgraded their operations in Nigeria, seeking

investment opportunities and offering corporate finance services as they aim to lead

the search for new capital to finance the growth of the economy.

Nigerias financial markets have recorded significant positive developments over thelast 12 months. Equity returns on the NSE ranked 3rd among emerging markets in

2006, behind Zimbabwe and China. A flurry of new issues and a bull market

supported by excess local and international liquidity have led to a 74.9% appreciation

in the benchmark NSE index during 2007. In the fixed income arena, Primary Dealer

Market Makers (PDMMs) have been appointed to create a secondary market for

trading in Nigeria sovereign bonds, leading to an active market with a 10-year yield

curve. Yields on the Nigerian bonds have continued to decline, with successive issues

achieving higher levels of over subscription from both local and international

institutional investors. Newly licensed pension funds, large commercial banks and

recapitalized insurance companies provide most of the local subscription to the bond

markets.

...translating to accelerated development of the local financial markets.

Source: Financial Datanet House Limited (FDHL), Afrinvest Research

Chart 4: Sovereign Yield Curve (November 12, 2007)

5.00

6.00

7.00

8.00

9.00

10.00

11.00

1Month

3Months

6Months

1Year

2Years

3Years

5Years

7Years

10Years

Current Yield (%)

Time to Maturity

Source: Afrinvest Research

1

2

3

4

5

6

7

8

9

O

ct-02

M

ar-03

Aug

-03

Jan

-04

Jun

-04

Nov-04

M

ar-05

Aug

-05

Jan

-06

Jun

-06

Nov-06

Apr

-07

Sep

-07

0

10,000

20,000

30,000

40,000

50,000

60,000Market Capitalization Index

Chart 3: NSE Market Capitalization (Trillions, Naira), Index (100=1984)

Naira, Trillions

Executive Summary

Local equity markets have

seen substantial appreciation

in size and valuation and

improvements in trading

liquidity over the last five

years. .

A long dated (10 year) risk

free yield curve has emerged,

with active, daily trading in

domestic currency sovereign

debt.

The OTC sovereign bond

market records nearly 1000

deals each week, valued at

up to US$1.3bn.

10

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Growth is broadly distributed across sectors, and primarily non-oil related.

National foreign exchange revenues and reserves are up; with the naira

holding up well against the U.S. dollar.

Of crucial importance, much of the stability in new growth comes from non-oil

related sectors. Agriculture, wholesale and retail trading, telecommunications and

services have been the largest contributors to growth in output over the last five

years. Crude oil related output on the other hand, has been unreliable: driven largely

by factors such as global oil prices and domestic production output. In any event, the

oil and gas sector continues to be an enclave, largely separated from the rest of the

economy, with bridgeheads only resulting from federal government revenue inflows

via petroleum taxes and royalties.

Domestic production output has declined significantly in recent years, due to violent

protests, kidnappings, and other militant related production disruptions. Anglo-

Dutch giant, Shell, Nigerias largest oil corporation, has been forced to shut down

almost 50% of its production capacity in the on-shore Niger Delta region, with largely

offshore based ExxonMobil recently assuming the top spot in Nigerias production

rankings. Total national output has thus dropped by almost 0.5m barrels per day to

about 2.2m barrels per day.

Regardless of recent developments in the oil and gas sector (Nigerias major source of

foreign exchange income), the countrys currency has proven resilient against major

international currencies, particularly the U.S. dollar. We have seen essentially a

relatively stable naira/dollar regime over the last eight years, and a steady

appreciation of the naira during the last three of those years (2004 to 2007). Over the

same period, foreign reserves have soared, largely on the back of disciplined fiscal

planning by a more accountable democratic government. Now at over US$50bn, with

external debt almost wiped out, Nigeria has one of the lowest national debt andhighest national reserves to GDP ratios among emerging market countries.

Chart 5: Stable Non-Oil Related Growth, Volatile Oil-based Growth

- -

-10%

-5%

0%

5%

10%

15%20%

25%

30%

2000

2001

2002

2003

2004

2005

2006

(e)

2007

(f)

2008

(f)


Crude Oil Related GDP Growth

Non-Oil based Growth

Executive Summary

Non-oil GDP growth has

been steady, and is projected

to accelerate to 15% per

annum in the coming years.

11

Strong global oil prices

continue to help support

government foreign

exchange income, and

provide an anchor for

currency stability.

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This recent appreciation in naira valuations (in part on account of the general slide in

the value of the dollar across global markets) has supported inward flows of foreign

investments into the local fixed income and equity markets. The impact of this has

been quick to emerge: declining yields across sovereign bond maturities, a demand

driven stock market, and new private equity inflows across sectors. While some of this

demand can be attributed to the emergence of local institutional investors (pension

funds) and an influx of domestic retail investors; these favourable conditions for

foreign inflows has provided a further source of supporting liquidity to the local

markets.

Fresh from an enforced round of consolidation in 2005/2006, Nigerias lenders are

rapidly growing into the macro opportunities in the market. There are now 11

Nigerian banks in the ranks of the top 1000 in the world (according to The Bankermagazine, measured by Tier 1 Capital), up from only 7 in 2006. Nigerias banks are

achieving greater scale and profitability from lending to large corporates and

institutions, as well as a fast growing consumer market. Total banking sector deposits

have doubled during 2007, with credit to private sector growing at an annualized

rate of 72% (to Q1 2007). By year end 2007, up to 7 Nigerian banks had more than

US$1bn in capital; and more than 10 banks had a total market value in excess of

US$2bn each. Credit to retail consumers is becoming increasingly available, with most

banks reporting the fastest loan book growth rates in their consumer loan portfolios.

Of crucial significance, growth has not occurred at the expense of credit quality, with

total bad loans (Non-Performing Loans, NPL) as a share of total loans declining to an

average of less than 8% for the entire industry (down from over 20% prior to

commencement of sector consolidation).

Nigerias newly capitalized commercial banks, are tapping into emerging

opportunities.

0

10

20

30

40

50

60

70

2000

2001

2002

2003

2004

2005

2006

2007(e)

2008(f) 0

20

40

60

80

100

120

140

160

Foreign Reserves (US$bn) Annual Average Interbank FX Rate N/$

Chart 6: Growing Reserves, Stable Currency

Nigeria Foreign Reserves, US$ bn

Naira-USD Exchange, Naira = 1USD


Executive Summary

12

Positive domestic andinternational views of the

long term prospects for the

naira has become a key driver

of continued inward flows of

investment into Nigeria.

Government fiscal disciplineat a time of high oil prices is

leading to a rapid build-up in

dollar reserves.

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Commercial realities appear to be driving a new round of capital raising.

While M&A speculation continues to be rife.

Capital raising was the dominant theme for 2007. Nigerias banks, immediate

beneficiaries of macro-economic growth are seeing various new opportunities for

deploying capital to capture market share. However, specific market opportunities

aside, some of the banks appear to be raising capital merely to stay abreast with the

competition and to tap into auspicious equity market conditions. In 2007 alone, up to

15 of the 24 surviving banks in Nigeria made arrangements to raise new money, with

average deal sizes within the US$250m to US$300m range, and a number of banksdoing deals in the US$750m to US$1bn range. Capital raising is expected to continue

well into Q1 2008. Afrinvest Research estimates that about US$15.1bn would have

been raised in new debt/equity by a total of 19 banks by early 2008 (based on

announced and completed deals since Q3 2006).

Aggressive capital raising aside, 2007 was also a year of intense speculation and

several failures as far as mergers and acquisitions are concerned. There have however

been a number of successes, notably the landmark Standard Bank merger of its

Nigeria operations into IBTC Chartered; and simultaneous Tender Offer to acquire

shares leading to a 50.1% stake in the new entity. More recently, we have seen boardlevel announcements of on-going discussions towards a merger between Sterling

Bank and Ecobank. There is also news that one of the countrys largest banks may be

successfully closing on a deal to acquire the last remaining privately owned bank.

Aside from the one successfully completed transaction therefore, 2007 has been

notable for unconsummated deals. Among others, we saw intense public speculation

regarding a potential First Bank-ETI combination; indiscreet moves by an aggressive

mid-tier bank to acquire one of Nigerias oldest banks; as well as speculation

regarding a tie-up between two banks, both of whom have since gone their separate

ways to seek new capital from the equity market. We expect that 2008 will see a

number of M&A deals that commenced in 2007 reaching closure. Following on those

closures, we anticipate that talks will continue between the ownership and

management of various banks during 2008 and profile in this report the nature oftransactions that we think could feasibly occur, and their potential impact on industry

structure.

0

2,000

4,000

6,000

8,000

10,000

2002 2003 2004 2005 2006 2007

Chart 7: Total Banking Sector Assets, 2002-2007 (Naira, bn)


Chart 8: Total Banking Sector Loans, 2002 - 2007 (Naira, bn)

0

500

1,000

1,500

2,000

2,500

2002 2003 2004 2005 2006 2007


Naira, Billions

Naira, Billions

Executive Summary

13

2007 has seen intense

speculation regarding

potential mergers between

several Nigerian banks. Only

one deal was completedduring the year: IBTC/Stanbic

January 2008


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Afrinvest banking universe

For the purposes of our analysis, we have relied on operating and valuation statistics

for publicly traded banks in Nigeria. Our calculations are based on operating

performance, current market valuation, and forecast financial performance for these

banks. Our data is based on most recently published financial statements for the

banks, and in some cases, Afrinvest estimates. Financial forecasts for the banks are

based on management discussions and our view of the banks most recent

performance and future outlook. Share price information is as at 5th December 2007.

Afrinvest Research segregates between top and middle-tier banks using three criteria:

Shareholders Funds, Total Assets and After Tax Profits. The banks in our top-tier

comparables universe are currently the largest by two or more of these criteria. The

rest of the banks in the industry make up the middle-tier universe of comparables. At

present, our top tier comparables universe includes: First Bank, GTBank, Interconti-

nental, Oceanic Bank, UBA, Union Bank, and Zenith Bank. Our middle-tier peer group

includes: Access, Afribank, Diamond, Ecobank, FCMB, Fidelity Bank, IBTC (pre-merger),

Bank PHB, Skye and Sterling Bank.

Chart 9: Top Tier1 vs Mid Tier Banks 2 vs. NSE (Rebased)

1Mid Tier Banks: Access, Afribank, Diamond, FCMB, Fidelity, Bank PHB, Skye Bank, IBTC, Sterling, Ecobank

2Top Tier Banks: First, GTBank, Intercontinental, Oceanic, UBA, Union, Zenith Bank

-50%

0%

50%

100%

150%

200%

250%

300%

350%

Oct-06 Dec-06 Jan-07 Mar-07 May-07 Jun-07 Jul-07 Sep-07 Oct-07

NSE Top Tier Mid-Tier31 October 2006 = 0


Executive Summary

14

Afrinvest Research actively

covers a group of 15 publicly

traded commercial banks,

segregated into top-tier and

mid-tier banks by

shareholders funds, total

assets and profits.

January 2008


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2007 Elections: More of the Same

Stable Politics, Better Economics

Key Risks: Infrastructure, Security, Corruption

Section 2

15

January 2008


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2007 Elections: More of the same (ruling PDP still in charge).

An independent President?

There have been early challenges for the new President

Incessant crises in the Niger Delta region

As widely anticipated, local, federal and state elections held in early 2007 produced

overwhelming victories for the ruling Peoples Democratic Party (PDP) in both the

executive and legislative arms of government, amid near universal condemnation of

the conduct of the elections. Former Katsina State Governor Umar YarAdua, strongly

backed by former President Olusegun Obasanjo emerged as the winner of the

elections, capturing 70% of total votes cast in a race that included former Vice

President, Atiku Abubakar and Muhammadu Buhari, a former military ruler.

Consensus opinion from local and international observers was that the elections wereseverely flawed and witnessed sufficiently widespread and flagrant irregularities as to

question the validity of the results. Notwithstanding this criticism, a new leadership

has emerged at all levels of government in the country. However, supreme court and

state election tribunal rulings have led to the overturn of elections in as many as five

of Nigerias thirty-six states, with five PDP Governors losing their seats over the last six

months. While there continues to be speculation that the presidential election

tribunal could overturn the national elections, it is thought that this will not be the

case and even then, that YarAdua would win any election re-runs, reinforcing the

view that the current administration will govern the country for the next 4 years.

Early criticism of the new leadership has centred on the view that the new

government may not be independent of the powerful former President, now firmly

established as leader of the ruling PDP. Consensus opinion is that President Umaru

Musa YarAdua, former governor of the Muslim northern state of Katsina, was

handpicked by former President Olusegun Obasanjo. YarAdua has struggled to

establish his independence from the powerful former leader, with much of the

country scrutinizing his every pronouncement for evidence of bias in favour of

Obasanjo. In addition, there is a widely held view that the new President commands

neither the respect that Obasanjo (a former military ruler between 1979 and 1983)

exuded nor sufficient will to stamp his authority and push through reforms. In his

first few months in office, President YarAdua has seized and missed several

opportunities to establish his authority and independence, thus, giving voice to criticsof his ability to run Nigeria.

Among other early challenges, YarAdua has had to face a stand-off with organized

Labour over tax and fuel price increases instituted by for President Obasanjo. The

increases were rescinded after three days of nationwide industrial action that

threatened to bring the economy to its knees. President YarAdua was widely

criticized for his handling of the grievances of Labour.

YarAdua has also had to contend with the continuing crisis, in the oil-rich Niger-

Delta region. With continued unrest, incessant kidnappings, violence and disruptions

to oil output, putting a definitive end to the Niger-Delta crisis will be a major issue


16

Nigerias ruling Peoples

Democratic Party remains

controversially in charge of

national affairs, continuing a

winning streak that has

lasted since the return to

democracy in 1999.

Incoming President Musa

YarAdua has been criticized

for being dependent on

former President Olusegun

Obasanjo for his position and

influence, and is only

beginning to assert his

independence of thought and

action.

Early challenges for YarAdua

has included a stand-off with

organized labour, violent

crises in the Niger-Delta, and

corruption scandals involving

senior party and legislative

officers.

January 2008


17/88


for the new President. YarAdua has not heeded to calls to declare a state of

emergency in Port Harcourt, the largest city in the region (where the safety offoreign nationals remains a concern). This has been in spite of an almost 25% loss in

daily crude oil output (2007 output forecast to drop to 2.2mbpd), and an escalation in

militant insurgency from violent political agitation to armed, organized crime.

YarAdua has also had to deal with internal wrangling within the PDP over selection

of ministers and key advisers. The President ended the speculation on these key

appointments with the announcement of a full list of ministers and advisers on July

26th, two months after assuming office on the 29th of May. In what appeared to be a

strong statement of his independence, the list did not include any member of the

Obasanjo cabinet.

A recent mis-understanding with the reform minded Central Bank Governor,

Professor Chukwuma Soludo over a proposed currency redenomination policy has

provided further opportunity for the President to demonstrate independence of

action. However, the Governor and President appear to have since closed ranks on

matters of monetary and fiscal policy, with several other CBN initiatives receiving

Presidential support and approval.

In the aftermath of the controversial elections of 2007, it is expected that President

YarAdua will make significant efforts to win the confidence of a deeply skeptical

populace by making political and economic decisions that demonstrate his stated

desire to be a unifying servant leader. Already, the President has shown

commitment to this course of action on a number of occasions. He has set-up a high

powered committee of well respected, bipartisan citizens to undertake a review of

the nations electoral system.

The President continues to express a strong distaste for corruption and to lead by

example, recently making a public declaration of his total net worth upon assuming

office, an unprecedented move in the nations history. Recent happenings in the

political terrain have also confirmed there will be no sacred cows. President YarAdua

remained pointedly uninvolved in a recent scandal in the nations lower legislative

house. More recently, the President has cancelled a large foreign telecoms equipment

supply contract, dubiously awarded after alleged bribes to senior government

officials.

On 30th October 2007 deposed Speaker of the House of Representatives, PatriciaEtteh and her deputy, Babangida Nguroje, were finally forced out of office over a

corruption scandal that had run for months. An investigation in August found that

the Speaker and her deputy had breached House rules in awarding contracts worth

Squabbles over key appointments and positions

Friction over macro-economic and monetary policy

YarAdua is making the effort to live up to expectations...

Espousing a policy of zero tolerance for corruption...

Despite early legislative turmoil...


17

More recently, the new

President has had to make

strong decisions regarding

monetary policy reforms,

briefly appearing to be at

odds with his internationallyrespected reformist Central

Bank Governor.

January 2008


18/88


US$5 million for the renovation of their official homes and the purchase of ten cars.

Ettehs refusal to step down had prevented the legislature from debating any billssince it was inaugurated in June, including the presentation by the President of the

federal budget for 2008, and caused brawls on the floor of the house between her

opponents and supporters. A new speaker, Oladimeji Bankole, was elected on 1st of

November by 304 votes against 20 to the candidate backed by the PDP party

leadership. The choice of Bankole has been interpreted as a signal that the PDP

dominated House of Representatives wants to assert its independence from the party

hierarchy.

YarAdua has also demonstrated a keenness to observe court injunctions and adhere

to judicial rulings, keeping to an early Supreme Court ruling directing the re-

instatement of an opposition party Governor in the contentious south eastern state

of Anambra, as well as a number of more recent rulings by electoral panels, reversing

election results in some states of the country.

The new President received mixed reactions to his conciliatory offer to form a

government of national unity encompassing the major opposition parties from the

2007 elections. The plans were rejected by several leading opposition figures, many

of whom commenced legal action challenging the results of the election.

Long sought after constitutional reform appears to be a front burner issue for the

new leader. Current expectations are for a process leading to the emergence of a new

constitution by as early as 2008. One key change expected to be captured in the new

constitution will be an amendment of the controversial Land Use Act, which vests

ownership of all land title in the state governments and thus constitutes a major

impediment to private land ownership. The new constitution may also provide for

greater autonomy for the national electoral body and may also contain resource

control provisions to assuage much of the ill will that has been generated in the

Niger Delta region.

In the financial services sector, many of the benefits of the growing economy are

beginning to emerge. Government reform policies in the banking, insurance, pension

and fixed income areas are combining to create real opportunities in the market.

Banking and insurance companies are already some of the largest drivers of equity

market appreciation. In the fixed income market, sovereign issuance by the Federal

Government continues to be the major driver of activity.

Despite the emergence of a long tenored (10 year) benchmark yield curve against

which corporate issuances may be priced, there is yet to be any significant offering in

the corporate bond market. There is however a CBN supported plan in the offing for

Upholding the rule of law

YarAdua has made efforts to reconcile rival political groups...

Sorely needed constitutional reforms now possible...

Financial services reforms continue...

Prospects for financial market growth still exist


18

YarAdua continues to display

a conciliatory approach to

governance, seeking to

bridge political gaps and

engage opposition leaders inhis government.

This new approach to

governance is in sharp

contrast to the single-minded

determination of his

predecessor, and leads many

to believe that there may

finally be hope for long

awaited constitutional

reforms in the country.

January 2008


19/88


long term bond issuances by Nigerian commercial banks. It is expected that

constitutional reform of the Land Use Act, together with the passage of a new

securitization law will eliminate some of the key obstacles to mortgage origination

and the emergence of a Mortgage Backed Securities (MBS) market, estimated to have

a potential size of up to N1 trillion (US$8 billion).

Under Governor Soludos management, the Nigerian economy has achieved

significant growth in recent years. Real GDP growth has averaged 6.0% p.a since 2004,

up from 3.8% in 2002, to N18.2 trillion (US$148 billion) as at Q3 2006. Over the same

period, headline Consumer Price Inflation (CPI) has declined to single digit levels

(8.5% in 2006 according to the CBN). Not surprisingly, much of the recent growth inoutput has occurred in the non-oil sectors of the economy (according to the CBN,

8.9% in 2006 versus oil sector decline of 4.7%). However, oil continues to play a major

part in the politics and economics of Nigeria (90% of government revenue is from oil

exports). A positive external balance of payments, caused in part by globally high oil

prices, has helped maintain a relatively stable exchange rate, with the naira

appreciating against the greenback for much of the last two years; though

performing less favourably against the euro and the sterling over the same period.

Nigerias external debt repayment continues to be a primary factor driving

international interest in the local markets. With just under US$6bn in external debt in2007, down from over US$30bn in 2006, and with about US$50bn in external reserves,

Nigeria has moved rapidly from being a highly indebted poor country to a new

emerging market opportunity. Coupled with a rapidly growing middle class

population, government commitment to continued spending on security and

infrastructure, and real sector production directed at over 140 million people; there

appears to be significant room for further economic growth in a stable Nigeria.

Sustained macro-economic growth...

Buoyed by lower debt and improved sovereign risk ratings.

0

20

40

60

80

100

120

140

160

2000

2001

2002

2003

2004

2005

2006

2007

(f)

2008

(f)

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70

80

90

2000

2001

2002

2003

2004

2005

2006

2007

(f)

2008

(f)

Nominal GDP, in US$ (bn) Oil Prices, in US$Chart 10: High Oil Prices, Growing National Output

External Debt

Debt and Reserves, in US$ (bn) Chart 11: Erasing External Debt, Building Foreign Reserves

Source: Afrinvest Research Source: Afrinvest Research


19

Ext

naRes

erl

erve

s

In financial services, thegovernment has expressed a

strong commitment to

transforming Nigeria into a

hub for sub-regional

transactions.

January 2008


20/88


But there are risks to the macro-economic upside...

Governments response has been painfully slow

The economy continues to suffer from various structural deficiencies including acute

infrastructural inadequacy and lapses in security of lives and property. These

inadequacies constitute both a drag on growth and a source of potential opportunity.

The large and difficult to quantify informal economy of artisans, traders and other

self employed persons are the major losers from the nations deficiencies as they are

unable to grow as fast as they would under more conducive economic circumstances.

The continued infrastructure, power and energy sector crises (bad roads, incessant

power cuts and persistent fuel shortages) inhibit growth at all levels of the economy.

They are also major contributors (together with profligate government spending) to

consumer price inflation. In the formal sectors of the economy, there is a greater

ability to withstand these deficiencies, albeit at great cost. Overall industrial output

declined by 2.6% in 2006 with other sectors driving growth, including: agriculture

(7.2%), wholesale/retail trading (13.7%), building and construction (12.1%), and

services (8.9%). Manufacturing capacity utilization increased to 53.3%, but remained

below the 2003 high of 56.5%. However, for the first time in the last five years,

Federal Government expenditure declined as a contributor to growth (10.6% of GDP

in 2006, versus 12% p.a average since 2002).

The Governments responses to these challenges have in part been encouraging.

However, aside from positive policy pronouncements, there is yet to be substantial

action towards addressing many of the problems. President YarAdua has vowed todeclare a state of emergency in the power sector and has announced an

acceleration of plans to increase electricity output to 10,000 MW by 2010. However,

the planned unbundling and privatization of the incumbent state-owned power

monopoly continues to be stalled. In sharp contrast, the government has moved

swiftly to dismantle the state oil corporation, the Nigeria National Petroleum

Corporation (NNPC) into several different agencies and companies. The NNPC

unbundling is said to be aimed at achieving greater efficiencies in the management

of the nations energy resources. This is despite a government sanctioned overturn of

the hurriedly arranged privatisation of the state-owned petroleum refineries,

achieved during the last few weeks of the Obasanjo administration. In other areas,

government maintains that its approach is to seek private sector-led solutions and to

focus on building institutions that will provide the necessary environment for reformsto thrive. As always, the devil will be in the details of implementing these much

needed changes.


20

We see key structural risks to

the Nigeria macro story,

particularly in the areas of

infrastructure, security and

corruption. These factors,

together with any significant

downward trends in global

oil prices could very quickly

combine to halt much of the

progress that we are seeing

in the country.

Nigerias government has

thus far been slow to respond

to tackling these risks andputting in place a cohesive

strategy for the future post-

Obasanjo. It is expected that

2008 will see bolder policy

decisions, beyond the

current strategy of cautiously

building on recent successes.

January 2008


21/88


Nigerian Banking Sector

Nigerian banks have arrived

Trading Places: Old generation makes way for new

Key growth drivers

Game changed: Bigger appears to be better

Section 3

21

January 2008


22/88


Nigerian Banks have arrived on the sub-Saharan Africa scene.

Substantial scope for growth remains.

In 2006, five South African banks constituted 83.9% of the largest 15 banks in Africa

and the Top 1000 banks in the world (measured by Tier 1 capital). By 2007, 11

Nigerian banks had emerged among the ranks of the Top 1000 banks in the world, of

which 18 were African. Of this group of 18, South African institutions have shrunk to

only 72.1% of the total (from 83.9% in 2006), while Nigerias 11 leading banks now

constitute 25.4% of the group.

Growth in the underlying Nigerian market has played as much of a role as sector

consolidation in achieving this emergence. Total assets in the Nigeria banking sector

have increased by 88% from N4.2 trillion (US$34 billion) in 2006 to N7.9trillion (US$64

billion) in 2007, with shareholders funds climbing 134% to approximately N1.7 trillion

(US$13 billion). Industry total loans and advances grew 33%, to N2.0 trillion (US$16

billion), a significant improvement over the 14% increase in the previous year. Loan

growth had stalled in 2005 as most banks focused on raising capital or merging to

meet new CBN capitalization guidelines. Of great importance, this growth has not

been achieved at the expense of asset quality, with non-performing loans declining as

a proportion of total loans from 16% in 2005 to 10% during 2006, and further down

to about 8% in 2007.

Despite this remarkable growth story, banking penetration in Nigeria remains at a

very low level relative to other emerging market economies. Total loans as a share ofGDP, 10.9% in 2006 is low when compared against a global average of over 130%, as

much as 50% in countries like Ukraine and Kazakhstan, and over 75% in South Africa.

Retail loans to GDP are at an even lower level as most Nigerian banks are only now

beginning to originate (or set up systems to facilitate) consumer credits. With rising

global commodity prices; in particular, sustained high crude oil price levels, mineral

rich Nigeria offers significant potential for increased corporate and retail lending.

These credits are required to meet the demands of a fast growing population (2007:

140m people), and the expanding corporate community. Already, several of the

leading players in the sector have begun to implement plans to expand lending

aggressively, with key targets being large ticket corporate transactions,

infrastructure/project finance and consumer lending. Nigerias banking sector and its

key participants appear well poised to shape the competition for sub-Saharan Africandominance over the next decade.

Nigerian Banking Sector Overview

22

Of the 18 African institutions

profiled in the 2007 The

Banker Top 1000 banks, there

are now 7 Nigerian banks,

together constituting over

25% of the top African group.

Despite this rise to

prominence on the African

scene, Nigeria continues to be

a remarkably under-

penetrated market for

commercial banking products

and services.

January 2008


23/88

Nigerias banks have seen tremendous recent growth...

...yet penetration remains low

At just over 10% of 2006 GDP, loan penetration in Nigeria remains low relative to

other emerging market and developed countries. With credit to the private sector

showing a more than 70% increase to Q1 2007, loans to GDP, accelerating from a

31% growth in 2005, the loan penetration rate is expected to improve in the nearfuture.


23

Chart 12: Nigeria Banking Sector, by Tier 1 Capital (Naira, bn)


187.2249.2 292.9

501.5

738.1

1,722.4

0

400

800

1200

1600

2000

2002 2003 2004 2005 2006 2007

Tier 1 Capital, Naira (bn)

0

40

80

120

160

UK

Germany

Sou

thAfrica

Kaza

khs

tan

Hungary

Czec

hRep

Ukra

ine

Po

lan

d

Russ

ia

Turkey

Georg

ia

Nigeria

Chart 13: Loans to GDP (2006, %)


Median = 50%

Nigerian Banking Sector Overview January 2008

Nigerian banks have grown

Tier 1 capital from N187.2

billion spread across over 80

banks in 2003, to N1.7 trillion

contributed by less than 25

banks in 2007.

Despite this rapid growth in

capital, banking penetration

remains remarkably low in

the country, as less than 10%

of total loans to GDP,

measured against a median

of 50% for a group of

emerging market and

developed economies wesurveyed.


24/88

Nigerias banks remain significantly underleveraged...

...and the countrys consumer credit market remains in its infancy

With retail loans at about 0.1% of 2006 GDP, Nigerias lenders have not even begun

to scratch the surface of lending to the countrys estimated 140m people. Other

emerging and developed markets we have surveyed report a 19% median retail loansto GDP ratio, and up to 100% in markets like the UK, indicating the scope that exists

for growth in retail business.


24

Chart 14: Deposits to GDP (2006, %)


Tier 1 Capital, Naira (bn)

0

40

80

120

160

UK

Germany

South

Africa

Kazakhstan

Hungary

CzechRep

Ukraine

Poland

Russia

Turkey

Georgia

Nigeria

Median = 49%

Chart 15: Retail Loans to GDP (2006, %)


0

20

40

60

80

100

UK

Germany

Sou

th

Africa

Kaza

khstan

Hungary

Czech

Rep

Ukra

ine

Po

lan

d

Russ

ia

Turkey

Georg

ia

Nigeria

Median = 19%


Even though Nigerian banks

have achieved impressive

growth in distribution

capacity and geographic

spread over the last five years,

they continue to lag the rest

of the world in deposit

generation: just over 11% of

GDP in 2006 versus a median

of 49% for the rest of the

world.

The lowest levels of

penetration are in the

consumer loan segment,

where Nigeria trails virtually

every other emerging market

country with a 0.1% retail

loans to GDP ratio. This is

clearly a sector still in infancy.


25/88


BankTotal Assets

(Naira, bn)

Total Assets

(US$, bn)

Union Bank 418.0 3.3

First Bank 364.0 2.9

Zenith Bank 215.0 1.7

UBA 212.0 1.7

Intercontinental 203.0 1.6

GTBank 185.0 1.5

Standard Trust 136.0 1.1

Afribank 86.0 0.7

Oceanic Bank 86.0 0.7

Wema Bank 71.0 0.6

Top 10 Total 1,976.0 15.6

BankTotal Assets

(Naira, bn)

Total Assets

(US$, bn)

UBA 1,191.0 9.5

Zenith Bank 972.8 7.7

First Bank 884.6 7.0

Intercontinental 704.8 5.6

Union Bank 667.8 5.3

GTBank 552.0 4.4

Bank PHB 382.0 3.0

Oceanic Bank 371.6 2.9

Access Bank 328.6 2.6

Diamond Bank 320.4 2.5

Top 10 Total 6,375.6 50.5

Chart 16: The Old. 2004 Top 10 Banks, descending order Chart 17: The New. 2007 Top 10 Banks, descending order

Source: Afrinvest Research Source: Afrinvest Research

25

Trading Places: Old generation makes way for the new

Within the sector, there has been a gradual displacement of traditional, old

generation banks (generally regarded as banks founded before the 19891990

banking sector liberalization) by the ambitious, new generation institutions.

Ranked by total assets, in 2004 Union Bank was the undisputed giant of the Nigeria

banking market, closely followed by the self re-engineering First Bank. Zenith Bank,

UBA and Intercontinental Bank made up the pack of top five banks. Wema Bank and

Afribank, veritable old institutions, were proud members of the 2004 elite class of

Top 10 banks.

Three years later, in 2007, there has been a remarkable trading of places. Afribank

and Wema are no longer in the Top 10. UBA (buoyed by its merger with StandardTrust Bank) has become the largest bank in Nigeria by total assets (and largest

company by market capitalization). Union Bank is now a lowly fifth. The re-

engineered First Bank continues to enjoy a prominent position, a testament to the

banks ability to re-invent itself and remain competitive in the new market. GTBank,

Oceanic, Access, Diamond and Bank PHB (all new generation banks) now make up

the bottom half of the Top 10, all but Oceanic being new entrants to the Top 10

category from 2004. Yet the changes appear to have only begun. With continued

growth in the market, increased interest from foreign investors, and continued

prodding by the CBN; it is expected that there will be further consolidation, leading

to potentially industry defining switches in market leadership.

Nigerias new generation

banks, mostly established

during the 1989/1990 banking

sector liberalization have

now completed the process of

usurping the industrys old

generation stalwarts.



26/88


26

Then and Now: 2004 Versus 2007. Trading Places...

Chart 18: 2004 Market Share Rankings, by Total Assets


0

50

100

150

200

250

300

350

400

450

UnionBank

FirstBank

ZenithBank

UBA

Intercontinental

GTBank

StandardTrust

Afribank

OceanicBank

WemaBank

Median = N194bn

Old Generation New GenerationTotal Assets, Naira Billions



*UBA is a mixed generation bank, following its 2005 merger with new generation Standard Trust Bank

-

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

UBA*

ZenithBank

FirstBank

Intercontinental

UnionBank

GTBank

BankPHB

OceanicBank

AccessBank

DiamondBank

Chart 19: 2007 Market Share Rankings, by Total Assets

Total Assets, Naira Billions New Generation Old Generation

Median = N610bn

January 2008


27/88


27

Enormous scope exists for growth in the Nigerian banking sector

Key growth drivers: infrastructure and the consumer

Banks are now redefining their business focus...

As we have seen, Nigerias financial sector remains severely under-intermediated.

Broad money supply (M2) is estimated at only 25% of 2006 GDP, versus an average of

250% of output in the developed and industrialized world. With a domestic savings

rate of 25.7% of GDP, there is significant scope for growth in provision of banking

services to the Nigerian economy. Traditionally, banks in Nigeria had focused on

capturing lucrative, low cost government deposits, and lending to low risk large

corporates. Alternatively, most banks focused on highly profitable foreign currency

arbitrage, exploiting pricing distortions between the official and parallel foreign

exchange markets. In recent times however, rapid growth in the underlying market

for credit has opened up a new vista for Nigerian commercial banks.

We see key growth drivers in the areas of infrastructure finance, corporate finance

and consumer lending. Much of the immediate new market opportunity lies in

expanding current business with large, structured corporates across various growth

sectors, and developing new products for the burgeoning retail market. Most

Nigerian banks currently have loans books dominated by corporate business, with

only a small (but fast growing) fraction taken up by retail loans. In corporate lending,

general consensus is that banks need to scale up to be able to break into the

potentially lucrative, enclave oil economy. Already, government efforts to enforce

local participation in this foreign dominated sector is underway. Various initiatives,

including mandatory local content limits and marginal field concessions to indigenousoperators are creating entry opportunities for well prepared financiers into this

lucrative market segment.

Interestingly, much of the talk among business leaders in Nigerian banking today is

about the huge, untapped retail market opportunity. Senior bankers speak about the

barely 15 million people estimated to have bank accounts in Nigeria (out of a

population of over 140 million), and the fact that only a small proportion of these

ever use those accounts. A lot of emphasis is put on the abysmally low levels of

leverage currently being taken up, even by employed professionals with steady

income streams. More recent numbers relating to mobile density and mobile phone

usage (currently almost 40 million subscribers) point to an active underlying retail

market. Finally, the recent explosion in retail demand for equity securities (1.2 millionapplications in one recent public offer, and an even larger secondary market

participation) indicate that the Nigerian consumer is now a potentially lucrative

banking customer.

With interest rates continuing their steady decline, and inflation reasonably under

control, banks have ventured boldly into the business of risk asset origination across

various sectors and tiers. Of note in this regard has been the surge in securities-

backed lending. A rising stock market has led to a surge in margin loans to stock

investors. Retail loans are also a new source of opportunity from an emerging middle

class, on the back of increased distribution capacity (in 2006-2007, bank branches

increased by 11%, from 3120 to 3460), and the development of new retail lending

products. Consumer finance for automobile and household purchases are a popular

new innovation, as are debit and credit card products. Bank distribution is further

Economic growth is opening

up new markets beyond

traditional currency arbitrage

and yield curve exploitation,

historical sources of much of

the sectors profitability.

An immediate source of

opportunity appears to be in

intermediating excess

national reserves and new

found banking capital into

financing to bridge Nigerias

huge infrastructure deficit.

Nigerias untapped retail

market is considered to be

the primary, long term

market opportunity; with

most industry players now

setting up systems to

originate higher yielding

consumer risk assets.



28/88


28

enhanced by the creation of mini branches and the proliferation of ATMs and other

e-banking channels. At the highly competitive corporate end of the spectrum, banksare still able to generate new business: financing large ticket transactions that had

hitherto been the near exclusive province of international banks. Various large ticket

syndications in the telecoms, cement, oil and gas, industrial chemicals, maritime and

power sectors have provided opportunities for the banks to put their newly acquired

balance sheet muscle to work.

Capital raising was the dominant theme of 2007. Consensus opinion in the banking

sector is that size is imperative, and that the largest players will be the leading players.

This view has set about a scramble to raise capital, across the balance sheet(debt/equity) and from various sources (domestic/international) utilizing different

instruments (Ordinary Shares, Eurobonds, OTC and listed Global Depository Receipts,

Multi-lateral Loans, Equity linked Notes among others). This quest for capital has

coincided with the 2007 global liquidity glut, and heightened local awareness about

capital market opportunities. This fortuitous series of events has allowed virtually

every major bank in Nigeria to arrange a capital raise in 2007. At last count, 15 of the

24 banks had made arrangements to raise new money, with average deal sizes in the

US$250 million to US$300 million range, and a number of banks doing deals in the

US$750 million to US$1billion range. As at December 2007, 13 banks had raised or

were completing transactions to raise over US$12 billion from the capital markets.

.and battling to raise new capital: to finance growth

Already, we are seeing thatmarket conditions and

investor demands for returns

to invested capital are driving

an increasing redefinition of

banking focus to long term

risk origination versus short

term market trading.

Further, Nigerias banks are

aggressively tapping into

auspicious market conditions

to raise capital, ostensibly to

finance growth into these

market opportunities.



29/88


29

A further US$3 billion in new capital remains to be raised from already announced

equity placements and public offerings by 3 banks. In total, the 15 banks shown in Chart

20 will have raised a total of US$15 billion in new debt/equity capital from the domestic

and international capital markets in the 16 months between December 2006 and March

2008.


Chart 20: 2006/2007 Capital Raising by Nigerian Banks

Source: Afrinvest Research, based on publicly available deal data as at December 2007

Company Deal Type DateDeal Size(N, bn)

Deal Size(US$, bn)

Status

Intercontinental Public Share Offering Dec-06 95.0 0.80 Completed

GTBank Eurobond Jan-07 43.4 0.35 Completed

First Bank Eurobond Mar-07 21.7 0.18 Completed

Oceanic Public Share Offering Apr-07 175.0 1.40 Completed

UBA Public Share Offering Apr-07 92.0 0.70 Completed

Diamond Private Placement Jun-07 16.6 0.13 Completed

First Bank Public Share Offering Jun-07 470.0 3.80 Completed

GTBank Public Share Offering July-07 99.2 0.80 Completed

Access Public Share Offering Aug-07 70.0 0.60 Completed

Skye Private Debt Aug-07 12.5 0.10 Completed

Diamond Public Share Offering Nov-07 62.0 0.50 Completed

FCMB Public Share Offering Nov-07 70.0 0.60 Completed

Fidelity

Public Share Offering Nov-07 48.0 0.40 Completed

Afribank Public Share Offering Dec-07 100.0 0.80 In Process

Bank PHBPublic Share Offering

Dec-07

85.0 0.70 In Process

ZenithPublic Share Offering

Dec-07


First Inland

Public Share Offering

Jan-08


Union Private Placement TBC 180.0 1.40 In Process

Total Debt/Equity 1,870.4 15.06

January 2008


30/88


30

Second round consolidation off to a fine start.

Opportunities abound, but size matters...

...but challenges await the post-consolidation mega banks.

While the recent scorecard for Nigerias banks is impressive...

Future emphasis will be on increased competition, return on capital, asset

quality, earnings growth and staff quality

2007 was also notable for the completion of the first post-CBN mandated

consolidation, with the merger of Stanbic Bank Nigeria (a fully owned subsidiary of

Standard Bank of South Africa) with IBTC Chartered Bank. Standard Bank is expected

to retain at least a 50.1% stake in the resulting entity, Stanbic IBTC Plc. There are also

strong indications that two other banks (Ecobank and Sterling Bank) have reached

advanced stages in merger discussions. In addition to these, there continue to be

rumours of several other potential combinations. We predict that this second phase

of consolidation will herald a new era of competition in the sector, and may result in

no more than 15 surviving banks in Nigeria by the end of 2009.

With 75% of September 2007 market share (measured by total assets) held by the top

10 Banks in the industry, the Nigeria banking sector is becoming an increasingly

consolidated one, with size being a critical determinant of market success. Current

trends are for the largest banks to work closely together in club deals, ranging

from large ticket syndications to overnight inter-bank lending. Very often, these top

banks are able to gain access to the largest corporates and to command lowest cost

deposit liabilities. Market opinion of the top 10 is also markedly different from that

of the trailing pack, with the larger banks often receiving more favorable coverage.

When the dust settles on all the capital raising, attention will turn to the onerous

task of achieving return on capital levels that will justify the huge investor interest

that has been generated in the sector. Valuations in the sector are (in many cases) rich

and have priced in much of the expected returns in the industry. It will thus take

exceptional earnings growth to generate any price performance that compares to the

appreciation of the last two years. Already, the industry is trading at an average 2008

forward P/E multiple of 21.4x, with the mid-tier banks trading slightly higher on a

forward basis (21.6x) than the top-tier banks (21.1x).

Overall banking sector price performance has been outstanding in the last 12 months.

Rebased to zero on 31st October 2006, Nigerias banking sector stocks had

appreciated 192.1% by 31st October 2007. This price growth has been more

prominent for the mid tier group (284.9%) than for the top tier group (99.4%). For

Nigerias banks to deliver similar levels of value to shareholders over the next 12 to 24

months, significant efforts will be needed to put capital to work, capture market

share, manage emergent credit risks, and generate greater earnings.

There will be challenges to achieving these objectives. Amongst others, increasedcompetition from foreign banks, particularly in the corporate banking, project

finance and corporate finance arena will put pressure on these attractive sources of

earnings growth. Similarly, competition from other local players in the financial

With two M&A transactions

achieving some measure of

success during 2007, the

sector looks sets to shrink to

no more than 23 players in

early 2008 (from 25 in

2006/2007); with potential

for further consolidation

before the end of 2008.

The desire to remain in the

leading category of market

share owners will be a key

driver of further mergers, as

banks compete to b e in the

crucial top 10 group

Notwithstanding any revenue

gains from consolidation; or

new market access provided

by greater amounts of capital,

Nigerias banks will now be

pressed to deliver on

aggressive market

expectations of profit growth.

Nigerias banks have

performed spectacularly in

terms of operations and

valuations over the last few

years, with early investors

reaping great rewards.



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services sector (insurance companies, investment banking firms and asset managers)

will restrict earnings growth for the commercial banks in these other lucrative growthareas. In more traditional areas, banks continue to face challenges with a large skills

gap for executing new product initiatives. In areas such as mortgage origination,

consumer finance products, structured finance and margin lending, banks are in

danger of putting large amounts of value at risk with insufficient knowledge to

manage these risks. In sophisticated areas such as currency and fixed income trading,

where banks have discovered new ways to generate income, there is a dearth of

skilled personnel, and attrition levels are high.

Most importantly, as banks begin to put larger amounts of capital at risk in the

origination of unfamiliar risk assets; there is insufficient experience or data with

which to effectively assess and manage these risks. In the rush to grab market share,

there is a very real risk that the industry ratio of non-performing loans to total loans

may see an upward spike. Further, with new found liquidity and access to large

amounts of capital, management of Nigerian banks will be challenged to apply

rigour and due care in capital allocation and investment decision making. To this

extent, continued regulatory vigilance will be an important element of maintaining

industry attractiveness. Already, indications are that new foreign and domestic

investors alike are paying close attention to banks performance and are likely to

react negatively to unfavourable news and/or earnings releases.

Risk management has become a crucial consideration.

However, achieving future

results of similar magnitude

will require significant more

effort and ingenuity in a

more sophisticated and

competitive market.

We see risk management as

the key new area of

competence that will define

winners and losers in this

new, complex environment.

Managing consumer credit,treasury and other emergent

risks will be a key business

imperative, now more than

ever.

31




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32




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Post-consolidation Scenario

New Rules: Size is Imperative

New Entrants: Top Dollar, Tougher Market

Grand Ambitions: Expansion and Diversification

Consolidation Endgame: Our Crystal Ball

Section 4

33

January 2008


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New rules: Size is imperative

Consolidation has been quick and decisive. From 89 banks in 2004, we have seen a

rapid decline in the number of banks in Nigeria to 24 as at last count. Going further,

we have also seen a consolidation in market share within the industry. Nigerias top

ten banks now control over 75% of market share (measured by total assets) leaving

barely 20% to the next group of ten banks. This consolidation in market share is the

result of an intensely competitive environment that we anticipate will continue well

into the future. Larger banks in Nigeria have inherent advantages relating to access

to the largest quality deals and clientele, lowest cost retail deposits, ability to attract

scarce management talent, public perception and access to government and

international financial groups. Larger banks are also better able to access the capital

markets, enjoy lower cost corporate financing, and participate in lucrative, exclusiveclub deals (both in the overnight trading market and in the large ticket project

finance market). Consensus opinion in the industry is that to be relevant, a bank

needs to be in, or within punching distance of the top ten.

To achieve this, Nigerias banks have found it imperative to further capitalize, merge,

or acquire another bank. In 2004/2005, a bank with a capital base in the region of

N25bn was generally considered safe, large and competitive. Today, with total

industry Tier 1 Capital at N1.7 trillion (US$ 14 billion), the average Nigerian bank has

over N60bn in shareholders funds. Indeed, amongst the largest seven banks are up to

three banks with total capital in excess of N125 billion (US$1 billion). This number is

expected to increase to at least five banks before the end of 2008. Clearly, the stakes

are higher, and the larger banks have every intention of dominating the market.


34

-

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400.0

600.0

800.0

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1,200.0

1,400.0

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Top Ten Next TenNaira, Billions

Chart 21: Nigerian Banks by Total Assets, September 2007

Median = N148.5bn

Median = N577.2bn

Source: Afrinvest Research, based on recently available audited company data

Nigerias ten largest banks

control the lion share of the

market (over 75% of total

assets), and have preferential

access to the largest

corporates and transactions.

January 2008


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New entrants: top dollar, tougher market

New entrants (primarily offshore financial institutions) seeking to establish a presence

in Nigerian commercial banking will find this a challenging proposition. During

2006/2007, we saw a great deal of interest in Nigerian bank acquisitions. Emerging

market private equity investor, Actis was first of the block paying US$134 million to

acquire a 19.1% stake in Diamond Bank in a deal that was done at a healthy discount

to market (9.5x 2008E P/E and 2.3x 2007 P/BV). Standard Bank of South Africa was

also able to conclude a transaction, albeit at a higher entry price. In September 2007,

the largest bank in Africa crossed the last regulatory hurdle for its US$1.6 billion

merger and tender offer transaction involving Stanbic Bank Nigeria Limited and IBTC

Chartered Bank. The transaction was completed at steep valuation multiples (P/E of

28.6x 2008E earnings). Furthermore, the tender offer price required a 45.4% premiumto the share price of IBTC at the time of completing the transaction, a hefty sum,

even in Nigerias high growth market. In both instances (IBTC and Diamond), the

banks share prices have remained steadily above the levels at which the transactions

were completed. Afrinvest acted as financial advisers to Actis and to Standard Bank

on their respective transaction.

It is expected that any further transactions will be done at generous multiples.

Already, Union Bank has received shareholder approval to place up to 30% of its

share capital for sale to a strategic, international investor. While there are indications

that a suitor may have been pre-selected that opportunity could well turn into an

auction for one of Nigerias most underperforming banks. It is clear that bank

acquisitions will not come cheap in the Nigerian market. The CBN has indicated thatit may not be supportive of further acquisitions of Nigerian banks by international

players, a factor that could further complicate any potential deal. However, it is also

clear that organic expansion to achieve the competitive scale required to do business

in Nigeria may be an even more expensive route to establishing market presence.

Our take therefore, is that much of the M&A action we may see in the near future

will involve mergers of domestic and regional players, supported by strong capital

market conditions. Already, several domestic players, having successfully completed

capital raising in 2007, are seeking new national and regional expansion

opportunities via acquisitions. Other marginal players, having determined that it

would be best not to compete, are seeking merger opportunities, at valuation and

control thresholds that would satisfy their investors. We expect that these trends willcontinue, and in the next two years will result in a Nigerian banking sector that

consists of no more than fifteen domestically strong, regionally dominant and

globally connected institutions.


35

Despite numerous inquiries

from offshore institutional

investors, we have seen

limited success with bank

acquisitions in Nigeria, with

Actis and Standard Bank

being early winners in this

regard.

We expect that prohibitive

valuations and regulations

will pose major hurdles to

any further large scale

strategic acquisitions byinternational groups.

Further consolidation is likely

to be driven by combinations

of local players, supported by

strong capital market

conditions.

January 2008


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Grand ambitions: expansion and diversification

One sour point in our assessment of Nigerian banks in 2007 is the lack of different-

iation in the banks strategies for winning in this fast growth market. As far as

understanding the market opportunity is concerned, senior bankers are almost

unanimous in their assessment of where the money is - (1) Consumer finance,

infrastructure and corporate finance; (2) oil and gas lending, project finance and real

estate; (3) mortgage finance and securitizations; (4) fixed income and equity

issuance/trading; and (5) continued growth in corporate lending.

While we share this view of the market opportunity, we observe striking similarities

in the banks approaches to tapping the market. Each claims to be working hard at

branch expansion and strategies for capturing retail market share. Each claims to beraising capital and strengthening their balance sheet to be able to take part in large

ticket financings. Further, each claims to be hiring the best people and setting up the

systems to be number one in investment banking.

Our view is that not all the banks will be able to execute on the Nigeria market

opportunity. In particular, the key requirements for success in the more specialized

emerging areas may not be accessible to all the banks. Management expertise, risk

management systems, customer knowledge and market intelligence are only a few of

the critical requirements. Talent in particular continues to be a scarce commodity in

the local market, with most banks resorting to hiring expatriates and Nigerians from

abroad. Attrition rates are high in the more specialized areas, compensation levels

are extremely competitive, and in some cases are fast approaching Wall Streetstandards.

Already, a number of banks are demonstrating competence at tackling these new

businesses. In some cases, the results are beginning to show. Earnings growth rates

remain remarkably high, with even large, established banks posting year-on-year

turnover growth of 30-50% during 2007. For the smaller, faster growing banks,

growth rates of 100% and above have not been rare and may continue for at least

the next 12 to 18 months. Loan growth is a strong driver across sectors (81.2%

growth in banking credit to the economy as at Q3 2007). Consumer loan penetration

is a primary driver on the retail side; particularly for financing automobiles and other

durable goods. Corporate lending remains a growth area in the near term, but is a

highly competitive and low margin business. Capital markets provide another area ofopportunity, with fixed income and equity trading helping drive growth. Most banks

are licensed market makers in government bonds, as well as active lenders to stock

market investors.


36

We have observed a lack of

differentiation in strategic

approaches to the Nigeria

market opportunity by most

of the banks in the country.

Despite the clear market

potential, we are convinced

that only a few will be

capable of executing on the

Nigeria market opportunity.

We see loan growth in

higher margin risk products;

and the effective

management of these risks

as the primary driver of long

term success.

January 2008


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Consolidation Endgame: Our Crystal Ball.

Scenario I: Mid-tier banks consolidate to achieve top-tier status.

Scenario II: Top-tier bank acquires mid-tier target.

Scenario III: Top-tier banks combine to become undisputed leader.

Afrinvest Research believes that cost reduction and efficient resource allocation will

be key elements of any winning strategy going into the future. While much of the

talk in the industry is of increased revenue opportunities, and many of the banks are

awash with capital - and hence somewhat spendthrift, we believe that the real

winners will be banks that are best able to manage costs and resources. Already, it is

clear that significant opportunities exist for banks to more efficiently utilize resources

by deploying services on the back of common platforms. Our analysis reveals that the

single largest cost element for commercial banks in Nigeria is electric power

generation across branches. This is one cost that could very easily be reduced by

consolidating branches across merging or partnering banks. We believe that the

greater the cost synergies and the smarter the capital and resource allocation, thebetter the chances of winning in the future. We offer three M&A related scenarios to

achieving these objectives.

We see possibilities for two or more mid-tier banks to merge, with the objective of

more rapidly achieving top-tier status, while current shareholders retain a relatively

healthy balance of ownership and control in the new institution. Already, Ecobank

and Sterling Bank shareholders have elected to go this route. While this is a move

that could achieve a degree of cost/resource allocation synergies across the

afrinvest nigeria banking report 2008[1]

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