New frontiers: Resurgent equity and higher levels of capitalisation are moving the market forward

Strong growth in both equities and bonds in 2012, driven by foreign portfolio inflows that tripled from $5bn in 2011 to $17bn in 2012 (roughly a quarter of foreign currency reserves), according to the World Bank, cast off the long shadow of the 2008 financial downturn. A rotation into equities by foreign investors, followed by local institutions, saw the Nigerian Stock Exchange (NSE) end 2012 as the world’s ninth-best-performing stock market. The inclusion of naira-denominated Federal Government of Nigeria (FGN) bonds on two main emerging market bond indices from August 2012 enshrined the local fixed-income market as a top pick for global investors.

As liquidity returns to Nigeria’s capital markets, authorities are pursuing plans to deepen, diversify and develop local markets through structural reforms and the introduction of new products. Intense volatility was seen again in June 2013 amidst a global sell-off of emerging and frontier-market asset classes, prompted by concerns of looming tightening monetary policy in developed markets, but Nigeria has proved more resilient than its larger emerging market peers. While 2012 was a watershed year for liquidity and portfolio inflows, the key for authorities in 2013 has been attracting a new supply of equities and bonds at the same time as strengthening the regulatory framework.

EQUITY SURGE: As the continent’s second-largest exchange by capitalisation (after Johannesburg), at roughly N12.23trn ($77.07bn) in mid-November 2013, the NSE has recovered from a scarring downturn in 2008 that saw its value drop some 70% in a year. Created in 1961, the NSE had 198 listed equities by the end of 2012, making it one of the most populated bourses on the continent, although it remains a relatively shallow market driven by 10 stocks that account for around 70% of market capitalisation. The sharp downturn in equities from early 2008 caused the market’s capitalisation to decline 45.7% year-on-year (y-o-y) in 2008 and 33.7% in 2009, having grown 74.7% in 2007. What started out as a foreign sell-off linked to the global credit crunch grew into a domestic crisis as banks were found to hold significant non-performing margin loans to exposed brokers. Local investors largely stayed out of the market during tentative rallies that saw the NSE rebound 18.9% in 2010 before declining 16.3% in 2011 – local investors’ share of transactions decreased from 69% in 2009 to 33.2% and 38.6% in 2011 and 2012, respectively, according to data from Russian investment bank Renaissance Capital. While total turnover in shares grew only 3.67% y-o-y to N658.22bn ($4.15bn) in 2012, according to NSE data, the market benefitted from eager foreign buying that pushed its All-Share Index (ASI) up 35.45% y-o-y to 28,078 by year-end 2012.

MARKET CAPITALISATION: Meanwhile, market capitalisation grew from N10.3trn ($64.9bn) to N14.8trn ($93.2bn) in the year to the fourth quarter of 2012, while the value of shares traded rose sharply from N145.1bn ($914m) in the first quarter of 2012 to N255bn ($1.6bn) one year on. Banks and building materials were the key drivers of performance in 2012 as the banking sector returned sharply to profitability after three years of sanitising by Central Bank of Nigeria (CBN) reforms. By June 2013 Nigeria was the fourth-best performer in Africa after Ghana, Rwanda and Uganda – all far smaller bourses – with the ASI growing a further 28.8% to 36,146 in the first half of 2013, according to figures from Financial Derivatives Company (FDC), an investment advisor. Although the 2012 rally was largely driven by healthy dividend yields of around 5% by listed firms, companies increasingly retained earnings in 2013 to offset high financing costs, while revenue and profit growth in the corporate sector remained flat in the first quarter of the year. The N2.45trn ($15.4bn) in capital gains recorded in the first half of 2013 matched the N2.44trn ($15.37bn) achieved in the 2012 financial year. Having exceeded its 2008 peak of N12.6trn ($79.3bn) by early June 2013, the NSE faced a similar sell-off to its emerging market peers due to concerns related to the slowing of the US Federal Reserve’s quantitative easing programme. Foreign investors drove a 5.37% decline in the market to N11.43trn ($72bn) in June alone as a wave of profit realisation took hold. Yet in comparison to the sell-off in major emerging markets, which saw the MSCI Emerging Markets Index drop 13% in the month to June 20, frontier markets fell 8% in the same period, according to Bloomberg data. While this reflects the stickier nature of trading on shallower frontier markets, it also suggests the strong growth potential of Nigerian stocks. “We are seeing a correction in equities but I don’t think we will see the index fall below 30,000 this year,” Bismarck Rewane, CEO of FDC, told OBG. “Valuations will need to fall in equities, while lower yields on bonds will spur a temporary shift back into the money markets.”

Although some price-to-equity (P/E) ratios, such as those on key fast-moving consumer goods stocks, fell sharply from the over 30 times achieved by early June 2013, the average market P/E of around 13 times remained attractive to value investors.

STRUCTURE: With only six new listings since 2010, the NSE continues to be driven by a handful of its largest stocks. The key drivers of market performance are banks, which account for around 30% of the market; four companies affiliated with Lagos-based manufacturing conglomerate Dangote Group, including Dangote Cement, Dangote Sugar, Dangote Flour Mills and the National Salt Company of Nigeria, accounting for another 30%; and fast-moving consumer goods and breweries, which make up much of the balance.

Alongside the ASI and the NSE30 Index, a capitalisation-weighted index tracking the largest stocks, the NSE hosts five sectoral indices: NSE Consumer Goods; NSE Banking; NSE Insurance; NSE Oil & Gas; and the latest, introduced in April 2013, the NSE Industrial Index.

Industry accounts for only around 4% of GDP, but the sector comprises 28% of stocks listed by market capitalisation, according to Access Bank. While most traders’ universe consists of the key 35 largest stocks, there are signs of investor appetite for further issues and a more diversified offering of sectors that is representative of Nigeria’s economy. Most notably the capitalisation of mid-cap stocks grew faster (at 43.78%) than that of large-cap stocks (39.7%) in 2012, according to World Bank figures, although small-cap stocks rose a mere 9.59%. Although the exchange witnessed a rapid influx of new listings in the five years to 2009, new supply has slowed markedly since then, with only one major initial public offering (IPO), Dangote Cement’s in 2010, having taken place since (see analysis).

FOREIGN DEMAND: Trading on the NSE since 2009 has been dominated by foreign portfolio investment, reaching highs of 66.8% and 61.4% of transactions in 2011 and 2012, respectively, according to data from Renaissance Capital. Highly concentrated in 35 stocks, such foreign funds dwarfed domestic participation until 2013. The number of Nigeria-exposed equity-tracking funds has also increased in the past year. The iShare MSCI Frontier 100 Index allocates 11.65% weight to Nigeria. The Guggenheim Frontier Market ExchangeTraded Fund (EFT), run by Bank of New York Mellon, has a smaller exposure of only 3.66% to Nigeria – the eighth-weighted on a list that includes mainly Latin American markets alongside Egypt, Lebanon and Kazakhstan.

The third fund is the Market Vectors Africa ETF listed on the New York Stock Exchange (NYSE), with 19% exposure to Nigeria, split between banking (21.1%), materials (14.6%), energy (13.9%), telecoms (11.4%), capital goods (7.6%), insurance (5.7%), food, beverage and tobacco (4.1%), and others.

In April 2013 the first offshore tracker dedicated to Nigeria launched on the NYSE: the Global X Nigeria Index ETF holds 28 stocks, with 41% weighted towards financial services, including Diamond Bank, 24% to energy, 13% consumer discretionary goods, 11% consumer staple goods and 5% industrials. The fund, whose custodian is Standard Bank, charges a 0.68% expense ratio and pays dividends once a year. The ETF had grown from $1.5m at issue in April 2013 to $3.1m by June.

FGN BONDS: Nigeria’s fixed-income markets gained renewed impetus in 2010, buoyed by clearer market regulations, reduced issuance fees, the relatively low returns of equities and a rapid rise in the value of pension fund assets, to N3trn ($18.9bn) by the end of 2012. In July 2011 the CBN lifted minimum holding periods of one year, which had been imposed during the 2008-09 financial crisis for foreign FGN bond holdings, in a bid to encourage more inflows and stabilise the naira. The market capitalisation of Nigerian bonds leapt 55.61% in 2012, to N5.82trn ($36.6bn), with seven new state and corporate bond issues and three federal government issues, according to NSE figures. As of August 2013 there were a total of three federal government bonds and the market capitalisation of Nigerian bonds had reached N6.17trn ($38.9bn).

The inclusion of FGN bonds in JPM organ Chase’s Emerging Market Government Bond Index, making Nigeria the second African country after South Africa to be a part of the index, prompted yields on five-year FGN bonds to drop some 400 basis points in the six months to around 12.12% by December 2012, according to the International Finance Corporation (IFC).

Analysts such as the Nigeria Economic Summit Group estimate the index inclusion prompted an inflow of $1.5bn into FGN bonds in itself. Credit rating upgrades to “BB-” by Fitch and Standard & Poor’s in 2011, and Nigeria’s first rating from Moody’s at “Ba3” in November 2012, have supported foreign inflows.

The UK’s Barclays Bank then included 13 FGN bonds worth $13.9bn in its Emerging Markets Local Currency Bond Index in March 2013, prompting bond yields to drop 110 basis points in the first quarter of 2013 alone, according to FDC, which estimates yields should be maintained at around 10-11% in 2013 on the back of increasing reserves, oil prices and economic growth. The value of cash transactions for government bonds has fallen for three years in a row, by 11.14% in 2012 to N7.1trn ($44.7bn), according to the NSE, a sign that investors want to lock in rates. The Federal Ministry of Finance’s (FMF) Debt Management Office (DMO) is taking this opportunity to pay down its local currency debt load and rebalance its 2013 borrowing towards offshore sources with its $1bn Eurobond issue in July.

In February 2013 the DMO retired N75bn ($472.5m) in matured bonds for the first time and in June announced plans to reduce domestic borrowing to N500bn ($3.15bn) in 2014, down from N577bn ($3.6bn) budgeted for 2013. This is a stark contrast to the peak of N1.1trn ($6.9bn) issued in 2010, more than the N867.5bn ($5.47bn) budgeted for that year.

With domestic debt of N6.1trn ($38.4bn) and foreign debt of $6.1bn by the end of the first quarter of 2013, according to the DMO, Nigeria has ample space for additional borrowing. The DMO plans to raise the share of longer-maturity foreign borrowing from 14% in 2012 to 40% over the medium term to lock in historically low offshore funding rates.

STATE BONDS: Gathering pace since 2009, the state government bond market has drawn significant issuance since then, with 17 state bonds on the market by early 2013. Implicitly guaranteed by the FMF, state issuance is only possible for those regions with internally generated revenue shares of above 35%. Lagos has been the largest issuer, securing the lowest coupon rates of 10%, although Osun, Oyo and Rivers States are coming to market in 2013. In October 2013 the first sukuk (sharia-compliant) bond was issued by the Osun State, while the FGN sukuk is pending despite new regulations on sukuk issues published in March 2013, which reduced the scope for double taxation. The most liquid bonds are those from Lagos, whereas those in states like Osun or Gombe remain sparsely traded. Banks and pension funds have dominated state and corporate bond issues, with their share of issue rising from 74.72% in 2010 to 93.12% in 2012, according to Stanbic IBTC data.

CORPORATE BONDS: United Bank for Africa has been the most prolific corporate issuer, with two tranches in 2010 and 2011, raising its Tier-2 capital. Dana Group, a Nigerian conglomerate, launched the local market’s only convertible bond in 2011. Meanwhile, the IFC launched the first naira-denominated supranational bond in early 2013, raising a total of N12bn ($75.4m) when it had originally only planned N8bn ($50.4m). The African Development Bank followed suit in July 2013, announcing the upcoming sale of $1.5bn in local currency issues split between Nigeria and Zambia.

As the market evolves, Stanbic IBTC expects more floating-rate issues linked to benchmarks like Treasury bill (T-bill) rates or the Nigerian Inter-Bank Offered Rate (NIBOR). While corporate bonds trade at a premium to FGN and state bonds, yields have come down to the 14% range as of the second quarter of 2013, compared to around 12% for state bonds. Although there is a pipeline of state issues in 2013, the corporate market remains relatively subdued, but a number of midsized banks, including Stanbic IBTC and Diamond, are issuing bonds locally in 2013. “Potential corporate bond issuers have been cautious about accessing the markets as a result of high rates, and the number of rated corporates remains small,” Samuel Sule, deputy manager of the debt capital markets division of Stanbic IBTC Bank, told OBG. “It is a pension fund investment requirement to have at least one investment-grade rating to tap this large pool of funds.”

Over the longer term, following oil industry reforms, incorporated joint ventures operating onshore are expected to significantly raise their funding through local fixed-income markets. In 2013 ExxonMobil announced its intention to tap the local bond market in 2016 for $900m to finance its joint venture with the state oil company, the Nigerian National Petroleum Corporation.

Meanwhile, in July 2013, the National Association of Securities Dealers launched an unlisted over-the-counter (OTC) platform for equities and bonds, which could create competition for banks’ proprietary OTC trading in the long run (see analysis).

OFFSHORE LISTINGS: The Nigerian government offered its debut $500m, 10-year Eurobond priced at 7% in January 2011, and domestic corporations have since been following the state’s example. While banks have led the offshore issuance of Eurobonds and global depository receipts (GDR) through London, a growing pool of blue-chip firms are joining the market. In July 2013 Nigeria returned to the markets with a dual tranche: a $500m, five-year bond and a $500m, 10-year Eurobond.

Access Bank and Fidelity Bank launched issues of $350m and $300m in five-year Eurobonds, respectively, in early 2013, adding to that of Guaranty Trust Bank (GTB) already on the market. FBN Holdings plans to raise $500m in a Eurobond later in 2013, while Diamond Bank is hoping to raise $550m. GTB was also the first to issue a GDR in 2007, followed shortly by Diamond Bank. Although these issues remain thinly traded, the third GDR issue by a Nigerian bank, Zenith Bank, in March 2013 ensured more liquidity by offering existing investors in its stock on the NSE the option to convert 50 shares into a GDR without a conversion fee. The GDR price rose from its issue price of $6.6 to $6.9 within the first few days of trading.

MONEY MARKET: Investors have remained keen on short-term T-bills ranging from three to 12 months. Indeed, T-bill cash transactions increased 28.75% in 2012 to N13.92trn ($87.7bn), according to CBN data. “Investors are still very keen on T-bills as they like the Nigerian growth story,” Stanbic IBTC’s Sule told OBG. “Yet Nigeria is still closely indexed to the oil price.” With bids four times above the amounts on sale in 2013, for yields ranging from 9.4% to 11.6% on 91-day bills, investors have rallied to T-bills. Meanwhile, the market in commercial paper (CP), or bankers’ acceptance notes, showed signs of life when Stanbic IBTC launched the first CP since the financial crisis in September 2012. A CP can be issued by BBB-rated banks and A-rated corporates as short-term (15- to 270-day) money market funding instruments of at least N100m ($630,000) in multiples of N50m ($315,000). The market had been inactive since a temporary CBN ban in 2009. Following abuses of CP by banks disguising their deposits prior to the banking crisis and reducing their dues to the Nigerian Deposit Insurance Corporation, the regulator published new guidelines in late 2009 requiring a CP to be registered with the Central Securities Clearing System (CSCS), strictly regulated and held on banks’ balance sheets. “The 2009 guidelines on CP are too strict; it is a lot to go through for short-term papers of 90 days, on average,” the FDC’s Rewane told OBG. “Nonetheless, we do expect renewed interest in CP this year.”

While CP rates fell to around 12.5% in 2013, bank loan rates as low as 13% for working capital have remained competitive. Stanbic IBTC issued a first tranche of N11bn ($69.3m) in September 2012 at 14.3%, at a mere 60 basis point premium on T-bills at the time. In total, Stanbic IBTC plans some N100bn ($630m) in CP issues, and expects other banks to follow. At the height of trading in 2008 the CP market was worth some N300bn ($1.89bn) a day. “CP rates are benchmarked to T-bill rates, while rates on bank lending tend to be stickier,” Sule told OBG. “Should inflation and T-bill rates trend downwards we foresee more interest in the CP market.”

UPGRADES: Under its five-year development plan, the NSE’s new management has been forging ahead since April 2011 with upgrades to its trading system and towards the dematerialisation of traded shares. Having upgraded to an automated trading system in 1999, which combines auction-style, direct trading, negotiated deals and a quote market, trading on the NSE currently runs on the NASDAQ OMX Horizon platform.

Trading switched in September 2013 to the new NASDAQ X-stream platform. While originally planned for a June 2013 launch, migration was delayed to September to allow sufficient time for brokers to upgrade. “The move to the new trading platform in September requires significant investments by brokers to upgrade their trading systems,” Layi Olaleru, Cordros Capital’s head of operations, told OBG. “We estimate it will cost on average N50m ($315,000) for each broker, which should reduce the number of active brokers significantly.” The new platform’s higher bandwidth and capacity will provide for high-frequency trades. The X-Gen programme aims to leverage the country’s mobile phone proliferation by enabling retail investors to trade electronically through their brokers from anywhere.

CSCS: The market’s CSCS, which is 27%-owned by the NSE alongside leading commercial banks, has been encouraging the dematerialisation of physical shares on the market to allow for fractional trading and more efficient, transparent and secure trading. The proportion of dematerialised shares reached 72% by June 2013, according to CSCS, although the largest migration occurred during the boom years of 2007-08 – all new share issues are de facto dematerialised. The clearinghouse also expects to move in 2014 from T+3 to T+2, shortening the settlement process by one day and improving liquidity – a transition made easier by the upgrade of its post-trade settlement mechanisms to match the new X-stream platform.

BROKERS: Despite some 242 broker-dealer firms licensed as of the end of 2012, the top 10 brokers control the majority of trading – some 76.4% in 2012. These included two bank subsidiaries (Stanbic IBTC Stockbrokers, the biggest, and FBN Securities, the sixth largest), one foreign-affiliated broker (Russia’s Rencap Securities, 2nd) and seven local independents (Chapel Hill-Denham, CSL, ARM, Cordros Capital, Vetiva, BGL and Meristem). “A large number of licensed brokers appear technically near bankruptcy,” Cordros Capital’s Olaleru told OBG. “With average broker commissions of 1% for retail investors and 0.35% for institutionals, it is hard to see how any broker with less than 2% of daily trade value (on average) could survive in the long run.”

While commission fees are capped at 1.35% by the regulator, the Securities & Exchange Commission (SEC), larger qualified investors, with investable assets of over N20m ($126,000), can negotiate fee structures with their brokers. During the downturn following 2008, a number of broker-dealers launched investment banking and advisory services to bridge their income gap, while a few mergers occurred, such as Chapel Hill and Denham’s in 2009 and Dunn Loren Merrifield Investment’s acquisition of Access Investment in March 2013. FSDH, a broker covering equity, fixed-income and money markets, was awarded a merchant-banking licence (with N15bn [$94.5m] capital requirements) alongside South Africa’s Rand Merchant Bank in November 2012. The NSE has set a goal of demutualising itself in the next four years, with the ultimate aim of publicly listing. “Brokers are not eager to merge since they are afraid of losing an NSE licence,” Kyari Bukar, CSCS’s CEO, told OBG. “Indeed, when the NSE is demutualised all licence-holders will automatically become NSE shareholders.” While the National Assembly has proposed lifting capital requirements for brokers from N70m ($441,000) to N500m ($3.15m), the SEC and the NSE have favoured a more even-handed approach. The exchange expects the shift to the new trading platform to weed out brokers unable to make the required investments, while closer attention to risk management, governance and reporting standards has led to more enforcement action.

REGULATION: The NSE has significantly improved its front-line enforcement of market standards since 2011. It sent a strong message in July 2011 when it temporarily suspended 48 firms for failing to publish annual reports on time, while in April 2012 it penalised a further 72 for failing to meet reporting requirements. The level of compliance with reporting requirements, disclosure and transparency standards has risen sharply, with full compliance of annual report submission in 2012. Greater compliance can also be attributed to the listing rules in which the NSE raised disclosure and reporting standards; the launch of the X-issuer, which has made the market more transparent and has eliminated leakage of price-sensitive information; and the X-compliance report covering the compliance status of companies. Listed firms that disclose forecast are now required to issue profit warnings. Full- and halfyear International Financial Reporting Standards-compliant accounting has been required since 2012.

The 2007 Investment and Securities Act significantly strengthened the SEC, although the commission has operated without a board since early 2012 due to parliamentary disputes. With its budgetary funding cut (SEC funding is not included in the 2013 budget), the commission’s capacity is reduced. Beyond funding challenges in the near term, the IMF has called for the SEC’s independence and capacities to be strengthened, with much more frequent inspections of broker-dealers, for instance. Uniquely, the regulator earns a commission from all trades. “Nigeria is one of the only markets globally where the market regulator, the SEC, levies a commission on every trade,” Cordros Capital’s Olaleru told OBG. “Although the fee was halved to 0.3% in 2009, brokers would like to reduce it further.”

The NSE requires bond and equity issuers to be rated by two agencies. The pensions reform expected in late 2013 will reduce the number of ratings firms from two to one. Nigeria hosts three credit ratings agencies locally: the largest, Agusto & Co., a subsidiary of South Africa’s Global Credit Ratings, and two smaller outfits, Pharez Ratings and Brickfield Road Associates. Standard & Poor’s is also reported to be opening a local office.

MARKET MAKING: Central to creating new liquidity in the market and improving price discovery, the SEC appointed 10 market makers for equities and 10 for bonds in 2012. Meanwhile, four securities lenders were licensed in 2013, namely United Bank for Africa Capital, Stanbic IBTC, First Bank and Capital BanCorp.

By lending shares, these market makers will allow for short-selling, the selling of borrowed shares in the hope of a price drop (although only they are allowed to naked short sell, in which case their position is not covered). This will also add new liquidity that will enable broker-dealers to give two-way quotes (for bid and ask) as low liquidity has limited most brokers to one-way quotes. While the securities lenders were still establishing their books in mid-2013, the largest securities lender will be Asset Management Corporation of Nigeria (AMCON) once the market starts – holding shares worth 4% in Access Bank, 17% in Ecobank, 4% of FCMB, 13% of Sterling Bank, 20% of Union Bank and 99.9% of the three bridge banks that remain from the banking rescue. Coupled with the shift to T+2 settlement securities, lending is expected to significantly drive liquidity.

NEW ASSET CLASSES: The NSE is also working to broaden its portfolio to include derivatives, with plans to introduce options from 2014, followed by forwards and swaps in 2015. “While derivatives trading has yet to start onshore in Nigeria, a number of international banks have started marketing offshore hedging instruments to Nigerian corporates,” Solape Hammond, Calag Capital’s CEO, told OBG. “JPM organ and Deutsche Bank offer contracts to hedge foreign exchange exposure, and Standard Chartered is looking to introduce futures contracts for key commodities like cocoa, cassava, rice and sugar. An onshore commodities exchange would make a lot of sense.”

Although Abuja has hosted the Abuja Securities and Commodities Exchange (ASCE) since 1998, it has never seen significant trading. In June 2013 New York-based Africa Exchange Holdings acquired the privatised ASEC. While Nigeria sells vast quantities of cocoa, cassava, sesame and others to private commodity traders like Olam and Cargill, the idea is to draw the trade through the exchange’s planned network of strictly regulated warehouses and silos and encourage more efficient and transparent price discovery.

OUTLOOK: Nigeria’s growth story has made it one of the key exchanges to watch, particularly given its resilience in the face of the June 2013 global emerging market sell-off. While Nigeria remains exposed to international investors’ risk-on, risk-off switches, a growing pool of domestic investors is returning to the equity market for the first time since 2008. With relatively new management enacting key structural reforms to deepen the markets, Nigeria’s private sector will find more alternatives to meet its growing need for capital.