Banking sector recapitalisation: A risky trajectory for future mergers, acquisitions

BY VANESSA KELECHI

The March 28, 2024, circular from the Central Bank of Nigeria (CBN), titled ‘Review of Minimum Capital Requirements for Commercial, Merchant, and Non-Interest Banks in Nigeria’,¹ set the stage for significant shifts in the financial landscape since the first quarter of 2024. This regulatory move is expected to reshape the landscape of banking in Nigeria, triggering a wave of restructuring as banks strive to meet the updated criteria through various means including fresh equity capital injections, rights issues, offers for subscription, license upgrade/downgrade and mergers and acquisitions (M&As).

The ripple effects of the recent recapitalisation directive are being felt across the banking sector. As banks gear up to infuse new capital through heavily advertised rights issues², private placements and offers for subscription, the pathway for future mergers and acquisitions (M&As) is being carefully scrutinized. The future standing of banks hinges on their ability to comply with these new requirements. This article explores the uncertainties surrounding bank M&As in light of the CBN’s recapitalisation exercise and its potential long-term implications for the sector.

The prevailing macroeconomic challenges and headwinds necessitate that banks bolster their resilience, solvency, and capacity to support the Nigerian economy. Consequently, the recapitalization mandate is seen as a move to ensure a safer, sounder, and more stable banking system, in line with Section 9 of the Banks and Other Financial Institutions Act (BOFIA) 2020.³

The context of recapitalisation

The CBN’s circular outlines an upward revision of the minimum capital requirements for various categories of banks in Nigeria. Commercial banks with international authorization now require a minimum capital of N500 billion, those with national authorisation need N200 billion, and regional commercial banks need N50 billion. Merchant banks with national authorisation must meet a N50 billion requirement, while non-interest banks have requirements of N20 billion for national authorisation and N10 billion for regional authorisation. The directive mandates banks to meet these new capital thresholds within 24 months, commencing April 1, 2024, and concluding March 31, 2026.

Existing banks must ensure that the minimum capital specified comprises paid-up capital and share premium only, explicitly excluding Additional Tier 1 (AT1) Capital. Given the significant capital requirements, mergers and acquisitions present a viable pathway for banks to enhance their capital base.⁴ The new regulations are likely to drive consolidation in the sector as smaller banks may struggle to meet the new thresholds independently. This situation creates opportunities for larger banks to acquire smaller institutions, thereby expanding their market share and operational capabilities.⁵

Strategic considerations

For banks, the decision to pursue mergers or acquisitions involves a complex strategic evaluation. The key considerations include:

a. Financial viability: Assessing the financial health and compatibility of potential merger or acquisition targets.

b. Regulatory approval: Navigating the regulatory landscape to secure the necessary approvals from the CBN, Nigerian Deposit Insurance Corporation (NDIC), Securities and Exchange Commission (SEC) and Federal Competition and Consumer Protection Commission (FCCPC).

c. Market position: Enhancing market presence and operational capabilities through strategic consolidation.

d. Operational Synergies: Towards achieving a stronger competitive position.

Uncertainties and the future of M&As

The uncertainties surrounding the recapitalisation exercise and its impact on M&As are influenced by factors such as the willingness of banks to merge, the availability of suitable partners, and the overall economic environment. Banks must also consider the potential for increased competition in the sector. As institutions meet the new capital requirements, they may seek to expand their market share through aggressive growth strategies resulting in
either heightened competition or near market monopoly.

Equally, the integration of merged entities can be fraught with operational complexities, cultural differences, and potential regulatory hurdles. Banks must also be wary of potential market disruptions and the impact on customer confidence during the transition period.

Banks must still navigate the complexities of merger control regulations, which require prior approval from the Federal Competition and Consumer Protection Commission (FCCPC) for transactions that meet specific turnover thresholds. The FCCPC’s merger control regime necessitates that any transaction leading to a change of control and meeting the statutory turnover threshold must receive approval before implementation. A merger is deemed to
have occurred when one or more undertakings directly or indirectly acquire control over the business of another undertaking. This can be through the purchase of shares, assets, amalgamation, or a joint venture.

In addition to regulatory hurdles, the economic landscape poses significant challenges. These include inflationary trends, volatile exchange rates, and other domestic and international economic shocks. The directive aims to ensure banks have a robust capital base to absorb unexpected losses and continue supporting economic growth.⁶

Here, we examine several illustrative scenarios to highlight the key legal and regulatory considerations.

Scenario I: Veto authority with a significant minority shareholding

Investor X acquires a 20 percent stake in Bank C. Although this shareholding is below a 25 percent threshold, it grants Investor X significant blocking rights over key decisions such as capital restructuring and strategic mergers.

Analysis
The 20% stake, combined with blocking rights, enables Investor X to significantly impact Bank C’s strategic decisions. This situation might prompt the CBN to evaluate whether such a stake, even if below the standard regulatory thresholds, could have material effects on the bank’s operations and market position.

Discussion points

a. How should the CBN assess the influence of a 20 percent stake with blocking rights in the context of recapitalisation?
b. What criteria should be used to determine if regulatory intervention is needed to address potential anti competitive impacts?

Scenario II: Board appointment rights

Investor Y acquires a 15 percent stake in Bank D and secures the right to nominate for appointment two out of five board members. This arrangement grants Investor Y significant influence over Bank D’s governance and strategic direction.

Analysis
Investor Y’s right to nominate a significant portion of the board provides substantial control over Bank D’s strategic decisions and governance. This influence could lead to strategic shifts that prioritise Investor Y’s interests over those of other stakeholders.

Discussion points
a. Should the CBN evaluate the impact of board appointment rights in recapitalisation?
b. What safeguards can be introduced to balance shareholder influence and maintain fair governance practices?

Scenario III: Contractual rights and regulatory review

Investor Z acquires a 10 percent stake in Bank E, accompanied by a contractual agreement granting preferential voting rights, veto power over major financial decisions, and access to sensitive financial information. Investor Z equally gains the right to participate in decisions requiring unanimous approval, such as major structural changes.

Analysis
The contractual rights acquired by Investor Z, despite holding only a 10 percent stake, may trigger concerns regarding material influence. The combination of preferential voting rights and access to sensitive information could significantly impact Bank E’s decision-making and operational strategies. This challenges traditional thresholds for material influence and raises questions about regulatory oversight.

Discussion points
a. What specific contractual provisions should be scrutinised to prevent undue influence or competitive disadvantages?
b. Should the CBN consider the impact of unanimous voting rights in cases of minimal shareholding?
c. What thresholds or criteria could be established to address influence in such scenarios and ensure effective regulatory oversight?

Projection/recommendations

The potential for regulatory intervention remains high, as the CBN continues to monitor the sector for any signs of systemic risk. This exercise also brings to the fore issues related to minority shareholder rights and antitrust considerations. Ensuring fair treatment of minority shareholders and maintaining competitive balance in the market are paramount. The Federal Competition and Consumer Protection Commission (FCCPC) plays a crucial role in overseeing these aspects, ensuring that M&A transactions do not create monopolistic entities that could stifle competition.

Navigating these regulatory and operational challenges requires banks to adopt a strategic and meticulous approach. Engaging in thorough due diligence, seeking expert advisory services, and fostering transparent communication with regulators are essential steps. The process involves regulatory approvals, shareholder agreements, and adherence to stringent disclosure requirements.

Accurate valuation and thorough due diligence are critical in M&A transactions. Banks must conduct comprehensive assessments of their potential merger partners to identify any hidden liabilities, evaluate the quality of assets, and understand the overall financial health of the institution.

In submission, the CBN’s recapitalisation exercise has set in motion a series of changes that will shape the future of Nigeria’s banking sector. A well-capitalised banking sector will likely attract greater investor confidence boosting foreign direct investment (FDI) and greater participation in the Nigerian financial markets. Enhanced investor confidence will also support the growth and development of the broader economy.

Vanessa Kelechi, a corporate/finance lawyer, can be contacted via [email protected]

*Footnotes

1 FPR/DIR/PUB/CIR002/009.

2 Currently, Access Holdings has raised N351bn rights issue and Wema Bank has been admitted N8.572bn rights issue amongst others.

3 The CBN equally launched the Banking Sector Recapitalisation Programme 2024 in furtherance of this.

4 In contrast to the previous minimum capital requirements for banks, which included shareholders’ funds, the new circular specifies that the minimum capital must consist solely of paid-up capital (and share premium for existing banks). This excludes retained earnings and Tier 1 Capital (AT1 Capital) will no longer be considered in the calculation of minimum paid-up capital.

5 Similar regulatory reforms can be traced to the CBN Universal Banking Guidelines 2000, Recapitalization Drive of 2005, CBN Regulation on the Scope of Banking Activities and Ancillary Matters 2010, CBN Guidelines on Regulatory Capital [Section 3] culminating in the recent reform on the basis of the currency market illiquidity.

6 As referenced in the circular.