The Federal Government’s recent decision to draw the first tranche of about $1.5bn from a $5bn financing arrangement with the United Arab Emirates’ First Abu Dhabi Bank (FAB) marks another important chapter in Nigeria’s search for innovative ways to finance its budget and manage its growing debt obligations. The transaction has generated considerable public interest because it departs from the conventional methods through which governments usually borrow money.
Instead of issuing Eurobonds or taking a straightforward syndicated loan, Nigeria has opted for a sophisticated financial instrument known as a Total Return Swap (TRS). While such arrangements are common in advanced international financial markets, they remain relatively unfamiliar to many Nigerians and even to a number of financial market participants. The complexity of the structure has attracted both praise and caution, with supporters viewing it as a creative financing solution while critics warn that it introduces new risks that deserve careful consideration.
To appreciate the significance of this development, it is important to understand the difficult financial environment in which the Federal Government currently operates. Like many developing countries, Nigeria faces a widening gap between government revenue and public expenditure. Large investments are required to build roads, railways, power infrastructure, healthcare facilities and schools, while debt service obligations continue to consume a substantial portion of government revenue.
At the same time, borrowing from the international capital market has become considerably more expensive following the sharp increase in global interest rates over the past few years. Investors have become more selective in lending to emerging and frontier economies, demanding higher returns to compensate for perceived risks. Consequently, issuing new Eurobonds has become significantly costlier than it was only a few years ago.
Against this background, the Federal Government has been exploring alternative sources of external financing that could provide access to large amounts of foreign exchange without immediately returning to the Eurobond market. It is within this context that the financing arrangement with First Abu Dhabi Bank should be understood.
According to reports, the recently accessed $1.5bn represents only the first drawdown under a broader facility of up to $5bn, which may be accessed in stages over time depending on the government’s financing requirements and the satisfaction of agreed conditions.
The financing itself is structured as a Total Return Swap. Although the name sounds highly technical, the underlying concept can be explained in relatively simple terms. A conventional loan is straightforward. A lender gives money to a borrower, who agrees to repay the principal with interest over an agreed period. A Total Return Swap, however, is not a conventional loan. It is a derivative contract, a financial agreement whose value depends on another financial asset.
Perhaps the simplest way to understand the arrangement is to imagine someone who wishes to borrow money from a bank but instead of merely signing a loan agreement, also pledges valuable investment assets as security while agreeing to exchange the financial returns generated by those assets under a separate contractual arrangement. In effect, the lender provides the required cash while the borrower commits specified financial assets to support the transaction.
The arrangement therefore combines elements of borrowing, collateral management and risk sharing into one integrated financial structure.
In Nigeria’s case, the Federal Government receives United States dollar funding from First Abu Dhabi Bank while providing naira-denominated Federal Government securities as collateral. These securities remain government obligations but become encumbered for the duration of the transaction, meaning they cannot be freely used or traded because they have effectively been pledged to support the financing arrangement. This is one of the major distinctions between the facility and a conventional sovereign loan.
One reason governments sometimes prefer such structures is that they can unlock substantial funding even when traditional borrowing channels become less attractive or more expensive. Countries such as Angola and Senegal have previously utilized similar arrangements after conditions in the international capital markets became more challenging. For Nigeria, the facility offers another avenue to obtain foreign exchange without immediately issuing another Eurobond, thereby diversifying its funding sources.
Another feature attracting attention is the pricing of the transaction. When the arrangement was first announced earlier this year, the interest cost was estimated at approximately SOFR plus 3.95 to 4.00 percentage points, together with certain transaction fees. Since then, global interest rates have moderated somewhat. The Secured Overnight Financing Rate (SOFR), which serves as the benchmark for this transaction, currently stands at roughly 3.6 to 3.7 per cent, compared with over 5 per cent when discussions around the facility first became public.
Consequently, the all-in borrowing cost on the current drawdown is now around 7.6 to 7.7 per cent, excluding certain fees and transaction costs.
To many Nigerians, expressions such as SOFR and basis points may sound unnecessarily technical, yet the underlying idea is actually straightforward. SOFR is simply the benchmark interest rate used by financial institutions around the world when pricing many United States dollar loans. It measures the cost at which financial institutions borrow money overnight using United States Treasury securities as collateral. Because these Treasury securities are regarded as among the safest financial assets in the world, SOFR is generally considered a near risk-free base interest rate for dollar transactions.
Whenever an international borrower such as Nigeria raises funds, lenders add an additional percentage above SOFR to compensate for the risks associated with lending to that particular country. This additional charge is known as the credit spread or risk premium. In Nigeria’s case, the premium of about 4 percentage points reflects investors’ assessment of sovereign credit risk, exchange rate uncertainty, liquidity considerations and prevailing market conditions. In other words, while the United States government can borrow at rates close to SOFR because it is regarded as one of the safest borrowers in the world, countries perceived to carry greater economic or financial risks must pay an additional premium to attract lenders.
Viewed from this perspective, Nigeria’s current borrowing cost sends two messages simultaneously. On one hand, it confirms that international lenders are still willing to provide substantial financing to the country despite prevailing global uncertainties. Maintaining access to international credit markets is itself an important positive signal because it demonstrates that investors continue to regard Nigeria as creditworthy.
On the other hand, the relatively wide spread above SOFR also reflects the higher level of risk that international markets currently associate with the Nigerian economy. Countries with stronger credit ratings typically pay much smaller premiums, while frontier economies often pay significantly higher spreads.
Supporters of the transaction argue that, judged against prevailing international market conditions, the pricing remains competitive. One aspect of the pricing that has received comparatively little public attention is the arranger’s fee of 1.5 per cent attached to the facility. Although such fees are common in large international financing transactions, the magnitude of this charge deserves careful consideration. If the entire $5bn facility is eventually drawn, a 1.5 per cent fee would amount to approximately $75m.
Even if the fee is applied proportionately to individual drawdowns, it still represents a substantial additional financing cost over and above the interest payable on the facility.
From a public finance perspective, the relevant issue is not whether an arranger’s fee should exist but whether its size is justified by the complexity of the transaction and consistent with prevailing market practice for comparable sovereign financing arrangements. When combined with the interest spread above SOFR, the arranger’s fee increases the effective economic cost of the facility and should therefore form part of any comprehensive assessment of whether the transaction represents good value for Nigeria.
Be that as it may, the government maintains that the cost compares favourably with what the country might have paid through other external borrowing options and that the financing will assist ongoing efforts to refinance more expensive debt, strengthen fiscal management and provide additional resources for critical infrastructure projects.
The attraction of the arrangement therefore lies not only in the amount of money available but also in its flexibility. Unlike a single lump-sum borrowing, the facility allows drawdowns to be made in stages as funding needs arise. This means the government does not necessarily incur interest charges on the entire $5bn immediately but only on the amounts actually accessed. Such flexibility can improve cash flow management and potentially reduce unnecessary financing costs.
Nevertheless, attractive features should never be confused with the absence of risk. Financial markets rarely provide significant benefits without corresponding obligations. Indeed, many of the concerns being expressed by international institutions such as the International Monetary Fund, Fitch Ratings and Moody’s do not arise because the facility is inherently inappropriate, but because its complexity introduces obligations that are less obvious than those associated with ordinary government borrowing.
Some of these obligations could become significant if economic conditions deteriorate unexpectedly, particularly if the naira weakens sharply, domestic interest rates rise considerably or Nigeria’s sovereign credit rating comes under renewed pressure.
Understanding these less visible obligations is essential to forming an objective assessment of the transaction. While the first drawdown undoubtedly provides valuable foreign exchange at a time when fiscal pressures remain intense, the long-term success of the arrangement will ultimately depend not only on the government’s ability to manage the financial risks embedded in the structure but also on whether the borrowed funds are invested in projects capable of generating sufficient economic returns to comfortably meet future repayment obligations.
If the benefits of the facility are relatively easy to appreciate, the obligations embedded in the transaction require a little more explanation because they represent the very issues that have attracted caution from international financial institutions and credit rating agencies. These risks are not necessarily reasons to reject the financing arrangement outright.
Rather, they underscore the importance of understanding that sophisticated financial instruments often contain obligations that become more demanding when economic conditions deteriorate.
Perhaps the most distinctive feature of the arrangement is the requirement for Nigeria to provide collateral in the form of Federal Government securities denominated in naira. At first glance, this may appear entirely unremarkable since lenders routinely demand collateral to protect themselves against possible default.
However, the amount of collateral required under this arrangement is considerably larger than the amount actually borrowed.
The agreement requires what is known as a 25 per cent haircut on the pledged securities. The term “haircut” can easily be misunderstood because it does not imply that Nigeria is paying an additional fee. Rather, it refers to the discount the lender applies when valuing the collateral. If securities worth one hundred dollars are pledged, the lender does not recognize their full market value but instead treats them as being worth only seventy-five dollars for lending purposes.
In practical terms, every dollar borrowed must therefore be backed by approximately one dollar and thirty-three cents worth of government securities. Consequently, if Nigeria eventually draws the full five billion dollars under the facility, it would need to pledge government securities worth the equivalent of roughly six billion, six hundred and seventy million dollars.
This over-collateralization provides additional comfort to the lender but comes at a cost to the borrower. The pledged securities become tied to the transaction and are no longer freely available for other financing operations during the life of the agreement. Although the government continues to own the securities, their use becomes restricted because they now serve as security for the financing. In effect, valuable financial assets become locked into the transaction.
The implications become even more significant because the value of these securities is not fixed throughout the life of the facility. Instead, they are reviewed regularly under a process known as margining. In simple language, this means that the lender periodically reassesses whether the pledged collateral remains sufficient to support the outstanding loan. If market conditions change in a manner that reduces the recognized value of the collateral, Nigeria must provide additional securities to restore the agreed level of protection.
An everyday illustration may help explain this concept. Suppose a bank lends money against a house whose market value subsequently falls sharply. The bank may require the borrower to provide additional security because the original collateral no longer offers adequate protection. The same principle applies here, except that instead of property, the collateral consists of government securities whose value fluctuates with movements in financial markets and the exchange rate.
This feature introduces one of the most important risks associated with the arrangement. Since the loan itself is denominated in United States dollars while the collateral consists of naira-denominated securities, changes in the exchange rate become critically important. If the naira depreciates substantially against the dollar, the dollar value of the pledged securities may decline even if their naira value remains unchanged.
Should that happen, the lender may require Nigeria to pledge additional securities in order to maintain the agreed collateral coverage.
The consequences could become particularly challenging during periods of economic stress. Exchange rate depreciation often occurs at precisely the time when governments are already under pressure from declining revenues, rising inflation and tighter financial conditions. Having to identify additional collateral during such periods could further strain public finances and reduce policy flexibility.
The value of the collateral may also decline for reasons unrelated to the exchange rate. Government bond prices fluctuate continuously in response to movements in domestic interest rates. When interest rates rise, the market prices of existing bonds generally fall. If Nigerian interest rates increase significantly, the market value of the pledged securities may decline sufficiently to trigger additional collateral requirements even if the exchange rate remains relatively stable.