Daily Equity Report
Seed Weekly - The African Bank Debacle
African Bank Investment Limited (Abil) has had immense media coverage as the bank went into decline to the point where the Reserve Bank authorised a bailout and placed the bank under curatorship.
African Bank is not a bank in the traditional sense, which is largely funded by a retail deposit base. Rather this bank had very little by way of retail deposits and was mostly funded by institutional bondholders.
Banks are typically risky businesses given the way that they have their balance sheet structured between equity and debt. While each business will vary in the amount of debt that it can take on, a typical (non bank) business may have a debt to equity ratio of around 0.5, i.e. for every rand of equity the business has, it will have half the amount of interest bearing debt. SABMiller, for instance, has a debt to equity ratio of 0.6.
Banks, almost by definition of the nature of the business, operate at far higher levels of debt to equity. In the last set of account, African Bank recorded that it had equity of R 10.3bn, preference share capital of R 1.1bn and total liabilities of R 55bn.
Essentially African Bank borrowed large tranches of money in the capital markets by issuing various bonds in order to raise capital. As a bank it had very little by way of retail deposits. It then lent this combined capital out into the retail market by way of unsecured shorter duration loans at higher rates of interest.
The business model started to unravel when the bank extended loans that it could not fully recover and when it made multiple loans to the same highly indebted client base. It also became clear that the bank did not adequately provide for non-performing loans. This has the effect of overstating their profitability and the recoverability of their loans.
Despite a recapitalisation exercise earlier in the year, it got to the point where the Reserve Bank had no choice but to place the bank into curatorship. At the same time the Reserve Bank announced a recapitalisation plan of R 10bn sourced from the five major banks plus Capitec and the PIC in capitalising a new “good bank” from a portion of the assets.
The various investors into African Bank will be treated as follows
• The price of the equity in African Bank fell from around R10 per share at the beginning of the year to 31 cents before the share was suspended. Existing shareholders will be able to participate in the recapitalisation of the new “good bank” when it relists, but it is now highly unlikely that equity investors will recover their almost 100% losses.
• Senior debt holders will have their debt transferred to the new bank at 90%. I.e. investors in these debt instruments will take a 10% “haircut” of their capital. There is a degree of uncertainty at this stage as to the recoverability of the balance of the outstanding bonds and accrued interest.
• Subordinated debt holders will remain invested in the “old” bank. It is not clear at this stage what their write down will be, but it is likely to be substantial.
Seed Investments exposure
Given the size of African Bank, especially in the bond market, there were many equity, money market and multi asset unit trust funds that had exposure to the equity and debt of African Bank.
While it was widely reported that Coronation had the largest exposure to African Bank equity, the size of this equity exposure in its various portfolios was relatively small compared to two other equity funds, namely the Momentum Value fund which suffered a 10% write down and the Stanlib Value fund with a 6.1% exposure to African Bank’s equity.
• The Seed Equity Fund had no exposure to African Bank Investments equity.
• The Seed Absolute Return Fund had one direct senior debt instrument, which has subsequently been sold. It also had a very small exposure to the Atlantic Stable Income Fund. The estimated total impact on the Fund to investors was -0.06%.
• The Seed Flexible Fund had a two mandates with asset manager Atlantic – a bond mandate and a cash mandate. The estimated total impact on the fund to investors was -0.09%.
• The Prescient Wealth Multi Strategy FoHF had 15% allocated to 36One. This manager has publicly announced that they were short African Bank shares, which generated a net return of approximately 1.6% for the fund itself and hence an approximate 0.24% gain for investors in the Fund of Hedge Funds.
The African Bank failure is a clear indication that all investments carry risk. In this case even many money market funds, which many investors perceived to carry no risk at all, were impacted. Quite obviously while some managers avoided the risk by not investing, or on a more select basis even shorting the shares, most fixed income managers had a small allocation to African Bank debt.
We continue to assess each investment that we include into the portfolios not only on the basis of the expected return, but more importantly on the basis of the various risks that they carry. Sizing the investment position for both risk and return is a crucial element in risk management and hence portfolio management. While we would always like to avoid all losses of a permanent nature for our clients, we do believe that in this particular circumstance where billions have been written down, losses for our clients are relatively small and commensurate with the additional risk.
If you have any questions at any time on this or any other issue, please do not hesitate to contact us.
Ian de Lange
Tue, 19 Aug 2014- 09:16
021 914 4966