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A spotlight on Steinhoff’s corporate debt

Mispricing creates risks.
Local Steinhoff bonds have not repriced. Picture: Chris Ratcliffe/Bloomberg

The Steinhoff implosion has cast a spotlight on South Africa’s market for corporate debt, which is notoriously illiquid, despite there being over 1 500 debt instruments listed on the JSE.

This is a problem, but it is less visible when healthy companies do as they are meant to do: raise debt (for capital expansion, for instance), pay the coupon on it, and pay back the principal investment on the maturity of the note.

However when there is a blowout, as in the case of Steinhoff or before that, African Bank, the lack of liquidity creates a problem.

Steinhoff has debt worth about €10 billion (R160 billion) on its balance sheet. Of this R8 billion is in outstanding local notes which are held in investment portfolios across SA. Many conservative income unit trusts have exposure to Steinhoff notes that will cause losses.

Steinhoff also trades euro-denominated debt in Europe. This debt was, until this week, rated as investment grade, and is held by, among others, the European Central Bank. However rating agency Moody’s downgraded Steinhoff debt by four notches last week, citing concerns about the company’s liquidity and debt capital structure.

Read: Steinhoff share price plunge nears 90% as debt cut to junk

Following events last week, including the announcement that the release of Steinhoff results would be delayed as a result of allegations of fraud, the price of the company’s equity collapsed from about R56.00 to about R7.00 on Monday. At the same time the price of its European bonds fell by 40%, trading down to about 50 from a price of over 80 earlier in the week, and above 100 as recently as August.

However, Steinhoff’s local notes did not trade in the first day after its share price collapse, and astonishingly the price of the local debt barely changed after this, with some trading at 90, some at 95 and the majority at 100 (par value), or above.

“It is clear that carrying local debt near full price is unrealistic,” says David Knee, chief investment officer at Prudential Investment Managers.

The reason the price of the debt has been slow to fall, he says, is because the banks, with one or two exceptions, do not act as market makers for listed corporate debt; after the debt is first issued it rarely trades and the prices on the JSE become very old as they reflect only the most recent transaction. The banks will not step in to buy the debt when no one else will. This is the difference between the South African and European debt markets and is the fundamental weakness with the South African system.

As a consequence, “those investors now buying and selling those unit trusts holding Steinhoff debt are likely not trading at the correct price (net asset value),” says Knee. “Unit trusts themselves will also be trading Steinhoff at incorrect prices, although for now no trades have actually occurred.”

The South African bond market is pathetic, says Andrew Canter, CIO at Futuregrowth Asset Management. “You cannot talk about ‘trade’ because local bonds are bought and held, they don’t trade. This means that right now it is impossible to accurately price the Steinhoff debt in your fund.”

In such cases fund managers have three choices: they could freeze trading in the fund, which from a regulatory perspective is highly unpopular. Or they could create a ‘side-pocket’ where the tainted debt is removed from the fund and isolated in a separate fund. This was the route for many funds holding African Bank. Or they could attempt to reprice the debt.

“Given that nobody knows what the debt is worth and the complexity of the business (multiple businesses, jurisdictions, serial acquisitions, questionable accounting standards), cleaning this up could take time. I would advise side pocketing,” says Canter.

Data from Bloomberg suggests that Sanlam, Nedgroup Investments and Stanlib Asset Management are the largest holders of Steinhoff’s local listed debt.

Abax investments, managers of the Nedgroup Investments Flexible Income Fund has opted to use pricing information from the offshore bonds in order to mark its portfolios. “This has resulted in a 1.1% negative impact on the portfolio from this position,” the company said in a statement. “Our debt is primarily in the two-year area maturing in 2020, which falls due before the company’s large debt maturities from 2021 to 2025. We will vigorously engage with the company and stakeholders in order to assert our rights as debt holders and maximise the value of our client’s investments.”

In addition to the South African notes, several banks have issued local credit-linked notes (CLNs) on the back of Steinhoff debt. CLN’s are financial instruments that are used to package and transfer credit risk.

It is worth noting that the issuer, usually a bank, is not obligated to repay the debt if Steinhoff were to default. The total amount that has been issued is unknown as these structures are highly opaque. For instance the note will look (in name) like a note issued by Standard, Absa or Nedbank and it is not immediately clear that the primary credit exposure in that note is Steinhoff.

SA banks have issued hundreds of millions of CLNs with partial or full exposure to Steinhoff. “These notes are also held by income unit trusts. The banks that are supposed to provide daily prices on these instruments will often continue to show these trading at par, which is clearly inappropriate,” says Knee. “This also presents a separate risk to unit holders of the unit trusts.

“The last time we saw this was with African Bank. It was using offshore dollar-denominated bonds which offered a higher yield, so the local banks packaged them into CLNs. It was only after the offshore bonds had fallen by 50% that the CLNs repriced.”

Bondholders will be hoping that Steinhoff has enough assets to settle its bonds as they mature. There is an estimated R2 billion in onshore debt and EU2 billion in offshore maturing in 2018 (R600 million matures this week).

It does appear that a portion of the local debt is guaranteed by Pepkor, now held by Steinhoff Africa Retail (Star). This follows from the 2016 transaction that saw Steinhoff acquire 92.3% of Pepkor for R62.8 billion.

“Star is a good business, it is cashflow generative, and its businesses are growing against a generally poor retail background in SA. This is most definitely a plus. As far as we can see the EU bonds don’t have this guarantee,” adds Knee.

Of course what shareholders don’t know is whether Star was used to guarantee any other debt. “There were no explicit figures detailing the scale of guarantees in the Star offering prospectus. Certainly if Steinhoff was to fail there could be some material requirements on Star from a cashflow perspective,” he says.

More light will be cast on the subject with the release of audited financial statements, which will be at some point in 2018. In the meantime investors in both equity and debt are unable to accurately assess the scale of the problems and the fundamental net worth of the company and the securities they own.

According to Morningstar these funds are exposed to Steinhoff debt. It is not an exhaustive list and does not include unlisted bonds or CLNs:

Nedgroup Inv Flexible Inc A

6.1%

Momentum Income Plus A

3.2%

STANLIB Extra Income R

2.8%

STANLIB Enhanced Yield A

1.7%

ABSA BCI Institutional Flexible Income A

1.6%

SIM Bond Plus R

1.4%

STANLIB Flexible Income A

1.3%

Momentum Maximum Income A

0.8%

Investment Solutions Superior Yield A

0.6%

STANLIB Income R

0.5%

SIM Active Income A1

0.5%

Sanlam Namibia Active A

0.3%

STANLIB MM Enhanced Yield B1

0.2%

SIM Balanced R

0.1%

 

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Like most salary earners (I suspect)I am no finance guru. If I was I would do my investing myself, no? I rely on my financial advisor to invest for our pension and have always paid professionals for professional advice. I read what I can and try to make sense of most of it. So far so good. There is nothing I understand about this article to be honest. I don’t know what a “side pocket” is….. I thought its something on my jeans. Most of the experts above seem to be guessing at best. What I do know however is Steinhoff is a listed company and it gets audited every year. It goes belly up overnight. And now I see that no one actually has any idea how the company was structured or how much it owes. This is unacceptable to put it lightly. We lay folks actually have no protection if this is the way the investment industry works. I may as well use an astrologer for advice in future. Or tea leaves. If a surgeon repairs my hernia and its botched I am going to sue his tuchas. Why are the “financial advisors” not accountable is a train smash like this ….. ? I am not upset about normal price fluctuations and the market…. those are within reason and part of the game. I am talking about a total collapse. As far as they guys at Steinhoff are concerned, I hope just deserts are on the horizon for you all including the board who were in charge while this was going on. R100 million a year on racehorses and you make an exit with a note saying “sorry” ….? You can’t be serious. This is not a fender bender in a shopping maal parking lot you git. I know the difference between cake and manure and this is not cake.

The truth is picking the right share is like throwing darts at a spinning dartboard whilst half drunk and blindfolded, standing with one leg on a balance board. Anybody who claims otherwise is delusional. How many advisors rated Steinhoff a “BUY” or at least a “HOLD” a month ago? I rest my case.

We are living in a new world of smoke and mirrors, of greed and corruption, of fake news and creative accounting. If we believe that “financial advisers” can sift through all the BS and also see clearly into the future we are fooling ourselves. This disaster is absolute proof of that. No one will take better care of our money than us. Problem is, we are now in a world where we have to become our own experts in finance, investment, insurance and health. Yes, the days of trusting your doctor are also over too. The conventional medical profession are not interested in curing you, they don’t want to lose a customer. The light at the end of the tunnel is that if we are prepared to put in many hours of research everything is at our finger tips through Google. Beware, Steinhoff is not the only ponzi scheme, the whole financial world is basically one big ponzi scheme.

Very accurate description of most retail investors.

Spot on Boepie.

if you read the book “Too big to fail” you’ll, like me, still not be a finance guru but at least see the action. Meanwhile, believe everything Futuregrowth says as credible and informed; the CEO almost got fired a year or two ago when he moved to limit exposure to ….Eskom….

This is why I believe in the “Stop Loss” method, some Guru’s say it is not a good thing to put a stop loss on your shares, but this method saved me plenty, I only believe the Guru’s when I’m desperate, and currently I’m far from desperate:-)

End of comments.

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