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Fitch downgrades SA fund

Update: Absa removes all Abil investments from its Money Market Fund.

Fitch Ratings has downgraded the Absa Money Market Fund by three notches and placed its credit rating as well as that of six South African funds’ on a negative ratings watch.

The downgrade and negative watch is driven by these funds’ exposure to African Bank following the bank’s receipt of emergency support this week from the South African Reserve Bank.

As a result of the SARB’s rescue, holders of senior and wholesale debt instruments issued by African Bank have had their holdings written down to 90% of face value while subordinated instruments have been written down to zero.

The funds on negative watch include:

The negative watch reflects both the realised write-down on African Bank debt instruments and the potential for further credit deterioration or negative effects on instrument prices, Fitch says. It also affords Fitch time to determine the most appropriate way to incorporate African Bank’s evolving credit risk profile into its rating analysis.

“Fitch’s move is entirely understandable,” says Steve Rogers, joint MD Taquanta Asset Managers, which manages the two Nedgroup funds placed on negative watch.

“They were under pressure to say something given that it has been three days [since the SARB stepped in to save African Bank], and under those circumstances they almost had to over-react.”

However, Rogers is convinced that with time to really examine the numbers, a stable watch will be restored. In Nedgroup’s case the Core Income Fund (more aggressive than a money market fund), held a 5% exposure to Abil while the degree of exposure in the Nedgroup Money Market Fund was .5%.

“A 5% exposure equates to a 50 basis point loss, which is roughly one month’s interest in most money market funds,” explains Rogers. That implies that once this haircut has been taken, the annualised yield on the fund would drop (by means of illustration) from say 6% to 5.5%, which is still in the ballpark of the institutional call rate.

Effect of African Bank Senior Debt Impairment assuming a fund
has a 5% exposure

Investec believes the ratings will be resolved as soon as Fitch gains greater clarity around the restructuring of African Bank.

“Once the restructure has been finalised, we believe the debt in the ‘good bank’ – to which our Money Market Fund has exposure – will have a significantly better credit quality and rating,” it said in a statement. “We are also confident that the full impact of the exposure of our funds to African Bank debt has now been taken.”

However the downgrade of the Absa Money Market Fund from AA+ to A reflects the impact of the write-down of the fund’s African Bank exposure on its price and income.

Update: Absa announced Friday afternoon that it had removed all African Bank investments from its Money Market Fund.

“This will provide certainty and confidence to investors in the Absa Money Market Fund as the fund will only have exposure to the five large banks and the government,” it said in a statement, adding that all investors in the fund would be treated in a consistent manner going forward. 

Of the money market funds rated by Fitch in South Africa, Absa Money Market Fund has the highest, longest-dated exposure to African Bank.

Armien Tyer, head of the investment cluster at Absa Wealth says that on Friday 8th August, Absa’s R52.5 billion money market fund had a 3% exposure to African Bank in the form of prime-linked deposits.

The size of Absa’s exposure was too large to be absorbed only by a reduction in yield, which meant that a capital reduction was necessary. Accordingly, Absa had to effect a 0.3% write-down on the investments of its 132 000 money market clients. The Financial Services Board (FSB) was emphatic that the write-down needed to be done in one day, according to Tyer. He explains that this was both for technical and regulatory reasons (an accounting period is one day), as well as for reasons of fairness, as if the reduction was smoothed over time some clients could’ve withdrawn their money, leaving those still invested to absorb the loss.

“If you work on a 0.5% return per month in a money market fund, it takes 16 to 18 days before the capital is recovered through interest,” Tyer highlights.

Effect of African Bank Senior Debt Impairment assuming a fund has a 3.2% exposure

Fitch considers the level of loss incurred inconsistent with a highly rated, stable unit value, money market fund.

“These Abil exposures were in the fund when they [Fitch] revised the ratings just a few months ago. It came as a bit of a surprise when they downgraded us, for the simple reason that the remaining “good” bank’s assets have just been underwritten with a R10 billion capital raise and the Sarb wouldn’t have done this if there was a possibility for another writedown,” Tyer commented, adding that ratings actions were generally backward-looking.

Fitch will reconsider the negative watches as it gains greater clarity on the status of debt instruments issued by African Bank. A key decision point, the company says, will be the first maturities of African Bank debt instruments held by Fitch-rated funds, which it expects within the next six weeks.

Additionally, Fitch will use the negative watch period to gather additional information on the funds’ exposure to African Bank, strategies for managing African Bank exposure, and African Bank’s credit quality.

It is worth noting that only 11 funds in South Africa have been awarded a rating by Fitch Ratings. Of these six were placed on negative watch. However there are other funds, not rated by Fitch, with direct exposure to African Bank.

The problem is that information on exactly what these funds are holding is difficult to get hold of and, once you do, tricky to interpret.

Which begs the question of whether fund managers need to be more transparent about what they are investing in.

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