CAPE TOWN – The South African Reserve Bank’s (Sarb) decision on Sunday to put a rescue plan in place for African Bank (Abil) has not come without controversy. While some analysts have applauded it, others have suggested that the market should have been left to decide whether the lender deserved a second chance.
Given that Abil’s business model has shown itself to be severely deficient, there is good reason to question whether any kind of rescue operation is worth it.
“I think the consumer-facing microlending story in South Africa is outrageous,” says Adrian Saville, chief investment officer at Cannon Asset Management. “It is a crime on society. That business can applaud itself for scavenging off the poor is an outrage.”
Informed by this total lack of faith in the business model, Saville believes that more good would be served by allowing Abil to fend for itself.
“My philosophical stance is let the business fail,” he says. “It has an atrocious business model and management hasn’t demonstrated its capability to run the business effectively. So why keep it alive?”
Saville believes there are only two reasons he can see for rescuing the business:
“The first is that the Reserve Bank believes that there is contagion threatening the stability of the system and that needs to be properly managed. The second is that there is a vision for the rescued business beyond its existing model.”
It is the first of these points that is gaining the most consideration. Investment professional at Old Mutual Investment Group’s Electus Boutique Siboniso Nxumalo believes that Sarb had little choice.
“Confidence is an essential ingredient to a bank’s existence,” he says. “When banks lose market confidence their funding costs rise rapidly and this impairs their business model.”
Since Abil clearly lost the confidence of the market last week, Nxumalo believes Sarb had to step in to prevent an uncontrolled collapse.
“By their nature, banks are systemically important entities in the economy,” he says. “And as we saw in 2008, economies are also extremely sensitive to bank failures.”
He says this holds true, even though Abil is not a bank in the true sense.
“Even though Abil is not a bank with depositors, it is still a financial institution that takes money from somewhere and lends it out,” he says. “It is funded by big institutions like banks, asset managers and insurance companies, and if all of their investments were reduced to zero that would have a big impact on the funding market in South Africa.”
He points out that when dealing with financial institutions, one has to look beyond just the simple outcome of Abil no longer being able to operate.
“What happens if we write down R54 billion worth of funding?” he asks. “There will be a huge impact on the South African economy and the South African funding market, particularly in the money market.
“Liquidity could dry up, the cost of lending could ratchet up, and all that ultimately impacts the wider economy,” Nxumalo argues. “Consumers would end up paying higher rates because we let this one entity fail.”
Nolan Wapenaar, the head of fixed income at Efficient Select, believes that Sarb intervention was necessary for this reason.
“Sarb acting decisively and showing some leadership and courage was a good thing,” Wapenaar says. “I think that our central bank is one of the key strengths of our financial institutions and one of the positive contributors to why our credit ratings are where they are. And I think this has probably enhanced its international reputation.”
He believes that the Sarb has acted according to international norms. He points to the example of Banco Espírito Santo in Portugal, which has a lot of parallels to the Abil story. Last month the bank announced numbers that shocked the market, and the very next weekend the central bank put it under curatorship.
“Even the structure of the plan shows that Sarb is following the same route as that taken with Banco Espírito Santo,” he says. “It is a tried and tested formula, and I think that that’s healthy.”
He points out that the rescue does not mean that bond holders walk away unscathed. Leaving 10% of debt with the ‘bad’ entity, means that investors will take some pain.
“Sarb is teaching senior and subordinated bond holders a lesson and I think that is healthy for long term capital markets,” Wapenaar says. “Previously whoever bought the most credit risk looked like the smartest asset manager, because his risk paid him the most. But it doesn’t look that way any more. It’s just unfortunate that it’s their clients who will suffer.”
Perhaps the most interesting component of the rescue plan is that all four of South Africa’s big banks have moved collectively to underwrite the capital raise. They are joined by Capitec and the Public Investment Corporation.
“The big banks stepping in gives the appearance that they are worried about contagion,” says Cannon’s Saville. “And here it would have been helpful to understand not just that the business was being rescued, but why it was being rescued. In the absence of that, people are going to speculate about who had the biggest exposure.”
He does however add that the banks acting collectively does have a big positive in that it underscores the stability of the local banking system. This is an area where he finds agreement with Efficient Select’s Wapenaar.
“It is a positive statement from the banks who have underwritten the capital raise as to their ability to continue to operate,” Wepenaar says. “For Capitec in particular to stand up and say they will underwrite some of this is actually a great outcome.”
However, Electus’ Nxumalo does warn that we shouldn’t presume that the rescue means that Abil has a definite future.
“If all the banks are underwriting this rescue, what incentive do they have to make sure that the ‘good bank’ survives?” he asks. “They would effectively be funding their future competition.”
He puts forward the suggestion that perhaps the new Abil will prefer to collect outstanding loans while gradually winding down the business. The banks would be interested in winning over any good and profitable clients from Abil rather than allowing the entity that survives to keep them.
“Obviously all of these things were done in a hurry, so its difficult to speculate,” he says. “But over the next few months we are going to see the consequences of what just happened and it might be more significant than we took it for.”