RANDS AND SENSE
I wrote an article in August 2014, when Moody’s downgraded Capitec Bank’s credit rating by two notches, a week after the South African Reserve Bank (SARB) placed African Bank under curatorship. It was titled “Capitec is not African Bank”. Now, almost three-and-a-half years later and after Viceroy’s Capitec report was released this week, my view hasn’t changed.
In my August 2014 article I said the Moody’s downgrade was unwarranted and dangerous. “Dangerous from a behavioural point of view, in that after investors’ African Bank experience, the downgrade could easily trigger a stampede of both equity holders and retail depositors into selling shares and withdrawing deposits. Banking is different from any other business in that ‘when SAB’s share price goes down, their clients don’t buy less beer; when a bank’s share price goes down, depositors reconsider whether their deposits are safe’ (quote by Prudential’s Marc Beckenstrater).”
Recently, Viceroy released a report on Capitec which I think is self-seeking and malicious. In short, it asserted that:
- Capitec is a predatory lender.
- The bad debts in Capitec’s loan book are much higher than Capitec’s numbers (R11 billion), with the implication that Capitec will have to make a significant write-off. (For some context: Capitec’s net profit for the year ending February 2018 is expected to be around R4.1 billion.)
- Capitec has been charging its clients excessive fees and will face a class action claiming R12.7 billion in refunds.
- The South African consumer is in financial stress leading to further bad debts for Capitec (and obviously other South African banks).
The report may have caused unnecessary concern for Capitec depositors.
Depositors get very worried when a bank’s share price falls – this became a death spiral in the case of Saambou, BOE and African Bank. Depositors (and investors) must bear in mind:
The SARB released a statement indicating that the bank meets all prudential requirements and is in good financial health.
Viceroy made no effort to talk to Capitec to test its calculations.
Capitec refutes Viceroy’s allegations and calculations.
I highly doubt that the allegations contained in the report are true.
1. Capitec is a predatory lender?
Capitec started off in 2001, providing short-term loans in the high risk market to clients at very high rates. Over the years the bank has gradually broadened its product range to where short-term lending has become a much smaller percentage of its loan book and profitability. The loans charge high interest rates, which are necessary to make lending in that segment sustainable. Generally these loans are used for home improvements, education and often to fund working capital for small businesses.
True, many of the loans are used recklessly. And yes, interest rates are high, so often clients become caught in a debt trap. However, the industry is heavily regulated with many rules protecting clients. Given the size of the bank, I would think that if there were gross or persistent irregularities they would’ve been picked up by the regulators by now.
Although advertising plays an important role in driving consumer behaviour, prospective clients choose to go to Capitec for loans, and the percentage of loan applications turned down is very high. The rate at which Capitec keeps growing proves the demand for these loans – which doesn’t sound predatory to me.
2. Bad debts are understated and Capitec will have to make significant write-offs?
I don’t think this is true. Capitec has since inception been very prudent in making adequate bad debt provisions as soon as a client misses a payment.
The bank’s non-performing loans (NPLs) as a percentage of total loans has grown to 7.8%, and its reserves to 17.0% of its loan book. Especially the reserve percentage is high, both in historic terms and compared to international peers, reflecting the current economic situation in South Africa. An extra R11 billion in non-performing loans would mean that 33% of Capitec’s clients are in distress and cannot repay their loans or the loans are being kept alive by continuous rescheduling or relending. In addition, because Capitec has been prudent in writing off loans that are three months in arrears, their NPL ratio will always be lower than that of peers in its industry.
Based on our research of similar banks internationally, an additional R11 billion bad loans would mean Capitec is one of the worst banks in the world. An understatement of this magnitude would imply consistent and systemic fraud and would have been extremely difficult to hide from auditors, the SARB and analysts for so many years.
3. Capitec has charged excessive fees?
This is difficult for analysts to prove or disprove. Logic dictates that if so many clients keep switching from other banks to Capitec, it must be delivering a better service and at a lower cost than competitors. Although it’s difficult to compare charges for similar products, clients are generally thorough when looking at the options. Yes, there are unhappy clients that are taking Capitec to court but they represent a very small portion of its clients.
4. The South African consumer is in financial stress?
Our economy has effectively stalled and has been shedding jobs. Consumers are indeed under stress (hence the increase in non-performing loans and build-up of reserves) but for this to become problematic the situation would have to deteriorate further via a higher cost of living (weak rand, higher inflation and higher interest rates). Instead, with the election of Cyril Ramaphosa the opposite has happened: The rand has strengthened, which will put downward pressure on the cost of living and should lead to increasing employment. Over the next few years distress levels should fall rather than increase.
It boils down to whether or not we can trust Capitec’s financial statements. Over the years we have seen many instances where managements have deliberately set out to deceive investors (most notably Enron and more recently Steinhoff). When researching companies, analysts spend a lot of time interviewing managements, analysing financial statements and comparing ratios across both local and global peers. Based on our research, and my experience over many years and in many countries, I would be very surprised if Capitec has been systematically misstating their financial statements. But one never has 100% certainty, which is why it is so important to control risk by limiting the size of individual investments in portfolios.
In terms of capital and reserve ratios, profitability and growth prospects – Capitec is not African Bank and should continue to gradually take market share and, unlike, African Bank, the evidence suggests that it will be around in its present form for many years to come.
Kokkie Kooyman is a portfolio manager at Denker Capital. This article appears with kind permission from Denker.