The market is understandably concerned about the allegations made about Capitec Holdings Limited (Capitec) business and practices. Addressing the recent market news and conjecture, we would like to offer our investment views on Capitec.
The market is understandably concerned about the allegations made about Capitec Holdings Limited (Capitec) business and practices. Addressing the recent market news and conjecture, we would like to offer our investment views on Capitec.
As part of our credit process we review all exposures regularly and, prior to this week, Capitec was last reviewed in December 2017. Our investment views are based on our proprietary research, which takes into account both qualitative and quantitative factors. We will not comment on others’ investment research reports on Capitec. The opinions herein reflect our own credit assessment, and are based on information we have had to date, and thus may change if additional information comes to light. Further, we do not comment on the Capitec share price or value.
Our current credit view is based on the following considerations:
- We have previously, over several years, expressed our concerns about the potential for excesses and malpractice in the personal unsecured lending market. We consider that the industry must ensure it fulfills both the need for competitive access to finance as well as responsible lending practices. Broadly, we believe that lending should best be made for productive purposes (e.g. housing, education, business generation) and not for consumption.
- The risks in the South African unsecured lending market are well known – notably the levels of consumer debt, the sales techniques used in granting loans, and the relative weakness of the South African economy. These macro factors have been considered in our credit assessment of Capitec and in our fair-value assessment of Capitec bonds. Low GDP growth and rising unemployment have placed the South African consumer under strain, resulting in a rise in debt review applications and increasing arrears across the sector.
- These industry dynamics and economic headwinds faced by consumers and this sector have been part of the reason why Futuregrowth’s internal credit rating of Capitec has differed from the official credit rating and from the bond market’s sentiment on the company. Our differing view on the appropriate rating and hence pricing (i.e. yield) of Capitec bonds has meant that we have generally either not participated in auctions, or priced our bid-yields higher than the market clearing price. As a result, our credit exposures to Capitec are relatively low in our clients’ funds.
- Capitec’s response to the weakening economic and consumer credit landscape has been to appropriately tighten its credit policies and restrict access to credit for higher risk customers. It does this, for example, by reducing the number and size of loans made to people reliant on overtime or bonus payments, or to those with a history of late cash repayments.
- While we understand there may be some instances of branch activities exceeding the boundaries of responsible lending practices, we are of the view that this is not a systemic problem within the bank. In our experience, the company has shown restraint from stretching the boundaries of the National Credit Act (NCA), and has demonstrated robust and transparent reporting.
- We believe that certain of the personal unsecured lending industry risks have been somewhat mitigated by recent regulatory changes arising from the National Credit Regulator (NCR) governing affordability assessments, interest rate caps and the introduction of mandatory credit life insurance.
- Capitec's historic monoline focus has resulted in less business diversity compared with traditional top-tier South African banks, exposing the bank to cyclicality, additional regulatory risks (due to the unsecured lending asset class focus), and limited revenue diversification.
- Notwithstanding the above, Capitec has performed well throughout the instability in the unsecured lending space over the past few years, and in the face of a low-growth and volatile economy. We attribute this resilience to the following factors:
- Capitec’s growing transactional banking presence now contributes roughly 40% to its total income from operations[1]. This was an intentional strategy to reduce reliance on the unsecured lending business.
- In our view, Capitec's proactive strategic positioning and risk management practices have positioned it to adequately respond to the current challenging operating environment.
- It is important, when assessing the riskiness of any loan book, to give consideration to provisioning practices, including bad debt write-offs, and capital levels. In response to economic conditions, Capitec has, in addition to tightened lending policies, implemented conservative provisioning and write-off policies. In our assessment of Capitec, we have found the following:
- Capitec’s arrears coverage ratio[2] for the interim period ended 31 August 2017 was 237%, relative to an average of roughly 66% amongst the Big 4 SA banks and 43% amongst other unsecured lenders.
- Capitec’s Non-Performing Loan[3] (NPL) ratio of 5.4% is significantly lower than other unsecured lenders. This is a result of Capitec fully writing off all loans that are three months or more in arrears. What does this really mean? It means that, when a customer has a loan that is three months or more in arrears at Capitec, company policy requires that loan to be written off as a bad debt (while loan repayment is still pursued). In contrast, other lenders may only raise a provision against either the whole or a portion of the outstanding loan. This conservative provisioning and write-off policy for Capitec results in these loans no longer reflecting in the loan book as non-performing, and therefore not being included in the NPL figure.
Footnote:
[1] This figure is calculated on a net basis (i.e. net transaction fee income relative to total net income from operations after loan impairments).
[2] The arrears coverage ratio is the percentage of loans in arrears (by value) that are covered by provisions.
[3] The non-performing loan (NPL) ratio is calculated as gross value of loans in arrears (one or more missed payments) as a percentage of the gross value of the total loan book.
- We believe that Capitec is well capitalised, with capital levels adequately reflecting the relative riskiness of the underlying asset base. This is shown by Capitec’s Capital Adequacy Ratio[1] (CAR) ratio of 34.6%, relative to a Big 4 average of roughly 16%. As at the interim period ended 31 August 2017, Capitec had equity of R17.1bn and R5.9bn of provisions, amounting to R23bn of cushioning against loan losses. This amounts to 50% of gross advances[2].
- All banks have similar features: Analysts need to look closely at the level of gearing, and the potential for asset liability mismatches (e.g. funding long-term customer loans with short-term deposits which can be withdrawn). For Capitec, we observe that:
- Relative to the Big 4 SA banks average leverage[3] ratio of 13 times, Capitec’s leverage of 4.9 times is substantially lower.
- Due to the shorter term of its loan book, Capitec was the only SA bank to meet the new Basel III Net Stable Funding Ratio[4] (NSFR) requirement as required by the SARB. It is a SARB requirement that all banks have a NSFR of at least 100% from 1 January 2018. As at the 28 February 2017 financial year end, Capitec had an NSFR ratio of 187% which is higher than the 100% requirement.
- Because Capitec uses wholesale funding (raised from the institutional market), longer term fixed-deposits from retail customers, and internally generated cashflows to fund its lending book, it places the excess retail deposits in other liquid assets. As a result its Basel III Liquidity Coverage ratio (“LCR”) of 1152% is considerably higher than the 100% minimum. The LCR measures whether there will be enough liquid assets available in a 30 day stressed scenario (e.g. a “run” on the bank where retail depositors withdraw their money).
- Traditionally, a bank’s wholesale funding comprises roughly 30% of total funding. In Capitec’s case, only 13.6% of total funding is raised from institutional investors. Retail deposits, albeit often short-term, are considered to be “sticky”, whereas short-term institutional funding can be fickle and withdrawn in large amounts on quick notice.
- The practice of rescheduling loans in arrears may distort the true performance of a loan book. We have analysed the percentage of Capitec’s loan book that results from rescheduled loans and are satisfied that this is not a significant portion of the loan book (i.e. +3%) nor has it consistently been increasing over time. This is something that we will remain alert to. Furthermore, we note that Capitec increases the provision for these rescheduled loans to reflect the higher risk. Loans that are rescheduled from arrears status are subject to a 51.9% provision, relative to the 7.6% that is provided for current loans and the 15.3% that is provided for loans that are rescheduled from a current status.
Footnote:
[1] The capital adequacy ratio (CAR) measures a bank’s capital as a percentage of its total risk weighted assets. Capital refers to equity and other instruments that are contractually designed to absorb losses before the bank becomes insolvent and depositors lose funds.
[2] Gross advances refers to the total value of all current outstanding loans to customers before taking into account any provisions raised against the balance. Loans written off (more than 3 months in arrears) would not be included in gross advances.
[3] The leverage ratio is a simple gearing metric, which removes the effect of risk-weighted assets. It is calculated as Total unweighted assets/Equity.
[4] The Net Stable Funding Ratio (NSFR) aims to ensure closer matching of long-term asset cash flows with long-term funding cash flows. It was designed to encourage banks to use stable funding sources and reduce their dependence on short-term funding.
- We have found Capitec’s integrated reporting and disclosure to the market to be comprehensive and transparent. It provides robust disclosures and transparency on loan vintages, arrears levels, provisioning and rescheduled loans.
- Our experience of Capitec’s management over time has been positive. They have been open and transparent and, more crucially, they have not broken any promises made to date. They have always availed themselves for questions and site visits, and are proactive in their management of the lender relationship.
In summary, it is our view that Capitec is a stable, healthy alternative lender, and our research has not caused us to be concerned about their solvency, asset quality or liquidity. Whilst the unsecured lending sector is inherently risky, prone to excess, and works on the boundaries of responsible lending, it is our view that Capitec has been prudent in managing its lending book, and endeavouring to accord with sound lending practices. We believe that Capitec has adequately managed the industry risks and remains well capitalised, which will provide a cushion in the event of any significant impairment shock.
Futuregrowth has been a funding partner of Capitec for over 15 years, and we remain so.
For any queries contact:
Adele du Bois Botha | adeledb@futuregrowth.co.za | 021 659 5476
