01 Mar 2006, Credit
South Africa's uniquely troubled twentieth century history has left its mark on today's financial markets, as on every other aspect of the country's life. The apartheid years left a distorted economy and social structure which will take a long time to repair, and the years of international isolation - along with strict exchange control regulations which remain partly in place - have made South African firms more likely to turn to bank loans than to the capital markets for finance.
Some local bankers talk of Australia as a possible model for the development of the South African credit market. Australia has gradually developed from a situation where banks provided most corporate borrowing requirements, to one where companies increasingly turn to the capital markets and credit investors are comfortable with high-yielding corporate credit. The argument runs that South Africa could and should develop in a similar way. But there are notable differences between the two. Massive disparities in income continue to dog South African society, and there are still large numbers of citizens who have no access to credit, or indeed to any banking facilities.
On the other hand, South Africa's economic growth in recent years has been spectacular, and growing consumer affluence is likely to lead to more assets becoming available for securitisation. The past few years have seen a significant shift in majority economic empowerment, with affirmative action programmes and the Employment Equity Act helping to promote the growth of a black middle class and create a whole new set of consumers. The retail banks have also been attempting to reach out to those consumers who are still 'un-banked' by creating new types of low-cost account. This in turn is likely to lead to more people getting home loans, car loans and credit cards - and much of that growth is likely to be funded through securitisation.
A significant corporate bond market, however, could take longer to develop, and synthetic credit is virtually non-existent in South Africa. "There is just not enough credit and not enough liquidity," says one local banker. "An illiquid, small corporate bond market makes for an illiquid, small credit default swap market." With virtually no domestic credit default swap market and hedge fund involvement still insignificant, there has been no opportunity for structured credit products such as collateralised debt obligations to develop.
A further barrier is the fact that South African banks have little need to lay off credit risk. "The banks may lay off some risk to a specific name from time to time," says the banker, "but at this point they would like to get hold of more, not less, corporate risk. The last thing they want to do is lay off the spread." So long as this situation endures - and as long as exchange controls make it virtually impossible to diversify by sourcing assets from abroad - the growth of a structured credit market is likely to be some way off.
South Africa has a liquid and active market in government debt, but the development of a corporate bond market still faces some big hurdles. Garth Greubel, chief executive of the Bond Exchange of South Africa (BESA), says that while there is a very liquid government bond market, the corporate bond market has only been in existence since 1998, and still faces a significant challenge from commercial bank lending. "Bank lending still accounts for the majority of fund-raising by South African corporates, and it's very competitive at present," he says. "Interest rates are historically low at present, so it is often cheaper to take on commercial loans."
The BESA is an independent, self-regulated market, which also functions as the official regulator of South Africa's bond market. Bond issuers can choose to bypass the BESA via private placements, but if they issue on the BESA the instruments are regarded as regulated for the purposes of mandates.
Simon Howie, in the fixed-income team at Investec Asset Management in Cape Town, says that as recently as six years ago there were no debt capital markets to speak of in South Africa. "With a few exceptions, such as South African Breweries (SAB), there had been no corporate bonds, and no true securitisation." Now, the fixed-income market totals around 620 billion rand ($101bn), of which credit accounts for around 180 billion rand ($29.6bn). The credit universe can be subdivided into parastatal debt, or debt from state-owned institutions, at around 60 billion rand, and bank debt, corporate bonds and securitisation each totalling around 40 billion rand.
Two high-yield issues by South African corporates generated a lot of excitement last year. Mobile phone operator Cell C issued EUR400 million of seven-year notes and a further $270 million of 10-year subordinated notes in July. Cell C is rated BB- by S&P and B2 by Moody's. Earlier in the year, food producer FoodCorp (rated B+ by S&P and B2 by Moody's) issued EUR175 million in seven-year senior secured notes, in a deal that was oversubscribed despite coming perilously soon after the GM and Ford downgrades.
So far, though, there have been no domestic high-yield issues, and the challenges to such issuance remain formidable. Fund managers tend to be prevented by mandates from buying sub-investment grade credits, and even those managers who can invest in them are confronted with the problem of concentration risk.
"The first domestic high-yield issue will be faced with the problem that anyone buying it will not be able to get diversification from other similarly rated instruments," explains the BESA's Greubel. To take one high-yield name into a portfolio of investment-grade issuers would not generally be considered good practice by fund managers. Instead, the normal approach would be to have a diversified portfolio of high-yield names. But this is not an option for South African managers, and so their ability to move down the credit curve is restricted.
However, some observers do see signs of a relaxation in mandates and a more adventurous approach to sub-investment grade names. Riaan Kemp, head of capital and debt markets at Absa Bank, says spread compression has driven some investors lower down the credit curve. "In 2001, the minimum credit rating that we saw investors willing to accept was double-A minus," he recalls. "By the end of last year it was single-A minus and this year I believe some investors would accept triple-B plus." Kemp also believes mandates are becoming less restrictive as funds become more comfortable with credit.
As well as difficulties in placing corporate issuance with investors, there is also the fact that the bank market remains the first choice for most firms wishing to raise capital - although that is slowly changing in a more credit-focused environment. Peter Schneider, managing director of securities firm First South Capital, says that post-apartheid South African banks are well-regulated, with strong capital adequacy ratios, which in turn has meant that most local corporate borrowing requirements have been covered by bank lending.
"Strong bank balance sheets have meant there has been little need for a corporate bond market to develop until recently," he says. "In the past, very stringent exchange control regulations meant that life insurers and pension funds couldn't really invest offshore, and corporates themselves could not raise money offshore. That has changed in the past 10 years or so, and South African corporates such as global brewer SAB Miller are increasingly raising money overseas."
Schneider adds: "We also have much more effective domestic credit pricing now, partly because of the increased involvement of the rating agencies." These changes have encouraged more South African corporates to look at the possibility of raising money through public bond issues, both domestically and on the international markets.
Gill Raine, in charge of financial engineering at Rand Merchant Bank, a division of FirstRand Bank, agrees that there is still relatively little bond issuance by South African corporates. She notes that most issuance that does take place is from higher-rated entities such as mining firm Anglo Gold, Toyota Financial Services and industrial groups such as Imperial and Barloworld. However, she predicts that this will change gradually as asset managers develop a greater acceptance of credit risk, and points to the Australian market - where traditional adherence to investment-grade credits has slowly developed into greater appetite for high-yield issuance - as a likely model for the development of South Africa's bond markets.
"Investors will begin to accept that it's not necessarily riskier than investing in equities on a risk/reward basis. That realisation is already starting to grow," she says.
Nonetheless, last year's two high-yield bond issues were taken offshore by lead manager Citigroup, as it was clear that such large volumes of paper simply could not be placed in the domestic market. South African borrowers also face a couple of obstacles that are not present in the Australian market: exchange controls and the 'sovereign ceiling', which prevents individual bonds from being rated higher than South Africa's sovereign rating when placed in international markets. South Africa's sovereign rating for foreign currency debt is BBB+ from Standard & Poor's and Fitch, and Baa1 from Moody's. Exchange controls have already been lifted for individuals and are being relaxed on the movement of capital to and from other African countries, but phasing them out altogether is expected to be on a gradual basis rather than by a 'big bang'.
Raine expects to see more corporate borrowing in the future and says the impact of Basel II will see borrowers increasingly turning to the capital markets rather than to bank funding. "Up to now, banking growth has been largely retail-driven rather than boosted by wholesale activity," she says. "That is going to change as companies look to raise capital to finance badly needed infrastructure improvements." Large projects in transport, electricity and other infrastructure requirements could boost the domestic bond market if companies choose to raise in the capital markets. For example electricity supplier Eskom is expected to come to the domestic and overseas bond markets this year to raise some of the 100 billion rand ($16bn) it requires over the next three years for infrastructure projects.
EXCHANGE CONTROLS KEEP LID ON BOND ISSUANCE
South Africa's exchange controls have had an impact on the way South African companies choose to raise debt and to invest. Arguably, limits on the amount of currency that can be taken out of the country by South African companies have been the single biggest factor standing in the way of the development of a liquid domestic bond market.
Exchange controls limit even the largest South African firms from taking capital out of the country. By putting a cap on the potential for overseas acquisitions, the regulations effectively force even the fastest-growing and most aggressive South African firms to sit on cash piles, with the result that even major firms have very low gearing. This limits the need for South African companies to tap the domestic capital markets.
In the apartheid era, breaching the exchange control regulations was considered tantamount to treason, and so corporates rarely circumvented them. Recently, says Schneider of First South Capital, "the rules have been less strictly enforced, enabling the larger South African corporate entities to expand globally." An amnesty in 2004, under which all resident firms could declare their foreign assets and then either leave them offshore and pay a 10% penalty, or repatriate them and pay a 5% penalty, has also enabled residents with previously undisclosed offshore assets to invest them more openly in productive business rather than hiding them in discreet investments earning little or no income.
Exchange controls are widely expected to be lifted altogether in the next few years. In the meantime, though, they not only limit the need for domestic corporate bond issuance, but they also mean that the credit universe for pension funds and other South African institutional investors is extremely limited. For local asset managers, who are generally only able to manage local credit, it is extremely difficult to gain diversification on high-yield names. This in turn is likely to hamper the development of a domestic high-yield market.
SECURITISATION: RMBS TAKES THE LEAD
2005 was a strong year for the South African securitisation market, which only really began in 2001. Some of the dramatic growth in the market can be attributed to it starting from a very low base. Rapid growth in the country's economy since interest rates began to stabilise three years ago has fuelled a boom in home and auto loans, and to some degree in credit card borrowing, which in turn has prepared the ground for securitisation.
Garth Greubel, chief executive of the Bond Exchange of South Africa (BESA), says that in 2005 the securitisation market grew by 193% year-on-year. According to Moody's, term securitisation volumes now stand at 22 billion rand ($3.62bn). Unlike in the bond market, there were many new issuers: securitisations by first-time issuers increased 55% year-on-year in 2005, according to the BESA.
Moody's figures show that last year was also the first time that residential mortgage-backed securities (RMBS) overtook asset-backed securities (ABS) as the largest asset class by volume, although RMBS issuance was boosted by a single deal. RMBS volumes reached 10.7 billion rand ($1.7bn), up from 2.5 billion rand in 2004. This compares with total ABS volumes of 9.7 billion rand in 2005.
The single biggest issue in the market to date is the 4.5 billion rand ($740m) RMBS from Blue Granite Investments No.1. Launched in October 2005, the deal was backed by mortgages originated by SA Home Loans on behalf of Standard Bank, and was a debut RMBS for Standard Bank. Amongst other types of securitisation in the South African market are auto plan sales for finance houses and banks and a storecard securitisation.
"We're still seeing lots of RMBS," says the BESA's Greubel, "but car receivables are also growing. BMW has just announced it will do a 1.4 billion rand securitisation this year, but both Toyota and Daimler-Chrysler have issued in the corporate bond market. We've also seen securitisations of credit card receivables, other car receivables and aircraft leasing."
Riaan Kemp, head of capital and debt markets at Absa Bank, says he is confident that this year's securitisation volumes will outstrip 2005's. "Typically we're seeing a lot of bank asset securitisation," he says. "In 2003 we did the first auto loan securitisation from a bank asset perspective and then Standard Bank did the first home loan securitisation last year. This year, we are looking at doing more home loan and auto loan securitisations, as well as the possibility of doing credit card receivables transactions." Although the commercial mortgage-backed securities (CMBS) market is still small, Absa has three mandates for CMBS deals this year, in addition to an existing deal on tap.
South Africa allows employees to borrow from their pension funds to buy houses, and so a market in pension-backed home loan securitisations has started to develop. However it remains small. Kemp says Absa did one deal last year, one in 2004, and will probably bring one to market this year.
One of the big milestones in the development of South Africa's securitisation market was the formation of asset-backed commercial paper conduits by the banks. The five main banks - Absa, Standard Bank, Nedbank, FirstRand and Investec - now have conduits, and a sixth conduit has been set up by RMBS company SA Home Loans, a firm that makes home loans and funds them through securitisation. "The banks' conduits are now themselves very large investors," says Howie of Investec, "and they are particularly active investors in floating-rate securitisations. They have to some extent fuelled the growth in that market, and have also helped to create spread compression - which in turn has made it more attractive for the banks themselves to tap the securitisation market."
Banks have been coming to this market for funding, as consumer-driven economic growth has increased their capital needs and led to both greater bank bond issuance and more bank asset securitisation. Spreads on triple-A securitisations have moved in from around 60bp over Jibar (Johannesburg Interbank Agreed Rate, South Africa's equivalent to Libor) to around 30bp over Jibar in the past three years. "We've seen spread compression across the board, driven by demand which has increased dramatically as conduits came into the market and by asset managers becoming more comfortable with credit," says Howie.
Public debt: 37.7% of GDP
External debt: $44.3bn
The country's high-yield market spluttered into life last year with two issues from Cell-C and FoodCorp. Securitisation is also a highlight, with RMBS now leading ABS in terms of volume for the first time.